Mad Hedge Fund Trader

Investing in Coffee: An ETF Guide

SI thought you'd never write about coffee! Where is the tidal wave of global hot money surging to next? Coffee has moved up 24% to $1.48/pound since the July low, to a new high for the year on decent volume, and technicians are pounding the table that an upside breakout is imminent. This is both good and bad news, as coffee can be your worst nightmare to trade, being an unholy marriage of weather and international politics. Brazil is still the Saudi Arabia of global coffee production, with traders glued to screens looking for the most recent weather forecasts that might affect the country’s fragile Arabica and Robusta trees. That makes coffee an indirect play on Brazil’s appreciating currency, the real. Rising fertilizer prices and El Nino are causing supply problems in Vietnam and Indonesia. A multiyear draught is hurting production in Kenya. And demand is soaring where? In China, where fashion conscious consumers are replacing traditional teas with coffee. Yes, coffee is a rising emerging market standard of living play. If I haven’t scared you off, you can trade coffee futures on the New York Mercantile Exchange, where one March, 2010 contract (KTH10.NYM) buys you 37,500 pounds of the caffeine laden commodity worth $55,500, with a margin requirement of only $3,640. My coffee consumption alone in preparing this letter makes it a strong buy. If you want to know how to get set up on trading these, or any other futures contracts, please email me at madhedgefundtrader@yah...

The Fed: Waiting for Absolute Clarity on Rates

bdc I managed to catch up with David Wessel, the Wall Street Journal economics editor, who has just published In Fed We Trust: Ben Bernanke’s War on the Great Panic. I doubted David could tell me anything more about the former Princeton professor I didn’t already know. I couldn’t have been more wrong, as David gave me some fascinating insights into the inner soul of our much vaunted chairman of the Federal Reserve. Bernanke was the smartest kid in rural Dillon, South Carolina, who, through a series of improbable accidents, ended up at Harvard. He built his career on studying the Great Depression, then the closest thing to paleontology economics had to offer, a field focused so distantly on the past that it was irrelevant. Bernanke took over the Fed when Greenspan was considered a rock star, inhaling his libertarian, free market, Ayn Rand inspired philosophy in great giant gulps. Within a year the landscape was suddenly overrun with T-Rex’s and Brontesauri. He tried to stop the panic 150 different ways, 125 of which were terrible ideas, the remaining 25 saving us from the Great Depression II. This is why unemployment is now only 10.2%, instead of 25%. The Fed governor is naturally a very shy and withdrawing person, and would have been quite happy limiting his political career to the local school board. But to rebuild confidence, he took his campaign to the masses, attending town hall meetings and meeting the public like a campaigning first term congressman. The price of his success has been large, with the Fed balance sheet exploding from $800 million to $2 trillion, solely on his signature. The true cost of the financial crisis won’t be known for a decade. Now that having pulled back from the brink, the biggest risk is that we grow complacent, and let desperately needed reforms of the system slide. How Bernanke unwinds this bubble will define his legacy. Too soon, and we go back into a real depression. Too late, and hyperinflation hits. That’s when we see how smart Bernanke really is.

ETF Market Trends: Technical Strength of Rally Expands to S&P 500 and Nasdaq 100

kfs If I’ve told you once, I’ve told you a thousand times, stay out of those crummy neighborhoods, where the street corners are crowded with high priced stocks of dubious moral character wearing stiletto heels, fishnet stockings, miniskirts, and shoulder handbags. Sure, I know you young traders have needs, think with your hormones, and believe you can live forever. But if you absolutely have to go slumming, at least use some cheap protection. I noticed today that the January 1030 S&P 500 puts were selling at a bargain $19 today. That means for a mere $950 you can buy some decent downside protection for a $55,000 portfolio that takes you all the way out to January 15, 2010. That is bang on the support level that held in the last sell off. If you double top here on the charts and go down for a retest, you double you money. If yearend profit taking causes us to sell off going into the holidays, and we break that support, you make more. If the market melts down the day after we flip the calendar page to 2010, a distinct possibility, then you hit a home run. If the lemmings keep driving this market up every day for two more months, then you lose $900, or 1.72% of your portfolio, pennies, really, against the huge returns you have booked so far this year. It’s a win, win, win, lose pennies trader. I know that the pros that have done for a long time put these trades on without even thinking about it. It’s all about risk control. Since I am a cheapskate, I only like strapping on trades that have a risk/reward ratio overwhelmingly in my favor, and with the volatility index today a bargain 23%, this fits the bill nicely. Buy your storm insurance when the sun is shining.

Hedge Funds Down in October - Hennessee Group

nds The hedge fund industry is still emerging from the ashes of 2008, but will inevitably grab a larger share of the investing public’s assets. Low interest rates and hero status made it way too easy for inexperienced, untested, and sometimes unscrupulous managers to raise new funds that charged management fees as high as 3%, with a 50% performance bonus. Behind every “liar loan” was a bond manager happy to soak it up through securitized Fannie Mae (FNM), Freddie Mac (FRE), or bank debt, shorting Treasuries against them, and then leveraging the 40 basis point spread 50 times to generate a highly marketable 20% annual gross return. Never mind the risks. It was easy money, as long as there were lots of liars- which mortgage brokers herded in by droves, and as long as spreads narrowed-which they did for most of the 21st century. By the beginning of 2008, assets under management soared to $2 trillion. The melt down that followed wiped out large numbers of funds, and raised gates for the survivors, making investors wonder if they would ever get their money back. Total assets plunged to $1 trillion in the blink of an eye through a combination of redemptions and market losses. The new era that is emerging will be populated with humbled and chastened managers offering more disclosure, lower fees, no gates, and thanks to Madoff, oodles of third party oversight. Their portfolios will have less leverage, be invested in more liquid securities, and bring in lower returns. But the new generation will also offer investors battle tested strategies that survived the 100 year flood. Bridgewater, with $37 billion in assets, is now the largest hedge fund, followed by JP Morgan with $36 billion, Paulson & Co. at $27 billion, DE Shaw showing $26 billion, and Soros still at a hefty $24 billion. Long track records and a Gucci cachet will assure that these will prosper. Fees will settle down to the 1%/20% range. For the rest of us this means more capital bunching up in the most successful trades, as we have already seen this year in financials, China, oil, copper, and the multitude of short dollar plays. It is also going to be much harder to get new fund launches off the ground.

Recent Weakness in Equities, Commodities Is a Buying Opportunity

ati The scariest costume I saw on Halloween worn by a kid dressed as the Dow Jones Industrial Average. Listening to all of the gnashing of teeth and hand wringing after the Friday close about broken trend lines, accelerating downside volume, and crisscrossing moving averages, you would think that a time machine had just magically transported us back to the dark days of March, 2009. The volatility index (VIX) has popped from 20% to 30% in a week. Impressive. A new CNBC poll says that two thirds of investors are now expecting a “W” shaped recession, and that the next big move in the market is down. Once all of the performance chasers finally got the equity weightings they should have had last March, the market could only go down. We cut through support in the S&P 500 at 1050 like a hot knife through butter. Next stop: 980. Then hold your breath.

Is This Rally Toast?

nji In view of today’s dreadful market performance yesterday, I am repeating my GLOBAL RISK ALERT issued on October 14. Every asset class, including stocks, Treasury bonds, currencies, commodities, and precious metals, got slaughtered across the board today. The liquidity surge may be taking a pause. Keep in mind that if you are running big longs here, you are swimming at the deep end of the pool.When everything is working, and my portfolio is firing on all 12 cylinders, I pinch myself and ask “Is this real? What can go wrong?” I’m reminded of the slave whose task it was to remind conquering Roman generals “All glory is fleeting.” Virtually all of my recommended core longs in gold, silver, Canadian, New Zealand, and Australian dollars, Brazil, Russia, India, South Korea, Taiwan, Vietnam, and junk bonds are at or near highs for the year. I called the bottom in Natural Gas within 40 cents, and mercifully baled on my one short in US government bonds, the TBT. What we are seeing is a global surge in liquidity as cash emerges from the bomb shelter, squints at the day light, and then rushes to buy the first thing it can find. Everything is going up, regardless of fundamentals. It is the proverbial tide that is lifting all boats. You can make a lot of money in these conditions, but there is no way of knowing if this will last for one week, or another year. But they can go on much longer than you think. In the last two liquidity driven markets I traded, Japan in the eighties and NASDAQ in the nineties, fundamental analysts railed against the tide for years, claiming that stocks were overvalued, each call getting their office moved ever closer to the elevator and men’s bathroom. When someone finally did throw the switch on these markets, it got dark amazingly fast. Tokyo went out at an all time high on the last day of 1989, and then dropped a staggering 45% in January. NASDAQ plunged just as fast from its 2000 top. The one thing we can all be certain about is that the survivors have vastly improved their risk control after our recent crash. Make hay while the sun shines, but keep your finger hovering over that mouse. The level of risk now is definitely much higher than it was in March. When the next real downturn starts, it could resemble a flash fire in a movie theater.

All Eyes on the Dollar

onc Of course you knew it was going to happen like this. After churning around just below the old high, and sucking in as many profit takers and short sellers as possible, gold blasted through to a new high for the year of $1,038. Never mind that the triggering event is complete balderdash, a story in Britain’s Independent newspaper asserting that the Middle East is holding secret global talks to price crude in the yellow metal or other currencies (click here ). It didn’t hurt that Australia cut its interest rates by 0.25%, the first G-20 country to do so. There probably isn’t enough gold in the world to finance more than a few weeks of global oil production. Total gold holdings would only fill two Olympic sized swimming pools. But never let the truth get in the way of a good trade. The confirming moves couldn’t be more ubiquitous, with the Canadian, New Zealand, and Australian dollars all up big, commodities strong, and silver also going ballistic. Regular readers will all recognize these as old friends of mine, core longs that I have been strongly recommending since the beginning of the year. I have been trying to get investors into gold since it was at $800. If you aren’t in gold by now, I can only tear my own clothes and flagellate myself for my abject failure to convince you of gold’s merits. US government debt is exploding, and with foreigners holding a large part of our paper, the only way to get out of this mess is to devalue the dollar. It’s like Obama invited China’s president Hu Jintao to dinner at an expensive Upper East Side restaurant, fakes a sudden case of food poisoning, leaving him with a big fat bill. Next stop $1,200, then $1,500, then the old inflation adjusted high of $2,400. If you want me to help you get set up to trade futures in any of this stuff, please email me at madhedgefundtrader@yah... If you want to know where to buy physical gold and silver in size, or coins with the tightest spreads over spot, check with the experts at www.millenniummetals.net by clicking here.

ETF Trends: Equity Bulls Continue Their Charge for No Fundamental Reason

uufn Since I have had such a hot hand in natural gas, many have asked me to comment on yesterday’s surprise announcement that the ETF, UNG, finally got permission to issue new shares. The easy answer here is that UNG will crater. There is no reason for the fund to trade at a premium whatsoever, which at one point traded as high as 20%, an overvaluation you normally only see in closed end funds at bear market bottoms. These ETF’s are simply pass through vehicles which make it easier for investors to own NG in stock form when they are legally unable, or too lazy to open a futures trading account. They should never trade more than 1% out of line with the underlying to account for the admin and execution costs of running such an instrument. The people who made the killing here were the handful of hedge funds that were able to borrow UNG shares, sell them short, and go long the futures, locking in a guaranteed 20% spread. They will cash in their profit next week. Something similar is still going on where smart industry players have locked up salt caverns to store gas, buy it cheaply on the spot market, and sell it forward. This is possible because yesterday you could buy October at $3.25/MCF and sell it for April delivery at $5.32, giving you an annualized return of 127%. Leverage that, and you are talking about some serious money. If you were wondering where the money was coming from to buy those G5’s, this is it. The fundamentals for the industry are still terrible, and there is a risk that the market could completely grind to a halt when the country runs out of storage, so the volatility will remain huge. This week’s move explosive 44% move from $2.40 to $3.44 was nothing more than pure short covering. I expect a quick double in NG once the storage issue is resolved, and the cheapest, cleanest, and most liquid way to participate is though the futures. If you need help in how to do this, e-mail me at madhedgefundtrader@yah...

4 Reasons Investors Shouldn't Rely on Fixed Income ETFs

tyujk. It’s time to take another look at the short US Treasury bond ETF (TBT). I first recommended this 200% leveraged bet that long dated bonds were going down big time in January at $35, catching a near double to $60 (click here for report) . We have now retrenched back to $45, and it’s time to reload the boat. The US government has now committed to $9.1 trillion in debt issuance over the next ten years. Foreign governments will need to borrow as much to fund their own bail out/stimulus programs. Did I mention inflation? There is absolutely no way the ten year can maintain a 3.40% yield in the face of this onslaught. It is clear that zero short rates are driving investors, many of whom will only buy Treasuries, into making terrible investments. This is what the awesome bid to cover ratio of 3.2X for today’s three year auction is telling you. The dollar clearly sees this and is hitting a new one year low. It’s just a matter of time before bond investors put on their bifocals and see the locomotive that is about to run over them.

V-Shaped Recovery? Try M-Shaped Meltdown

dfghj. Wow! One triple digit move down in the Dow, and all of a sudden, everyone is bearish. Once invisible falling home prices, soaring deficits, bogus corporate earnings, catatonic consumers, a crashing Shanghai market, and a suicidal Baltic Dry Shipping Index are now staring nervous stock owners in the face, eyeball to eyeball, and the picture is not pretty. Expect a run at Walmart on the Imodium and Kaopectate supplies. Even Robert Prector, of Elliot Wave fame, was on the tube proclaiming an end to a bear market rally. Did all the BSD bears just come back from family vacations to find the short selling opportunity of the year? Technical analysts think so.

Time for California Muni Bond Investors to Take a Stand

Who can blame you? As the California budget battle reaches white hot temperatures, Fitches has cut the rating on the state’s debt to A-, and placed it on “credit watch”, a warning of further downgrades. The move is a delayed recognition of reality, as is the rating agency industry’s practice. The legislature tried, but failed to pass $12 billion in budget cuts, which governor Arnold Schwarzenegger said he would veto anyway, because they didn’t meet the full $24 billion tab (see my previous dispairing piece at www.madhedgefundtrader.... In the package were increases in motor vehicle registration fees, $1.50 a pack in additional tobacco taxes, cancellation of health insurance for one million children, a production tax of 9.9% for in-state pumped crude oil, the firing of thousands of teachers, firefighters, policemen, and probation officers, and more smoke and mirrors accounting shenanigans that kick the can into the future. Some of the changes were only possible through a redefinition of the English language that turned “taxes” into “fees.”As California goes, so goes the nation, as many states will follow the Golden State into financial Armageddon. In a new era of soaring unemployment, restrained consumption, high savings, and crashing stock and property prices, states dependant on taxes on incomes, sales, capital gains, and property appraisals don’t do well. Make sure those muni bonds are insured. Why do I get the sickening feeling that I am watching a rerun of Thelma and Louis?

Time to Forsake Stocks for Bonds? Arnott and Arends Square Off

Good place to take some trading profits. The whir of the printing presses again spooked the bond market, taking ten year Treasury bond yields up to 3.14%, and the 30 year to 4.10%, a one year high. This is going to be a recurring event over the next several years, and a short in long term Treasury bonds should be a core position in any portfolio. My favorite play here, the Power Shares Lehman 20+ ETF (TBT), a 200% short play on the sector, has been on an absolute tear, up 40% since January. We are early days into this trade, and once inflation hits, the TBT could see a spike to $200 in its lifetime.

Key ETF Performance: 4/7/09

I would put the (TBT) at the core of any portfolio. If stocks sell off from here you should get a rally in Treasuries that will be ripe for selling into. There is no way that investors are being compensated for their risk with yields at these levels, especially with massive global government reflationary efforts guaranteed to bring a resurgence of inflation. I think the futures contract on the long bond will collapse from 127 now to inder 70 in three years, once hyperinflation hits. With the leverage offered by a futures contract, the returns will be huge. However, this is not a riskless trade. There have already been several rounds of stop loss buying by traders who jumped into this strategy too early, as unimaginable buying kicked in at 120, 125, 131, 136 and finally 141. In Japan the ten year bond eventually hit a low of 0.46%, making our ten year at 2.85% look incredibly expensive. That works out to a futures price of 200 or more. Of course we are not Japan. The Treasury has done more to repair things in 60 days than Japan did in 15 years, and Japan has still not adopted full mark to mark accounting. Some 19 years after their bubble burst, the country is still seeing subpar growth, and ten year yields have made it back up to only a measly 1.25%. There are also constant games going on in the bond futures markets like expiration plays, engineered short squeezes in the underlying, and bogus news leaks. PIMCO, the Newport Beach based Pacific Investment Management Company, the world’s largest private bond investor, plays this market like a violin. Still, I think it’s worth a shot. Take another look at the Power Shares Lehman 20 year plus ETF (TBT), which gives you a 200% short on the sector. This will be the last bubble we can short into for a long time.

The Economy Is Bottoming

I say the glass is half full. Call me an optimist, but I am starting to see crocuses of economic recovery busting out all over. Long side traders now have a spring in their step after a 23% rise in the Dow in three weeks, the best move since 1938. If it is true that the stock market anticipates moves in the real economy by six months, then a lot of managers are going to come back from their summer vacations in September to find a surprising batch of new orders. Commodities have been on an absolute tear this year, especially oil and copper, classic harbingers of future business activity. Just look at my favorite, Freeport McMoran (FCX), which soared 170% from the November lows. The downward momentum of a whole range of economic indicators is slowing. The durable goods number was actually up last week! The mother of all inventory adjustments is almost over. Retailers are still offering the deals of the century, but there is very little left in the back room. The Baltic Dry Shipping Index has tripled off of its November low, hinting that international trade may come out of its comatose condition. And they are no longer looking for organ recipients for the major airlines. Now I hear that semiconductor makers are expected to make their Q1 targets. Maybe it’s because spring has arrived, and the girls on the Embarcadero have shed their overcoats for low cut tank tops. Or maybe the $4 trillion in global stimulus is starting to have its desired effect.