Anthony Davian's  Instablog

Trading, a skill mastered working around contradictions. Many are summarized by studying the familier trading catch-phrases. But letting profits ride runs the risk of allowing winners turn into a losers. The trend may be your friend but by the time it ends the position is often back in the red. Don't try to catch a falling knife because if price is falling fast and furious trying to play the hero gets expensive. A new favorite is don't be a dick for a tick which can be as financially damaging, leaving the trader sitting on a thumb while price heads off unless he decides to chase price. Only trade with money you can afford to lose but who can afford to lose anything?

A well known currency trader sends out a weekly letter documenting the alerts sent out with the results of the alert subscription offered. The spreadsheet touts a 400% return since 2008 and a 70% win ratio on profit target #1. Looking over the trade log though the picture gets a little gloomier. The average loser is almost 40% larger than the average winner. We can call it bullshit because it contradicts the 3 to 1 R/R ratio or we can say this trader calls market direction very well and can make allowances on the downside until he is 100% sure the trade is bad.

Similarly a Forex trading contest I took part in a few years ago had an eye opening result. The winner traded this system: His profit target was 1 pip -- his stop loss was a margin call. He won on the basis of the largest 1 month ROI (over 100%) and smallest draw-down. When interviewed by the contest sponsor, another well known personality in FX circles, the winner said he would never trade this way with real money.

Pulling the trigger on a trade requires some idea of where price has the potential of going. That potential might represent three times the risk we took on the trade. But all traders have had price get 2/3 of the way there on a good move and turn around just as quickly. Trades have gotten with in one pip and flung back in this traders face. Having 30 or 40 pips in your pocket only to see in turn around is a really crappy feeling.

Rudyard Kipling refers to triumph and disaster as two impostors in his poem “If”. Triumph is the Ferrari sitting in the driveway and losing, the margin call that causes your wife to throw a frying pan at your head. They are impostors because while we wish for one and dread the other, buying the Ferrari can be and often is a let down. The margin call, if you are able to dodge the frying pan, is often not as bad as you thought. How many traders in the Schwager books haven't recieved on. Not many.

Everything in trading is about potential. Is a trade that doesn't reach its target really a winner? What about a trade that is stopped out to the pip and turns around just as quickly and races to a finish line that is no longer there. Every time the trader sits down at his station he has the potential to be disciplined and follow his plan or the potential to forget everything he knows and screw up.

So if things are not working out, it's best sometimes to sit down and try to simplify even if simplifying bucks standard trading wisdom. Call it shaving with Occam's Razor. In the end the concept of fear is often misapplied. Traders must be MORE afraid of not winning than losing. Read below. It couldn't be summarized better.

If

by Rudyard Kipling


If you can keep your head when all about you
Are losing theirs and blaming it on you;
If you can trust yourself when all men doubt you,
But make allowance for their doubting too;
If you can wait and not be tired by waiting,
Or, being lied about, don't deal in lies,
Or, being hated, don't give way to hating,
And yet don't look too good, nor talk too wise;


If you can dream - and not make dreams your master;
If you can think - and not make thoughts your aim;
If you can meet with triumph and disaster
And treat those two imposters just the same;
If you can bear to hear the truth you've spoken
Twisted by knaves to make a trap for fools,
Or watch the things you gave your life to broken,
And stoop and build 'em up with wornout tools;


If you can make one heap of all your winnings
And risk it on one turn of pitch-and-toss,
And lose, and start again at your beginnings
And never breath a word about your loss;
If you can force your heart and nerve and sinew
To serve your turn long after they are gone,
And so hold on when there is nothing in you
Except the Will which says to them: "Hold on";


If you can talk with crowds and keep your virtue,
Or walk with kings - nor lose the common touch;
If neither foes nor loving friends can hurt you;
If all men count with you, but none too much;
If you can fill the unforgiving minute
With sixty seconds' worth of distance run -
Yours is the Earth and everything that's in it,
And - which is more - you'll be a Man my son

Diclosure: non

By: Mr Eb

Electronic Arts (EA) is probably the company dearest to my heart growing up. I had many pleasant childhood memories playing games like One-on-One and Seven Cities of Gold on the Commodore 64 and Populous on the Amiga. They simply made great innovative games then. Somehow however the company lost its way over the years. Last week's earnings report was the culmination of the demise as it announced one-third of its future title pipeline will be cut and another 1500 employees will be laid off on top of the 1100 fired just 9 months ago. Many of its AAA title launches such as Brutal Legend have flopped in the market-place. Even games like Dragon Age Origins and Need for Speed Shift are being discounted with promotional coupons and sales in the retail channel, a clear sign EA games are not selling to expectations.

Looking back, one of the warning signs was the famous EA Spouse blog, where people internally knew the company was burning people out. The pattern was hiring talent, buying companies, and churning games out. The intense development cycles even as short as one year, bureaucracy, and lack of respect for their employees drove some of their best talent away. Management clearly didn't mind as long as the profits were flowing, but if you squeeze the golden goose too hard eventually the quality suffers.

A key inflection point in my opinion is when EA decided to pay the NFL hundreds of millions more to get the exclusive on the football license. This told the world that money and power was all that mattered and this company decided it could not compete in the marketplace with Take-Two 2K Sports by making better games.

Although the seeds of the decline were there for a while, I believe a huge part of the blame has to be laid at the feet of the current CEO, John Riccitiello. John was the chief operating officer of EA from 1997 to 2004. He then went off to co-found a venture capital firm called Elevation Partners until April 2007, when he was brought back to become CEO of EA. From there he had a series of decisions that to this day destroyed hundreds of millions, if not billions of shareholder value.

1. Infinity Ward
If you have been reading the news the past week, you know that Activision's Call of Duty Modern Warfare 2 has launched to great fan-fare selling $550 million worth of product in its first five days setting the record for biggest entertainment launch in history. But did you know that Infinity Ward, the key developer team of the Call of Duty franchise, started out making Medal of Honor games for EA? During that time John Riccitiello was a important managerial executive when the key members of the developer team left and joined up with Activision. I do not know the details of the departures, but the simple fact is he was there when the most important, future best-selling billion dollar intellectual property value slipped to a major competitor.

2. Bioware/Pandemic
After John left EA to start Elevation Partners, his first major deal was investing $300 million into Bioware and Pandemic in November of 2005. This was a head-scratcher to many people in the games industry. Most of acquisitions to this point have been the low tens of million dollar range from Irrational Games to Bungie which was bought by Microsoft. The only other mega-acquisition was Microsoft's $375 million cash buy-out of Rare, which by this point everyone knew was complete disaster.

It also didn't make any sense because the market was clearly going to action-oriented first person shooters on consoles like Halo and Call of Duty. To invest hundreds of millions in a primarily niche PC role-playing game developer (Bioware) and a second rate action game developer (Pandemic) was be-fuddling to say the least.

John became the CEO of VG Holdings (Pandemic + Bioware) until he quit to become CEO of EA in April of 2007. This is where things get interesting because six months into the job, EA announced it was going to buy Pandemic and Bioware for $620 million in cash and $155 million in equity retention. $775 million dollars to buy his ex-firm's portfolio company. The kicker is since John was a founder of Elevation Partners and ex-CEO of VG Holdings, he would make up to $4.9 million from EA buying the company he invested in 2 years ago. If that isn't a huge conflict of interest, I don't know what is.

EA in their press release said John recused himself during the board meeting where the acquisition was discussed, but that is a total joke. As a newly minted CEO of a company considering a $775 million acquisition, obviously he had to be a driving force in completing this deal. The EA CFO at the time said they expected Pandemic and Bioware to do "in excess of" $300 million in revenue in 2009 and 2010.

Flash forward today on news that the Pandemic founders of are leaving the firm, hundreds of people are being laid off, and Pandemic studio is essentially being shut down. Pandemic's core titles like Mercenaries 2 were flops. So two years after spending $775 million dollars for two studios, one of them has gone under. We are talking at least hundreds of millions of dollars at least in lost value. The $300 million of revenue projection at time of acquisition? A total pipe-dream.

3. The9 Limited
In May 2007, EA bought a 15% stake in The9 Limited for $167 million. Obviously John was excited about the potential of online games in Asia to do this large investment. The problem was The9 really didn't own much in terms of intellectually property. Over 90%+ of its revenue and earnings came from distributing and operating the World of Warcraft game in China which it licensed from Blizzard. Once Activision merged with Blizzard, it decided to pull its WOW license from The9 and give it to Netease. Consequently The9 plummeted in value as it lost over 90% of its revenue. The EA stake is now worth less than $30 million. Over $137 million of shareholder money lost from Mr. Riccitiello's investment skills. As a long-time gaming industry executive investing in a company that had that kind of risk with the WOW license at a sky-high valuation is unconscionable.

4. Take-Two
John decided he had to have the Grand Theft Auto franchise. In March of 2008, EA announced a $26 a share take-out offer for Take-Two, a huge premium to the company's stock price. This was a $2.1 billion offer. This time John was fortunate as Take-Two management repeatedly spurned the offer to the point EA gave up trying many months later. One year later, Take-Two was trading under $6 a share a stunning 77% below John's offer. Even at Take-Two's current stock price, if the deal went through, EA would of lost over a billion dollars in shareholder value.

5. No credibility
Forecasting one thing and then having reality be different over and over again has destroyed Mr. Riccitiello's credibility to the markets. Every year John goes on the earnings calls and repeatedly states how great games are. A year ago he told analysts how good the 2008 version of Need for Speed was. Last week he said previous Need for Speed games were lacking.

He also defended the $680 million EA spent for mobile cellphone game maker Jamdat in 2006 when he wasn't even at the compan. Everyone in the industry knows that the mobile cellphone gaming market is moving towards standardized platforms such as the iPhone and Android OS. To argue that Jamdat was a good acquisition when it's core competence is porting games across dozens of cellphone SKUs is becoming obselete is ridiculous.

After all these failed decisions, the fact that the Board of Directors let's John keep his job and do more over-valued pricey acquisitions is a travesty. Last week EA bought Playfish for up to $400 million for 4-5Xs revenue. Playfish is "the fad" of the moment developing social networking casual games. Given Mr. Riccitiello's investment track record, it wouldn't be surprising this is another disaster in the making.

The problem here is John is going to make his millions every year even though he destroys hundreds of millions and billions of shareholder value given the decline of the stock price. If the Take-Two deal went through, EA would of even been in worse shape. The people who suffer are thousands of hard-working EA employees who lose their jobs and see how life savings in company stock implode. The madness must end. It's clear that John doesn't know what he's doing. He must go.

Disclosure: At time of writing, the author does not have any position in Electronic Arts. If Mr. Riccitiello is fired, the author vows to buy EA stock that day. You can contact the author on Twitter: mreb or email: a(atsign)earningsbreakout.com

By: David Stone

SeekingAlpha.com recently had a very interesting article titled The Unsustainable Lie of Inflation. Paco Ahlgren writes compellingly about propaganda in the context of inflation. The “Big Lie” is that national economic policy promotes inflation with the motive of seducing consumers to believe that their possessions are worth more. The authors panacea for the “Big Lie” is abandonment from fiat currency and return to a gold/metal standard.

Interestingly, in a former life, Alan Greenspan was a gold bug and lays out a few bullet-points on how this could be accomplished in a September 1, 1981 article titled Can the U.S Return to the Gold Standard? It was essential reading as my primary question wasn't why but how. Greenspan v1.0 writes that a scaled in plan using gold-redeemable Treasury Notes is how you would accomplish such a thing.

Humorously he also writes “A commission to study the issue, with strong support from President Reagan, is in place.” I assume the strong support faded when Reagan realized a GS would force him to actually be fiscally prudent and not just talk about it. The politically agile Greenspan dropped Objectivist as his middle name and the rest is history. Greenspan v2.0 never saw inflation he couldn't fight with an interest-rate hike.

Greenspan writes immediately after a period of social, economic, and political unrest. The Vietnam Era subsided into the Oil Embargo and double digit inflation of the 70's. So it is easy to see how he would be looking to change a few things.

But currency is simply a medium of exchange developed long ago to facilitate trade. The lure of gold is that supply is fairly stable, availability is more or less known and it is valuable because of its scarcity and its beauty. Advocates of the GS object to the manipulation of economies by government and central banks.

The central arguments are fiat currency makes deficit spending easy, fiat currency relies heavily on governments/central banks intervention into an economy, and fiat currency is to blame for inflationary cycles. I find that these objections are more about government policy than how the gold standard would fix them.

Fiat currency does make deficit spending easy. Politicians are, always have been, and will be forever spineless. I guess it's the nature of the beast. What is funny is that many of us think that our group (which ever group one tends to identify with) is somehow more fiscally prudent than the other. I've simply accepted that they are all the same. They somehow figure a way to funnel their gross spending habits toward whichever agenda they support.  Don't worry each group finds a way to screw up and if yours isn't writing the checks today, they will be tomorrow.

Fiat currency does rely heavily on central banking to respond to economic threats. This may be seen as a distortion of free market capitalism but is it? Since Adam Smith is credited as the authoritative observer of capitalism, I will recount his thoughts. Smith knew that an economic system had to work within the confines of a stable political ones. When he wrote The Wealth of Nations, England was a true monarchy. People had to pay taxes, interest rates were set (albeit infrequently) by the crown and most people owned no land. Adam Smith did not have opinions on whether taxes or arbitrary interest rates were right or wrong. He saw them as a fact of life and observed what worked best within them.

Fiat currency may cause inflationary cycles. The last significant period of inflation was the seventies as this is what Greenspan is responding to in his editorial. In 1971 Nixon abandoned the post-WW2 Bretton Woods agreement and the U.S. said a fond farewell to the GS. The OPEC Oil Embargo soon followed and the decreasing value of the USD is at least partially to blame. So yes the last significant period of inflation occurred after the U.S. abandoned the GS. After a sweeping economic change like 1971 it would be expected that at least some turmoil would ensue and it did. Why is the GS that creates inflation of 10% one year and -2% the next better.

A cursory look at inflation data is fun because you see the big numbers jump out and try to associate them with historic periods. One thing is clear. War economies tend to red-line our currency. The most interesting year though is 1932, the nadir of the Great Depression. 1932 saw a 10.3% INCREASE in the value of our currency. It seems currency deflation is a result of economic stress also.  Ahlgren strangely argues that deflation is somehow good.

Now the word hyperinflation has also been batted around quite a bit. Hyperinflation has occurred only twice in the United States. The first time was as the continental congress tried to create a cohesive government after the Revolutionary War. The second time was in the short lived confederacy. Hyperinflation is an anomaly usually created by immature or inept political and/or economic leadership. Now if and when inflation hits 10% the media will probably call it hyperinflation because it sounds sexier but in reality it will be just plain old boring inflation. Inflation above 100% and you can call it what you want because the U.S. as we know it will most likely have ceased to exist.  Our political leadership may be inept, but hopefully it's not that inept.

A gold standard tends to make economic and political shocks acute. Instead of a somewhat gentle increases of unemployment everyone is out of work very quickly putting a snowballing sequence of stresses on the system. The money supply contracts creating bank runs and eventual closings. Financing comes to a grinding halt and further operations are effected. All this can happen virtually overnight.  At this point the only one able to clean up these catastrophic messes is guess who? Uncle Sam and usually by circumventing the GS. In the past the GS has been blamed for as much hardship as GS advocates say has been created by its abandonment. So is this really better?

But Ahlgrens chief complaint is inflation and the way he discusses it is puzzling. He seems to think people in general are confusing price with a products real value. Here is an example:

“As humanity has progressed, technology has always increased our standard of living, and created more efficiency. And this has almost always resulted in falling prices. If you don’t believe me, think about how much bananas must have cost in Norway during the 16th century. Or think about how expensive cinnamon must have been in England in the 10th century. Most people would never even see these commodities – let alone be able to pay for them. Today, bananas and cinnamon are accessible globally, to anyone, at very low costs. Technology caused them to depreciate over time – not increase in price, as your government would have you believe should have been the case. Or how about the most contemporary – and perhaps best example of all: the computer industry, and Moore’s Law. Prices of computers don’t increase over time -- they decrease with obsolescence and improved technology.”

The use of computer prices and banana prices and Moore's Law as  deflationary examples is troublesome. Yes the prices of bananas and computers have decreased tremendously in the past twenty years but the value of the banana is nothing once it is eaten and a computer can only function properly as long as the technology is relevant. The computer prices rapid falling is not deflationary, it is technological and market driven. Ahlgren seems to confuse this.

He goes on to say:

“In theory, it’s a great idea. You buy stuff, the Fed keeps inflation at about 3%, and in most cases, after a long period of time, your stuff seems more valuable. You can boast to your friends at work and at parties, 'I bought my house for $50,000 in 1977, and today it’s worth $200,000! I’ve quadrupled my money!'”

In the above paragraph he contends that people are confusing nominal and real prices. I agree that inflation is the primary reason that the house is now $200,000 but it is also the primary reason that that same person made $5000 per year when he bought the house and $40,000 per year when he retired. The houses real value never really changed. Comparing a computers falling price with a houses increasing price doesn't make any sense because the factors of time and life of product are left completely out of the equation.  If he is trying to argue that our standard of living is diminished by inflation I have open ears.  By most accounts it is falling which is indeed troubling, but is this inflationary?  If someone is not able to realize the difference between nominal and real price propaganda isn't to blame – ignorance is.

Adam Smith writes extensively on real prices in The Wealth of Nations. He observed (I think correctly) that labor is the only way to compare a products true price. A house costs $300,000 to build today because of the compounded labor costs involved in not just building the house, but creating all the products that the house is made up of with a nominal amount of profit margin for the many business interests in the complex chain of production. At $20 per hour this hypothetical house takes 15,000 man-hours to complete. The same equation would hold true of the computer and bananas. He even writes about the cost of gold in this context with much of it being the military costs of subduing a local population in gold-rich foreign colonies. It is a simple but effective way to gain perspective on the riddle of price.

My opinion is that the call to return to the GS is largely about anti-government sentiment and government spending than about the benefits of the GS. Do GS advocates have a firm grasp of the consequences of a GS as well as the benefits? Our economy has been shown to tolerate mild to significant periods of inflation fairly well. Arguments can be made on both sides of issue and even I am sometimes drawn to the romantic notion that the GS would be a return to a simpler, better time.

The hard truth is that fears of real hyperinflation are unwarranted because if the U.S. ever reaches that point we will all be worried about more important things than our purchasing power. It will be guns and butter time baby!

Would a government that has been unable to keep its checkbook balanced stick to the intent of a GS when several times in U.S. History gold redemptions were summarily abandoned. Post-1929 FDR even went so far as to outlaw the possession of gold specie.

Ahlgren thinks otherwise and while cutting a decent argument, the hyperbolic propaganda quotes leave me hollow. Yes those things were said but context is everything. The Keynes quote at the beginning of the article was actually a call to curb inflation. I guess the current economic climate makes a ready villain out of all though. That and the idea that anything is better than this. I'm not so sure!

Disclosure: none

By: Dasan

The fourth element of the monthly Dasan Stock Digest is the Dasan Focus Report. In this report, I cover whatever I find interesting at the time. In this particular issue, I will cover what has to be the story of the week for any stock investor - the trading in Amazon shares in 2009, culminating in Friday’s 25% move.

Many value investors worship at the feet of Ben Graham, who literally wrote the book on Value Investing. He came of age during the Great Crash in the 1930s and was the first person to put in writing a method of stock market investing that relied on buying cheap stocks. In his seminal work, he made a strong point that stock investors should always invest with a Margin of Safety by buying a stock that is trading for below asset value. This is where most Value Investors stop. They keep repeating “Margin of Safety” as if it were a mantra.

I will make a controversial statement (I like to do this often) and say that Margin of Safety is as real as the Tooth Fairy. There is no such thing as a Margin of Safety, because even tangible assets (such as printing presses or semiconductor fabs) can become almost worthless if they don’t produce earnings.

The most important, brilliant, massively valuable insight that Ben Graham had to offer was his metaphor of “Mr. Market.” He said the best way to think about the market was it was like a business partner with emotional problems. You own half of, say, an online bookstore. Your partner owns the other half. When his hemorrhoids are flaring up, he goes a little nuts and offers to sell you his half of the business for only $50. You have the chance to either buy him out or do nothing. Then, if the moon crosses Jupiter a certain way, he offers to buy you out of your half for $118, even though yesterday he would have paid only $88 for the same business. Warren Buffett, the richest man in the world, often says understanding this fact about the stock market is the most important key to investing.

Ladies and Gentlemen, I will take the metaphor even further. Mr. Market does not just have emotional problems, but he has Tourette’s Syndrome, Clinical Depression, and a bad Crystal Meth habit all at once! If you don’t believe me, take a look at what has happened to the trading of Amazon (AMZN) stock over the last year.

On Friday, after reporting good earnings, the stock jumped 26% in one day. This means about $10 billion of market value was created out of thin air in one day! Take that, efficient market theorists!

Let me start by taking a look back a few months.

In the beginning of 2009, the chorus of naysayers on Wall Street was saying how terrible Amazon was. It was too expensive, the P/E was too high, the consumer was dead, and so on. What you really had was the set-up of a lifetime to buy quality stocks.

How did Wall Street analysts handle things? Look at the chart below. On Jan 4th, 2009, when AMZN was only trading at $54.46 per share, the average of all analysts ratings was 3.51, implying about 2/3s had “hold” ratings and only 1/3 were “buy” ratings. Look at the craziness at the far right of the chart - once the stock jumped to $118, the average of all ratings was 4.05, a record high on the same day the stock hit all-time highs! The chart of analyst ratings is rather flat, since most analysts on wall street just put a “hold” when they mean “sell” or “I don’t have any idea what I’m talking about .” But it’s clear that there is little value from following these analysts, and in fact, it may be smart to do the exact opposite.

OK, I’ll admit being long stocks in the first quarter of 2009 was too scary for most people. So forget about that. How about waiting for the smoke to clear a bit? How about waiting until Amazon had already gone up from $52 to $79?

Here’s my commentary from my blog on May 25, 2009, when I reviewed my portfolio decisions in Q109:

“My idea was to stick with “Triple A Tech” through this storm. By Triple A Tech I mean AAPL, ADBE, AMZN. Three companies with rock-solid defenses and enormous moats. I was told by many that “shorting AMZN is a no-brainer – the consumer is dead.” My thought was the world’s most efficient e-tailer becomes even more valuable as high costs and collapsing sales put their competition out of business.

Independent thinking wins out again. Notice- contrarian thinking – simply buying the stock that was down the most didn’t work – nor did avoiding AMZN because it had a high multiple.” weblink

Ok, fine, you’ll say - this is ancient history. What do we do with Amazon stock now? That is the question I hope to help answer in the next few pages. Dasan's letter is a premium product at davianletter.com. Please visit the subscribe page to learn more about Dasan's premium product.

Disclosure: long AAPL, AMZN, ADBE

By Philip Dunham

Can’t The Fed at Least Pretend To Care about USD? Does anyone Care Anymore?

That may be a bit extreme. Of course the Fed cares about USD but for now it is on the backburner. Last week, in its statement following the FOMC meeting, Board members effectively capped short rates when the line

including low rates of resource utilization, subdued inflation trends, and stable inflation expectations
was added (Full text of FOMC statement with changes highlighted on page 4 of PDF). This addition was an attempt to flatten the yield curve, without raising short rates, by reducing inflation expectations priced into the long end of the curve. In theory, this should bring long rates down marginally. However, markets bushed this off rather handily. The initial response to FOMC in treasuries was curve steepening until 30 year bonds bottomed on Friday following news that U.S. unemployment had reached 10.2%.

Until last week, as was evident by put buying in Eurodollars as a hedge against a spike in short rates, participants were still slightly skeptical of either Bernanke’s commitment to lock down short rates or whether the labor market would improve relative to expectations. Both of those fears were quelled last week by the statement and employment data. On one hand, short rates are so low, the only possible direction is higher. That may be the case from a risk/reward standpoint when looking at just the short end, however it would be contingent of surprisingly positive developments on the labor front as we can rule out the FOMC pulling a 180 and adding some hawkish element to the statement in the foreseeable future. As of now, given enthusiasm in equities, the likely scenario seems to be flattening of the curve via the long end provided buyers of long dated treasuries are willing to take down supply thrown at them by Treasury.

One last element of the statement worth noting was the $25 billion reduction in planned agency debt purchases from $200 to $175 billion. This was a mildly hawkish development. The rationale for which, the FOMC explicitly stated “reflects the limited availability of agency debt”. The statement went on to say that the committee expects agency debt and MBS purchases to be completed in Q1 2010. That said, it does not mean QE will be withdrawn. Simply for now given available data and forecasts no further purchases are necessary but the Fed left its options open by leaving unchanged the statement, “The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted.”

The ECB meeting was rather boring with few significant developments in growth or inflation outlook. However, in typical form, the ECB’s Trichet was able to find some way of adding a hawkish spin to the statement. This came in the form of a statement regarding liquidity measures implemented in response to the financial crisis. Specifically, Trichet noted,

Looking ahead, and taking into account the improved conditions in financial markets, not all our liquidity measures will be needed to the same extent as in the past. Accordingly, the Governing Council will make sure that the extraordinary liquidity measures taken are phased out in a timely and gradual fashion and that the liquidity provided is absorbed in order to counter effectively any threat to price stability over the medium to longer term.
This is intended to gradually prepare markets for withdrawal of liquidity. Owing to the differences in factors affecting U.S. and EuroZone economies and hence differences in nature of the respective liquidity programs (The ECB liquidity facilities are not quantitative easing measures while the Fed and BoE programs are) it is important to note that the ECB will be withdrawing liquidity while the fed will simply stop purchasing securities outright while retaining those securities on its balance sheet.

Technically, if EUR/USD can close above 1.5050 it should test 1.5200. On a weekly chart, the cross is approaching overbought, but not historically high levels. Near term support is 1.4900. Despite its potential to move higher, it must be acknowledged that long term risk reward is not favorable at current levels given the move from roughly 1.2500 since March. EuroZone has few catalysts this week. Monday, German foreign trade was lower than expected at €9.9 billion vs. expectations of €11.2 billion but EUR/USD rose regardless as the risk trade was back in vogue.

The BoE, in a bipolar episode decided to increase its asset purchase program by £25 billion to £200 billion after deciding not to increase the program at its prior meeting. While an expansion of QE should be negative for the currency that is being devalued, the market had priced in a 50 billion increase in QE and GBP readily caught a bid. The BoE continues to proceed rather aggressively albeit somewhat unpredictably in its implementation of QE. The pause in QE expansion may have been an attempt to splash a bit of cold water in the face of traders short GBP which had built a sizable speculative position in GBP/USD in late September-early October. The £200 billion of asset purchases should be completed in approximately three months. From there, similar to the Fed, the BoE will leave its options open by keeping the scale of the program under review. The rationale for expansion of QE was obviously the weak U.K. GDP data two weeks ago. I can’t help but wonder what the longer term implications of QE are. Particularly considering inflation had been surprising higher than expectations earlier in the year. Additionally, a story from Bloomberg noted that Fitch has fired a “warning shot” that the U.K.’s credit rating is most at risk of all AAA rated sovereign debt. Which is ironic and a bit comical given Gordon Brown is contemplating a £1 billion helicopter order. The Fitch comments are something worth contemplating. What is clear however, is that the notion developed countries will control public spending during recession is laughable.

Technically, GBP/USD has had solid support since last week from around 1.6300. Monday, it opened moved higher with broad USD weakness crossing above 1.6800 and closing slightly below that level. Tuesday, it was able to shake of the credit rating warning from Fitch, trading as low as 1.6600 and rebounding to close unchanged at 1.6739. So far this week price action is consistent with further upside to at least 1.700. Wednesday, the focus will be the BoE’s quarterly inflation report.

The U.K. budget situation offers a perfect segue. Shall we take a look at Gold?

November 3 India announced it had purchased 200 metric tons of gold from the IMF between October 19 and 30 at market based prices. This puts the RBI cost basis somewhere between 1,065 and 1,029. Although I had expected a near term correction to approximately 1,000 last week before moving higher, we at Davian Letter have reiterated over the past year that the floor under gold continues to edge higher. The reasoning behind the thesis is rather simple. In responding to the global financial crisis, major developed world countries will devalue fiat currencies via fiscal and monetary expansion to stimulate their respective economies. That said, gold long position is getting crowded. 53.6% of COMEX open interest is speculative long while 7.5% of speculative traders are short. I will concede that futures only track spot prices, however futures should reflect sentiment of the more broad gold market as a whole. Judging by COMEX positioning, without an influx of new traders that are not typical participants in the gold market, there are few additional traders to initiate additional long positions. So I’ve noted the long term case for gold as well as the fact that the trade is becoming crowded but fundamentally it is difficult to make a case to fall in any meaningful way below 950 at absolute lowest, but more likely support is 1000.

AUD/USD continues to defy gravity, but for good reason. Interest rate expectations had become a bit extended in late October after the RBA meeting November 2 when some had expected a 50bp rate hike but were disappointed by only getting 25bp. However after correcting to around 0.8950 enthusiasm for the highest rates of the major currencies re-asserted itself, the cross strengthened to close at 0.9304. given relative strength and Australian unemployment to be released tomorrow, AUD/USD should set highs at levels not seen since July 2008.

USD/JPY continues to trade based on yield differentials and as long as U.S. short yields decline, JPY will strengthen. Simple as that. For the week ahead, the cross should trade sideways to lower.

Taking these factors into account, broadly, USD upside is limited. Interest rate differentials and outlook given interpretation of the FOMC statement does not support sustained strength in USD. The G20 meeting did not help USD’s cause after ministers made no mention of USD weakness and only reiterated commitment by member countries to keep stimulus measures in place until the global recovery is on solid footing.

Disclosure: None

By: Stiletto Stocks

Hi TDL darlings, sorry for my prolonged absence. I pulled an Alice in Wonderland and drank a funny little bottle of unidentified liquid labeled “Drink Me” and here I am, one month later with a new pair of Marc Jacobs shoes and some new stamps in my passport that I can’t quite make out. So, where to start than talking about everybody’s favorite-but-forgettable store in the mall. And no, I’m not talking a certain sketchy magazine rack behind the food court.

Research released by Goldman Sachs derivatives traders today advised investors to buy bullish November calls on The Gap ($GPS) ahead of October sales results, announced later this week. Gap, the parent company of Old Navy and Banana Republic, reports Q3 2009 earnings Nov. 19, and Goldman is suggesting the company may beat projections for revenue and sales. As I have discussed in the past, same-store sales data are critical in the retail world, and historically can drive large swings in retail stores’ stock price. The Goldman analysts forecast that sales data will be above consensus due to recent and upcoming sales promotions (I have a 30% off Gap stores promotion for November 12-15 sitting on my desk as we speak—apparently, all the ladies in my office have me pigeon-holed as “the fashion crazy girl.”) The research briefing also discusses the currently attractive pricing of options and $GPS’ low implied volatility relative to peers as rationale behind its recommendation of buying November $22 calls for 0.90.

If you’ve been chart-watching this AM, $GPS got a nice little bump, and at time of writing is trading at 22.28, 1.6% above the 22.01 open. Nothing to write home about until Nov. 19.

From my vantage point, Gap has made some substantial improvements to help begin to pull it out of its slump beyond the factors the analysts mention. Namely, the company’s branding and positioning. Remember when Gap was hip? Think of the old ads—fresh, clean, almost Apple-like TV spots that featured catchy music, dancing, and often-zany colors that appeal to an increasingly design-forward and neurotic American buying public. Then, Gap got old. Generic. If you were like everyone else, you wore Gap (or Old Navy/Banana Republic, depending on your income level.) Even the advertisements became generic. Remember the “Everybody in Leather/Cords/Vests/etc.” campaign? The target demographic (teens through young families) don’t want to look and dress like “everyone else”—at least, they don’t want to be told they do! (By the way, does anyone notice how there's a dude choking in the above photo? Must be staring at the jumping guy's crotch!)

In many ways, Gap is the Apple of the apparel retailing world. Everyone has at least one item of clothing from a Gap company, much like everyone has an iPod and increasingly an iPhone. The two have store presentations that are sleek, pleasingly minimalist, and blissfully unprepossessing. Unlike $PSUN, $ANF, or many other retailers, you don’t feel you need to be a specific size, age, or ethnicity to shop at Gap, or own an Apple product. But where Apple has shined and Gap (for the past several years) has faltered is in brand presence and presentation. When you buy an Apple product, you are buying into a hip alternative to Microsoft’s “square” products. You are part of a unique tribe of consumers who are creative, unique, and “think different.” Gap, meanwhile, has positioned itself as the store in the mall that will clothe anyone. There’s something to be said about Abercrombie CEO Mike Jeffries’ ideas about maintaining brand exclusivity—when you sell to everyone, you’re bound to lose a lot of shoppers in the process. No one feels cooler after buying a boring old pair of Gap khakis—at least, that has been the story in past years.

Today, Gap is starting to show signs of hipper times. The company launched its 1969 Premium denim, which it launched with a sexy, American Apparel-esque advertising campaign a few months ago. The jeans promise the style and high quality of $200 designer jeans for starting price tag of around $60. And to be honest, these jeans are great. Improving sales after several quarters of slump aside—the company is getting back its leaner, younger-minded image. Since May 2009, $GPS has generally outperformed the S&P Retail Index (^RLX) appreciably—on the year, $GPS has climbed nearly 70%, while the index has gained around 30%. Look back in time to 2005-2008 for comparison: Gap was a veritable dog, lagging the sector up to 20% during that timeframe.

Much like $ANF, Gap is moving increasingly into international markets (Gap franchises currently exist in more than two dozen countries), and the company will be opening its first store in China in 2010. International and online businesses have grown to about one-fifth of the company’s sales, and the company is smartly steering itself in that direction (tacitly acknowledging the weary state of apparel retailing in the US). Revamping the company’s product lines has taken Gap of fashion life support, and if global retail demand continues, the brand has a real chance of getting back its old place on the shelf of “cool generic” with IKEA, Apple, and other Stuff White People Like.

Disclosure: long $ANF, long $AAPL at time of writing.