Thursday, 16 October 2008

Are "algotrades" responsible for the crisis?

The article in The Guardian (UK) titled "Was software responsible for the financial crisis?" discusses a conjecture that trading algorithms, which are increasingly being used by quants in equity, commodity, and derviative markets, are one of the culprits behind the recent financial crisis and negative developments in global markets' performance.

With rapid development of programming tools and sophisticated trading platforms, a growing number of market players switch to the use of programmed trading. The article primarily blames quants for the use of programming and modelling tools in trading of derivatives. Whether it is correct or not, I am not sure. They surely developed a lot of new derivative instruments lately, many of which had been made possible thanks to very sophisticated models and computer-based programming. Some of the synthetic derivative instruments, say in option markets, can be analyzed and valued only with the help of the computer.

On the trading side, emotionless trading robots are pre-programmed to initiate trades when certain combinations of market conditions are realized. Panic or no panic, fear or no fear, euthoria or no euthoria - an algorithm-based trade takes place or is stopped. The presence of such non-human players in the marketplace is likely to amplify volatility and cause wild daily and weekly moves simlar to the ones we observe lately.

What's the lesson? It surely helps to learn what most common trading models are out there and make trading decisions accordingly. The second lesson is to avoid sophisticated derivatives. The recent crisis demonstrated that their valuation is fairly subjective and, ironically enough, is largely prone to the human error (on the programming and valuation side).

Wednesday, 20 August 2008

MDA Companies with the Longest Records of Dividend Growth, Summer 2008 Update

In the previous post, I started an overview of the most recent changes in Mergent's Dividend Achievers, a quarterly publication which tracks a list of North American companies which have regularly increased their annual dividends for at least ten consecutive years.

In this post, I update the list of MDA leaders in terms of the longest history of uninterrupted dividend growth, which I first published here based on the Winter 2008 edition of Mergent’s Dividend Achievers.

Why are we interested in learning what companies have the longest dividend payout and growth history? The reasoning is simple – if the company has paid and has increased dividends for a sufficiently long period, then it is very unlikely that it will discontinue this policy in the future. It all has to do with reputation and expectations. The management of such companies will try to do anything in order to keep the dividend payouts and annual dividend increases alive. No matter how bad the economic environment is and no matter how small these dividend increases are, we can anticipate with a very high degree of certainty that each year the members of the Mergent’s longest dividend growers list will increase their annual dividends again and again and again…

Here is the updated list based on the Summer 2008 edition of MDA:

A few brief comments on the reported results:

First, we can see that the same companies populate the top of this list. It looks like I accidentally forgot to include NWN in the previous edition. I also expanded the list a little bit to include all companies with the history of dividend growth over 40 years. Other than that – the same names, only one extra year of dividend growth is under their belts.

Second, the average numbers at the bottom of the table show that the companies with a long history of dividend growth are on average ranked marginally higher in terms of their shorter-term total returns, which means that they are performing marginally better amid tough economic times than companies with a shorter history of dividend growth. In other words, a better performance during 1 last year than over 3 and 5 years coincides with the continuing correction in the equity markets, which means that the best dividend growers are doing relatively better when other stocks go down. Note that the rank numbers represent ranking among all members of the MDA list.

Third, if we look at where these companies are currently standing within the 52-week price range and compare it with performance of large indexes (Dow and S&P500), we see that they are on average close to the middle of the range as opposed to the teen percentiles for Dow and SPX.

Fourth, the average P/E ratio of these companies is quite high, which can be explained by two factors: (1) lower earnings due to the recent economic downturn and (2) stock prices that are quite resilient to the continuing correction.

Fifth, the industrial sector representation is pretty good in this top 31 list, which means that everybody can pick a company or two for his/her long-term portfolio.

Finally, dividend yields on average are far from being breathtaking, but a few companies have very decent 5+% dividend yields.

Disclaimer: The information presented in this post does not constitute an investment advice. DYODD when making an investment/trading decision on any of these companies. As of August 20, 2008, I own some of the stocks directly discussed in this post.

Sunday, 17 August 2008

Mergent's Dividend Achievers, Summer 2008 - Departures, Arrivals, and Candidates

Mergent's Dividend Achievers (MDA) is a quarterly periodical publication which is highly respected among dividend-growth-strategy investors. The Summer 2008 edition, which reflects corporate first-quarter results for 2008, was released on July 17, 2008 by the publisher, John Wiley & Sons.

I am planning to do a series of posts highlighting several different lists on the latest edition of Mergent’s selected group of Dividend Achievers.

By Mergent’s definition, a Dividend Achiever is “a publicly-traded company that has increased its dividends for the last ten or more consecutive years.” Depending on the industry, companies must also meet certain capitalization requirements in order to be considered a Dividend Achiever. Dividend Achievers represent 13 industry sectors and more than 50 industries.

Mergent currently offers an Index that tracks the daily performance of Dividend Achiever constituents. The inception date of the index was January 17, 2003. The price appreciation values of this index, which is reconstituted annually, are published by AMEX under the DAA symbol. If an Index constituent is acquired and is no longer actively traded, the company will cease classification as a Dividend Achiever.

Ten percent of 3,300-plus North American-listed, dividend-paying common stocks are classified as Dividend Achievers, which is not a very small sample, so I guess each dividend investor who looks for appropriate investment targets on this list should do extra research and should apply extra screening criteria to identify the best of the best.

The first post deals with the lists of most recent additions and departures from the Dividend Achievers group, along with the list of those companies that qualify in terms of their dividend growth history but do not make it to the MDA club because of Mergent's volume/liquidity requirements.

Dividend Achievers Recent Departures

The following former Dividend Achievers have not increased their regular cash dividends in 2008 and therefore were removed from the list:

  • Alabama National BanCorporation (DE)
  • Applebee's International, Inc
  • Briggs & Stratton Corp.
  • Chittenden Corp. (Burlington, Vt.)
  • Colonial Properties Trust (AL)
  • First Commonwealth Financial Corp. (Indiana, PA)
  • First Indiana Corp
  • Freddie Mac
  • Haverty Furniture Cos., Inc.
  • Healthcare Realty Trust, Inc.
  • Omega Financial Corp
  • Pacific Capital Bancorp
  • People's United Financial Inc
  • Progressive Corp. (OH)
  • SLM Corp.
  • Sterling Bancorp (N.Y.)
  • Sterling Financial Corp. (PA)
  • Sun Communities, Inc.
  • Superior Industries International, Inc.
As we can see, most of the departing companies are banks and financial services firms, including the most famous name, Freddie Mac. The financial crisis has hit them hard, and they were not able to maintain their historical dividend growth pattern.

Dividend Achievers New Arrivals

The following companies are classified as new Dividend Achievers because they have recorded at least ten consecutive years of dividend increases and satisfied the liquidity requirement for the period from January 1, 2008 to May 30, 2008:
  • Alexandria Real Estate Equities, Inc.
  • American Capital Strategies Ltd.
  • Bank of the Ozarks, Inc.
  • Block (H & R), Inc.
  • Cato Corp.
  • Corporate Office Properties Trust
  • Developers Diversified Realty Corp.
  • Energy East Corp.
  • Horton (D.R.) Inc.
  • Nationwide Financial Services Inc.
  • Northwest Natural Gas Co.
  • Owens & Minor, Inc.
  • Robinson (C.H.) Worldwide, Inc.
  • Royal Bancshares of Pennsylvania, Inc
  • Security Bank Corp
  • Shenandoah Telecommunications Co.
  • Stepan Co.
  • Suffolk Bancorp
  • Tompkins Financial Corp
  • Total System Services, Inc.
  • Univest Corp. of Penn.(Souderton)
Dividend Achievers Candidates

The following companies qualify in terms of their history of 10+ consecutive years of dividend growth but did not meet volume/liquidity requirements of the MDA list:

  • American River Bankshares
  • Arrow Financial Corp.
  • Artesian Resources Corp.
  • Bank of Granite Corp.
  • BOE Financial Services of Virginia Inc
  • Bowl America Inc.
  • C & F Financial Corp.
  • Center Bancorp, Inc.
  • Central Virginia Bankshares, Inc.
  • Centrue Financial Corp (New)
  • Citizens & Northern Corp
  • CNB Financial Corp. (Clearfield, PA)
  • Codorus Valley Bancorp, Inc.
  • Comm Bancorp, Inc. (PA)
  • Connecticut Water Service, Inc.
  • Elmira Savings Bank (NY)
  • Farmer Bros. Co.
  • FFD Financial Corp
  • Fidelity Bancorp, Inc. (PA)
  • First Defiance Financial Corp.
  • First Federal Bancshares of Arkansas, Inc.
  • First National Lincoln Corp. (Damariscotta, ME)
  • First of Long Island Corp.
  • First South Bancorp Inc (VA)
  • First United Corporation (MD)
  • Firstbank Corp. (MI)
  • Florida Public Utilities Co.
  • Greater Community Bancorp.
  • Harleysville Savings Financial Corp
  • HF Financial Corp.
  • Jeffersonville Bancorp
  • LSB Financial Corp.
  • MASSBANK Corp.
  • MBT Financial Corp.
  • MFB Corp
  • Middlesex Water Co.
  • National Bankshares Inc. (VA)
  • National Security Group, Inc
  • NB & T Financial Group Inc
  • North Central Bancshares, Inc.
  • Northrim BanCorp Inc
  • Ohio Valley Banc Corp.
  • Penns Woods Bancorp, Inc. ( PA)
  • Peoples Financial Corp. (Biloxi, MS)
  • Princeton National Bancorp, Inc.
  • Quixote Corp.
  • River Valley Bancorp
  • Savannah Bancorp, Inc.
  • Smithtown Bancorp, Inc.
  • Summit Financial Group Inc
  • UMH Properties Inc
  • Union Bankshares, Inc. (Morrisville, VT)
  • United Bancorp, Inc. (Martins Ferry, OH)
  • United Security Bancshares (CA)
  • Weyco Group, Inc
  • WGNB Corp.
  • York Water Co
I think this last list of potential MDAs can provide you with some very attractive candidates for your long-term dividend portfolio. However, there is a pretty high risk in there too, but who knows, maybe some of these companies will grow big over time and will remain stable dividend growers?


In the next post discussing the latest Summer 2008 edition of Mergent’s Dividend Achievers, I will summarize some of the top lists of MDA's selected dividend performers.

Disclaimer: As of August 14 2008, I do not own any of the stocks directly discussed in this post. The information presented in this post does not constitute the investment advice. DYODD when making an investment/trading decision on any of these companies.

Friday, 25 July 2008

This correction is not the end of the world as some bears predict

Every time the economy goes into a correction, the loud voices of perma bears notify you about the upcoming end of the economic and financial worlds, the mother of all recessions, the new great depression that will make the one from 1933 look pale, etc etc. This time is not an exception. Although I can understand the rationale behind most of such predictions, I do not think that this time we will witness something extraordinary. Yes, eventually the whole fiat pyramid of debt and worthless paper will collapse, but we still have a cycle or two left before it happens.

What qualifies me to make such conclusions? Well, this is what I see at my work. I work in the consulting sector and can therefore observe and value certain categories of transactions, including acquisitions, reorganizations, financing, and refinancing. According to what I see, the economy and the financial sector are far from being dead or incapacitated. Quite contrary, the volume and scope of the above-mentioned transaction categories keeps increasing, so that my workload keeps going up too (that is one of the reasons I do not have much time for blogging). Who said it will be a quiet summer? Nonsence.

First, a correction in many sectors of the US and Canadian equity markets made some companies very attractive for other domestic and foreign companies and investors. What's particularly interesting is that BRIC companies are becoming quite active in these acquisition activities, especially in the natural-resources and commodities sectors, but also in some traditional manufacturing industries. If this trend continues, in a few years we will see some traditional American companies being owned by Brazilians, Chineze or Russians.

Second, many companies are currently very active in refinancing their existing loans or in borrowing new debt, partly to finance new acquisitions and partly in anticipation of the higher rates in the future due to pretty rational and fully justifiable inflationary expectations. Whenever the periodic mini lquidity crises caused by recurrent panic bursts ease in the financial markets, there is a new strong wave of financing transactions.

I do not think we could see all of this activity if the economy were really in the bad shape. It is true that some of the companies will be out of business before this bear cycle is over, but this is a normal filtration process. It is very likely that by the end of the next year we will see another bull market on the horizon. I think it is going to be the alternative energy boom (or bubble if you prefer calling it this way). We will see.

Wednesday, 18 June 2008

The ground for the next bubble is being slowly prepared

In the last post, I mentioned a read about Green Environmentalist Gore's through-the-roof hydro bills. To be honest, I do not think Gore cares a penny about the Mother Nature, the effects of so called global warming, greenhouse effects, etc. More likely, Gore is on a mission in one of those crooked big-scale schemes that at the end of the day screw a lot of people, businesses, and countries and that make tons of money or achieve other objectives for their originators.

The Kyoto Protocol, for example, is an important building block in the big long-term environment-related project, whose ultimate objectives are to: (1) limit and control the growth of fast-growing developing economies, including BRIC's; (2) create a potentially big market for pollution rights and related derivative instruments; and (3) prepare the grounds and info support for the next big bubble, which will happen to be the Alternative Energy Bubble.

The macro-size bubbles are not created overnight, it takes time and money to grow them. We all know what happened, is hapenning, or is about to happen to the junk-debt, high-tech, AIDS-research, housing, asset-backed-securities, credit-derivatives, and traditional-fuel bubbles. For every such bubble, there is a well-planned and generously funded informational campaign. I think that harismatic Gore is a pubic figure in one of such campaigns.

We all remember all this bullshit about the new-paradigm perpetual economic growth, the new-age service economies, the Y2K end of the world for computers, AIDS' and SARS' global threat to the humankind's survival, real estate being your investment friend forever, elimination of mortgage risks through pooling and repackaging, global oil shortage, etc. Well, prepare yourselves for the next big one. The big players in the traditional fuel chain are getting prepared for the qualitative shift to the "eco-friendly" energy, and the currently inflated fuel prices is one of the last calls to make big money in this process of transforming from Big Oil, Gas, and Coal to Big Hydrogen, Solar, Wind, and Whatever. They, and the related players in such industries as transportation and auto manufacturing, can finally pull out some of those techs that they have been shamelessly keeping away from the widespread general public use for years and make some serious money.

Here is the cooking recipe for the energy market: First, heat up the good old markets with military interventions, media coverage, active support by loyal jackals in the financial services industry, market manipulations, and a lot of bullshit stories. Second, squeeze the markets and economies with high prices and try extracting the consumer surplus to the last drop. Third, through this process and by orchestrating the instability in the asset and debt markets, destroy the equity value of real-sector and high-tech businesses and buy them cheap, to be used later in your new project named Alternative Energy. Fourth, gradually dispose of the old product and old tools (in this context, coal, oil, and probably natural gas and the related techs, equipment and pipelines) by shifting the residual old market focus to the developing second-tier countries. Fifth, unpack carefully hidden new techs and open the new feeder. Sixth, make tons of money on sales of the new product, related techs and equipment, service support, and (of course) related financial instruments.

It is not to say that the transition process will happen overnight. It will take years, but this next bubble will inevitably come to replace those that have already lost or are losing public credibility. The Ponzy Scheme fiat-money financial system cannot function without new progressively increasing bubbles. The Alternative Energy bubble will be larger than the previous ones. When this new mega bubble bursts a decade or so later, it may be really laud.

Gore's green policy hypocrisy?

It was a pretty amusing read about "frugal" hydro consumption by the big-time green policy advocate, former U.S. vice-president Al Gore. According to the article published by the Tennessee Centre for Policy Research and titled "Energy Guzzled by Al Gore’s Home in Past Year Could Power 232 U.S. Homes for a Month," last year Gore's home "burned through 213,210 kilowatt-hours (kWh) of electricity, enough to power 232 average American households for a month ... Since taking steps to make his home more environmentally-friendly last June, Gore devours an average of 17,768 kWh per month –1,638 kWh more energy per month than before the renovations – at a cost of $16,533. By comparison, the average American household consumes 11,040 kWh in an entire year, according to the Energy Information Administration."

I looked at our last-year hydro consumption numbers, and it turns out our household - resident in a GTA municipality - spent much less than the average US houseold, at the fairly modest level of 4,100 kWh per year, which also happens to be over 50 times below Gore's household hydro consumption. I understand that a big estate requires a lot more electricity than a modest 2,000 sq feeter, but come on - if you claim to be an active environmentalist and if you believe that saving energy will save our Nature, then just live up to your principles and do something meaningful on your own - like downsizing your dwelling or, if you have tons of money, installing solar panels wherever it is possible.

On the other hand, it is quite possible that Gore's hydro bill reflects some extra business-related costs or that the reported numbers were made up by somebody - you never know what kind of info they are feeding you through mass media these days.

Monday, 16 June 2008

You can check how rich you are

A while ago, a friend sent me a very interesting link, Global Rich List. On this website, you can check how you are ranked in terms of your income in comparison to the other six billion inhabitants of our blue planet. The idea behind this little tool is simple: it is based on the income distribution data from the World Bank Development Research Group (which is an approximate statistical estimate, of course), you just have to select your income currency, enter your annual income amount, and click on the calculation button. If your income is above $47,500 (I would guess it is a starting salary for many college graduates in Canada and the U.S.), you are a proud member of the top 1% group of the world's richest individuals. Who cares if there are other 30-60 million people ahead of you on this list? You are rich, my friend!

Many people are probably whining and complaning every single week that they do not have enough money, that most other people are richer than them, that they can't afford buying many things. After looking at your global income ranking - provided that you live in Canada or in the US, have a university degree and a source of stable income from employment or self-employment - such complaints should cease for good. Living in one of the world's wealthiest countries, you should always be aware that the vast majority of people around the world do not even have basic necessities like clean water, food, and heating - something that most of us in North America and Europe take for granted.

Other side comments: The formula of economic well-being quickly becomes too complicated once you introduce extra variables into the equation. First, even if you make a $100,000 every year yet have over a million dollar debt, your real wealth is probably not that good - the most important thing is not how much you earn, it is how much you spend and save relative to your income. Second, this ranking tool does not take into account how much you have to pay for different consumption items and what portion of your household income you pay in taxes. Third, one should also take into account public sector services and the variety and quality of goods and services that individuals get in different countries.

We pay over 50% of our income in taxes (if you sum up income, payroll, consumption, and property taxes) in Canada, and prices on certain items (like food and housing) in Canada are very high. Yet at the same time we have access to reasonably good healthcare, education, social services, public security, and infrastructure. Overall, we are probably not entirely ripped off by our government, although of course we want certain improvements in the provision of public services and want sound changes in the tax system.

Sunday, 8 June 2008

The irrational market story and market manipulations at play

I think that under the current market conditions pretty much only intra-day trading (without keeping positions overnight) can generate you some consistent money. The alternative to trading would be to stay in cash and wait. The seemingly illogical phase continues, with the markets being manupulated big time by the governments, government agencies and agents, and big institutional players. Once again, the Thurday and Friday market responses reflected in the price of oil showed that very little rational, fair-market behavior is present at this time.

Since when should the garbage words of the Israeli TRANSPORTATION minister about the "inevitable bombing of Iran" deserve any attention? Since when do we not know that the US dollar is going to be a garbage currency over the next several years? We know that this is the case, so why pretend one day that the US dollar has some strength left and will rally and on the other day dump it on the EU CB Head's minor comments? Why believe some bubble-head analysts who seriously tell you the fairy tale that global physical oil demand is currently above global physical oil supply? Why believe analyst prostitutes from the financial services industry who tell you that the oil should be priced at 150, 200, or 400 dollars while at the same time their companies and masters play the commodity and derivative markets to profit off crowd responses to such announcements? Why do the markets believe nonsense unemployment statistics from the US government? The non-farm payrolls did not fall by 49K in May 2008, in reality they most likely fell at least by 200,000-250,000 once you take into account the ridiculous side adjustments, like the birth-death stats loophole. Boy, what a mess in the markets, the US public sector, and the US financial sector.

What is the solution to this mess? First, the feeding of the shameless bankers with easy money should be stopped and rigid controls of the financial sector and of the derivative and commodity markets should be introduced. Second, the private bank named the US Fed should be kicked out and its functions transferred to the Treasury. Third, Paulson should be fired and probably put on trial, along with the other Fed, Treasury, and US administration executives for the economic crimes that they engineered and implemented. The icon Fed head named Greenspan deserves to sit on the front-row bench as a part of this group. Fourth, the US money printing press should be stopped (figuratively speaking of course since most money is created electronically nowadays). Fifth, the oil Texas boy should not be the US president, as the US and global oil interests should not be in control of the US administration. Until he is there and until the US administration shamelessly acts in the interests of the big oil players, oil prices will stay high and market and statistical manipulations will continue. This is a direct example of the moral hazard story at play here.

Thursday, 22 May 2008

The game of "bad" and "good" economic news continues

The jobless claims data released today and the reaction to this information from the markets and media once again clearly show that:

(1) Nobody can and should trust the US government stats anymore;
(2) The US administration are totally desperate in trying to save the US economy from falling apart, and every single bit of non-negative news is being used to do that;
(3) Hopefully the countdown has already began on when the U.S. statistical scam becomes a loud public scandal and when everybody around the globe can see that the king and his key allies are in fact naked;
(4) Enthusiastic morons in the financial mass media are helpless (do they really believe in what they are saying every single day?); and
(5) Crowds of speculators pretend they believe the fake stories being told by the government and are trying to play according to the unofficial rules of the big game called Investing & Trading.

Monday, 19 May 2008

Gas prices keep climbing, and Canadians continue paying for it

It seems that Canadians pretty much are got used to high gas prices by now. Americans have been scared by the gas prices steadily climbing towards $4 per gallon, with the country average having passed the $3.75 mark for the regular gas lately. Meanwhile, Canadians are already paying over $4.60 per gallon, in part thanks to Canada's federal and provincial governments which have been silently robbing people with the excessively high average combined tax rate on gas.

Facing taxes on final fuel prices, gas wholesalers and retailers in Canada shamelessly (and I have to admit, quite rationally from the economic point of view) shift the total burden of those taxes to Canadian consumers who, for some strange reason, are content with the situation and have been paying whatever price they see at gas stations. I mean they complain too, but do it unofficially at home and in private conversations, and I do not see any material outcomes of these complaints. I never heard anybody publicly debating and questioning federal and provincial beaurocrats why, say here in Ontario, the federal and provincial governments have been running huge surpluses for several years in a row now, yet they continue working in a close tandem with gas producers and distributors to deliver the outragenously high prices for gas to Canadian consumers.

Again, I understand the economics of such behavior, since sellers and tax authorities would love to charge the highest economically feasible price/tax for the good with the inelastic demand to extract the total economic surplus from the average consumer. But at the same time I think this is an example of a huge hypocricy where government officials express their seemingly genuine concern about consumers (yeah, right!), yet do the opposite things that hurt the latter. I do not even comment here about gas producers, refiners, wholesalers, and retailers since this gang is one big collusive ring that cares about nobody but their own profits (and the profits of their financial Masters). Add Western governments, which are also largely a part of the big spiderweb scheme, and you get the fuel and energy markets and prices acting as one of the important links in a now almost global chain that keeps the majorty of people in long-term economic slavery. This is another story though...

Back to gasoline pirces in Ontario and Canada: Look at the comparison of gas taxes in Canada across provinces, presented at Well, according to this info, the price that the average Canadian fellow is paying for regular gas in 2008 includes 35% in combined provincial and federal taxes, in comparison with 20% in taxes that the average American dude pays. For example, the residents of Ontario pay C$0.10 per litre in the Federal Excise Tax, $0.147 per litre in the Provincial fuel tax, plus a 5% GST (the federal sales tax). What's particularly outrageous is that GST is charged on the full gas price inclusive of the excise and fuel taxes. It is a tax on a tax which effectively increases the 5% GST rate by almost 1.5 percentage points to 6+%. Nice, isn't it?

The federal excise tax on fuel has increased from 1.5 to 10 cents per litre over the last 20 years. The latest such increase from 8.5 to 10 cents per litre came more than ten years ago as a temporary deficit reduction measure, which Ottawa's fricken government amnesiacs conveniently forgot to remove despite the fact that they have been swimming in surplus money for several latest years in a row.

The proponents of such taxes argue that fuel tax revenue is spent on public infrastructure, public transit, environment, and all other public programs that one can link to the use of fuel and cars, related pollution, etc. I understand it and see some truth in this argument in principle, but do not get me even started here about how these revenue funds are spent in reality. As an economist who used to deal with Canadian government stats, I know that this revenue money was not and is not spent properly and fully on what it has been originally claimed to be allocated to.

You can say that gas taxes are even higher in Japan, UK, EU, and other countries. I do not care. I live in Canada, which is one of the world's not so numerous oil producers and exporters, largely thanks to Alberta's Oil Sands. And there are economic means and controls in an oil-producing country to make sure that provincial economies and Canadian consumers remain competitive and protected from the negative consequences of the spreading international economic crisis and a fuel price bubble. So far, I can only see empty rhetorical words from politicians who keep pumping gas-based tax revenues from Canadian firms and individuals.

The gas price was $1.248 per litre today. You can check the latest gas price trends at this page. The gas prices in Canada closely move with the price of oil. Because energy markets are quickly becoming a new bubble toy for speculators of all shapes, colours, and sizes, it looks like we are likely to see gas prices going further north for a while (despite an occasional correction here and there). And it looks like Canada's central and provincial governments will (unfortunately) be there too to enjoy increasing revenue proceeds from growing fuel prices.

Canadians are still spending...

I was shopping with my wife today at Yorkdale Mall in Toronto and, oh boy, I must tell you that Canadians are still very much into shopping, despite all economic worries and troubles with the big southern neighbor. It could be the fact that it was rainy today and there were not too many other things to do for many people, or maybe because it was the middle of the long weekend, but the big mall was literally packed with people. By the time we were were leaving around 5 pm, people were waiting in cars to get the most remote parking spots.

Also, on Saturday, I was doing grocery shopping at at one of Loblaw's Real Canadian Superstores, and it was packed too, with people buying a lot of stuff. Expensive food? No problem! Expensive gas? Who cares! The roads were packed with cars yesterday and today.

It looks like the recessionary mood has not really hit Ontario that much, at least not the GTA area. People are still driving a lot despite the outrageously inflated gas prices, and people are still shopping despite the proponents of a recession shouting every day about the gloomy econoic future from media's screens and pages.

Wednesday, 14 May 2008

Big investment powerhouses are increasing their exposure in energy commodities trading

It was an interesting news read from Reuters today about the intention of JPMorgan to increase its involvement in trading of enery commodities. The article titled "JPMorgan to start physical oil trade, eyes $200 oil" states that JPMorgan just announced that it will substantially expand its trading of energy commodities and energy derivatives:

JPMorgan will join a growing list of investment banks from Goldman Sachs to Barclays Capital seeking to boost profits on their big derivatives trading desks by gaining a foothold in physical markets.

The third-largest U.S. bank added 50 people to its commodities and energy trading and investment team last year and is on track to hire a similar number this year, taking the strength of the total team globally to 450, Masters said.

Earlier this month, it hired former Goldman Sachs banker Oral Dawe as managing director and CEO of its Asia Pacific commodities group, in addition to hiring more than a dozen traders in Asia recently to oversee its expansion in energy and metals.

And with oil prices surging more than 30 percent this year to a record near $127 this week, Masters said the bank would look at more ways to boost its presence in energy markets.

"Oil rising to $200? It could happen. This year? You could see it, although it would take a further shock to expectations," she said.

It is clear that JPMorgan is not the only investment bank which is currently looking for new innovative ways to make easy big bucks out of nowhere, after the old schemes with asset-backed securities and swaps recently stopped or nearly stopped working. For sure, there are other banks, which are currently salivating by looking at the big money flowing through the energy commodity markets. Since these creative crooks do not own physical energy commodities at source, they will try to find new ways to get the title on them through paper trading, which will almost surely involve complex energy derivatives.

What does it mean for prices of oil, natural gas, coal, and energy products? They are very likely to keep growing, boosted by speculative trading performed by big time market manipulators and insiders like JPMorgan. The recent $200+ oil announcement by Goldman Sacks was just one of the first stones thrown into the genral public pool to prepare them for the life amid skyrocketing energy prices ahead.

What does it mean for normal people? We will see multiplied volumes of speculative demand from big market players, which have received access to cheap liquidity thanks to the U.S. Fed and other Western central bankers joining the move. The new worthless money created in trillions of dollars will chase real material sources of value, which is largely represented by various commodities, including energy resources and energy products. Higher costs of energy commodities arising from increased speculation will surely result in very high general inflation rates and growing costs of food, transportation, housing and everything else. It can have pretty hard abverse effects on most people.

What are going to be the consequences for economies around the world? Not good, as prohibitively high costs of energy and fuel will effectively halt production activities of many companies and energy-intensive economic sectors. Even oil and gas producing nations will suffer through double- and maybe even triple-digit inflation rates.

The bottomline: The energy markets will soon see quickly growing levels of speculative activity, with everybody joining the party and with new derivative products being introduced to return-greedy investors. We all know how the story of mortgage-backed derivatives ended (well, not ended just yet, to be precise). In the case of energy derivatives, it will not be any different. We will see energy prices taken far away from their true fundamentals. The resulting chain reaction can surely hurt many people, organizations, and states.

Do the bankers care about possible dire consequences of their involvement in yet another market which they can screw up? I doubt it. They should have been punished hard for the subprime crisis and credit derivatives. Sicne they weren't, they will be fast in creating another bubble for their masters, and the main private bank, the Federal Reserve, will asist them in doing so by lending easy electronic and paper money in return for now wortheless securities left over on the banks's book from the preivious bubble.

Sunday, 11 May 2008

The oily bubble is getting blown

It is really disappointing to observe lately what is going on in the markets, especially commodity markets and energy commodities in particular. Over the last three-four weeks, the amounts of lies and fake news that are being released by the Talking Heads have exceeded all reasonable logical and illogical limits. I started collecting those stories, and I am sure we will hear a plenty more over the next several weeks or months of the crazy oil and gas rally.

Let's look at what is being fed to the speculator-infested commodity markets lately:

First, there are some mythical crazy rebel maniacs in Nigeria and other African countries who persistently (and conveniently when there is nothing else to feed the news-lines) blow up pipelines of Western oil companies in Africa. Show me just one hole in the pipeline. Show me just one rebel, alive or dead. Let me hear him talking about why he hates the pipelines so much, who provides him with the explosives and tells him where and when to blow the bloody thing. Please enlighten me how one pathetic pipeline in the middle of the African nowhere can disrupt the world's total supply of oil. Since when Africa became the key oil-producing region? I thought the oil comes mostly from the Middle East, Russia, and South America. Well, apparently the analysts know better.

Second, we were recently told (again) that Ugo "Evil" Chavez apparenty can't stop thinking about cutting off the U.S. from the Venezualean oil. They are trying hard to convince us that somebody somewhere uncovered a 100+ computer files that prove that this such and such $%## has "closer-than-expected" ties with the Colombian rebels. Of course, the biggest world democrasy can't just stay away from this matter, and the bad guy Ugo needs to get a good public spanking by Uncle Sam. And of course, the brilliant analytical minds on Wall Street use a sophisticated deduction method to create a smart link between a computer file and the price of oil. Ethemeral files in an ethemeral notebook of an ethemeral rebel killed in green jungle contain Ugo's name and clearly demonstrate that he is into something bad and has those bad close ties with those bad bad guys. Wow, a rebel with a notebook writing about Ugo in the middle of the jungle hell! Skip several steps in the sophisticated cause-and-effect chain and here we go - the oil should be more expensive because this bastard in Venezuela will stop sending oil to the U.S. very very soon.

Third, those bloody unions in the U.K. are disrupting the whole oil sector in the U.K. and the EU. We can do absolutely nothing about it in this situation because we are big-time democracies and we should respect the rights of our precious workers to go on strike when they think it is necessary. However, the questions arise in this regard: Are the workers severely underpaid in this sector? Who tells them to go on strike? When do they tell them to go on strike and why? Was there really a strike after all? Would it have had any material impact at all if it actually had happened?

Fourth, there are constant reminders that there is a strong and growing demand for oil and gas in India and China, which stays robust ans is expected to continue its upward trend even in the middle of the current economic turmoil. This news makes me want to go to China and India and live there happily thereafter amid the never ending economic boom and bounty. But wait, I thought that China's well-being largely depends on its exports to North America and Europe. The latest cooldown in consumer demand in these regions can't help boosting China's ability to produce and sell their "Made in China" goods. Many of India's rapidly developing industrial and serivce sectors were doing great up until recently thanks to a strong trend in outsourcing among Western companies. If there is nothing to sell in North America and Europe due to the weak local demand, then it is not going to be much to outsource either. The exponentially growing internal consumption in India and China? Maybe, but look at their inflation rates and look at their still huge income disparities. Most people there will be struggling to get by in the coming years, facing food shortages and high food prices. Then why would you need a lot of oil there? To grow rice? To ride bicycles? When Western countries are getting one economic punch after another, China, India, and other quickly growing developing countries can't just continue flourishing as if nothing happened - they will go down too because their economies are too much dependent on the Western demand for their products and the Western investment. I am not buying this story.

Fifth, every week we hear that oil and oil product inventories in the U.S. keep shrinking although in reality they exhibit the opposite behavior lately - they keep growing. Well, then we are told that, if not this time, then next week they will shrink for sure. Besides, the US economy will start its strong ecnomic recovery any day now, and then oil will be in such a huge demand and we are unfortunately unprepared for this very realistic scenario with our meager oil inventories. By the way, who can confirm that oil and gas invenories are at the levels they are reported at? George Bush? Smart Ben? Uncle Sam? Who counted every single barrel or litre or cubic meter of these intentories and can prove that they are indeed there and not on paper only? (hey, who can prove that the U.S. gold is still at Fort Knox? :-))

Sixth, every month there are never ending recurring speculations that OPEC countries will cut off their production to keep oil prices high. Well, Uncle Sam, you (in very abstract theory) are controlling Iraq's pipelines now, you have been keeping Saudis, OAE, and Kuwait on a political, military, and economic leash, why don't you still control OPEC's oil supply? I know, it is all Iran's fault. Go get them, tigers.

Seventh, for some mysterious reason, amid the apparently booming world economy and extremely strong demand for oil, poor refineries are just getting by on the brink of bankruptcy and therefore have to cut their production for several weeks in a row now. Why is that? How do they face operating losses when the price of oil skyrockets and the difference between the cost of oil extraction and the final price is widening like nothing else? Nobody cares about poor little refineries, and bad big oil-company boys are taking all the profit money? Who in fact controls the refinery business? Are they affiliated with oil companies? Why do they conveniently have multiple maintenance closures when the price of oil wants to slow down or go down? Why are deadly fires and accidents taking place in some of them when the timing is right? Hmmm.

Eighth reason is my favorite, heard forn CNBC several weeks ago when I was in NYC (hotel stays are the only time I watch TV). Apparently Saudis and other major oil producing countries are deeply concerned about a quickly approaching shrinkage of their oil reserves. The good ol' oil fields are being depleted like there is no tomorrow, and there are no new big deposits in sight. Besides, apparently, oil extraction is getting more and more difficult and more and more expensive, so the opearing costs of oil producers skyrocket. Please give me a break. I know what's been skyrocketing lately: bonuses of oil executives, profits of oil companies, the size and luxury of their headquarter offices, numerouos management perks, etc. Not a long time ago, the operating costs of extracting oil in the Middle East were around $1-3 per barrel. OK, double it now to account for inflation and still double or triple more for higher transportation costs. $40, maximum $50 per barrel is the upper limit of the economically justified price of oil. I just do not believe any of the economics behind the $125 oil. The inflation and worthless dollar stories are not doing the satisfactory explanatory job here.

Ninth, there are assholes like whose Goldman Sachs and other Big Firm analyst slaves and their masters who throw in masterfully timed and engineered statements about a $200+ oil. These are the so called energy experts whose opinion for some strange illogical reason is still valued by the markets and who are using their access to mass media to justify the incredible stories of why oil should be priced 100% more than it is today and 400% more than it was just several years ago.

Tenth, you insert your own story...

Although I was being a bit sacrastic in the overview of some of the "expensive oil" reasons, the subject is not funny at all. It is not a secret that energy commodities lately are turning into another bubble area where the speculator money inflows are very substantial and are accelerating fast. We are not talking about physical commodities here any more. These are not the same commodity futures that originally served a very useful purpose of hedging and a guarantee of future delivery at specified prices. Now, it is just another intrinsically worthless paper that is used solely for speculation. I will not be surprised if the volumes of outstanding commodity derivatives, which de jure imply the presence of physical delivery of a physical commodity, in fact exceed (multiple times) the total volume of all discovered and undiscovered oil and natural gas reserves of this planet. Look at who is trading oil now! Funds, governments, government entities, banks, companies which are completely unrelated to the energy sector, individuals... Hey, even I am there, getting my valuable experience on how commodity markets operate and how people are getting screwed there big time for big bucks.

I think that some strong regulatory action needs to be introduced into these markets. Honestly, if I were in charge, I would impose a mandatory physical delivery of energy commodities. Do you need 1,000 barrels of crude oil deliverd to your little backyard or your fancy office in a month? No? Then get out from here, silly, and let only those who need price hedging and actual product delivery be involved in these markets. I guarantee that the prices of energy inputs and products will drop drastically if the real-delivery component is introduced into the system. The oil will cost what it is supposed to cost - $30-40 - not more. Will it happen in reality? Maybe sometime in the future. Definitely not now. We have too much worthless paper money chasing only a small quantity of physical inputs and products, but huge volumes of paper which is supposed to represent current and future products, goods and services. Occasionally, these paper instruments lose credibility from the public, and the masters and their slaves design new toys and inflate a new bubble to keep the gazillions of worthless dollars and other fiat currencies circling the little blue planet and generating real wealth for just of few of players.

Meanwhile, let's continue watching the show called "who is going to be the greater fool in this pricing game."

Responding to a question on Questrade

I received the following message from Ranv about the Questrade RRSP account:

I read your blog posting review of Questrade at:

I'm currently looking to open an RRSP account with a discount brokerage. I've never opened an account with a brokerage before so this will be my first time. I will likely make less than 20 trades per year so Questrade appears to be a good choice because they have low commissions and don't have an annual fee on low trading or low account balances.

Despite the fees though, I'm curious about their service. You wrote your review of Questrade in December of 2007. How do you feel about them now? If you're not happy with them anymore, can you suggest any other discount brokers that you are satisfied with?

Response to Ranv:

I did not have any issues with them so far, except for this delay with a $50 referral credit that I mentioned earlier. They eventually paid it several weeks later, after I bugged a customer service rep a couple of times, so the issue has been cleared now.

Overall, I think this is a very good discount brokerage, which should appeal mostly to small-scale investors/traders and those investors/traders who do not have a lot of regular account activity. It is true that they not offer the same scope of sophisticated services and investor customer support that are provided by big banks and full-scale brokerages, but they are not competing with the big guys in this market niche anyway.

My other comments so far, based on a six-month experience of having an RRSP account with Questrade:
  • The trading platform was never down when I was logged in during market and off-market hours and worked OK (I use only a base WebTrader);

  • The trades were executed very quickly - market order were processed instantaneously within a second, limit and stop orders worked well too;

  • You can easily track your account-related trading and fund-movement activity online;

  • The chat customer service was fast to get a response;

  • Getting a service rep on the phone was also not a big issue - the wait times were reasonable;

  • They never responded to email inquiries - that is a minus - if you do not respond, then why would you offer the email-message form on your website?

  • The paperwork support (statements, confirmations, income tax receipts, etc.) has been timely - no complaints there;

  • Email notifications about new services and changes in services were sent promptly;

  • All financial statements and other company-related paperwork were properly forwarded to my home address.

Like you, I do not trade very often - no more than 3-8 trades a month, and I think that this account is probably the first-best choice for small investor/trader guys like us. Definitely, nobody can beat Questrade in Canada in terms of fees and some services (like USD balances on an RRSP account). On the downside, you get a plain base package with limited interface capabilities, but you can always get extra services (like real-time live quotes, more advanced platforms with advance charting, etc.) for very reasonable extra fees - you will probably end up paying much more for equivalent services to their competition.

Unfortunately, I cannot comment about the services of other Canadian brokerages. Based on info comparison though, the account and trading fee structure is definitely the best at Questrade.

A bottom line: Six month later, I can still say that I would open an account with Questrade. In fact, next year I am very likely to open a tax-free savings account (TFSA) with them, once the new program starts operating in 2009.

Tuesday, 8 April 2008

Dumb money inflows, artificial rally, volatility, and more...

The markets over the last two weeks have been quite interesting to observe. In part thanks to the new credit facilities from the Fed, the banks bought more time to settle their issues. And, oh boy, there are still plenty of them. It will take quite a bit of time, maybe even a year or two, to clean up the risky mess associated with asset-backed securities and derivatives.

I do not really buy into recent bursts of optimistic chatting from government officials, analysts, and some traders that the worst is finally behind us and we all should move back into the market and load on fantastically cheap stock deals. It is not behind us, it is just a (relatively weak) bear market rally, which is largely being artificially engineered by big institutional players, with the full support and involvement of the Fed and drafted foreign monetary authorities.

This cheap money from the Fed is in part being used here to create the visibility of a super-pooper market rebound. The funds, banks, the Fed, and the government behind them are all in play trying to paint the rosy picture and convince the public that all is back to normal and we are all back to our direct flight to prosperity. That’s not quite true. I just do not see the fundamental reasons behind the recent rally attempts. The banks secured financing? 3+% gains in a single day? So what? The move looked so artificial, and the intervention was so obvious. "Putting lipstick on a pig" is the right expression to describe what is going on right now in the marketplace.

On a more personal note, I have been working on my short-term trading strategy lately, mostly on paper. By the end of the year, I should more or less have my trading system in place, with key components tested and settled. Meanwhile, I am quite tolerant to my current performance results. My small balance is up 4% since November 2007, which is not much but is still much better than the negative market performance over this period. Several losses (all unrealized, except one) in my portfolio were associated with: (1) any long-term holdings that I originally decided to buy when I opened the account; and (2) two stupid losses (one realized and one not), for which I am fully accepting my personal responsibility and which happened as a consequence of me deviating from my method and relevant criteria. I think that the discipline and the method are the two most important things for any trader. If you do not have both, you will lose in the long-term.

By the way, Questrade finally paid the overdue $50 referral credit. I actually complained about the delay with this payment in one of my recent posts. Well, with a 1.5 month delay and several calls to their customer service, they finally fulfilled their marketing promise. The issue’s been settled and closed now.

On the negative (and unrelated) side, I was unpleasantly surprised to learn that stop loss orders do not work on Canadian securities traded on TSX. How come? Is it just a Questrade thing or it is the exchange-related rule? That’s not very good. I am quite reluctant to trade U.S. stocks now because of the large volatility in the recent exchange rate movements. Giving up several percent of profit only due to a large change in the exchange rate (plus a big FX margin collected by Questrade) is really not an optimal idea given small sizes of my trades. Anyway, we have to use what we have, but not having stop loss orders in place on Canadian stock positions is not pleasant.

We can expect a very entertaining market activity over the next several weeks. The Fed and the Co (including all the banks, investment services firms, and funds) will try hard this week to break the 1,395 mark on S&P500, 12,800 on Dow Jones, and 2,400 on Nasdaq Composite. They are desperately trying to show that the momentum has been reversed and the worst part is over for the stock markets. Alas, the markets' history and the wisdom of top market players suggest that the current situation is merely an intermission before the second leg of the Bear market action. It is way too early to start shopping for bargains because there really ain’t any yet. This does not mean that there are no short-term trading opportunities. In fact, there are plenty, but very high levels of volatility should be taken into account when executing short-term plays.

Let's see what the new earnings season will have in stock for us. Many large Canadian and US banks will use Visa IPO proceeds to cover up the ugly losses and writedowns that they will have to report either now or at the end of the next quarter (or more likely, during both reporting periods). The other U.S. firms will ride on weakness of the U.S. dollar and their relatively strong international sales.

I think we will also see a lot of cases when a firm reports poor results, yet "miraculously" beats pessimistic analysts' estimates, and enjoy a boost in its stock price. The analysts, most of whom by the way happen to be employed by the Wall and Bay Streets, must be already very busy in drafting such plays: bad estimates - better than expected results - everyone is enthusiastic and happy, completely forgetting that a market-beating firm is still a piece of poorly performing and too risky garbage. The top executives will get their bonuses, the analysts and their bosses will get them too. And we will move on to the next stage of big lies.

Sunday, 6 April 2008

A brief look at U.S. Fed's new credit facility programs

It appears that the U.S. Federal Reserve, together with top heads from the financial services industry, are working overtime lately to come up with the new creative ways to save the butts of U.S. and global banks. Up until recently, what did we remember from our college economics courses about the Fed’s monetary-policy tools? Each good student knew that there were three key tools that the Fed used to conduct its monetary policy: open market operations based on repo transactions with Treasury securities, the discount window for overnight bank borrowing, and the more fundamental reserve requirement.

Well, we now have several brand-new additions to this family. The picture has changed dramatically over the last several months, as the Fed was desperately trying to prevent the U.S. financial system from the biggest and most deadly collapse in the U.S. history. From now on, students will have to memorize and understand three (!) new policy terms which can be conveniently labeled under one common title: Fed’s lending facilities.

This post provides a short description of each of the three new facility types, which include: (1) the Term Auction Facility (TAF); (2) the Term Securities Lending Facility (TSLF); and (3) the Primary Dealer Credit Facility (PDCF). Let’s go over each one of them in a bit more detail.

1. Term Auction Facility (TAF)

Since December 17, 2008, the Term Auction Facility program offers short-term fixed-amount funding to U.S. depository institutions via regularly scheduled bi-weekly auctions. All depository institutions that are eligible to borrow under the primary credit program are eligible to participate in TAF auctions as well. Although first introduced with the intention of being used as a temporary policy tool, TAF auctions now feel like a regular affair which will be used continuously for quite a while.

Each TAF auction is a closed-bid auction for fixed loan amounts which are a part of a total lending facility with a pre-set credit limit, with a fixed rate determined by the auction process (subject to a minimum bid rate). The stop-out rate at the March 25, 2008 auction was 2.615%, which in my opinion is a very good deal for those banks that are unable to secure affordable financing amid increasingly troubling developments in the U.S. financial sector. The regular term of TAF loans is set at 28 days. The collateral requirements on TAF loans are similar to collateral requirements on discount-window borrowing, which include (if I am correct) Treasury securities and AAA-rated government agency debt. Originally, the total monthly facility size was set at U.S. $30+30 billion = $60 billion. However, during the last month, the Fed has increased the originally planned monthly size of its TAF auctions from $60 billion to $100 billion. My feeling is that this increase is not the last one.

My resume on TAF: This facility is basically a crippled and limited centralized, government-backed alternative to the severely damaged market of financial commercial paper, which was closely associated with rollover financing of longer-term asset-backed security instruments. The banks would probably like to get a lot more than a fairly modest $100 billion, which looks rather pale in comparison with the outstanding cumulative risk exposure in the finanical services sector. They will definitely need much more to cover up the gaps in financing and to meet their payment obligations on the asset-backed and derivative junk. There are currently only a few volunteers to lend money to the banks in the open marketplace, given the amounts of so called asset-backed toxic junk on their balance sheets and even bigger amounts of off-balance-sheet derivatives that many of them created and traded. To make the matters worse, banks themselves are not willing to lend money to each other, even though traditionally the interbank lending markets were one of the most important sources of short-term financing for the largest banks.

The current size of TAF lending alone is definitely not enough to control the situation, therefore the Fed came up with a couple of other fresh ideas by starting lending Treasuries and cash to the selected largest banks via the Term Securities Lending Facility and the Primary Dealers Credit Facility.

2. Term Securities Lending Facility (TSLF)

The TSLF became the second new tool created by the U.S. Fed over the last four months. The new facility was introduced by the Fed on March 11, 2008. According to information posted on the Fed’s website, “the TSLF is a 28-day facility that will offer Treasury general collateral (“GC”) to the Federal Reserve Bank of New York’s (“FRBNY”) primary dealers in exchange for other program-eligible collateral. It is intended to promote liquidity in the financing markets for Treasury and other collateral and thus to foster the functioning of financial markets more generally.”

Aside: The primary dealers are the 20 large banks and securities firms that trade directly with the Fed. The current list of primary dealers can be checked here. The familiar faces in this group of potential insolvency and litigation candidates include J.P. Morgan, Bear Stearns, Lehman, Goldman, Merrill, Countrywide, UBS, HSBC, and Citigroup. See my earlier post on banking derivatives and you will understand why I am so sceptical about the long-term fate of these guys.

The size of the first TSLF auction conducted on March 27, 2008 was $75 billion, but the Fed indicated that the facility monthly limit can be expanded further up to $200+ billion. According to the Fed, in addition to regular collateral eligible for open market repo agreement transactions, the eligible collateral for TSLF lending includes “AAA/Aaa-rated private-label residential mortgage-based securities (MBS) and commercial MBS, as well as agency collateralized mortgage obligations (CMO) that are not on review for downgrade.”

Further, "the TSLF is a single-price auction, where accepted dealer bids will be awarded at the same fee rate, which shall be the lowest fee rate at which any bid was accepted. Dealers may submit two bids for the basket of eligible general Treasury collateral at each auction...At the TSLF auction, each dealer aggregate award is limited to no more than 20 percent of the offering amount."

The important difference between the TSLF and the TAF is that the TSLF is a bond-for-bond lending tool, as opposed to the cash-for-bond TAF financing, and it does not have an explicit impact on reserve levels in the banking system. Also, the auctions for TSLF borrowing are weekly and thus can be used more regularly and easily by the primary dealers than bi-weekly TAF auctions for banks. However, the collateral part is basically the key innovation component of TSLF lending. Essentially, what we have here is an opportunity for largest banks and securities firms to exchange the "top-rated" asset-based securities on their balance sheets for the less risky and more liquid Treasuries, which can be used as collateral in the “regular” market to secure cash financing by the big banks. In other words, by lending Treasuries to the major dealer banks, the Fed indirectly gives them a relatively low-cost opportunity to raise extra financing.

3. Primary Dealer Credit Facility (PDCF)

On March 16, 2008, the Fed announced introduction of the third new tool, the Primary Dealer Credit Facility, which is a modified and relaxed version of the old discount window borrowing, this time designed for primary dealers. On March 17, 2008, the Federal Reserve started lending through the PDCF, which allows the primary dealers to borrow at the Fed's discount window using several forms of collateral, including mortgage-backed securities.

Basically, a PDCF loan is an overnight repurchase agreement, or "repo," where a primary dealer sells its (potentially risky) security to the Fed and agrees to buy it back at a later date (generally the next day) at a higher price that includes interest. According to the Fed’s description, “the rate paid on the loan will be the same as the primary credit rate at the Federal Reserve Bank of New York,” which is “currently 25 basis points above the target federal funds rate.” “In addition, primary dealers will be subject to a frequency-based fee after they exceed 30 days of use within the first 120 business days of the program. The frequency-based fee will be based on an escalating scale and communicated to the primary dealers in advance.”

Now again comes the interesting part: “Eligible collateral will include all collateral eligible for tri-party repurchase agreements arranged by the Federal Reserve Open Market Trading Desk, as well as all investment-grade corporate securities, municipal securities, mortgage-backed securities, and asset-backed securities for which a price is available.” Wow. It means that basically whenever debt is priced (i.e., the already infamous "marked-to-model" pricing can be applied here) and is conveniently investment-grade-rated (by the way, rated by the agencies, which are not really independent from the banks), it can be used as collateral by a primary dealer to borrow money from the Fed. Here we are not even talking about AAA/Aaa-rated debt - the definition of allowed collateral extends to include all debt rated as low as BBB/Baa. Given the quality of credit ratings that the leading credit agencies have provided so far, I am very skeptical about the quality of debt that will be included as collateral under the PDCF program. Aside: I use credit-rating software programs regularly at work and can honestly say that the existing valuation approaches used by Moody’s and Standard & Poor’s are very weak and do not properly capture certain risks.

The PDCF lending program provides overnight loans with daily settlement, which can be re-borrowed (rolled over) each day up to a period of six months and which can be extended even further as the Fed’s vague terms indicate: “…longer if conditions warrant” – whatever it is supposed to mean. It is different from regular discount-window borrowing in several aspects. First, it is available to primary market dealers, not depositary institutions. Second, it has a longer term of funding, which is 120+ days versus only 90 days under regular discount-window borrowing. Third, the range of collateral permissible under PDCF lending is much broader and includes all kinds of investment-grade-rated government and private debt.

4. Summary

Summarizing the differences among the three facilities:

  1. TAF: Open to depository institutions, cash is borrowed, the total monthly facility limit is $100 billion, fixed lending amounts, fixed interest is determined via bi-weekly closed-bid auctions, lending term of 28 days, collateral is similar to collateral for discount window borrowing and presently includes Treasuries and AAA-rated government agency debt. (The collateral requirement will probably be further relaxed by the Fed??)

  2. TSLF: Open to primary dealers only, U.S. treasuries are borrowed, the total monthly facility limit is $200 billion, fixed lending amounts, interest is determined via weekly auctions, lending term of 28 days, collateral includes AAA/Aaa-rated government-agency and private debt including mortgage-based securities.

  3. PDCF: Open to primary dealers only, cash is borrowed, the total monthly facility limit is ???, flexible lending amounts, the borrowing rate is given by the current discount rate, term is overnight with a rollover option of up to 120 days, collateral includes investment-grade-rated (AAA/Aaa-BBB/Baa) government-agency and private debt including mortgage-based securities.

What can be said at the end about these Fed's innovations? I have several things to comment on:

First, I have a feeling that we will see the other similar creatures of the Fed during the upcoming months, as it tries to provide troubled banks and securities firms with crucially needed financing. Alternatively, the presently set credit limits on the existing facilities will be extended further because the current terms and conditions on the Fed's facility programs are open to such future upward revisions.

Second, I do not really believe in the short-term nature of these facility programs. Overnight or 28 days or six months, whatever - these loans will be rolled over multiple times until the bankers are able to fix their issues. The Fed will let them do it because it will take time (up to several years) to completely remove or restucture the unperforming instruments from the banks' books.

Third, I do not think that submitting auction bids over the phone to local Fed Reserve Banks is the most effective and transparent form of bidding for funds. Well, if we assume that the true intention is NOT to get the highest price for borrowed funds, then it is understandable, but otherwise this phone-hotline bidding procedure is very prone to manipulations and inefficient pricing.

Fourth, I think these programs represent the unprecedented misuse and abuse of the U.S. monetary system. Thanks to the Fed's facility arrangements, the social parasites from the financial services sector can now more easily borrow public funds to cover up and patch the consequences of their numerous misdeeds. To make the matters worse, the Fed does not provide a complete and prompt disclosure under any of the three facility programs on what banks borrow what amounts, on what specific terms, and in return for what collateral. Such a lack of transparency is clearly disturbing.

Fifth, the easy money that the banks will receive from the facility loans will flood the U.S. economy almost immediately and will create inflation, nothing more. Most of this money will not be able to find productive projects that generate real economic growth because such productive opportunities either do not exist in the present conditions or because the bankers will waste them as they are wasting billions of dollars each year on ephemeral create-a-bubble-and-grab-a-quick-profit-before-it-is-too-late schemes. What is the solution to the present situation that the Fed and the bankers are likely to pursue from now on? More likely, making another bubble, even bigger than those we have seen before. Do not be surprised if you see a new story filling up the headlines starting in 2008 and 2009 - say, the Alternative Energies Dream. Just be cautious and remember that it will only last a few years before we have an even worse lending.

Sixth, I believe that the introduction of these facilities is yet another significant step towards trashing the U.S. monetary system and the value of the U.S. dollar. The U.S. currency has not been backed up by gold or anything of real value since 1972 when the international Gold Standard system was killed. The only things that kept the U.S. dollar afloat were: reputation of the U.S. government and its debt, the crucial functional role as the world’s reserve and international settlements currency, and the size and global importance of the U.S. economy. None of these factors are strong (I would even say “present”) any more. Up until now, the U.S. Federal Reserve was backing up the value of the U.S. dollar with U.S. government debt, which has been ballooning in size at the geometrical growth rate yet was still considered as one of the safest top-rated debt securities around the globe. With the new lending practices, the Fed will stain its balance sheet with intrinsically junky asset-backed government agency and private debt instruments, which in my honest opinion do not have much real value in comparison with their original “market-based” valuations.

Since we have trillions of such securities issued and outstanding, it is clear where we are going in the case the Fed will have to step in and buy most of this junk. Newly minted paper notes named US dollars will not be worth much if the panic in the U.S. banking sector spreads and detonates the credit derivatives markets, which has grown to humongous proportions lately and will have a devastating effect on all other sectors of the economy on the case of the negative chain reaction. Even if the crisis is avoided this time and the financial system does not collapse, the consequences of having intrinsically worthless private instruments on the financial statements of the monetary-authority institution placed in charge of monetary policy of a large sovereign country will not be positive for the U.S. dollar and the U.S. economy in the longer term.

Saturday, 29 March 2008

Tips on searching for a vacation package

As I recently spent several long hours trying to find a good deal for a family vacation at an all-inclusive beach resort somewhere in the Caribbean, I thought I’d share some tips related to this process. These tips primarily apply to Canadians, but generally should work for Americans too. In the discussion below, I will limit my focus on search for vacation packages to resort areas.

  1. The first step in the process is to decide where you would like to go. It is your personal and budget-based choice in picking a region, country, resort area, and a resort. You should ask around your friends, relatives, and co-workers to share their recent experiences and general impressions about places they recently visited. Another good starting point for your research would be to read a couple of travel sections in weekend issues of local newspapers and a few of travel magazines. Of course, the best and most complete source of diversified information remains World Wide Web.

  2. Once you identified a country where you want to go, you should move to the second step of your search process: hotel/resort selection. I would strongly recommend using the Trip Advisor website at, which is an excellent source of thousands of up-to-date user reviews. For most popular resorts, they have 1-3 daily reviews posted by people from all over the world, but mainly from Canada, US, and Europe. A lot of Canadians post their reviews on this site, so you should probably pay closer attention to these reviews if are traveling from Canada, as they typically share many useful travel tips for Canadians. On the TripAdvisor website, you should type your selected country, say “Dominican republic”, in the search window and click on the “all hotels in (a country of your choice)” in the search results section.

  3. The list of hotels will start from top rated hotels in each of the several vacation destinations within the selected country. Picking up the resort area is your next task if you have not made the relevant decision at the first step. Each location typically has a combination of pros and cons that you can take into account. For example, most resorts in Puerto Plata in the Dominican Republic are relatively old, the beaches are not the top quality and often have big waves, but the prices are not very high and the service level is fairly high. Punta Cana resorts, on the other hand, are typically newer and larger, offer more facilities, the beaches are nicer than at Puerto Plata, but the prices are higher. La Romana hotels are cheaper, beaches are good, but the hotels are on the lower-quality end and most of the staff there do not speak English. Of course, this is my subjective "averaged" opinion based on what I heard and read. Once you weigh all of your pros and cons and select 1-3 preferred locations, you should move to the next step: deciding what parameters you want from your resort target.

  4. The parameters that you can consider when selecting your preferred resort include the resort’ star rating, price range, clientele orientation (e.g., families with small children, adults only, honeymooners, etc.), resort size, type of accommodations, size and quality of resort beach, resort facilities, sharing of facilities with the other resorts, number of buffets and a la carte restaurants, free activities, etc. Have this list of look-for features in mind and return to the TripAdvisor website.

  5. Note that there are certain times and locations when travel is not recommended to particular locations. The examples are: the October-November hurricane season in some Caribbean countries; the March Spring Break week when wild, drunken and swearing herds of US and Canadian teenagers take over many resorts in the Caribbean; the Easter week in the Dominican Republic when most resort activities and services are inactive; a few weeks when jellyfish take over waters in some beach resort areas; and so on.

  6. On the TripAdvisor website, pick up a resort location and search for a rated list of hotels/resorts operating in the selected area. Go through the list of the top 20-50 hotels and check their most recent reviews. I usually look at the first page summary with the latest reviews. If all or most of them are very good or excellent, then I look at the next 2-4 pages of reviews. If 90+ percent of them are good or excellent as well, then I read through these reviews in a bit more detail and look for the factors that I like or do not like. I also look at readers’ pictures of a resort located in the picture galleries.

  7. Based on this screening, I either select a resort to my preliminary target list or drop it from further consideration. Some resorts on the TripAdvisor site have top overall ratings and are high on the rated list, but their recent reviews are mostly bad. In this case, I exclude such resorts from further consideration, as it indicates the presence of possible recent issues. On the other hand, there are some resorts, which are ranked in the 30th-40th range but have excellent recent reviews; so I place such resorts on my preliminary list. At the end, I have a prelim list of 3-20 resorts, which I use in the next stage of my vacation package selection.

  8. At this stage, I go to the websites of several local travel companies (operators and/or brokers). In Canada, I would recommend looking at websites of,,,, and

    The last two are tour operators while the former four are travel agents/brokers.

  9. Select the travel dates you are looking for and check prices on all-inclusive packages at the resorts you have on your prelim list. Check prices with each travel company because sometimes some of them offer little extra deals or discounts. There may be also some variations in pricing of deals and packages available through different companies, but my general impression was that prices are the same on similar packages, so it is only your subjective personal choice from whom to buy a package at the end.

  10. At this stage, you get familiar with prices on specific resort packages, available dates, more detailed resort and package descriptions, etc. Based on this information, your preliminary list should now be reduced to 2-5 resorts that you really like. Here comes the final stage: tracking down the deal price.

  11. Before you buy your package on a spot, wait for a week or two and check prices periodically. If you start looking early, it does not hurt to sign up for weekly email letters from one or two operators, which provide you with descriptions of latest deals and discounts. Sometimes prices on vacation packages go down several hundred dollars per person. Sometimes there are deals on family and children travel. Sometimes, two-week vacation packages become only $200-300 more expensive than comparable week-long packages. Often there are really good last-minute deals on some packages, but remember that for good resorts during a busy travel season (usually, around Christmas and in February-April) you may end up without any package for your target travel dates if you decide to wait for the best last-minute deals, as the available spots can get sold out quickly. Also, keep in mind that deal prices can change fast and unexpectedly, so if you found a deal price at say 10 pm, it may not be available at 8 am the next morning.

  12. I noticed that deals tend to move in a wave-like motion, with a price on a package being higher before and after a deal and a deal price periodically moving further along time into the future. Most likely than not, no good deals will be available during the last two weeks before your planned departure date if the resort is very popular and if you decide to travel during a busy season.

  13. Once you found a deal at one of the top resorts on your final list, you can choose one of the operators or brokers to buy a package. At this stage, a price is typically same everywhere, so unless there are extra agent-specific incentives, it is only a matter of convenience of the online checkout at each agent’s website that should govern your final choice of whom to buy a package from.

  14. After you buy a package online, the agent will typically send you electronic tickets, travel/package itinerary, and supporting travel information via email. Call the package operator 3-4 days before your travel date to confirm your intention to go and your flight times. Make a similar call within 24 hours before you travel. Sometimes, the operators overbook resorts and flights, so it does not hurt to confirm you will be there, so that there are no unpleasant surprises later on.

  15. Finally, make sure that you have all travel documentation, IDs, tickets, cash, and personal belongings before you go to the airport. Check for possible flight delays before you leave. Arrive at the airport 3 hours before the flight departure time for an easy check-in and to reserve a window spot on a plane (sometimes you can reserve a plane seat for an extra fee at the time of your package purchase).

Once you are in your room/suite at the resort, RELAX from now on for the duration of your vacation and enjoy every minute of your time there.

Friday, 28 March 2008

Nasdaq's stock analysis tool

Just wanted to briefly share some info about a fairly new and free stock analytical source that I lately like: Nasdaq's Stock Quotes and Research info tool. Of course, there are many other nice info hubs, like Reuters, WSJ's Markets Data Centre, and MSN Money, but Nasdaq's tool scores well in a couple of dimensions.

It has several very attractively presented functions, like information on short interest (see this example), analyst stock research overview (example), information on key competitors (example), ownership summary (example) and detailed institutional holdings (example), and especially Guru Analysis (example). I like this latter feature that (possibly somewhat subjectively) evaluates a stock according to eight different investment/trading models. By looking at a stock using Guru Analysis' pie charts, you can approximately see whether it fits one or two evaluation methods that most closely characterize your trading or investment philosophy.

Sunday, 23 March 2008

Troubles with derivatives in the financial sector

I am still convinced that the credit derivatives bomb is slowly ticking in the financial services market, ready to explode and hit all other sectors of the US and global economies. For some extra recent info on the CDS topic, read Swaps Backers Rush to Prevent 'Credit Event' from the Financial Week publication about the recent developments in credit default swap ("CDS") markets, or read The Credit Default Swap ("CDS") Market – Will It Unravel? which gives a nice overview of what is going on in the CDS markets.

In this regard, a very interesting statistical publication is the Quarterly Report on Bank Derivatives Activities published by the Office of the Comptroller of the Currency ("OCC"), the U.S. regulator and administrator of U.S. national banks and their activities. It is a very useful piece of information which allows one to assess risks of certain U.S. banks. The latest available report as of March 23, 2008 is the Third Quarter 2007 report, which spells the word "trouble" across its pages. I can imagine what had happened with the already worrysome statistics during the last six months since the report's coverage. I thought it would be interesting to share several pieces of data from this report with the blog readers.

First, a couple of summary lines from the first page of the report:

This summary is basically saying that a degree of derivative and credit derivative exposure by U.S. banks was increasing at the double-digit quarter-to-quarter growth rates back in the second half of 2007 and that only a handful of banks dominated the scene in the banking sector's derivative market.

The following diagram from the report shows the trend in a value of total derivatives traded by U.S. commercial banks since 1990:

Whenever we see exponential growth (which is obviously the case on the graph above), we should note for ourselves that a correction is in order because no market growth can be sustained in the long run at the ever accelerating positive rates.

Now, here is a report diagram and a report table on a degree of credit exposure by the five largest derivative players among U.S. banks:

From the data above, you can get the idea who are the prime candidates for serious potential issues.

Finally, below are several summary report tables which show us mind-boggling figures about the extent of derivative, and CDS in particular, exposure of most major U.S. banks.

Note a discrepancy between the value of banks' total assets and the notional values of their derivative contracts. Because most derivatives are off-balance-sheet items and because the true exposures from such derivative contracts are not necessarily valued objectively and correctly at actual market prices, the banks get away just fine in their finanical reporting, leaving many investors oblivious of the ugly truth that lies beneath the surface and waits for the right market moment to get exposed (as it happened to Bear Stearns last week).

Speaking of Bear Stearns (we can legitimately call it a BS company now, I guess), keep in mind that the report's list includes only banks and not security dealers such as Bear Stearns, which all may be in even deeper mire than banks. Look at the guy on the top of the report's list of largest derivative players among banks. If the acqusition of the BS Co goes through as announced, JPMorgan will have an even bigger exposure in the credit derivatives market.

Look at JPM's credit-exposure-to-capital ratio. It is ridiculously high. Look at these ratios of the other top banks on the list above. I think that whoever has a credit-exposure-to-capital ratio above 50% is a good candidate for shorting, with those few banks which managed to get it above 100% being almost sure bets for trouble if the situation in the credit insurance markets gets really bad.

Look at the graph below to see how much exposure in the sub-grade credit derivatives the "top" banks (shall I say the "bottom" banks) have. Also, note that most of these contracts are 1-5 years in maturity which means that they are due to expire in 2008-2011.

If you do not see an issue here, then I do not know what can be called an issue. I will just name those banks that I think may be potentially facing very serious problems, on top of what they have had already due to the subprime crisis:

  • JP Morgan Chase (JPM)

  • Citibank (C)

  • HSBC Bank (HBC)

  • Bank of America (BAC)

  • Bank of New York Mellion Corp (BK)

  • State Street Corp (STT)

  • Wachovia Bank (WB)

  • Lehman Brothers (LEH)

  • Merril Lynch (MER)

  • If the CDS markets collapse for some reason (well, realistically there are very slim chances that it will happen because the government will bail out again), then the companies above will take the biggest hit. Please use your best judgement when investing in these banks.

    Graph and table credits: U.S. Office of the Comptroller of the Curency, Quarterly Report on Bank Derivative Activities, 3rd Quarter 2007.