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November 2015

ISIS: Oil as a Strategic Weapon

November 30, 2015 by EconMatters   Comments (0)

By EconMatters

I have to admit that I am a news junkie.  So my TV was glued to CNN on the day of the Paris terrorist attack.  During its coverage, one of the CNN commentators mentioned that ISIS makes about $2 million a day in oil revenue.  That piqued my curiosity and decided to find out more about ISIS oil operation.

Oil as a Strategic Weapon

According to FT, ISIS oil strategy has been long in the making since the group emerged in Syria in 2013.  The group saw oil as a funding source for their vision of an Islamic state, and identified it as fundamental to finance their ambition to create a caliphate.  ISIS controls most of Syria's oil fields where it created a foothold in 2013.  Crude is the militant group's biggest single source of revenue.

ISIS has derived its financial strength from being the monopoly oil producer in a huge captive market in Syria and Iraq.  Despite a US-led international coalition to fight ISIS, FT describes a "minutely managed" sprawling ISIS operation akin to a national oil company in just two years with an estimated crude production of 34,000-40,000 barrels per day (bpd).  

$1.5 million a Day to Fund The Terrorist Group

The group sells most of its crude directly to independent traders at the wellhead for $20-$45 a barrel earning the group an average of $1.5 million a day.  Without being able to export, ISIS brought hundreds of trucks and started to extract the oil and transport it.  According to an FT interview of a local sheikh, an average of 150 trucks is filled daily with about $10,000 worth of oil per truck.  Most traders can expect to make a profit of at least $10 per barrel.   

Son of Turkey's President Is In on ISIS Oil?

The arbitrage had the potential to go a lot more than $10 a barrel when oil prices were high.  Russia has accused Turkey of buying ISIS oil (allegedly the son of Turkey's President is involved, and also allegedly the U.S. is aware of it), reselling it to Japan and Israel for huge profits.  Smugglers have been using boats, pumps, carrying on foot, by donkey or horse.  Some see the oil production from ISIS as a contributing factor to the global oil glut pushing down oil prices. 

ISIS Adapts to Low Oil Prices

However, the biggest threat to ISIS oil production has been the depletion of Syria's aging oilfields despite the group's efforts to recruit skilled oil workers.  ISIS does not have the technology of major foreign oil companies to counter the production decline. 

ISIS has tried adapting to the new lower oil price environment by turning to oil midstream and downstream.  FT and Aljazeera both reported that ISIS has recently expanded into refining and petrol stations.  In ISIS-controlled territory, there's no shortage of demand.

Russia & China Eyeing Middle East While Obama 'Pivots' to Asia

It is widely acknowledged that one of the reasons the international coalition against ISIS has not been effective is the reluctance of the coalition to target ISIS oil infrastructure (trucks, oilfields, pipelines) where there's a large civilian presence, and for the potential environmental impact.  Russia jumped in to aggressively target specifically ISIS oil operation and infrastructure aiming to cut off its funding source after ISIS took out a Russian plane.  In essence, Russia is trying to push the U.S. aside and take a leadership role in dealing with the ISIS and Middle East chaos.

Russia's timing is impeccable just as the U.S. is 'pivoting' to Asia, while China is only too eager to help Russia with an eye on the Middle East energy assets for its future energy security.  The alliance of China and Russia may have been weakened on a now fragile economic ground due to the slowing economy in China and low oil prices negatively impacting Russia. 

However, the U.S. could be in serious trouble if the world starts trading oil in Reminibi instead of dollar now that IMF has approved Chinese yuan as a main world currency.

Coalition In-fighting

Judging from the allegation that Turkey is buying ISIS oil, and that Turkey shot down a Russian Jet within a narrow 17-second window (some say the actual window is only 5 seconds), there is some serious in-fighting within the coalition against ISIS (perhaps that's why Obama is desperate enough to drag Taiwan into the 'Coalition').  One thing seems to always ring true in international politics: When it is about money or self-interests, countries seem more than willing to go that extra mile despite any potential dire consequences. 

This could mean ISIS will keep its funding source with its oil making its way to all the intended and 'unintended' recipients like Japan, a significant U.S. ally.  ISIS has so far demonstrated its ample capabilities in adapting and organizing its operation, this suggest there's a long way to go in the fight against ISIS terrorists.

 


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Obama and His Big Mouth Put Taiwan on ISIS Radar

November 27, 2015 by EconMatters   Comments (0)

By EconMatters

One big news widely reported in Taiwan right now is that the national flag of the Republic of China (R.O.C. Taiwan) appears on ISIS web site video.  Above is a screenshot of the video with Taiwan's flag prominently displayed along side that of the U.S. and U.K.  The flags are supposedly in alphabetical order by country name.  The video was posted on ISIS web site on Wednesday, Nov. 25, 2015. 

According to a partial video on a Taiwan TV news show, ISIS also sends this errie message:

Our number only increases with faith.  And we are counting your banners, which our prophet says when it reaches 80, then the Blaze of War will find you.

You might wonder how ISIS came as far as seeing Taiwan as an equal threat as the U.S.? Taiwan's news media linked ISIS's sudden recognition of Taiwan to a statement made by U.S. President Obama at an Association of Southeast Asian Nations (ASEAN) summit in Malaysia last week. Obama said that Taiwan was one of the Asia-Pacific countries in a coalition against ISIS. 

It is true that Taiwan's military and Special Forces have heavy American military DNA. Due to the constant threat from China across a narrow straint, Taiwan has relatively heavy military defense (for a small island). A lot of Taiwan's defense miliary technology is supplied by the U.S. companies. Taiwan regularly sends military personnel to train in the U.S. while Taiwan's media reported U.S. Navy SEAL also sends trainers every so often to train one of the island's elite special forces units.  

In response to Obama's latest 'recognition', Taiwan governmnet simply said its current focus is on providing humanitarian assistance (i.e., We are NOT involved with Obama's 'Coalition').  Indeed, Taiwan's involvemetn with the chaos in the Middle East has been humanitarian aid to the region such as donating 300 prefabricated houses and nearly US$10 million in medical supplies to the refugees.

This stance is understandable as Taiwan had a ISIS panic attack when in February 2015, ISIS official Twitter channel twitted a picture of what looks like Taipei 101 Building (never confirmed) under atack.  This out-of-nowhere recognition by ISIS has prompted the Taiwan government to step up security measures, while President Ma Ying-jeou (馬英九) urged the public not to panic (Good luck with that).  

Ever since the Chinese Nationalists Party (KMT) retreated to Taiwan in 1949, it goes without saying that China has always viewed Taiwan as a renegade province that may be reclaimed by force if necessary.  In the 60+ years since then, the tiny island country has transformed itself quite successfully thanks to a series of financial and economic reforms by the Nationalist Party (KMT), while millions were killed by Mao's Cultural Revolution and the Great Leap Forward.  (On a side note, I'm not sure how the UK shadow chancellor thought it was funny to quote Mao in the Spending Review meeting.)

On the diplomatic front, Taiwan has sufferred many losses and betrayals.  Despite the fact that the Republic of China (Taiwan) was one of the the five founding and PERMANENT members of the United Nation (U.N.), Taiwan was ousted by the U.N. on Oct. 25, 1971 when U.N voted to recongnize Mainland China and to expel the R.O.C Taiwan. Since then, U.N. only recognizes the Communist China as the only lawful representative of China and has rejected calls to make Taiwan a member.  And Taiwan has almost always been excluded in any international economic pac (such as the TPP or AIIB) due to China's influeence.   

Taiwan instead strives to maintain extensive unofficial ties with countries that do not recognise it, focusing on trade, investment, culture and cooperation in non-political areas. Today, Taiwan has more than 100 representative offices in over 70 countries, including four offices in Australia (hense this detailed Taiwan brief on Australian Government site).

The sad fact remains that currently only 22 states (most of them you have never heard of) in the entire world recognize Taiwan as the Republic of China (ROC).  I guess the number should be 23 now, adding ISIS?     

Citizens in Taiwan actually do not appreciate Obama's sudden 'warm and fuzzy' officially putting the island on ISIS radar. After all, the U.S. does not even recognize Taiwan nor has helped Taiwan in anything of real economic or polical benefits.  And now Taiwan is a close ally of the U.S. in a coaltion against ISIS?  But of course.

ISIS already angered China after executing a Chinese captive last week.  Then, there's rising tension between China and U.S. over disputes in the South China Sea and The East Pacific.  So when Obama opens his mouth 'recognizing' Taiwan, ISIS jumps on it just to provoke China even more.

This is a chess match between ISIS, China and the U.S. using Taiwan as a game piece.  If ISIS strikes Taiwan (think the casualties at Paris in the much larger and stronger France), on whose hands will the blood be?

中華民國 是我永久的憂傷      


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Apple Stock is a 10 Year Short

November 25, 2015 by EconMatters   Comments (0)

By EconMatters

Holiday Melt Up in Stocks

Apple and most stocks do routinely well during the 4th quarter, and especially the last couple of months of trading after earnings are out, and the fund managers are pushing everything up with the goal of making their trading numbers by year end window dressing. It is amazing more people don`t realize this phenomenon and just buy December expiration calls on the SPY after the usual selloffs that happen in the third quarter, and wait for the holiday rally where stocks routinely melt up at year end.

$125 a Share

Apple almost touched $124 a share after earnings before some negative news came out regarding the supply chain which hinted at slower demand for I-Phones towards year end, and the stock reached its all-time high of almost $135 a share in late April of 2015. But if you are not already in at a good price for a long term short of Apple stock, then hope for one more run-up into year-end holiday trading to position yourself for the inevitable decline in this once Wall Street darling. Anything over $125 a share is an excellent price entry point to short this stock, and have a long term positive expected return on your investment from the short side. This stock should continue to put in lower highs and lower lows for the next five years, and ultimately continue lower for the next decade as this company eats through its massive cash reserves trying to come up with their next I-Phone blockbuster product in a declining margin world.

Large Institutional Ownership

Apple stock is a widely held stock by institutions, hedge funds and fund managers. This stock is basically a core holding in many fund managers portfolios, this is bad news once the bloom comes off of this rose, and investors start to see the long-term writing on the wall regarding increased costs and declining margins across the variety of Apple products it offers to consumers. In the end they are in a commoditized business, and this story never ends well judging by the history in this space over the last 50 years.

I-Phones Sales Hanging in There

I-Phones continue to hang on with newly created iterations with their slightly better bells and whistles but the improvements or differences between phone iterations are becoming less and less pronounced. Apple pulled the last big improvement in their phone out of the hat with finally giving in and producing a larger screen size for consumers. Sure there are still many I-Phone users who need to upgrade their phone, but I-Phones users are first adopters, that`s why they have I-Phones to begin with because branding and image are important to them so they don`t wait long to have the newest I-Phone. Stock prices are forward looking and the stock will move before the fundamentals fully become apparent to the overall market. By the time it becomes obvious that the trend in I-Phone sales is down for the foreseeable future, the stock will have long started its downward trek in price.

Smartphone Industry is a Mature Market

The cell phone and smart phone market is a mature industry, even basic and lower end smart phones essentially have the same comparable specs and features. And now that consumers have to pay full price for these small computers, consumers are going to think twice about shelling out $700 for a new I-Phone every year. Especially when the phones haven`t changed that much and they can get a pretty damn good equivalent smart phone for $50-$200 and in some cases even free with slightly older models. Once consumers get reoriented to the fact that they are basically buying the entire phone as no part is subsidized by their data provider, it is intuitive that I-Phone prices are going to come down to remain competitive in the market.

Margins Will Shrink for Entire Smartphone Segment

This is the next phase in the smart phone wars. First it was product innovation and differentiation. This phase as products become more and more alike is routinely followed by the price wars phase. And Apple has always tried to brand their way out of this problem by remaining the one premium branded product in the space. EconMatters view is that this may work for six more months but the writing on the wall will play out for Apple, and they will have to reduce prices just to stop the bleeding. As Apple is in for some brutal comps as I-Phones become too expensive relative to competitor offerings given the actual slight if any differences between smartphone specs. A consumer would find it difficult to justify paying $600 more for a phone when the only difference is a small icon on the back which will be covered up by a smartphone case nonetheless.

Beware of Spaceship Office Space

Beware in the history of building new office palaces or naming stadiums as this occurrence often through history signals the turning point in company fortunes. The list is long of company hubris at the top of the market spending out the wazoo for plush nice new office space only to have to move out of said office space or sell this luxury space at rock bottom prices in distressed times only a few years later. I expect this to be no different with Apple`s new spaceship offices in California. How many stadium naming rights deals have come undone over the years due to being taken over entirely or bankruptcy? The list is formidable to say the least! Candidly Bay Area real estate is probably in a bubble right now both on the commercial and residential side. And with the bubble in Unicorn and early stage financing of technology startups starting to show signs of cracking, it appears that technology stocks in general of many companies are going to experience difficult times based upon unrealistic expectations and cheap money evaporating that created unsustainable valuations. Thus let us label Apple stock as the signature leader in the decline of this bubble; the tech bubble bursting version 3.0.

The Electric Car Savior

This isn`t a surprise to Apple executives, why do you think they are working so hard on coming up with the next revolutionary product? This is why Apple is contemplating how far they can get into the automotive space, how profitable are heads up displays, or entire futuristic technology dashboards, can they profitably build an electric car without going bankrupt in the process due to cash flow drain? Investors are not going to stick around and wait to see if Apple can invent the next blockbuster product. Once the earning`s pain comes, this stock is going to get punished with 15% plus shellacking’s on future earnings releases over the next five years. I do think electric cars are inevitable replacements for the combustion engine, but is Apple really going to outcompete German engineering in this area? Is Apple going to produce more electric vehicles ten years from now than BMW? Does this seem like a positive expectancy investment?

Grow Old Gracefully

I think the most optimistic case for Apple stock is that they can just grow old gracefully so to speak and produce high quality products for their core competency in existing product offerings. I admire their research and innovative spirit looking for the next big technological breakthrough, but this requires cash, and it is a good thing they have stored a lot of nuts for this rainy day, because they are going to bleed through cash reserves over the next ten years like nobody`s business seeking the next I-Phone holy grail product. I hope for their sake they find it because their existing business is a commoditized product model, and margins are going to come down during the same time as the company`s overall cost structure is going to go up significantly.

Bear Market Environment

Apple stock has had some massive declines on several occasions over the last 10 years of this bullish market environment. Look for the stock to move around a lot as it continues to put in lower highs and lower lows in a continual downtrend over the next decade. Apple stock is a long-term short for the patient investor. There will be several short shark attacks as institutional investors bail after miserable earnings releases over the next 10 years. But just wait until interest rates rise and we are in a full out bear market environment for the real declines in this stock. The sheer size of this stock in portfolio holdings is impressive, so not a lot of buyers left in this name, but this represents a whole heck of a lot of potential future sellers in this name on substantive negative news.

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The Republican Party

November 24, 2015 by EconMatters   Comments (0)

By EconMatters

Extremism & Democracy

The Republican Party has been hijacked by the right wing Christian conservatives, the gun toting NRA extremists, the Tea Party extremists and the racially and culturally narrow-minded factions across the country. The party is a complete mess, it really has lost its way, and is destined to lose the Presidential Election to Hillary Clinton. The emergence of front runners in the Republican campaigning season of Donald Trump and Ben Carson speaks volumes regarding how far this party has lost its way.

Donald Trump

Pictures of Christian evangelicals putting their hands on Trump`s forehead during prayer make baby kissing look respectable on the campaign trail. Trump obviously got into the race as the attention whore that he is just because there are cameras involved, and this is what he does. The fact that he started polling well probably shocked this branding clown more than anybody, and then he started getting serious in pandering to every worst-case extremist tendency that so aptly defines the Republican party today. He basically has done the Democrat`s job in converting any remaining Republican moderates to the other side. Hillary Clinton and the Democratic Party should send Donald Trump a large thank you note after the election, he has made their job a lot easier. Donald Trump`s incessant pandering to every extremist group and their requisite views has basically confirmed what the Democrats have been saying and portraying about the Republican party for years. That they are a bunch of racist, homophobic, right-wing, gun-toting, tea-party simple minded extremists.

Ben Carson

Ben Carson could have been a breath of fresh air for the party, but no he had to start opening his mouth on the campaign trail. And he has said some pretty stupid things on the campaign trail. Things I thought a competent neurosurgeon was incapable of thinking or enunciating, let alone speak in public. The guy is basically an incompetent, senile idiot who if the Republican Party had any real platform with legitimate candidates would have been marginalized months ago on the campaign trail. I never realized how specialized competencies can be until this guy opened his mouth, and the incongruence between the thoughts rattling around this man`s brain, and what he did for a profession is astounding.  I am not sure how one can make it through basic medical school with such thoughts. He may have early stage Alzheimer’s or dementia of some sort. At any rate just another of the long list of un-electable Republican Party candidates.

Fiscal Conservatism

The Republican Party needs an overhaul, they need to get back to the core values of pro-business and job creation, entrepreneurial beliefs that once made this party a formidable political entity. They need to concentrate on fiscal conservatism as this will be sorely needed in about three years when all the entitlement spending really starts hitting the accounting books of the government. They need to focus on promoting lower taxes, simplifying the tax code, and cutting waste from bloated governmental programs like the military. In short, the government needs to be much more efficient in where and what they spend the taxpayer receipts on. The US has spent so much money supporting the military industrial complex over the last 20 years that the overkill factor is off the charts. I know the importance of having a strong military but the current spending is just comically ridiculous given the juxtaposition of the United States Military capabilities and the next nearest competitor.

Inefficient Capital Allocation

It is obvious that a large portion of this spending needs to be reassigned to more productive and efficient uses in the economy. This is where the Republican Party needs to steal a Democratic idea and really overhaul the healthcare industry. It doesn`t take rocket science to realize the quality of healthcare for the average citizen in the Scandinavian countries versus the United States and what these countries spend on the Military to realize poor capital allocation policies.

There is no reason that every American shouldn`t be able to walk into any healthcare facility at a moment`s notice and have all their medical needs met free of charge given the immense resources of this country. It is obvious that the entire healthcare system needs to be overhauled, costs are out of control and have been for decades; most of this is due to structural inefficiencies and the interplay between drug companies, insurance companies and the government – this relationship structure is broken.

It will require a lot of money and focus but this is going to happen by necessity if for no other reason as the current system will eventually implode. Since this is going to happen eventually, the Republicans might as well adopt this issue from the Democrats now that they have really screwed up the healthcare system with their failed attempt to fix it. Ideas go back and forth between the Party Platforms all the time, the Republicans need to steal this issue back from the Democrats.

The party needs to be much more inclusive from a sexual orientation, cultural values, and ethnicity standpoint. This is a no-brainer, it is an election after all, and sheer numbers count. But the real reason is that wake up Republicans America isn`t like your grandfather`s age, and that era ain`t coming back. Cities are multicultural landscapes with large populations of culturally and ethnically diverse people often with common goals of seeking a higher quality of life. In short, to be simplistic here good capable hard working, smart people come from many diverse ethnic and cultural backgrounds – yes even illegal immigrants. Get over it Republicans by giving this issue solely to the Democrats, you are essentially committing political suicide – you have become a stereotype, a caricature of a political party that is destined to lose elections.

Never Going to Attain Unanimity of Thought

Americans have diverse views on many issues, it is hard getting two people to agree on anything these days. All Republicans are not going to agree with each other on all the issues, some may be sympathetic to some issues and vehemently opposed to others. The key is to move to the center and have enough of the issues that are really important to voters to broaden the appeal of the party. Focus on policies promoting economic growth, lower taxes, and spending tax receipts more efficiently and not on one`s sexual orientation in the bedroom. The Republican Party has too many extremist views on far too many issues to be electable right now on the presidential stage. Right now it appears that Hillary Clinton is going to be our next President, and that means another four years of underachieving from a pro-growth business standpoint. And frankly, she is the only candidate I have seen who is even remotely qualified to run for President in this circus show of a campaign.

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Federal Reserve

November 23, 2015 by EconMatters   Comments (0)

By EconMatters

 
Rate Hike

The Federal Reserve has been telegraphing to markets that they are going to raise the fed funds rate by 25 basis points next month at its December Fed Meeting. The financial markets think they are serious this time and have been pricing in this 25 basis point rate hike for the past 6 weeks. The real question is that since the Fed has told us that they are Data Dependent for the past 7 years regarding changes to monetary policy, what has really changed in the economic data for the positive? Why now of all times do they decide to raise rates? Are they raising rates for the right reasons? These are just some of our concerns as the Federal Reserve embarks upon their final FOMC Meeting on December 16th2015.

John Williams

It is hilarious watching Federal Reserve Bank of San Francisco President John Williams flip flop on rate hikes faster than a politician on an issue after a new poll comes out. It has become obvious that this Fed member has no views of his own regarding monetary policy, he is basically Janet Yellen`s mouth piece, and is not an independent Fed member. If one just reads his statements over the course of 2015 regarding possible rate hikes, with an economy that hasn`t dramatically changed much in 2015, one would demand immediate and supervised drug tests on a monthly basis. Maybe I am being too hard on this guy, and that he has a difficult job of navigating Fed Policy politics, but he sure is coming across as an incompetent and unqualified board member that adds no real value to the committee.

Neel Kashkari

Any maybe that is why Neel Kashkari, has been chosen as head of the Federal Reserve's regional bank in Minneapolis to make everyone else appear more qualified in comparison. I am not sure why this Fed move hasn`t garnered more attention by the mainstream financial media, but what has Neel Kashkari ever done that makes him qualified to be a Federal Reserve Board member? And yes it is too easy a cynical softball setup for the peanut gallery to shout out “He worked at Goldman Sachs!” here. But he has accomplished very little in the Hedge Fund community, Investment Banking, his small time as a Portfolio manager at PIMCO, he made an unsuccessful run for governor of California in 2014, and was an unsuccessful aerospace engineer at TRW Corp. So unsuccessful in fact at TRW Corporation that he went to Wharton to get his MBA to reinvent himself at Goldman Sachs.

It seems the only thing this guy has succeeded at is kissing up to Hank Paulson while at Goldman Sachs, which landed him a high profile position at the Treasury Department during the TARP bailout program, by the way another colossal failure both in terms of policy creation and implementation. The guy has literally failed at every job he has ever done, and keeps getting promoted to better jobs with higher required responsibilities and required competencies. It is not like this guy has written extensively on monetary policy in his career or has a PhD in economics from a respected academic institution. This guy was literally pushing defense stocks on CNBC a couple of years ago while learning Portfolio Management at PIMCO. I realize that often employment success in life is knowing the right people and connections, but this is the Federal Reserve we are talking about, and not the Vice President of some obscure department in a sleepy corporation. Consequently the Peter Principle is alive and well at the Federal Reserve, has the Federal Reserve become one giant example of the Peter Principle?

Inconsistent Message

This brings us back to the fact that the Fed now is so motivated to raise rates just to show that they can actually raise rates, even when it is obvious to everyone in financial markets that there is no need to raise rates here. In fact, the Fed should have raised rates 3 or 4 years ago, and at the very least last year when GDP was more robust during the second half of 2014. In short, for the near term the Fed missed their opportunity window to raise rates, according to the economic data and overall global economic environment – them being ‘Data-Dependent’ and all.

Therefore, this rate rise is purely for show, the Federal Reserve has had 7 plus years to raise rates and they pick the time when China is struggling, and the ECB, Japan, and almost every other EM country is trying to weaken their currency. And they are going to do it, as they have extended so much credibility the last 6 weeks talking up this rate cut, that they would become a complete laughing stock by their most diehard supporters if they bailed out on this one. The Federal Reserve isn`t even consistent with their messaging within the same calendar year. As the reason they couldn`t raise rates back in June, another heavily telegraphed Fed Rate Rise Meeting, was because the US Dollar was too strong. They were worried about the effects of a strong dollar on the US Economy from a trade and corporate profits standpoint; not to mention its effects on emerging markets. Hello Federal Reserve, just six months later we have the same conditions with a strong US Dollar, it is not like anything has changed from a data standpoint to now suddenly merit a 25 basis point rate hike. I realize it is easy for me to sit back and criticize their actions, but it seems that from a logical reasoning standpoint if they can raise rates now, then they should have raised rates back in June.

Reasons Not to Raise Rates

The main reason the Federal Reserve shouldn`t raise rates now is that the ECB, which the Euro makes up the largest part of the US Dollar Index, is going full scale nuclear on devaluing their currency for trade competitive advantages over the United States. The second reason is that Emerging Markets haven`t shown a real pickup yet from their latest stimulus attempts, and are still hampered by being in the early stages of financial reform and structural rebalancing. The third reason is that commodities are being hammered with a strong dollar, further reinforcing deflationary pressures from a “Data-Dependent” standpoint given that the Fed wants to stimulate ‘inflation’ in the economy. The fourth reason is that there really is no need to now, that ship has sailed about 5 years ago, for all we know we have reached the other side of the business cycle, and are headed back into recession.

QE4

In fact, there can even be a case for QE4 as the inflation in the economy is coming mainly from Housing, (not enough affordable housing), and healthcare. Thus buying new bonds and lowering interest rates further might stimulate the housing industry in helping additional buyers move from apartment living into buying their first home; thereby lowering the steep rise in apartment rents of the last several years. This might also stimulate loan growth for both commercial builders and banks now that some have started to up their commitment to consumer home loans. Moreover, with regard to healthcare, raising rates isn`t going to promote or reduce inflation as this inflation is purely institutional to the absolute structural nightmare that is the healthcare industry today. A major overhaul will be required in the healthcare business over the next five years. The recent college try at reform has been a total and unmitigated disaster; we have only begun to see the fallout from this failed policy initiative.

The Gang that couldn`t Shoot Straight

The Federal Reserve is increasingly looking like the scared kid who is egged on to show his bravery by jumping from a high cliff to regain his ‘manhood’ in the eyes of the cool kids only to make a reckless decision with negative consequences. Yes the Federal Reserve needed to raise rates, but they probably should have started 7 years ago. After 7 plus years of being ‘Data Dependent’ why now?

In case the Fed hasn`t been paying attention, the world has devolved into a full out currency war, what the ECB has done to devalue the Euro in 2015 is not in the United States best interests. It makes for bad Fed Policy to raise rates now, it puts the US at a competitive disadvantage. All one has to do is look at the hit to the retail sector from the drop in tourism spending of this year due to the stronger dollar and compare this with the latest economic upturn in the European economic data with a weaker Euro to realize that currency devaluation as a strategy works and confers a strategic advantage for countries.

Really Federal Reserve, you pick now of all times to raise rates? I think I know why Neel Kashkari was recently selected to head the Federal Reserve's regional bank in Minneapolis, he makes the rest of the brain dead zombie Fed Members feel ‘comfortable’ and not threatened by actually making competent and sound monetary decisions for the US economy.

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Current Copper Price Below Cost of Production

November 21, 2015 by EconMatters   Comments (0)

By EconMatters

Long Dollar Trade

One of the common trades in financial markets these days is going long the US Dollar and shorting Commodities, especially the precious and industrial metals. This has been a bad year for commodities, and this trade has picked up steam with large fund flows the last 6 weeks.

Schizophrenic Fed & Employment Reports

This all turned around after the poor employment report of October 2nd, followed by some trade unwinding thinking the Federal Reserve may be on hold for the remainder of the year after the dismal October Employment Report. This resulted in about eight days of currency unwinds and around October 14th, Investors started putting the Long Dollar Trade back on as they realized the Fed still wanted to raise rates, and since China seemed to stabilize from a crashing standpoint, Fed Speak became hawkish to telegraph to financial markets that the December meeting was a potential live meeting for a rate rise. This trade really picked up speed when the November 6th Employment Report came in much stronger than anticipated with a robust 271,000 new jobs created for the previous month.

Trading Algos & Paper Markets

Oil has also been hit along with the metals but it has inventory issues to contend with and is in the midst of a price war for market share. But there is no such price war in the metals industry, and although China`s weakness has no doubt tempered demand, the precious and industrial metals are basically being hammered down in the paper markets by fund flows in this Long Dollar Trade. This trade has become such a reflexive trade, that if the US Dollar is strong, the trading algos just start attacking Gold, Silver, Copper, Aluminum, Platinum and Palladium. These metals by and large trade as a group with slight differences in the charts based upon any unique demand characteristics of the given metal.

Soft Demand

Demand hasn`t really fluctuated much for any of these metals the last six weeks, China and the global economy are just sort of trudging along with China`s rebalancing and the global economy growing somewhere in the area of 3.5%. But what has changed the last 6 weeks is the large fund flows into the US Dollar all trying to front run the Federal Reserve, and shorting the Euro, (which makes up the largest component in the US Dollar Index), with traders also front running Mario Draghi who has been telegraphing more future stimulus for the European Union.

No Shale Technology for Copper Mining

But at some point every asset has a price, it really comes down to price, markets often over shoot in one direction or the other, but ultimately, what is a ‘fair price’ given the dynamics in the market. Copper is an interesting market because it is being slammed down with Gold and Oil, and the supply side of the Copper market has had its issues in 2015, with supply constraints limiting new supply on the market. Most of the pressures have come from the demand side of the equation with China`s rebalancing. But Copper doesn`t grow on trees, and is actually rather difficult to get out of the ground and process from a cost perspective. The steps involved in actually processing Copper to get it in a marketable form are rather extensive and involve considerable resources. And with six straight weeks of slamming down by traders we have reached the low level of $2 on the Nymex December Futures contract.

Marginal versus Production Processing Costs

There are various estimates for what the Marginal Cost of getting Copper out of the ground is before supply is taken offline completely. But it is reasonable to assume that Copper is currently being priced well below the long term Production Cost of Processing the Industrial Metal, and a large component for this trend is strictly fund flows in the Long Dollar Trade.

Path Forward for Copper

I am not sure how much this trade has left in it for the near term, who literally knows with asset prices and financial markets these days. But my intuition is that this Long Dollar Trade will probably be pushed into the European Central Bank Decision regarding more stimulus measures and the Fed December Meetings regarding a 25 basis point hike. Also, two other contributing factors are the December 4th Employment Report and traders wanting to take profits before the actual event in early December.

Buy the Rumor, Sell the News

And given the fact that the Federal Reserve is probably going to go out of its way to talk dovish with a 25 basis point rate hike, almost a “One and Done” intended messaging given what the rest of the world is doing in this robust currency devaluation game; it probably means that traders buy the rumor, and sell the US Dollar hard after the actual news of a rate hike, at least in the near term.

Short Covering Rally

This is when traders will probably really unwind these Fund Flows with buying Gold hand over fist, covering the substantial shorts in the market, and simultaneously putting new money to work in Gold and the rest of the Industrial and Precious Metals. And if it starts getting cold Oil might even get a bid along with these commodities. We shall see how this all plays out in the market, but $2 Copper could be setting up for an ample short covering rally before 2015 ends!

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