CORN-Y

There was an article in ZH today talking about how corn futures stopped trading for the day due to massive price movement:

"Back in April, when we first discussed the hike in daily corn trading limits from $0.30 to $0.40, we had some cynical observations, namely that "inviting not only more vol (read bottom line for the business) but more margin, the CME is exposing speculators to far greater impacts from margin hikes (and drops). Which of course means a far great capacity and ability to kill any commodity rally dead in its tracks." Well, there is no margin hike today (yet), although based on today's action we fully expect one. The reason, we are currently at today's down 40 cent limit, a price of $5.925 a bushel, the lowest since July 1, and by the looks of things it will get far worse: as the chart below demonstrates right now sellers outnumber buyers by a ratio of 2000 to 1. Expect this ratio to get even bigger once the CME hikes corn (and who knows what other commodity) margins as soon as today."

With this information, I did some really really quick research and came up with a trade.

My trade thesis is:

1) With the 40 cent limit being hit (so much more selling interest compared to buying), a potential margin hike due to crazy volatility, and the retreat from commodities into cash... my guess is that corn futures prices will probably gap down again at the open.

Here is the graph of CORN, an ETF that follows the price of corn futures. If you look the last bar chart is the price movement today, and the 2nd to last is the price movement yesterday. Look at that huge gap down. I definitely think that if nothing else comes out of this, there will be a margin hike that will force selling of corn futures, lowering the price of them... lowering the price of CORN, putting any shorts in the money.

More about CORN. http://etfdb.com/2010/corn-etf-corn-debuts/

Vermont-based Teucrium Trading LLC

Teucrium Corn Fund ETV (CORN)

Like most commodity ETFs, CORN will achieve exposure to the underlying commodity through futures, in this case contracts traded on the Chicago Board of Trade. But unlike a lot of products out there, CORN won’t invest exclusively in near month contracts; assets will be split between second-to-expire futures (35%), third-to-expire futures (30%), and futures expiring in the December following the expiration month of the third-to-expire contract (35%).

There are many risks to consider in this trade, here are a few of them:

• CORN price tracking with corn futures price. (Considering this ETF is based on multiple corn futures contracts, this risk seems very small)
• Rise in the price of corn futures. Very possible with such a large gap down. This of course is the biggest risk.
• Settlement dates interfering with prices. The settlement date just passed (in Sept), and if you look at the ETF's composition, it appears that the any movement in settlement is largely offset by the proportion of long-term contracts.
• Counterparty risk. Who is Teucrium Trading? They have multiple commodities ETF's and look to be a pretty solid company. Besides, if you're shorting...

Good luck and happy trading.

Disclosure: I am currently short CORN.

Why You Should Short Bonds

There are three reasons why bonds would have a great return if you short them. They are as follows:

• The credit risk of most bonds (including sovereign bonds) is high - especially compared to their respective ratings.
• Interest rates are currently artificially low, and when they eventually rise - prices will fall (bond yield and price have inverse relationships).
• Bonds are denominated in currencies. Currencies, such as the USD, will lose a lot of value in the coming times (due to Keynesian monetary policy).

All these ideas are from Doug Casey, and he has a proven track record of being right on the condition of the economy and where it's headed.

Words of another

Here are some choice words from Rich Fisher, president of the Dallas Federal Reserve Bank, talking about the aftermath of Operation Twist:

Jan Mayen is a desolate volcanic island located about 600 miles west of Norway’s North Cape. It is the home of a meteorological and communications station manned in the harshest of winters by 17 hearty members of the Norwegian Armed Forces. If you read Tom Clancy’s Hunt for Red October, you would know it as “Loran-C,” a NATO tracking and transmissions station. In the video game Tomb Raider: Underworld, Lara Croft visits Jan Mayen in search of Thor’s Hammer, considered the most awesome of weapons in Norse mythology, capable of leveling mountains and performing the most heroic feats.

My brother Mike recently visited this station on Jan Mayen. This is the sign that greeted him.

In Norsk, it reads as follows:

“Theory is when you understand everything, but nothing works.”

“Practice is when everything works, but nobody understands why.”

“At this station, theory and practice are united, so nothing works and nobody understands why.”

Winning/Losing in the markets

Hi guys,

It's been a while since I posted, but as this is towards the end of the month... I thought I would review some of the trades I've made this month as well as provide some insight going forward.

I started this month down 30% because I got caught up in earnings announcements and decided to play a lot more earnings with a lot more capital than I rationally should have. I did not do my homework and decided to account for that by placing successively larger bets to account for my losses. In short, I began to gamble a lot. Trying to recoup losses when your portfolio was +20% for the year at mid-July really does have the psychological effect of grabbing at any string that presents itself to lift you out of the hole. Little did I know that most of the strings just had me falling further into the hole. Now that I've learned the hard way with little capital, the same reminders will come up in the future when I am investing with larger capital.

This month has been slightly different. I have stopped playing earnings (sans HPQ - which I will discuss in a future post). I decided to do a lot more reading and painting a larger macro picture and investing in broader trends rather than specific companies. As I read, I realized that even a great company in a horrible sector can lead you to bad outcomes. Thus, macro matters first, then back out the sector performance, then finally companies. Top-down approach.

One big bet this month has been the Eurozone. I have been reading significantly and following religiously on the Eurozone crisis. I have read about Merkel and Sarkozy so many times that I do literally see "Sarkozy" when they are mentioned together. That led me to short EWI and EWP at the beginning of the month. The playing out of the dramatics and the implementation of the short-sale ban has led me to take a few profits, but mostly to stay in the position - as it has really great returns, limited downside, and a great risk/reward ratio for the upside. Thanks to these two plays, my portfolio has rocketed back upwards and is in positive territory again.

Another one of the plays I've been in and out of has been gold. Instead of buying paper/physical gold, I have been investing in gold companies. The main position I like to play is the Canadian company, Yamaha Gold (AUY). They are a well managed company that usually does a little better than gold, while dropping a little less on dips (worth exploring compression trade soon).

Gold has performed marvelously over the past couple of months, and through my outlook still has some upside to it, though there might be a near-term correction. Monetary policy by printing and Eurozone worries keeps AUY in my port.

Another precious metal (PM) worth looking into is SLV. For lack of a good company with solid fundamentals and good management, I just hold the ETF. Silver had a sneaky run-up but for the most part has sold off due to possible margin-hikes and "risk-off" sentiment. I am still a holder as I feel market participants are pricing in further easing and blue skies when all the data suggests otherwise.

As for my outlook - I have just summarized it. Correction is imminent, it just depends on when. There have been multiple multiple low-volume days where the market just floats up on short coverings and High-Frequency shops running up the bids. All of last week was relatively light volume days. This week will further be light volume, sans some crazy announcement, until Friday's non-farm-payroll numbers, which IMO aren't going to look pretty. Many Federal Banks have already shown their numbers about a faltering and slowing economy... and how the Q2 GDP report could cause a 2%+ rally in the markets is anybody's guess (Don't tell me Ben's leaving the door open is the cause - QE3 had slowly been priced in during the week off bad numbers on Monday).

Europe is not looking any better. There are lots of liquidity issues going on in banks, and questions about insolvency are still lingering. CDS spreads are very wide and have lowered a little bit, but expect more widening to come. I have become a proponent of using CDS spreads as proxy for stock performance, as I think that bond-holders usually have a better gauge of the company's financials than equity holders. If they are buying insurance to cover their bonds, and the spread is going up... equity holders should be wary. While bondholders still might get back 80 cents on the dollar, equity holders get NOTHING. If CDS spreads continue to widen (which I believe they will due to liquidity constraints and ineffective leadership), look for further negative market reaction. For the limited upside on the Eurozone, it will take a long time for them to get things in order - and that will most likely require a new leadership, as current leadership (Merkel) is not likely to get the support needed for EFSF, and even if she does it's over for her political career. No one cares about the IMF apparently, as Lagarde's harsh words on the current state of affairs in Europe and US led to a world-wide rally in stocks, with greater than 2% gains in European indices.

I will end with BAC. Are they in trouble, or are they not? Apparently new facts appear every day, and I have differing views with people I deem smarter and more knowledgeable in the banking industry. I think that their settlement will ultimately cost more than $8.5b, but as my old-boss pointed out, any new lawsuits or adjustments will result in something that will be stretched out to 3 years and be settled when everyone's forgotten about it. Thus, I have changed my unhedged short position to a straddle position. Any news will move the stock significantly, as the headlines will be significant (like Buffett falling asleep in the tub and deciding that he will invest in BAC after only 24 hours to review the company's books - it takes a full team roughly 3 days to have a good picture of a company, let alone one with so many illiquid and complex assets such as BAC). So far, so good.

Markets just tanked... what now?

In case you've been living under a rock, the markets have moved significantly in the past 1.5 weeks.

Starting from last Monday, Aug 1st - the S&P 500 has fallen as-near-as-it-makes-no-difference 12%. What is going on?

Well the first reason is that US government was debating on how to raise the debt ceiling. The whole circus going on in Capitol Hill really showed you the ugly and greedy side of politics.

After the debt deal was signed, the markets didn't budge a bit as low GDP numbers and the looming possibility of debt downgrade by Moody's and Standard & Poors kept investors on edge.

ISM numbers came in and tanked the market early this week. This string of bad news was enhanced by trouble in the Eurozone, as Italy and Spain become more and more dangerous and could possibly need some life support. Italy's public debt of 130% of GDP is a very alarming figure, and the GDP figures come out tomorrow.

I don't know about you, but if I were to choose between that or the US jobs report as being a bigger mover in the markets tomorrow morning, I would say Italy's GDP by a mile. That number doesn't look like it'll please many people besides those short the market. The US jobs report tomorrow morning at 8:30am doesn't look too promising either.

There was a massive sell-off today as the VIX spiked and blue-chips were unloaded by investors moving into a risk-off scenario. Investors flocked to any safe security, including US Treasuries. For a moment, the 1M T-bill had negative yield. For those unfamiliar with the matter, that means you are PAYING the government to hold onto your cash for a month. Ridiculous. The 10-yr TIPS yield also fell more than 50%, moving inverse to the price.

What's to come?

My guess is more of a correction. Bernanke will use what's left of his warchest for QE3, but that should have the effect of a mouse coughing. Things don't look good people. The signs point to a global slow-down.

US - economic data looks weak and even though companies are beating earnings, the outlook doesn't look as rosy as it did at the beginning of earnings season

Europe - They've got their hands tied for a long time coming. Greece is barely supported, Italy is going to become a problem, Spain has some time to get things in order so long as GDP keeps growing. Portugal is being supported by Trichet and the ECB, but that can't last forever. You know something's amiss when Trichet goes against what he said he would not do in order to prop up the crumbling structure of the Euro. Godspeed to Europe.

China - Overheating. Expanding too fast, not enough infrastructure, the government is starting to strike a discord with the people. Growth is good, but China can't be a one-trick pony, and indicators are showing that the trick is getting old and consequences are starting to catch up.

Brazil - Actually, nothing too bad about Brazil. Growth and risk-on story. Look for pull-back of funds, and use that as an entry point for yield. IMO this is a better yield play that waiting it out in US equities, good luck trying to find something with decent yield in the US market.

Even gold seems to be affected, as people are selling off everything, including gold, to move into cash. I am usually contrarian, but when the smart money is leaving and risk is left on the table - that is not the time to be picking up the dice.

Retreat and live to fight another day.

What happens in this situation...

So I was thinking today, what happens when the AAA rating of US Treasuries get downgraded?

The part that I am thinking about is pension funds. They have to have an average weighted rating, and the usual pension portfolio holds some amount of long-dated treasuries to duration-match their portfolio with the duration of their obligation. So, when treasuries get downgraded to AA, the average weighting of the portfolio will thus fall. Pensions will then try and get rid of them and exchange them for AAA bonds that will push them back up to an adequate rating.

Two questions then arise:

1) How illiquid would the market become when all pension funds start dumping treasuries?

2) Are there enough AAA corporates /agencies/munis to cover the new increased demand?

The effects would then be a rising US treasury yield and a falling AAA everything else yield. Maybe play the spread?

Let me know your thoughts.

**UPDATE**

The answer to this question is that pension funds usually use and average of the 3 credit rating agencies as a rating for holding in the portfolio. Thus, this situation would only occur on the second rating agency downgrading the US (like that will ever happen), or if S&P decides to move US below A rating... which isn't going to happen either. Thus, it looks like we're safe for now.

What does it mean?

So just the other day, I decided to take a big position in a firm I was bullish about. I did my research and knew that the company was going to blow the socks off the estimated earnings. I knew further that the debt ceiling crisis had taken a toll on this stock as well as the greater market, this past week alone the stock had fallen ~ 5% and taken me from big gains to moderate losses.

Well after the close was the moment of truth. At then it hit. EPS was 22% above estimates. Actual revenue beat estimated revenues by 10%. Annual earnings revised up 40%. The stock was up 8% after hours. I had a BUNCH of naked calls. I slept well that night.

I woke up the next morning and saw that the bid/ask were nowhere near the highs of the prior afternoon. This was a stock with a daily avg volume of roughly 1 million shares, so I knew there might be some big spreads... but there wasn't. The spread was 5 cents, and it was flat compared to yesterdays close (read still down ~5% for the week). I was in disbelief.

The stock opened 1% up and proceeded to fall to -3.5% for the day, on average trading volume and no new information. I listened in on the conference call and all the analysts congratulated the company on a stellar quarter. The guidance was positive. WHAT is going on?

Well, rather stay in and find out, I got out before it dipped negative, though I lost out a lot on the costs of flat earnings when playing options. Now that I have some time to review the trade, I still can't seem to figure out what went wrong...

TTM and forward P/E are <10, good history of beating estimates, no real cost headwinds or economic slowdown forseen, CEO fielded questions in earnings call cleanly and positively, stock had been rising in the past month and had taken a turn when the impending debt ceiling had become a lot more of a reality than something to be aware of.

I still have a long-dated option in play, taking my nasty -8.5% tumbling this week. In options territory that's roughly a 20% loss. I am still bullish on the stock, and maybe I'll buy in more conservatively right after this debt fiasco is over, but this was one of those textbook stocks and textbook stories that you are supposed to tell at the dinner table - you do your homework, you're on the right side of the call, you get rewarded. Turned out not to be that way.

If you have any idea why a company (not this company in particular) would act in such a way... please give me some guidance. Thanks.