Fearless Traders, $100 Oil, Fuzzy Accounting and More!!

by Addison Wiggin & Ian Mathias

  • Dow hits 11,000, VIX at post-crisis low… Chris Mayer on the eerie lack of fear among traders
  • Did China make a deal? U.S. gets help with Iran… but told to keep quiet over the yuan
  • Byron King explains how $100 oil could come “almost overnight”
  • Plus, shocker of the day: Lehman was cooking its books

 

  Dow, 11,000!

We recovered from our spell of passion yesterday (reader comments below), only to discover the index of America’s largest companies really has crossed 11,000, closing the day at an 18-month high.

Barely a year ago, investors were clutching their Bibles, soaked in sweat, watching the Dow plunge below 6,600. Today? Who’s’ worried about a correction?

“We’ve definitely turned the corner,” some Wall Street analyst told the Journal.

Definitely? That’s our cue to place bets against the rally.

  We’re definitely among the minority, however. The volatility index fell to its lowest level since June 2007 this week. The VIX is at 15 today… light-years from the 80-90s suffered during Lehman’s collapse.

Even in the 20-year history of the index, 15 is low.

  “Fear gives intelligence to fools,” says Chris Mayer, citing the old proverb. “Turning it around a bit, we might say that lack of fear makes fools of wise men.

“Right now, fear looks cheap. With the VIX below 16, we are getting close to extreme territory. We are near the limits of what that great rubber band of life will absorb before it snaps back. The VIX usually hovers between 10-20. So we are not quite there yet, but the tension is building.

“Given all that is going on in the world, it is remarkable to find investors so unworried. The financial system is still a rather creaky affair. Leverage is still high. Banks remain undercapitalized. The credit cycle has not yet run its full course, as there are still significant credit losses hiding in the cupboards of banks.

“Then there are the governments of the world. The U.S. has awful credit metrics. It is bleeding money and owes huge debts. The states are also bleeding money and have large debts, including giant gaps in unfunded pension liabilities. They are perhaps worse off, because unlike the U.S. government, the states cannot print their own money. Then there is the EU. And Japan.

“There are only a few ways to cure such ills, and none is painless. One thing is for sure: These ills can’t go on forever. So despite being in the middle of a usual historical range, these are not usual times. In the context of our times, fear looks cheap.”

Chris gave his Special Situations readers a way to profit from a VIX comeback. For details, check out yesterday’s alert… or click here.

  One item helping to not cause fear today: Lehman Bros. accountants have been accused of accounting fraud. No! You don’t say.

Just as Enron did when it was collapsing in 2001, Lehman set up an a “small company — its ‘alter ego,’ in the words of a former Lehman trader — to shift investments off its books.”

The shadow firm, Hudson Castle, is hilariously similar to LJM, the most famous company Enron used to hide bad assets and cook its balance sheet. Both were born of a desire to hedge risky bets… both were “legally” separate entities but actually controlled by senior executives… neither was accurately reported to the SEC… both were ultimately used to smuggle toxic assets of the its parent’s balance sheet.

Yawn.

  Gold, which you might say is the VIX for global monies, is doing well in this market environment, too. The spot price hit a four-month high early Monday, $1,167 (check), and now rests about 10 bucks lower.

  Thanks to the coming Greek bailout, the dollar is down to a one-month low. The dollar index fell below 80.5 again yesterday, its lowest level since March.

  Two items in Asia this morning give us pause:

“China will firmly stick to the path of reforming its currency exchange rate,” President Hu Jintao opens with the first, “based on its own economic and social development needs.” That’s about as direct a response to the U.S.’ impending application of the dreaded “currency manipulator” label.

“In particular,” Hu added, to make it even more explicit, “China won’t push forward the reform under external pressure."

President Obama, on the other hand, announced with satisfaction that China has pledged to go along with his plan to impose sanctions on Iran. China, which gets 12% of its oil from Iran, has historically balked when it comes to wagging its official finger at Iran’s nuclear program.

“Mr. Obama assured Mr. Hu that he was ‘sensitive to China’s energy needs,’” claims a reporter for The New York Times, “and would work to make sure that Beijing had a steady supply of oil if Iran cut China off in retaliation.”

Hmmn… the U.S. backs off on the yuan, China gives in over Iran. One set of chess moves closer to a new oil war. Our projections show oil could go to $220 if such a war were to break out.

  Oil’s been in a steady state of decline since peaking last week around $87. This morning, after some bad earnings from Alcoa, it’s down to $83 and change.

  “From current levels of price and supply, I can envision oil prices spiking to well over $100 a barrel almost overnight,” warns Byron King. “We could wake up one morning to an energy disaster unfolding in front of us. I can think of all sorts of bad scenarios, from Mexico to Nigeria to the Middle East.

“Furthermore, Asian demand (a polite way of saying Chinese demand) now supports the price. The U.S. economy doesn’t dictate the price of oil anymore. Nor do oil companies. The price gets set in a worldwide market environment, where physical producers and supplies are almost bit players.

“And despite relatively high oil prices, we’re not seeing new oil production come online fast enough to replace the decline in output due to depletion. Just ponder the difficulty, capital and time frames for offshore deep-water development. Hello, Peak Oil.”

  The Polish economy, before their national tragedy this weekend, was enjoying a nice rebound. Its central bank had the pleasant problem of dealing with a “too strong” currency, the zloty. The Polish stock market hit a 21-month high last week.

But in American terms, the Poles lost a fully loaded Air Force One… the president, first lady, the military joint chiefs of staff, the central bank governor, the head of national security, the deputy foreign minister, three parliament speakers, the head of the Olympic Committee, two aids and over 80 other passengers died in a plane crash on Saturday.

They were trying to land in Katyn, Russia, of all places… the very same location where Stalin’s henchmen executed roughly 22,000 Polish prisoners of war in 1940.

Today, it’s hard to imagine a market environment with more uncertainty. And yet Polish stocks are holding up well… for now.

  On the other side of the planet, there’s a screaming bull market in… pulp?

The material used to manufacture paper or magazines, newspaper, copy paper, tissue and cardboard (aka pulp) hit a 15-year high this morning. At $918 a ton, it’s roughly 10% short of its record high set back in 1995.

Turns out Chile produces 10% of the global pulp supply, and that nasty earthquake back in February was smack in the middle of the country’s best pulp-producing region.

  “Bravo!” a reader writes. “The April 12, 2010, issue of The 5 is an all-time classic.”

“I just had to say how much fun it was to read Monday’s 5,” another adds. Yesterday’s issue “may have been one of the best pieces I’ve read from Agora in quite a while,” intones a third. “Thanks for lightening up my day,” writes a fourth.

The 5: As soon as we hit send yesterday, we began receiving platitudes in our inbox. We received so many… it has begun to make us nervous. Accordingly, as you can see, we’ve resumed our cranky, deficit hysteric forecasts.

  “As a Canadian, I take offense,” a reader writes in his own satirical response, “to The 5 implying that we are not doing our part to follow the new American ‘government knows best’ example.

“For instance, our long-established oligopoly of Canadian banks are all offering variable-rate mortgages at around 2%, nicely pushing housing prices up and making us all feel wealthier. Looks like the lowest you can go in the U.S. is 3% and change for an ARM.”

  “I’d like to add something to your quiver of insights,” a reader writes. “Keynesian economics really does (or did) have a legitimate function in a capitalist economy wracked by business cycles. Any honest, solvent government can use Keynesian strategies to good ends when a cycle tanks.

“The problem, which you guys so rightly observe is that our government is far from solvent; it uses what are called ‘Keynesian’ strategies to mask what Marx would have called ‘internal contradictions’ — and its not being honest with itself or its citizens, either. What we see now is not Keynesian — it’s simply consequences of overreach by an empire in decline. It’s not Keynesian at all, just chronic overspending.

 

“You should let me know when you’re going to be at the bar in Charm City. I’d really enjoy buying you guys a round of drinks. I’m just down 95 about 40 minutes.”

The 5: Cheers.

  “If the truth be known for all and by all,” the last reader writes, “liberal or conservative or progressive, we are all just GREEDY. This is the basis of the present-day dilemma in America. There is no one or correct answer. Capitalism, socialism, communism or any other -ism will not solve all problems.

“You folks should lose the sarcastic attitude. If you want what is ‘fair’ in a tax, then push for a ‘flat rate’ tax. No refunds, no cuts, no write-offs. Everyone pays the same percentage. If I want to read gossip or listen to ‘crybabies’ on the Web, there are plenty of blogger sites.”

The 5: Geez, there’s one in every crowd.

We don’t have a problem with greed or the flat tax. In fact, we liked Steve Forbes’ “flat tax on a postcard” idea from 2004… so much so he was our keynote speaker in Vancouver that year.

Unfortunately, that got shot down by the CPA lobby. A wide-eyed uncle of Ian’s likes to say the flat tax would be a “brain cell emancipation.” Imagine all the incredible, productive things IRS officials and tax professionals could do if they suddenly found themselves out of work. How many spouses would be made happy by lists upon lists of household projects finally getting completed? That’s reason enough alone to institute a flat tax.

Cheers,

Addison Wiggin

P.S. As part of a coordinated effort to get people talking about the deficit and debt piling up in Washington, the Peterson Foundation is hosting “2010 Fiscal Summit: America’s Challenge and a Way Forward” on April 28, 2010, in D.C. Former president Bill Clinton will moderate.

Many of the wonks and muckety-mucks we interviewed for the film I.O.U.S.A. will be there. We received our invitation to join them yesterday, too. Hmmmn… is it worth a journey into the belly of the beast?

P.P.S. David Walker, now president of the Peter G. Peterson Foundation, will give the opening address at our event in Vancouver, too. We posted the most up-to-date speaker list on Friday, here. If you haven’t already… have a look. It should prove to be among our most intellectually rigorous symposia in its 11-year history.

rspertzel

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