Thursday, December 23, 2010

McAlvany Weekly Commentary

2010: Our Listeners Questions Answered, Part III

BNN: Top Picks

Paul Harris, Partner & portfolio manager, Avenue Investment Management shares his top picks.

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10 Signs That Confidence In U.S. Treasuries Is Dying And That Financial Armageddon May Be Approaching

Selling government debt is a gigantic confidence game. For decades, investors all over the globe have gobbled up massive amounts of U.S. debt at incredibly low interest rates because they believed that it was a certainly that they would be paid back and be able to make a little bit of profit on top of it. Unfortunately, things have changed. Confidence is U.S. Treasuries is dying, and if confidence in U.S. government debt completely collapses at some point we could literally be looking at financial Armageddon. Why is that so? Well, when the world totally loses faith in U.S. Treasuries, interest rates on U.S. Treasuries will have to keep going up until enough investors are found to buy them. But much higher interest rates will mean much higher interest on the national debt and thus much higher federal budget deficits. That will erode confidence in U.S. Treasuries even further. In the end, a vicious cycle of eroding confidence and higher interest rates could ultimately lead to hyperinflation as the U.S. government and the Federal Reserve flood the system with endless amounts of paper money to try to keep the system solvent.

Faith in U.S. Treasury bonds is absolutely critical if the world financial system is going to continue to operate in a stable manner. In the post-World War 2 era, U.S. Treasuries have been largely viewed as the absolutely safest investment out there. So if there comes a point when the market for U.S. Treasuries completely collapses, it is going to cause unprecedented financial chaos. The worldwide derivatives market, which is already highly unstable, would almost certainly implode. Credit markets all over the globe would seize up. Global trade would quickly grind to a standstill. (more)

OIL FUTURES: Crude Settles Above $90/Bbl As US Stockpiles Fall

(Dow Jones)--Crude oil futures prices settled above $90 a barrel Wednesday, as declining supplies and an improving economy have pushed prices to their highest level in more than two years.

The U.S. has hemorrhaged 19.3 million barrels of oil since late November, with supplies dropping at their fastest pace since May 2008, when oil prices were well into record territory above $100 a barrel. Oil futures have rallied 13% since mid-November, putting crude on a track back towards triple digits.

Light, sweet crude for February delivery settled at $90.48 a barrel, up 66 cents on the New York Mercantile Exchange, after rising as high as $90.80 earlier in the session. Brent crude on the ICE futures exchange traded 49 cents higher at $93.69 a barrel.

"A settlement over $90 is a pretty key level. Now we're starting to see prices at the pump make really big moves," said Zachary Oxman, managing director of TrendMax Futures.

The move higher was sparked by another big drop in U.S. oil inventories in the latest Department of Energy report. Crude stocks fell by 5.3 million barrels in the week ended Friday, following a 9.9-million-barrel plunge in last week's report, the largest decline in eight years. (more)

$2tn debt crisis threatens to bring down 100 US cities

More than 100 American cities could go bust next year as the debt crisis that has taken down banks and countries threatens next to spark a municipal meltdown, a leading analyst has warned.

Meredith Whitney, the US research analyst who correctly predicted the global credit crunch, described local and state debt as the biggest problem facing the US economy, and one that could derail its recovery.

"Next to housing this is the single most important issue in the US and certainly the biggest threat to the US economy," Whitney told the CBS 60 Minutes programme on Sunday night.

"There's not a doubt on my mind that you will see a spate of municipal bond defaults. You can see fifty to a hundred sizeable defaults – more. This will amount to hundreds of billions of dollars' worth of defaults."

New Jersey governor Chris Christie summarised the problem succinctly: "We spent too much on everything. We spent money we didn't have. We borrowed money just crazily. The credit card's maxed out, and it's over. We now have to get to the business of climbing out of the hole. We've been digging it for a decade or more. We've got to climb now, and a climb is harder." (more)

Bond Fund Investors Pull Most Money in 2 Years as Interest Rates May Rise

Bond mutual funds had the biggest client withdrawals in more than two years last week as a flight from fixed-income investments accelerated.

U.S. bond funds experienced withdrawals of $8.62 billion in the week ended Dec. 15, up from $1.66 billion the week before, according to a release from the Investment Company Institute, a Washington-based trade group. Last week’s withdrawals were the largest since the week ended Oct. 15, 2008, when investors yanked $17.6 billion from bond funds.

Investors are retreating from bond funds after signs of an economic recovery and a stock market rally increased speculation that interest rates may rise. The selloff in Treasuries accelerated after the Federal Reserve last month pledged to buy $600 billion in assets to revive the economy. The 10-year note yields 3.35 percent, up from 2.49 percent Nov. 4, according to data compiled by Bloomberg.

Most of the money was probably pulled by institutional investors looking to lock in higher yields by buying bonds directly, rather than through funds, said Geoff Bobroff, a consultant based in East Greenwich, Rhode Island. (more)

House Values Fall 30%, But Property Taxes Keep Rising

Even though home values have plummeted by a third, property taxes are increasing: welcome to the Great Middle Class Squeeze.

You might think that with home prices off by 30% or more since the housing/credit bubble popped in 2006, property taxes would have declined by a similar percentage. But you'd be wrong: they've gone up. As if the massive reduction in home equity wasn't enough of a blow to the Middle Class, they're also paying higher property taxes.

Though house prices have declined roughly 30% nationally since the 2006 peak of the housing bubble, property taxes have continued their decade-long rise, jumping $45 billion (over 10%) since 2008.

Local governments are responding to declining revenues by jacking up all taxes and fees. To counteract sharp declines in property values, municipalities are raising their property taxe rates, squeezing more out of properties even as they drop in value. Though there are local variations, the result is the same: property taxes are rising.

In southern Washington, the rate jumped from $10.06 to $11.60 per $1,000 of assessed value--a leap of over 15% in one year.

Even as assessed valuations slumped by over 13% annually, property tax revenues statewide increased 2.1% to $8.8 billion--a $181 million increase to taxpayers. Though Washington state has limits on property tax increases, local government's property tax rates do not rise or fall with assessed value--they're set by budget requirements. So falling prices do not translate into lower property taxes. (more)

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Pimco says 'untenable' policies will lead to eurozone break-up

Andrew Bosomworth, head of Pimco's portfolio management in Europe, said current policies are untenable in the absence of fiscal union and will lead to a break-up of the euro.

"Greece, Ireland and Portugal cannot get back on their feet without either their own currency or large transfer payments," he told German newspaper Die Welt.

He said these countries could rejoin EMU "after an appropriate debt restructuring", adding that devaluation would let them export their way back to health.

Mr Bosomworth said EU leaders were too quick to congratulate themselves on saving the euro last week with a deal for a permanent bail-out fund from 2013.

"The euro crisis is not over by a long shot. Market tensions will continue into 2011. The mechanism comes far too late," he said. (more)

Scott Minerd's Detailed Pre-Mortem On What Europe's Bank Run Will Look Like, And Other Observations

We traditionally enjoy the periodic letters by Guggenheim's CIO Scott Minderd. His latest piece, "The Opening Act to the Broader Crisis" is no exception. In it, the strategist dissects the European crisis, compares it to the subprime debacle and sees it as the precursor to the eventual downfall of the euro, a surge in the dollar, the "federalization" of Europe and the adoption of QE by the ECB. The key must read item in the current report is Minerd thought experiment of what a wholesale bank run, first in Ireland, and then everywhere else in Europe, would look like. This is especially important as one could, as Scott claims, start at any moment. What does this mean for investments? "If we are on the brink of crisis in Europe, which I believe we are, then there are several expectations we can draw about the investment landscape. First and foremost, the dollar will strengthen rapidly against the euro; U.S. Treasuries will rally; equity prices in Europe will fall; and credit spreads will widen, at least temporarily. In general, risk assets will experience choppier waters, especially as the crisis intensifies." Yet somehow this is a disconnect with the Guggenheimer's recent Barron's round table bullish statements on stocks and high yield bonds: "Let me be clear, I am not changing my mind on any of these investment theses, but a crisis in Europe will likely interrupt, but not derail, certain bullish trends at some point in 2011." It is ironic that Minerd brings up subprime as an analogy to Europe: after all his response is precisely the same that everyone else who appreciated the gravity of the subprime contagtion used at the time, starting with The Chairman. To wit "it is contained." All else equal, and it never is, we fail to see how a surge in the world's funding currency, the USD, will not generate an all our rout in every single risk asset, The Chairman's gushing liquidity notwithdtanding, due to trillions in short dollar funding positions.

Here is how Minerd, who obviously realizes this dichotomy, attempts to resolve this glaring irony: (more)