Archive through March 16, 2008

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pse

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Post Number: 197
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Saturday, March 15, 2008 - 08:45 am:

Hi Rudy

If the Aus Cash close is used (the aus cash mirrors the XJO in terms of raw value and is pegged to the futures re trajectory and range) the overall decline is 80pnts (vs36). This is proportionate to the Dow’s fri decline of 195, which suggests an “approx” and equivalent 84pnt XJO drop mon morning; so the futures has factored in BS news and DJIAs’ Friday movement. As such, tells us to expect an XJO drop of at least 80pnts mon morning. But as u indicate, it is unlikely to stop there.

A side note which as an ex intraday futures trader I’m sure you’ll appreciate – any significant discrepancy between aus futures, DJIA and indicative opens of the top XJO aus stocks, at open on any given morning, is a wonderful trading opportunity – but you have to be quick!

- peter

"TRADE WHAT IS, NOT WHAT MIGHT BE"

rdumas

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Saturday, March 15, 2008 - 08:53 am:

The downside of Bush's plan to wean the US off oil. Poor old Benny gets ignored by Bush the genius. See article from the Australian Investment Review below.

==============================================================

The Death of Ethanol

You wouldn't normally expect President George W Bush to understand irony, especially irony generated by the markets.

There he was last week telling the International Renewable Energy Conference in Washington that the US should "get off oil" and again calling for more use of ethanol, despite concerns the corn-based fuel is driving up food prices and isn't more environmentally friendly than gasoline.

"We gotta get off oil; American has got to change its habits. It should be obvious to all, demand has outstripped supply, which makes prices go up," media reports quoted the President.

Well, that's what's happening to corn, wheat, coal, oil, soybeans, soybean oil; and sugar prices have been rising. Some have hit records as stocks of the commodity fall and output remains steady or falls because of drought and farmers switching between crops.

In fact the very thing that ethanol is supposedly to partially replace - oil based fuel - is making the biofuel, in fact all biofuels uneconomic.

The seemingly remorseless rise of oil to unheard of levels ($US111 a barrel or more) is slowly strangling the attractiveness of replacement fuels, such as biofuels, because it is dragging up the price of corn, other grains and oil seeds.

At the same time rising demand for food, just as world stocks are at record or near record lows, is also boosting the prices of agricultural commodities.

The costs of production are rising because energy costs are on the rise; steel, aluminium, plastic and other raw material prices are on the rise; even land in rural parts of the US and Europe is rising in value because of the boom in the prices of corn, wheat, canola, soybean, cotton, etc.

At a time when Mr Bush is urging the US to 'get off oil' and offering ethanol as the main route, the economics of its production are worsening. Not even production and tariff subsidies can keep over 50 planned plants afloat and many others have closed or cut back on production to conserve cash.

US Fed chairman, Ben Bernanke did late last week in an appearance before the US Senate Banking Committee: he pointed out the subsidy drives up the price of ethanol in the US, increases other costs, and inflates the cost of corn. Removing it, he said, would contribute to lowering price pressures. His sensible words fell on deaf ears, especially in the White House.

Over a third of America's huge corn crop is consumed in ethanol production in the US which attracts a subsidy from the government and is protected by a 54 USc a gallon tariff from imports, especially from Brazil which makes its ethanol from sugar.

That tariff expires later this year and who in an American election year, would be game to call for its abolition?
US ethanol production rose 38% to a record 636.8 million gallons in December from a year earlier, according to figures released earlier this month by the US Energy Department. Stocks of the additive totaled 441.4 million gallons, up 20% from year earlier while down 6.1% from November.

America currently has 143 ethanol distilleries in the US, with the capacity to produce about 8.2 billion gallons of the fuel a year, according to the Renewable Fuels Association in Washington. These are not all operating, or operating to capacity.

Part of President Bush's plan to wean the US off oil includes big investments in ethanol, and the energy bill passed by Congress and signed by Bush in December calls for refiners to replace 36 billion gallons of petrol with ethanol by 2020, up from about 7 billion gallons presently. About half of that will come from ethanol made with corn.

"That's good if you’re a corn farmer, and it's good if you're concerned with national security," Bush said. But Chinese and European buyers are offering more for corn than are US ethanol producers.

Bush acknowledged some of the problems with ethanol, particularly its role in pushing up the price of corn. The price of corn has doubled since 2006 which has pushed up the price of chicken, beef and poultry, not to mention basic food costs in Mexico and other Latin American countries.

Crops like wheat and soybeans are becoming more expensive as farmers devote more acreage to grow corn as they rush to satisfy the demand for ethanol.

"I'm beginning to hear complaints from cattleman about the price of corn," he said. "We're going to do something about it."

I reckon George will leave office still promising to do something about it; perhaps he should be reading the US farm and business media where the surging price of corn has cut a swathe through existing and planned ethanol plants.

Last week the huge privately owned agri giant, Cargill, abandoned plans for a $US200 million plant in Kansas. Another unfinished plant was sold out of bankruptcy and plans for up to 50 new plants have been shelved in recent months.

With the credit crunch helping, high corn prices have all but ruined the economics of ethanol, especially for new plants.

The water consumption of the big new plants in the US is causing surprise, despite claims from the industry that can be 'water neutral' none are.

Besides the 143 ethanol plants in the US, with a further 60 under construction. Work on some of those has stalled because of the surging cost of corn, the credit crunch and rising building costs.

Corn prices have risen from less than $US2 a bushel in 2006 to a recent high of more than $US5.70. That's driven margins down to an estimated 3 USc a gallon, mostly for established large low cost plants: even with oil over $US103 a barrel.

And it's just not in the US. Biodiesel plants in Britain and Europe are also closing or on care and maintenance because of the surging price of animal and food waste and the main raw material, rapeseed canola.

Europe wants more than 10% of its energy needs to be met by biofuels in about three years time. At the moment that won't happen because existing plants can't operate with canola prices at current high levels.

And in Asia last week Indonesia's biggest biodiesel plant, a $US5.5 billion operation planned by local and Chinese companies, was abandoned because the cost of palm oil (the raw material) has been driven higher by surging Chinese demand for it and other edible oils.

The cost of the main ingredient of palm oil that can be refined and added to existing fuels, is selling for more than twice the price of the same oil based product, low sulphur gasoil, which has significantly more contained energy.

In its latest commodity outlook, the Australian Bureau of Agricultural and Resource Economics (ABARE) said.
"The United States, Japan and the European Union are the largest importers of ethanol and Brazil is the largest exporter. The United States is also an important exporter of ethanol, produced largely from corn, mainly to other North American Free Trade Association countries — Canada and Mexico.

"Like the world market for sugar, the world market for ethanol is distorted by a range of subsidies and market access barriers.

"In the United States, for example, there is a tariff and import duty on ethanol imports equivalent to a 25 per cent tariff.

"In the European Union, the tariffs are 45 per cent and 24 per cent on undenatured and denatured ethanol respectively. As well, in both the United States and the European Union, there are market access concessions that favour ethanol imports from developing countries.
“This is one of the reasons why Jamaica is a major re-exporter to the United States of Brazilian hydrous ethanol after its conversion to its anhydrous form.

"If the market access barriers for ethanol in the United States and the European Union were removed, the world price for sugar would probably be considerably higher.
“It is possible that the import duty of US54 cents a US gallon (US14 cent a litre) on ethanol could be lowered to enable the United States to meet its ambitious biofuels supply targets."

If you are taking a medium term view on ethanol, you'd have to believe that the demand for food in the shape of grains, edible oils and even sugar will (except for sugar in Brazil where ethanol is too deeply entrenched) will continue to make its economics unpalatable to car drivers, unless heavy protection and subsidies continue, especially in the US

Even in Brazil, a medium term outlook should start raising questions simply because the country has this year revealed massive oil and gas strikes offshore.

They will take years and billions of dollars to develop, but they are so large they will change the energy picture in the Western Hemisphere, offsetting Venezuela's shrinking reserves.

This is approaching energy self sufficiency seduce Brazil into abandoning its drive to boost ethanol as a petrol additive? It current has around half the fuel market for cars.

That would change the dynamics of both the ethanol and sugar industries

==============================================================

ody

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Saturday, March 15, 2008 - 09:04 am:

BERNANKE'S HELPLESSNESS

$200 million thrown to the wolves, and another meltdown on Wall Street very soon after, despite the initial delight of those that thought the money would address the problem. It does not and cannot, as it does not "fit" the problem it is meant to address. Inasmuch as it has a significant impact, it obfuscates the issues and delays the solution, which in essence is that the banks and others will have to come clean and work through the whole debacle that they have been so detrimental in creating.

It is conceivable that matters in the short-term would have been worse if the Fed had not intervened at all. But by doing it much too late, and constantly reflexively rather than preventively, it actually delays the crash and subsequent recovery that are needed. Bernanke and many other Americans still think you can buy yourself out of a problem like this one; continue to think that "next time" the bandaid will work; waste good money in the process - and will in the end still not be able to prevent the whole problem having to work its way through the system. Solid investment, and a stable share market, will not occur until much more is known about the problems that are yet to flow through and come into the open - so that it will also become more evident what will definitely fail, and what is worth supporting to succeed.

Instead of facing the inevitable "unwinding" of this all, Bernanke - who MIGHT have achieved something if he had acted about a year earlier and forcefully - with all his tinkering has made the problem worse in that he has created more uncertainty and anxiety. People do realise - at least outside the US, but partly also inside it - that you don't throw $200 billion into the system unless the situation is very, very serious.

This approach is not that of capitalism "proper": a system in which he strong will flourish and the weak perish because they have to live on their own wits and accept the workings of market forces. These ill-conceived dole-outs are worse than the in-built protective mechanisms which tend to avoid disasters like these in what Bush calls he economies of "Old Europe": those that have a clearer idea as to what is left to the free market, and what is done ONGOINGLY, and as part of the system, to modify capitalism and to ensure it does not go off the rails.

One good quote to mention may be the following: "The creative destruction of capitalism, that's what the Fed is working to prevent." I agree with this, in that if you do have a system which is not a mixture of capitalism and social welfare, you must let the inherent workings of your system take their course. If you do break that rule, you should do it in a much bigger and earlier way than Bernanke did, so that everyone knew of the deviation, so that it could have made some impact, and people would have known it was a one-off - not the beginning of endless tinkering. But in essence capitalism US style was never even given either the opportunity or the instruction to fix its mess. Having been warned months in advance by Roubini and other prognosticators, Bernanke sat on his hands or took ineffective measures, one after another, until this day.

If there is perhaps one genuinely hopeful piece of news right now it would be that at present US inflation does seem to be improving: that might reduce the risk of stagflation, one of the most poisonous syndromes to deal with (because central banks can't). Maybe at last the consumers of America are indeed getting more cautious: the effect of that will probably add to the recessionary pattern, but that's not bad. We NEED the recession to be a fact and not something guessed at, as part of the pattern of clarity without which nothing can be planned.

Back to other work. I shall make it a firm principle not to write more than one post a day, and there will be many days when I shan't even do that. This is just a break - I can't make it an important part of my life just now. Very grateful to other posters for the good work they do.

starboard_tack

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Saturday, March 15, 2008 - 10:39 am:

Bear Stearns Demise

What are the implications of it?

The US Investment Banking industry is now suggesting that Bear Stearns, the 5th largest investment bank on Wall Street, will not survive. After yesterday's bailout by the federal reserve (the FIRST in history!), it is suggested that clients will no longer trust them - and leave them in droves.

Why would a bank try to buy what is left of them when they think that they can attract their clients by aggressive competition?

More importantly, why would the clients trust any of the other banks any more than Bear Stearns in the current climate?

The downfall of Bear Stearns was not overnight - it has been developing since the middle of last year. The timeline quoted below is very revealing. Note how they have played down/ denied their problems. Their (potential) final demise seems now to be totally down to customer CONFIDENCE.

The following quote is from TimesOnline

Declining fortunes

Jun 14, 2007 Bear Stearns reports second quarter profits down 10 per cent to $486 million

Jun 22 Bear Stearns pledges up to $3.2 billion in loans to bail out two hedge funds hit by sub-prime losses and investor redemptions

Jul 19 Bear Stearns writes to clients informing them that two of its hedge funds now contain “very little” or “effectively no value”

Aug 1 Two Bear Stearns hedge funds file for bankruptcy and another has its assets frozen

Sept 20 Bear Stearns reports third quarter profit down 61 per cent to $171 million

Oct 4 James Cayne, chief executive, says: “Most of our businesses are beginning to rebound.” Alan Schwartz, president, says: “The market is in the early stages of a recovery”

Oct 22 Bear Stearns outlines an agreement with China’s CITIC under which both will invest $1 billion in each other. The deal is now in doubt

Nov 28 Bear Stearns announces it will cut 650 jobs

Dec 20 Posts fourth-quarter loss of $854 million, the first quarterly loss in its 85-year history. Dec 20 Barclays sues Bear Stearns for allegedly misleading the UK bank over the performance of two collapsed hedge funds.

Dec 28 Mr Cayne sells $15.4 million of the bank’s stock

Jan 9, 2008 Mr Cayne resigns as chief executive but stays as chairman; Mr Schwartz takes over

Mar 10 Bear Stearns states that “there is absolutely no truth to the rumours of liquidity problems that circulated today in the market”

Mar 12 Mr Schwartz says: “We don’t see any pressure on our liquidity, let alone a liquidity crisis”

Mar 14 Bear Stearns confirms it has secured a funding agreement with JPMorgan Chase and the Federal Reserve Bank of New York. Mr Schwartz says: “Bear Stearns has been the subject of a multitude of market rumours regarding our liquidity. Amidst this chatter, our liquidity position in the last 24 hours had significantly deteriorated” }

"The pessimist complains about the wind;
The optimist expects it to change;
The realist adjusts the sails."

kate

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Saturday, March 15, 2008 - 11:51 am:

Starboard Tack
JP Morgan had a large stake in Bear Sterns before the bailout, I would think this is an opportunity for a take over or merger.
The link from Bloomberg may give you more information.

http://www.bloomberg.com/apps/news?pid=20601087&sid=a7LxuUzRcMTM&refer=worldwide

Regards
Kate

ody

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Saturday, March 15, 2008 - 12:18 pm:

Bear Sterns

Good stuff, Kate. Here is more - fitting in with your understanding of the situation. I add no further comments (lack of time), but the article illuminates the matter yet further.

http://money.cnn.com/2008/03/14/news/bearstearns.fortune/index.htm

starboard_tack

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Saturday, March 15, 2008 - 12:35 pm:

Hi Kate,

You could be right but this article from CNN is interesting. It raises some questions about whether Bear Stearns has any value left to takeover or merge with.

Some parts of the article...

"Once this happens, no one will deal with them," said Joseph Rizzi, a veteran banker who focuses on risk-management. He equated the crisis of confidence to the one that caused Barings Bank to collapse after its massive trading scandal. "The remaining franchise value, customers and employees, will evaporate," he said.

And...

"I think they're finished," said Richard Bove, a bank analyst at Punk Ziegel. "Bear Stearns's biggest problem is that they're losing customers at a rapid rate. It's easier to get Bear's business by attacking it rather than buying it."

This article from BusinessWeek asks who might be next! They point out that Lehman Brothers shares dropped 14% on Friday!

Regards,
Starb'd

"The pessimist complains about the wind;
The optimist expects it to change;
The realist adjusts the sails."

kate

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Saturday, March 15, 2008 - 01:17 pm:

Starb'd
I think the Business Week may have hit the nail on the head when it said there may be companies other than JP Morgan that have a finger in the Bear Stearns pie. If they are anything like our banks who aren't making any profit(and in some cases small losses)on mortgages they have to be stretched to the limit. Perhaps the Fed can literally not afford to help BS because if it went to the wall it could cause huge damages to the other banks.

Next week the banks report and the Fed makes it decision about interest rates. How are they going to stabilise the USD if they reduce interest rates up to 100 basis points. It may help businesses but it has absolutely no effect on the mortgage rate.

Regards
Kate

resillent1

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Saturday, March 15, 2008 - 11:08 pm:

At a time when some are sitting on cash it may be good to think just what a bank account represents?

That account represents an ability to consume in the future beyond the level of your future physical production.

What needs to remain stable for your future consumption plans to be realized?

Actual consumption needs cannot be stored for long. Total consumption basically needs to equal total production.

For every person who is consuming in excess of their production at any particular time, another needs to be producing excess to their consumption.

To the extent that financial assets exceed the actual productive capacity of the economy, they cannot be redeemed in full unless the physical economy grows to match the value of the financial assets.

How did you’re bank balnce come about? Have you solely saved as a result of production in excess to your consumption or is their funny money creation in there from “non-physical” financial activities?

It seems to me that there is too much funny money in the system. Financial assets far outweigh the physical economy. A result of excess money supply in conjunction with “mark to market” concepts driving assets prices, which in turn were used to justify yet more money supply.

Now things have turned, asset prices are falling, inflation is rising All of this is good to the extent that it brings financial assets back in line with the physical economy. In time, aggregate values for stored consumption will fall to meet physical reality.

What must be avoided though, as financial assets shrink back to physical reality, is an impact on the physical economy itself. If the economy fails to grow or worse still shrinks not only will aggregate living standards need to fall but also financial assets will need even greater contraction to reach reality.

Now back to your bank account. What’s your money doing to finance current production and investment in productivity? If your bank is not on lending then the answer is nothing.

Knock the federal reserves if you wish, but as I see it the best corse of action is to avoid damage to the physical economy and to do that you must keep the liquidity and credit flowing. Inflation will be much more severe on funny money financial balances than real physical production. Inflation is a lesser evil than starving the physical economy of the capital it needs to function and improve productivity. This is probably the major lesson from the great depression.

So is cash really King? If the credit squeeze isn’t addressed than your bank will probably become a dubious counterparty. If it is addressed than “real” inflation (devaluation of money) isn’t going to be kind over any sort of extended time frame. USA already has negative real interest rates.

For the long term, owning the means of production through ownership of shares makes much more sense to me as a way of securing future consumption ability, than does a financial instrument such as a bank account.

Given the current valuation for shares, inflation outlook and financial counterparty risk is long cash and short shares the safest and most logical strategy.

(Message edited by Resillent1 on March 16, 2008)

rdumas

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Sunday, March 16, 2008 - 08:16 am:

Hi PSE,

I agree with you about the fall through the 5222 mark first thing on Monday morning as the financial sector will get severely hit. The ADRs in the materials sector were positive on the friday night and hence they may hold up the market to a close on the support level of 5222 and wait for the next US market move.

The financial sector which early last week had dropped 39.4% from its highs is currently down 35.4%. I suspect that it will have another go at the 39.4% sometime on Monday. Ian Huntley mentions that the financial sector dropped 40% during the 1987 to 1991 period so in the grander scheme of things the situation that we find ourselves in is pretty bad.

With all major indices in primary down trends and the US economy becoming a cot case, I can't see how the materials sector can withstand the onslaught in the medium to longer term.

easymoney

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Sunday, March 16, 2008 - 09:06 am:

Resilient1,
a very interesting and thought provoking post.

I wonder though, whether the physical/asset dichotomy is clear cut. I would have thought that the range of economic activity is more on a sliding scale with some activity more at the asset end, and other activity more at the physical end. For example, people who provide finance to warehouse and distribution firms, or those who trade the futures markets for primary produce (the proverbial pork bellies) would be somewhere in between the two.

What worries me about these dubious dichotomies is what happened during the dot.com boom. Then there was the "old" economy and the "new" economy. Of course there was no such thing. There was in reality simply a sliding scale of how speculative a business was.

Two of them say they're Jesus.
One of them must be wrong.

Industrial Disease
Dire Straits

easymoney

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Sunday, March 16, 2008 - 09:25 am: