Presenting The World's Most Profitable Hedge Fund Ever: FRBNY LP

When one has $2.9 trillion in costless AUM (because if the cost is breached, one just doubles down, especially if one prints the money), it is not all that surprising to generate $77 billion in profits in one year (think of the hubris emanating from that particular year end letter), or even $385 billion in profits in the past 10 years. Yet it is still a stunning number considering the rest of the $2 trillion hedge fund industry lost about 10% in 2011. Which is why we all bow down to what is without doubt the world's most lucrative and profitable generator of P&L in history: the Federal Reserve, which for the second year in a row has printed (pun intended) over $70 billion in profits. And who is the lucky LP? Why the US Treasury of course, which for the second year in a row will pocket all the proceeds from PM Ben's immaculate trading perfection. Of course, there is one caveat for this spotless performance sheet: what happens when Fed interest expense surpasses interest income? But why worry - everyone tells us this can never happen, so it obviously can never happen...

The Fed's P&L:

From the Federal Reserve:

The Federal Reserve Board on Tuesday announced preliminary unaudited results indicating that the Reserve Banks provided for payments of approximately $76.9 billion of their estimated 2011 net income to the U.S. Treasury. Under the Board's policy, the residual earnings of each Federal Reserve Bank, after providing for the costs of operations, payment of dividends, and the amount necessary to equate surplus with capital paid-in, are distributed to the U.S. Treasury.

The Federal Reserve Banks' 2011 estimated net income of $78.9 billion was derived primarily from $83.6 billion in interest income on securities acquired through open market operations (U.S. Treasury securities, federal agency and government-sponsored enterprise (GSE) mortgage-backed securities, and GSE debt securities). Additional earnings were derived primarily from realized gains on the sale of U.S. Treasury securities of $2.3 billion, foreign currency gains of $152 million, and income from services of $479 million. The Reserve Banks had interest expense of $3.8 billion on depository institutions' reserve balances and term deposits.

Operating expenses of the Reserve Banks, net of amounts reimbursed by the U.S. Treasury and other entities for services the Reserve Banks provided as fiscal agents, totaled $3.4 billion in 2011. In addition, the Reserve Banks were assessed $1.1 billion for the cost of new currency and Board expenditures and $282 million to fund the operations of the Bureau of Consumer Financial Protection and Office of Financial Research. In 2011, statutory dividends totaled $1.6 billion and $375 million of net income was used to equate surplus to capital paid-in.

The preliminary unaudited results include valuation adjustments as of September 30 for Term Asset–Backed Loan Facility (TALF) loans and consolidated limited liability companies, which were created in response to the financial crisis. The final results, which will be presented in the Reserve Banks' annual audited financial statements and the Board of Governors' Annual Report, will reflect valuation adjustments as of December 31.

The attached chart illustrates the amount of Federal Reserve Banks' residual earnings distributed to the U.S. Treasury from 2002 through 2011 (estimated).

Precious Metals Market Most Oversold Since 2008

In September of last year we saw gold jump two standard deviations above our gold intermediate-term risk indicator’s average, a feat only seen on three prior occasions (2006, 2008, 2009). Since then, gold has significantly worked off its overbought condition and fallen by over 20% to its recent low on December 29th. Now, the recent decline has been sufficient enough in both time and magnitude to drop our gold indicator to a very oversold reading of more than 1 standard deviation below its historical average. The last time gold was this oversold was back in 2008 and represents the second most oversold reading since gold’s secular bull market began, and likely represents a major buying opportunity as the long term fundamentals (negative real interest rates, global currency debasement) remain.

Source: Bloomberg

As with gold bullion, the same can also be said for large cap gold stocks as seen by the NYSE Arca Gold BUGS Index (HUI). Our intermediate term risk indicator for the HUI is also at extremely oversold readings of more than one standard deviation below its historical average. Readings in this vicinity have served as major buying opportunities in the past as gold stocks have soon recovered after finding a footing.

Source: Bloomberg

It has been remarked by many analysts that gold stocks have significantly lagged behind the price performance of gold bullion. This action has significantly depressed the values of gold shares which are selling at valuations last seen in 2008 when viewed by the price-to-sales ratio (P/S). Given the elevated price of gold, gold miners are flush with cash and represent bargain values. It is typically readings near 6.5 in the P/S ratio that gold miners run into trouble. Also, holding the price of gold constant, with the current P/S ratio for the HUI coming in at 4.0681 the mining index would need to rally 60% before gold stocks would begin to become overvalued, which would give a price target of $832 for the HUI Index.

Source: Bloomberg

For investors who continue to believe in the secular bull market for gold bullion and have a decent level of patience, today’s miners represent an attractive long-term entry level given their significantly oversold condition and cheap valuations.

Kass: 10 Reasons for U.S. Stocks to Rally

I reported two weeks ago on “Doug Kass’s 15 surprises for 2012”. Hedge fund manager Kass of Seabreeze Partners is a familiar and respected name on this blog, and readers are always keen to learn his views. I therefore thought his 10 reasons for the U.S. stock market to rally might also be of interest. The full article appears on The Street and I urge you to read it in its entirety. A summary is provided below.

Kass said: “I have rarely been accused of being an economic/stock market cheerleader, but I believe the U.S. stock market will surprise to the upside in the near term for the following fundamental, technical and sentiment reasons:”

1. Poorly positioned market participants

Watch not what they say; watch what they do. And the dominant investors (retail and institutional/hedge funds) are underinvested and/or skewed disproportionately in a “flight to safety” into fixed income over equities.

2. Technical breakout

[Breaking out of the recent trading range] will encourage technically based chasers of market momentum.

3. Big rotation

Don’t market historians tell us that a better tone for the financial sector is a necessary condition and reagent for a better stock market? Yet that turnaround of the financial continues to be treated with skepticism by most.

4. Misplaced preoccupation with Europe: The European situation has improved. Timid policy response is moving toward “shock and awe” — yet investors are still scared to wake up every morning to rising sovereign bond yields, and that fear is keeping them sidelined.

5. Recent earnings cuts discounted

Memo to negative strategists: The market has likely already discounted (with a 15% decline in price-to-earnings ratios in 2011) a diminished profits outlook.

6. Likely regime change in the U.S.

Though the odds of a Republican presidency have improved, most investors are ignoring this “market friendly” development that could occur within the next 12 months.

7. Better economic data

The prospects of a self-sustaining U.S. economic recovery have been more solidified in the past six weeks. (I continue to be of the view that ECRI’s Lakshman Achuthan’s recession call is wrong-footed.)

8. Contained geopolitical risks

We should monitor but not let geopolitical issues predominate our investing thinking.

9. Market-friendly rates

Low interest rates around the world in 2012-13 mean that any model based on interest rates results in a very inexpensive market valuation. (I continue to expect a massive reallocation trade out of bonds and into stocks.)

10. Lower volatility

Crazy market swings scared off and alienated investors over the past year. Shouldn’t the recent collapse in volatility help bring back investor confidence?

Don Coxe: 2012 To Be A Better Year Than 2011

Europe will muddle through with less impact on the US

from FinancialSense.com:

Jim is pleased to welcome back Don Coxe, Chairman of Coxe Advisors LLP. Don sees a brighter picture for 2012, with Europe muddling through its debt problems. He is also bullish on blue-chip dividend stocks, the agriculture sector, and sees better days ahead for gold investors.

Don Coxe has more than 39 years of institutional investment experience in Canada and the US. He is Strategy Advisor to BMO Financial Group. His investment journal, Basic Points, published since 1992, and his conference calls are distributed exclusively for their clients in North America, Europe and Asia.

Click Here to Listen to the Interview

McAlvany Weekly Commentary

Your Gold in 2012

A Look At This Week’s Show:
-Eleven great years in gold: slow and steady
-Major supply sources are not keeping up with demand
-The East dominates the West in gold consumption

• 
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Break through $35.50 makes Endo Pharmaceuticals a good buy for traders and investors

Endo Pharmaceuticals (NASDAQ:ENDP) — This specialty pharma company develops branded and generic prescription drugs used primarily to treat and manage pain and urologic disorders.

Its recent acquisitions led fundamental analysts to project a 17% increase in revenues for 2012. And its entry into new therapeutic areas will benefit the company in the future.

ENDP is estimated to have earned $4.62 in 2011, and expects to earn $5.42 in 2012. S&P gives a price target of $46 based on 8.5 times their 2012 estimate.

Technically the stock is forming a cup-and-handle bullish formation. A breakout through $35.50 gives a target of $42. But longer term, the stock could go much higher, thus ENDP is recommended for traders as well as investors.

Investors Intelligence: Latest Sentiment Readings on Stocks

from King World News:

With continued volatility in stock markets, today King World News wanted share, with its global readers, key portions from the latest Investors Intelligence report: “Stocks started 2012 with a solid single-day advance and then avoided any sign of profit taking during consolidation sessions the remainder of last week. Most newsletter editors are aware of historical stock market patterns and noted positively the gains around the Christmas holiday that extended through the start of January as further favorable signs. Index and medium term indicator charts all held existing bullish status with only some modest caution flags. The Advisors showed some new optimism.”

Investors Intelligence continues: Read More @ KingWorldNews.com

Gold Bottom Targets Trend To $4,000

There has been so much talk about gold and so little understanding of the reality behind the move in the price of the yellow metal over the last 90 plus days that I think it's necessary to separate the wheat from the chaff. I want to discuss what gold has done, where it's at now, and then end with where it's going from here and postulate why it's going to do what it will do. Right now you need to understand that gold is beginning the twelfth year of major bull market; perhaps the most unprecedented bull market in our lifetime. Here's a quick snapshot of what that bull market has looked like since the 1999 bottom and the 2001 retest of that bottom:

and from the point of view as an investor, this is about as beautiful as it gets. As I mentioned above gold is entering the twelfth year of its bull market and has posted gains in each and every year. Below I have listed gold's closing price on the last day of each year:

2000 -- $273.60
2001 -- $279.00
2002 -- $348.20
2003 -- $416.10
2004 -- $438.40
2005 -- $518.90
2006 -- $638.00
2007 -- $838.00
2008 -- $889.00
2009 -- $1096.50
2010 -- $1421.40
2011 -- $1566.80

I know of no other market that can make this claim although I will admit that I don't follow certain markets like milk, wine and ferrets.

Now I want to look at the same time period but from a different perspective, this time in terms of corrections, because every primary bull market of any duration experiences secondary corrections. Every significant move in price has reactions and there is no way around it; you just have to be smart enough to recognize it for what it is, a reaction, and sit tight. So here it is:

If you include the current reaction, the eleven year old bull market is now in its seventh correction and the previous six have run anywhere from 12.1% on the low side to 28.9% on the high side. The current reaction that has led to all the negative rhetoric is stuck right in the middle at 17.2% and yet the media trips over itself to call a top, just like they did the other six times. I would like to point out that they were wrong then and they are even more wrong now, if that's possible, and here is why.

I have drawn a very simple nine-month daily chart of gold and I've put in the only two lines that matter. The top line is downward sloping and represents resistance while the bottom line is also downward sloping and represents support:

For those oF you who have followed my work you'll recognize the support line from articles dating all the way back to the September low. Two week's ago I mentioned that I was looking for a test of strong support at 1,522.30 and a couple of days later we did in fact spike down to 1,523.90, and I now believe that will prove to be the bottom.

One of the reasons I believe we've seen the bottom has to do with the 90-day cycle, one of the most dominant cycle's in the markets over the last decade. Gold topped with an all-time closing high of 1,900.60 on August 22nd and then declined to a closing low of 1,548.70 exactly ninety days later. That in my opinion is not a coincidence. Since then gold has rallied to yesterday's 1,622.20 close, and that was the second consecutive close above what was good resistance at 1,605.50. What's more the back-to-back double-digit rallies on Wednesday and Thursday were in spite of strong rallies in the US dollar and general weakness in stocks. Three weeks ago such conditions would have driven the price of gold down twenty or thirty dollars, so it appears we have a change in character. As I've mentioned before a change in character often precedes or accompanies a change in direction.

Perhaps the most important development in the world of gold has to do with the fact that China, one of the world's largest importers of gold, is no longer content to buy their precious metal for the floor of the COMEX or London metals exchange. Why? There are two principal reasons:

• The COMEX has more than US $86 billion in contracts (obligations) floating around at any one time. Yet in storage they have slightly less than US $3 billion. So the COMEX is not only woefully short of supply should there be a run, they are allowing large traders to flood the market with paper gold in an effort to suppress the price. If you're China and you're building your inventory, that's not in your best interest.



• There are questions regarding the purity of the metal sold by the COMEX and London metals exchanges.

I should mention that a number of larger players, like Sprott and Kyle Bass, are following in China's footsteps and the end result will be a default by the COMEX and a collapse of the paper system.

All of these big players are now going straight to all the large mining companies and they are inking deals to buy all their production right from the source! That means that the flow of physical into the COMEX will slow to a trickle and eventually dry up altogether. That in turn will expose the biggest fraud of all, i.e. that the US has no gold. The purported massive gold supplies that exist in Ft. Knox, New York and several other places are all a work of fiction. The gold disappeared a long time ago. That should make a lot of foreign central banks that supposedly have gold on deposit in New York, very, very unhappy!

• Finally, all of those calling for an end to the gold bull market seem to forget one important thing. All major bull markets end with a spike up based on greed and euphoria and not a top molded out of fear and despair, as would be the case today. ¹ Fear and despair would mark a bear market bottom but it has never signaled a top in a bull market and this will not be the first time. Gold has not topped, I believe the bottom in the reaction is in, and if I am right we are about to embark on the third and final phase of our bull market, and that's the phase where the general public finally piles into the gold market. It is almost always the most lucrative phase and it is the phase that always caps a major bull market. That phase will take gold up and through US $4,000 with fewer interruptions than most could imagine. My advice is to buy gold (silver) here and hide it some place until all the smoke clears.

Chart of the Day - ONEOK (OKE)

The "Chart of the Day" is ONEOK (OKE), which showed up on Tuesday's Barchart "All Time High" list. ONEOK on Tuesday posted a new all-time high of $88.38 and closed up 1.61%. TrendSpotter has been Long on the stock for about 3 months since Oct 18 at $72.25. In recent news on the stock, Morgan Stanley on Nov 15 upgraded ONEOK to Overweight from Equal Weight and raised its price target to $93 from $82 based on growth from Bakken and Mid-Continent and the company's dividend growth. ONEOK, with a market cap of $9 billion, is engaged in the natural gas business.

Trading Lesson 9: How To Use Cycles

Everything in nature moves in cycles. . . the cycles of the seasons ... night and day... tides... phases of the moon. Each year, animals hibernate... geese migrate... salmon swim upstream to spawn... and every seven years lemmings run into the ocean.

While nature's cycles are very visible, there are many cycles in the futures markets that are not quite as obvious. Often the reason some cycles are not easily seen is because the interaction of many large and small cycles makes individual cycles harder to see.

Cycles are the tendency for events to repeat themselves at more or less uniform intervals. One of the easiest cycles to see and understand is the seasonal cycle. Agricultural commodities have a repetitive annual price pattern called the seasonal price cycle. More than 70 of the time, the lowest cash prices of the year for corn, cotton and soybeans occur during the fall harvest period. Due to increased marketings, cattle and hogs also have price weakness during the fall. Wheat and oats tend to make seasonal lows during their summer harvest. Seasonal price trends are a reflection of regular annual changes in supply and demand factors caused by weather, production and demand.

After a seasonal cycle has bottomed, a trader knows prices should not drop below the seasonal low until after the seasonal high has been made, normally several months later. After the seasonal cycle has topped, the uptrend is over and prices should move lower until the seasonal cycle bottoms. Traders who know the direction of the seasonal cycle are able to follow the profitable maxim of trading with the trend.

Keep in mind there are sometimes some surprising differences in the seasonal pattern of cash and futures prices for agricultural markets.Futures markets try to anticipate the cash market due to expected production and expected demand. Therefore, futures market may bottom as much as two months ahead of the cash market. For example, the hog futures market may bottom in August, anticipating the fall low for the cash market, but the cash hog market may not bottom until October.

While the causes of seasonal cycles are known, the causes of other cyclical patterns are not always known. The Foundation for the Study of Cycles (124 South Highland Ave., Pittsburgh, PA 15206), a nonprofit organization, has cataloged thousands of cycles using detrending processes. Some of the longer-term cycles they have identified include the 9-year wheat cycle, the 5'/2-year corn cycle, the 5'/2-year cycle for precious metals, the 25-month and 38-month soybean cycles, the 11-year cattle cycle, and the 4-year business cycle.

The theory of cyclical analysis is that events will occur within a cycle to move prices in the expected direction of the cycle. The basic drawback of fundamental analysis is that the events causing changes in supply and demand are not known until after the fact, well after tops and bottoms have occurred. All fundamental information relative to supply and demand is in the market each trading day. But the market usually moves before the fundamental reasons are known. Cycles help traders pick the direction of price moves before the news comes out.

To analyze a futures market based on cycles, it is necessary to isolate the dominant cycles affecting price activity. Once these dominant cycles have been identified, future price expectations can be established by combining the effects of these dominant cycles. Long-term cycles, such as the yearly cycles identified by the Foundation for the Study of Cycles, tell you the direction of the overall price trend. Shorter cycles, weekly and daily, can then be used to determine when long-term cycles have topped or bottomed and when to enter and exit a market.

Most markets have a dominant short-term daily cycle which may be as short as 14 calendar days or as long as 35 days. Most of the meats and grains, for example, have a short-term cycle averaging 28 calendar days. Combing two or more of these short-term daily cycles forms a dominant intermediate-term weekly cycle which runs 6 to some 20 weeks from low to low, depending on the futures market. When the short-term cycles are combined with a larger cycle, the smaller cycles will look like the drawing at the bottom of this page.

Cycles are seldom symmetrical, and their patterns differ in bull and bear markets. In a bull market, the crest of the cycle tends to lean to the right because the highs are to the right of the midpoint of the cycle. This is called right translation. In strong bull markets, the length of the cycles tend to contract (shorten) slightly.

Just the opposite is true in a bear market. In bear markets, the cycles tend to be slightly longer than they were during bull markets. Cycles in bear markets tend to peak early in the cycle to the left of the midpoint - called left translation. Note the 13-week cycle from August to November on the K.C. May wheat had right translation up to the seasonal high and left translation coming down from the winter seasonal high. Right translation quickly followed by left translation is often the way a longer-term cycle high is made. Seasonal lows are often made the way Dec. hogs bottomed in September with extreme left translation followed by extreme right translation.

Trendlines are also an important tool to confirm cyclical tops and bottoms. Penetration of a trendline drawn from the crest of two cycles of similar length confirms that the next longer cycle has bottomed. In bull markets, breaking an uptrend line connecting the lows of two similar length cycles will confirm that the next longer-term cycle has crested.

The wheat charts on these pages are a good example of repetitive patterns which are helpful in profitably trading a market. For the long-term perspective, these charts show wheat when it was declining toward the 9-year cycle low, which is expected the next summer. The current seasonal cycle began in August, topped in December and is expected to bottom with the 9-year cycle the following summer.

Near the 13-week cycle low in February, intermediate-term traders would be taking profits with plans to sell again as the next 13-week cycle crests. The next cycle high is likely to come early (left translation) because the dominant 9-year and seasonal cycles are pointing down. The crest of the 13-week cycle may be made with the crest of the first 28-day cycle out of the February low. This 13-week cycle should bottom again about 13 weeks from the February low, which would put the expected low in May (plus or minus 15). The next 13-week cycle low would be due in another 13 weeks in August, which would be the most likely time for the seasonal cycle lows.

On the Chicago July wheat chart, three 28-calendar-day cycles make up the 13-week wheat cycle. Breaking the uptrend line connecting 28-day cycle lows confirmed the 13-week cycle high in November. The winter seasonal high was confirmed during the January collapse when prices dropped below the previous 13-week low (Nov. 25 low). The 13-week cycle low in February was confirmed by breaking the downtrend line connecting 28-day cycle highs. Shorter-term traders would be trading the 28-day cycle highs and lows in the direction of the intermediate-term cycle.

Cycles are most accurately measured from low to low. It is not unusual for a cycle to have a variation of plus or minus 15 of the length of the cycle, and expectations should be established accordingly While the most probable times for cycles to top and bottom can be established, cycles do sometimes stretch, shrink and, on occasion, disappear. It is a common feature of cycles to correct themselves as time passes. A cycle that runs too short, for example, might then make an adjustment by running longer on its next repetition. Chicago July wheat had two short cycles in September and October, which was followed by a cycle that ran more than five weeks from mid-October to late November.

Alright, time for one last quiz - can you identify the two cycles indicated on this chart from the MarketClub member's area: