Fed Cuts Rates, GS and CFC Suffer, Toy-flation, an Ethanol Forecast, and More!

by Addison Wiggin & Ian Mathias

  • Anxious for the rate cut on the 18th? Rest easy… it’s already happened
  • Goldman’s fancy quant fund takes a big hit… how “buying the dip” always works… until it doesn’t
  • Countrywide borrows $12 billion to keep itself afloat… evidentially, a “buying opportunity” in this day and age
  • “The key fundamental” that keeps the dollar down…
  • History rarely repeats, but often rhymes… proof below
  • Plus: Kevin Kerr’s 2-year ethanol forecast…

With the markets hanging in the balance… and waiting for the Fed… we begin with these insights regarding rate cuts:

“The Fed has ALREADY lowered the fed funds rate,”
claims The Survival Report’s Brian McAuley. “With gold taking off and the dollar tanking, it would appear to anyone who objectively looked at the markets that the Fed had already announced that it is lowering short-term interest rates.”

“This table shows the daily average fed funds rate since Aug. 8 — two days before the credit crunch hit the fan on Aug. 10. You can see that since Aug. 10, there have been just two days that the fed funds rate has been over the official target of 5.25%.

“During every other day over the past month, the actual fed funds rate has been maintained well below the official target. In fact, the average fed funds rate since Aug. 10 has been 4.96% — 29 basis points below the official target of 5.25%.

While everyone is wondering if the Fed is going to lower rates at next week, it has effectively cut rates 25 basis points over the past month. Helps to explain why the dollar has been trading lower against other major currencies and why gold has rallied. Of course, “Survivors” have a gold position to hedge this trend… it’s up 8% since Brian recommended it three weeks ago. Click here to protect your stocks during the coming correction.

From North America to Europe to Asia, most benchmark indexes gained about 1% yesterday,
including all 18 Western European markets. The International Herald Tribune (IHT) attributed the global rally to the better-than-expected initial jobless claims report in the U.S.… proving the media, if not investors, will turn even the smallest morsel of good news into a reason for buying stocks.

Alas, as we write this morning, euro markets have successfully given back all of yesterday’s gains, and then some.

The U.K. mortgage lender Northern Rock announced that it will be forced to tap the Bank of England for emergency financing. Bad bets in the British housing market dried up all liquidity for the lender. In turn, the FTSE 100 and all other euro indexes are at least 1% in the red as we write.

Look for this uneasiness to spread across the Atlantic today.

The Goldman Sachs Global Alpha fund — the firm’s flagship quantitative fund –- suffered 22.5% losses in August, the worst month of its 10-year history.

“The negative results,” says a release from the fund managers, “and especially the magnitude of the poor performance, were largely due to systemic pricing pressures driven by massive delevering across the market.”

That’s how clever people trying to keep their jobs say, “We shorted the hell out of the yen and went long on Aussie dollars because the computers said so.” The sudden unwinding of the carry trade you read about in these pages lost GS investors something to the tune of $1.8 billion in August.

“There is no real analysis or brilliant programming going on in any of these quant funds,” explains Mish Shedlock. “Every damn one of them is trained to buy the dip in anything and everything with enormous leverage. They are all trend followers that will fail spectacularly when the trend changes. Leverage guarantees it. Buying the dip works until it doesn’t. When it doesn’t, it results in a tremendous number of blowups.”

The fund is down 33% for the year. Ouch.

Countrywide, GodMozilo’s creation, was forced to borrow an extra $12 billion to help cover the costs of its flailing business,
the company announced yesterday. Evidently, that $2 billion investment from Bank of America last month didn’t even scratch the surface.

Countrywide has borrowed somewhere in the neighborhood of $25 billion since its downward spiral began in July. Yet “Eased fears of a crippling cash shortage boosted its shares nearly 14%” yesterday, reports the L.A. Times.

That’s the world we live in… a $12 billion bailout plan sets off a $2 surge of an $18 stock. The fact that CFC was able to find lenders brave enough to fork over this much cash might be a sign that Countrywide won’t go out of business. But 14%? Crazytown.

Retail sales rose 0.3% last month,
the Commerce Department announced this morning. Wall Street quants had their fingers crossed for a half a percent rise, but this is all they got.

Worse, if you x out auto sales, retail consumption actually fell 0.4%. Building materials and gasoline sales fell the most. But furniture and electronics saw notable increases. We suspect the consumer is done with making home improvements… but is still happy to break out the plastic for cheap and easy entertainment.

The second-quarter current account deficit fell slightly, to 5.5%,
from 5.8% in the first quarter, the Commerce Department also reported this morning. This latest $190.8 billion deficit is the smallest since the third quarter of 2005.

“Historically,” says our currency man Chuck Butler, “whenever a country’s current account deficit reached 4.5% of GDP, a currency crisis usually followed.” The last time the U.S. was anywhere near 4.5% was in 2000… the euro was worth about 83 cents.

“In my opinion,” Mr. Butler continues, “you can talk about bubbles bursting, and mortgages melting, and low interest rates and recessions all you want. Those just illustrate the awful fundamentals in the U.S., but when you come right down to it, the financing of the current account deficit is the key fundamental that put the dollar into the weak dollar trend in 2002, and it won’t come out of that weak dollar trend until the current account deficit has been corrected, or at least is far along down the road to correction.”

The dollar budged a bit off its historic lows last night.
It’s at $1.389 versus the euro. But the dollar index is still at 79, as low as our generation has ever seen it. Ho hum.

The more things change, the more they stay the same,”
writes Greg Guenthner of Bulletin Board Elite this morning. Gunner’s had his head buried in The Panic of 1907
, out now in bookstores. Here’s an excerpt that provides a worthy retort to your “end of history” friends:

To understand fully the crash and panic of 1907, one must consider its context.

  • A Republican moralist was in the White House
  • War was fresh in mind
  • Immigration was fueling dramatic changes in society
  • New technologies were changing people’s everyday lives
  • Business consolidators and their Wall Street advisers were creating large, new combinations through mergers and acquisitions, while the government was investigating and prosecuting prominent executives — led by an aggressive young prosecutor from New York
  • The public’s attitude toward business leaders, fueled by a muckraking press, was largely negative
  • The government itself was becoming increasingly interventionist in society and, in some ways, more intrusive in individual life
  • Much of this was stimulated by a postwar economic expansion that, with brief interruptions, had lasted about 50 years.
A mob
trying to get its money back, 1907

For more from Gunner, including his small-cap trading strategy, click here.

A reminder: “The building boom in ethanol plants is likely to go bust by the end of 2007,”
writes Kevin Kerr from Italy, “and the whole industry will probably peak sometime in 2008.” Before jet-setting over to Milan, Kevin wrapped up his Midwestern ethanol assessment tour, and had this to report:

“Reduced return on investment, increased supplies of ethanol and, ultimately, falling prices will bury this industry sooner than most people think. In Minnesota alone, ethanol production is projected to top 620 million gallons this year, or about 10% of the overall national production. As the national production number goes beyond 7-8 billion gallons, it’s likely that margins will drop as prices fall. Fourteen billion gallons of production is likely by 2008, and at that point, I think we will see the peak.

“Ethanol from corn is not going to last. I estimate that the ethanol revolution will dwindle by the end of 2008.” Place your bets accordingly.

Toys will be as much as 10% more expensive in 2008,
says a study today from the AP. Apparently, the over 3 million tainted toys coming out of China since June will have domestic toy makers “increasing vigilance” next year. The cost of such vigilance, naturally, will be passed on to you.

If the AP’s 10% hike is on target, it would be twice the government’s current measure of average consumer inflation – about 4.7%. “Most of the rising costs come from emergency third-party testing in the U.S. by both makers and sellers,” says the AP.

In response, Chinese manufactures have delayed a massive rollout of their latest kiddie sensation:

“Block-o-Lead” – Probably 10% more expensive in ’08

“I have an idea for the ‘fixers’ of some of the current mess in the housing industry,”
writes a reader. “Why not form a company/advisory panel/whatever-have-you to get the subprime borrowers (and the not-so-smart huge home equity line users) hooked up with the real estate speculators in the ‘hot’ real estate areas?

“This way, when the subprime borrowers and home equity line users lose their houses back to the banks and mortgage companies that sold them these fancy finance plans, they can find a place to rent from the speculators that can’t sell their properties! They deserve each other. And as for the banks and mortgage companies that played the part of a Judas goat and led the naive and the greedy to their ‘slaughter,’ well, I guess our ‘big brother’ will step in and ‘punish’ them.”

The 5 responds:
We can picture it: Half of Detroit will be locked in two-year leases on “reduced” waterside rentals in Boca Raton.

“I wanted to send you a short note to let you know my thoughts on your 5 Min. Forecast,”
writes a reader. “I am a subscriber to tons of online information services in order to get up to snuff on financial matters. I find yours to be the most succinct, clear and useful. Thank you for your brevity, for not bombarding me with advertising and sales pitches and for the excellent overview of current market conditions.”

The 5 responds:
It’s been roughly five months since we launched The 5. E-mails like this arrive every day. We rarely have time to respond. But today, we have a few extra seconds, so… thanks for your support. We hope The 5 is as interesting and enjoyable to read as it is to write.

Have a good weekend,

Addison Wiggin
The 5 Min. Forecast


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