All Gassed Up

Fed Governor Bernanke's testimony last week, along with the continuing slow motion collapse of the bond insurers, made it clear the Federal Reserve will continue to print money like it is going out of style in a vain attempt to forestall the coming implosion of our financial house of cards. Sooner or later, this flood of money will lead to hyperinflation here in the US. The above picture is an actual photograph of a German woman burning paper money in her furnace in 1923 because it would cost more than the pile of money at her feet to buy firewood, so it actually made more economic sense to use her money to heat her house.

Hopefully, you are taking steps now to safeguard your financial future, including buying gold through one of the various methods discussed in previous posts. Today I'd like to spotlight a different commodity which has just broken out of a two year congestion period - natural gas. As oil prices have gone through the roof lately, natural gas prices had stayed relatively low. Every previous time this has happened in history, natural gas prices have risen to "catch up" to the rise in oil prices. So what's the best way to play this?

The most conservative investors can play the rise in gas prices by buying shares in the natural gas exchange traded fund (symbol: UNG), which mimics the rise in price of natural gas futures contracts, without the extra risk and hassle of margin calls. Unfortunately, since this ETF is based on futures contracts, there are no long-term options available, although there are currently options that run out as far as October 2008.

A good single company stock play on natural gas is Chesapeake Energy, one of the largest natural gas companies in North America. After a huge run up over a five year period, it too had been in a period of consolidation over the last two years, but has recently broken out and up of that pattern, just like natural gas itself. It has a very strong balance sheet and a number of politically prominent board members, including former US Senators. Most invitingly of all, over the last few years the CEO and other insiders have regularly bought millions of dollars worth of Chesapeake shares with their own money.

It is important to keep in mind that natural gas has one critical difference with other energy sources like crude oil, coal, or heating oil - it cannot be transported by sea except in liquid form - and the liquid form requires special processing terminals in seaports. North American has very few such terminals, and efforts to build more inevitably run into the NIMBY (Not in My Back Yard) syndrome from community residents and environmental activists. That is why natural gas prices soared so high when the Gulf Coast was threatened by Hurricane Katrina a few years ago. This provides a natural competitive barrier against large amounts of imported foreign gas for Chesapeake.

A higher risk strategy is to purchase Chesapeake call options. Regular readers know I prefer to buy the longer-term LEAPS to smooth out short term price volatility (see previous posts for a detailed explanation of how options work). I bought some January 2010 $60 strike price call options two weeks ago and they are now up about 40%, but there should be more room to run in the near future.

The obvious danger here is that Chesapeake shares get dragged down with the general market if there is a large stock decline, which is why I prefer the longer-term options. Another way around that is to use the highest risk strategy of buying natural gas futures contracts directly. This is difficult for the small investor because natural gas is a very large contract with some of the highest margin requirements of any futures contract. So the small investor who wants to go this route is best advised to purchase options on natural gas futures contracts instead. This has the added advantage of not requiring any margin and hence not being subject to margin calls.

One final thought - I find it extremely humorous when Senator Clinton tries to make the case that Obama will not be able to withstand the "Republican attack machine" that will be unleashed on him if he should become the Democratic nominee. The reality is that anyone who can withstand the Clinton attack machine has nothing to fear from the "vast right wing conspiracy!"

How Low Can They Go?

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2008 Forecast

"That sound you hear out there is reality knocking on the door. It has been standing out in the cold for a long time and it is not happy with us."

-James Howard Kunstler

Wish I had better news, but it's not looking good for the US of A in 2008. By this time next year, the President-elect will already be talking about the "Newer Deal" she plans on implementing in her "first hundred days" to help with the economic collapse that is upon us. Just as her husband "discovered" in 1993 that there was no money to pay for his promised middle class tax cut, expect Robert Rubin to have to give Hillary the bad news that this nation is already more than 9 trillion dollars in debt and the foreign lenders have cut us off.

Regular readers already know what is coming later this year, or at the absolute latest in 2009. Some recent updates can be found here, here, and here. Many of you are no doubt thinking that a financial collapse could not happen in the United States of America. The truth is that it has happened many times throughout our history, most recently in the lifetimes of many of our senior citizens. Here is an excerpt from the Ainsworth's Financial Service newsletter of March, 1932:

Every wage earner, every producer of capital, is a speculator whether he would be or not. We must speculate on how we are to make our income, and after we have made it, we must speculate on how we are to keep it where it will be safe until it is needed. Speculation is just another name for intelligent assumption of risks.
Now most of my friends who are out and out speculators frankly admit the fact, as opposed to that so-called investment class who would like to think that they take no speculative risks. By all the time-honored yardsticks of financial measurement these out and out speculators should have failed in the last two years of declining stocks and grain futures, and those who invest for a six percent return should have their capital intact. But such has not been the case. As a matter of fact, very few of my old speculator friends have lost all they had, yet every speculator I know of has less in 1933 than he had in 1929. On the other hand, millions of people who never meant to risk a dime have lost their lifetime savings in the four years following 1929.
Many of my very close friends who look with horror on so-called speculation have lost all they had through the failure of banks, building and loan associations, and defaulted bonds, where they had their savings invested; or else they have failed through the decline in farm lands or city real estate. This doesn't seem quite fair since those who never asked more than a six per cent return certainly had a moral claim to safety of principal.

The coming economic collapse is going to be a great shock to almost all Americans. Please take advantage of the literally once-in-a-lifetime investment opportunities that are unfolding before you so that you do not end up like so many good, decent, unsuspecting people did during the Great Depression through no fault of their own other than failing to educate themselves and then act on that education. If I was only allowed to give one piece of advice for 2008, I would advise you to read Jim Sinclair's web site at least every other day or so from now until the crisis is over.

Fearing the Freeze

Neither Lean Hogs nor Live Cattle have yet hit their buy targets mentioned in the previous post, although Live Cattle came very close and the hogs look like they are trying to put in a bottom here. We will continue to wait for all the stars to align correctly before committing capital. In the meantime, one of the most exciting commodities out there, Frozen Concentrated Orange Juice, looks like it is entering a seasonal down pattern. And unlike Lean Hogs or Live Cattle, it's probably OK to go ahead and short it now. In fact, I did just that yesterday and am already up over two points on the trade. As you can see on this chart, this year's seasonal down leg has already begun:

The reason for the traditional drop in OJ prices from mid-January through the beginning of March is weather-related. More than 90% of the frozen concentrated orange juice sold worldwide comes from oranges grown in either Central Florida's citrus belt or Sao Paulo, Brazil, and the majority of that comes from Central Florida's citrus belt. Since OJ is a very thinly traded and volatile market, a freeze in Central Florida during the winter or a hurricane during the summer or fall that damages Florida's fragile orange trees can cause OJ prices to shoot up dramatically. I went to high school in Central Florida and I vividly remember stories on the local news showing farmers putting heating units near their trees during cold snaps to protect them from frost.

Orange juice processing companies are well aware of this seasonal risk, and therefore tend to buy futures contracts from about September through December every year to hedge against the risk of frost in the winter. Once the peak season for freezes passes in mid-January, those companies sell their futures contract "insurance policies," and the OJ price drops dramatically until March, when the companies begin buying futures contracts again to hedge against the summer hurricane risk.

While this appears to be a slam dunk trade, as Naval Academy graduate Robert Heinlein informed us in his classic novel The Moon Is a Harsh Mistress, there ain't no such thing as a free lunch, and the danger in this trade is clearly that you short OJ futures and then there is an unexpected late freeze in Central Florida that causes prices to move against you very quickly. So if you take this trade, watch the weather in Central Florida like a hawk and bail out at the first sign of approaching cold weather! Also, with such a potentially volatile commodity, tight stops are highly recommended.

Since my brother is an Obamite, I have listened to Obama speak a few times now, and I am very impressed with his oratorical ability. His acceptance speech in New Hampshire was, I thought, very similar to Jesse Jackson's keynote address at the 1984 Democratic convention, one of my all-time favorite speeches, although Obama's was obviously much shorter and suited to its specific occasion. Both speeches really jump out and grab you emotionally, and both men are very, very good at delivering such speeches.

The problem, of course, with both speeches is that the specific economic proposals contained within them would not actually help the people they spend the rest of their speeches implying they really want to help. Bottom line: America has a more than $9 trillion dollar foreign debt that China, Japan, and the Gulf Arabs own a huge piece of. The dominos have started falling - first housing, then sub-prime mortgages, then sub-prime mortgage derivatives, then the hedge funds that owned those derivatives, and now the banks that lent money to the hedge funds and loaded up on lots of derivatives themselves. Since consumers can't tap into their home equity anymore, they are maxing out their credit cards to pay for greatly inflated gas. They have already stopped going to Starbucks, and they are even spending less than usual at Target and Walmart. The next dominos to fall are auto loan companies, followed by banks that own large amounts of credit card debt that will never be repaid. The whole house of cards is finally coming down, since the Asians and Arabs who have financed this charade for several decades have finally tired of it, and are now diversifying out of dollars and into gold, which is re-assuming its historical role as the world's reserve currency.

None of the candidates are talking about the only issue that will matter by November when millions more adjustable-rate mortgages have reset and the banks are failing - how to avoid another Great Depression. The correct answers are simple to state, but politically undoable until the average consumer feels much more pain than they do now: drastically slash government spending with no sacred cows (the military, Social Security, Medicare, etc.) left untouched to balance the budget, and re-establish some form of modified gold standard to restore the stability of our currency as the founding fathers insisted upon. Instead, the candidates are all babbling about health care. The one thing that will never happen is another good, old fashioned, New Deal-type government entitlement program costing billions of dollars. That jig is up once and for all. Our foreign payday lenders won't lend us the money to finance any more living beyond our means as a country, so we will have to bite the bullet and "endure the unendurable," until we have our financial house in order.

And you can just forget about anybody in the mainstream media raising this issue with any of the candidates...it has been positively surreal watching the Clinton News Network, NBC, and the rest of their ilk abandon Hillary and Bill and embrace Obama like a teenage girl experiencing her first crush!

You've got to love Camille Paglia. Check out her latest dissection of Hillary.