Category : Concerning the Financial Markets

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Positioning for (intermediate-term) dollar weakness

By now, almost everyone throughout the financial landscape is aware of the relentless rally in the dollar that has been taking place since early May of last year. During the past 10 months the US Dollar Index rallied from 79 to over 100! To help put that into perspective that’s an increase in the value of the dollar of over 25% in less than one year. The dollar strength that we at GFC have been witnessing over the past year has truly been remarkable. Recently however, technical developments are indicating a higher probability of the dollar taking time to catch its breath before the bull-trend in the buck is ready to fully resume.

As you can see in the chart below. The dollar spent the month February in a consolidating triangle pattern. It broke topside out of this patter in early March to close over the 100 level for the first time since April of 2003, the highest the index had been in almost 12 years. It was indeed a major accomplishment for “King Dollar”. An important guideline to remember in Elliott Wave Theory is that thrusts from triangles are often terminal, and the subsequent bearish price action since the dollar reached the 100 level has reinforced this belief held by Elliotticians. We at GFC are expecting additional dollar weakness to resume over the next 3-4 weeks with the 94.00 area as an initial downside target with additional dollar weakness possible.

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Recently, GFC has been monitoring bullish developments within the precious metals markets, particularly in gold and silver.   Admittedly, both gold and silver have lost a lot of their luster as they have each experienced a continuous bear market since late 2011. Both markets saw re-tests of their previous lows in March and have each subsequently staged nice rallies against the backdrop of the aforementioned dollar weakness.  Sentiment towards gold and silver remains at a bearish extremes with very few people expecting gold to rally.

Taking a closer look at gold, we can see that prices successfully tested gold’s previous low around $1,141 from back in early December.  It then rallied strongly up to $1,219, experienced a 50% pullback, and resumed its bull-trend with conviction yesterday.  Gold seems to be tracing out a corrective Elliott wave pattern known as a flat correction. Flat corrections are A-B-C patterns that have internal wave counts of 3-3-5.  We have labeled the chart accordingly to help readers visualize the pattern.  Sections A, and B, are miniature a-b-c structures with wave C developing into a traditional impulsive 5-wave Elliott wave sequence.  We are expecting gold to make a sharp run towards the wave A high of $1307 an ounce in the weeks ahead.  How prices behave in this target area will help determine any additional bullish potential for gold.  (Please be aware that the bullish setup and price pattern in Silver is strikingly similar) Dollar weakness should play a contributing role to the rise of both of these metals in April.

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Oil is a commodity which, relative to last year’s dramatic price decline, has stubbornly stabilized over the last 3 months.  As you can see from the chart below, the trajectory of oil’s drop since early January has noticeably slowed.  Similar to gold and silver, oil displays a strong bullish engulfing candlestick pattern from around the 50% retracement level of its most recent rise.  Additionally, notice the volume earlier this week as the volume contracted during the 3 day retracement and seems to have resumed yesterday despite it being a light trading week because of the Easter holiday.  Negative sentiment regarding oil is at an extreme.  With most trend following traders and hedge-funds having shorted oil, it seems as though we could see a sizable short-covering induced rally.

The financial press has been quick to rationalize a continued decline in oil.  Particularly, the Wall Street Journal has been running front-page stories about the pending Iranian-nuclear deal which would reduce economic sanctions and enable Iran to sell significant amounts of oil to the world.  If this were to occur, it would add to an already overwhelming oil supply surplus.  Astute market observers should be able to look at the recent price action and conclude that the potential of additional barrels of Iranian oil being brought to market is already fully priced in to the market.   Therefore, any fundamental news related to the delay, or potential cancelation of this agreement should talks dematerialize, will likely produce a bullish reaction in oil prices.  Just today, we saw that the deal is likely to be delayed further into the future as U.S. Secretary of State John Kerry extended the duration of his stay in Switzerland with tired hopes of being able to reach a deal.  The oil market traded today as though the deal will fail or at least be delayed.  A weakening dollar is also likely to contribute to a rise in oil prices.  GFC maintains its previous cited price target above $58.

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One industry that is projected (almost universally) to reap significant benefits from depressed oil prices is the aviation sector.  Our curiosity regarding this widely held belief led us to conduct a stock screening of some of the leading domestic airline stocks. One stock that captivated our attention by appearing particularly vulnerable at this point in time is Delta Airlines, Ticker Symbol: DAL.   As you can see in this chart, Delta has been consolidating from its highs having used the $43 area as support multiple times.  Each time Delta’s stock price touches this area it becomes more and more likely to break.  Additionally, Delta has two gaps sticking out like sore thumbs waiting to be filled beneath this support area.  Finally the high volume swing point from the middle of October last year around $30 is likely to get tested eventually.  High volume swing points such as these tend to get tested eventually. They act as a magnet for the market to revisit over time.   It is GFC’s strongly held belief that DAL is likely to come under considerable selling pressure if/when prices close substantially below the $43 area.  Additionally, the intermediate bounce in oil we are forecasting isn’t likely to provide shareholders of DAL any favors.  GFC recommends shorting DAL with an initially price target of $36 with a stop loss at $46 (further bearish potential exists).  At this time we recommend investors positions themselves for the overall effects of dollar weakness and adjust their portfolios accordingly over the intermediate-term.

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Valley of the kings

The tech world of Silicon Valley is an odd and confusing place that is often hard to put into traditional financial context.  With a resurgence of VC funding and IPOs that rivals the influx seen in the 2000 dotcom bubble, some worry another bubble is starting to form.  Chronically low interest rates and equities at all-time highs mean cash is cheap and plentiful and burning holes the pockets of large tech companies. Not just in new technology and acquisitions, but in something more physical and permanent – lavish new headquarters. But is this the wisest use of capital?  The Economist recently published an article detailing some of the concerns with these new expensive buildings – and also made some cautious parallels with the dotcom boom in the late ’90s.

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Building new headquarters as a symbol of your success isn’t a recent development. One infamous example is the Pan Am building in Manhattan.  Built in the 1960s, Juan Trippe famously signed a $115M 30-year lease which included $1M or 10% equity stake in the property.  At the time it was the largest commercial lease ever signed for a building in Manhattan and in line with Juan Trippe’s massive ego, the building had 30ft “Pan Am” logo erected at the top.  At the time Pan Am seemed poised to dominate the airline world – it had recently purchased a fleet of new jets and was about to take delivery of the largest airliner in the world, the 747. But as deregulation took hold and the company struggled under unionization and poor management, other airlines stepped in and began eating away their business.  In the last days of the airline, Pan Am was forced to sell its stake in the property as it was drowning in red ink and relocated its headquarters to Miami.  Another prominent example is the iconic Sears Tower in Chicago.  Completed in the early 1970s, the Sears Tower was designed to consolidate office space for Sears as well as become an iconic symbol for the retailer.  Unfortunately Sears’ growth did not line up with its forecast. With pressure from other retailers the building remained mostly vacant as other cheap office space flooded Chicago.  Eventually Sears left the building entirely in 1995 and today the building no longer even bears its name.  The is just a sampling of corporations that, at their apex, decided to show their success by putting a stake in the ground and erecting massive monuments in their name – history is littered with many more.

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Recently there has been an eerily similar comeback in headquarters planning. On February 27th, 2015, Google submitted a proposal for permission to build an even larger headquarters than its current “Googleplex” in Mountain View.  Google isn’t the only tech giant looking for new digs. Facebook, Apple, and Amazon all have plans for extravagant new office spaces.  These examples are more of the exception than the norm and firms like Google and Apple have ample amounts of cash on hand to bankroll these large capital investments.  But for other small and medium sized companies and startups looking to keep up with the Joneses, building or moving into a new building just to impress investors or clients can be fatal.  Buildings should always be considered overhead and never an investment, and when a company decides to make a move it’s a good idea to take a hard look at their performance and core business.  Even for Google and Apple, a strong argument could be made this money would be better spent elsewhere, or better yet given back to the shareholders.

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So what does this mean from an investment strategy perspective?  Below are a few examples of tech companies who decided to invest in new expensive headquarters, and the stock price today:

Company Date of Announcement Stock Price at Announcement Stock Price at Writing
Groupon September 12th, 2013 $11.76 $7.60
Twitter June 13th, 2012 $44.90* $48.44
Zynga March 5th, 2012 $13.97 $2.70
*Stock price at close on first day of trading

These data are tertiary market intelligence which are often understandably overlooked despite their usefulness as financial indicators.  Despite the proliferation of free accessible data, much of these data are in disparate forms and in multiple locations.  The task of collecting and normalizing these data can be prohibitive.  One good example of tertiary market intelligence is a study published by Yale Law Journal in which a meaningful correlation was drawn between corporate aircraft movements and future stock price action.  These data sets have been available for some twenty years, but this is the first useful application. This perhaps is another example where data could be leveraged as a corporate barometer, and in conjunction with other market indicators could be a useful and profitable measure.

January 2015 Market Recap

Significant volatility characterized the first month of the year as financial markets displayed significant instability across a broad spectrum of asset classes.  The decline in commodities has been relentless, specifically in oil.   After observing the decline in commodity prices, GFC must conclude that the specter of global deflation is becoming a reality.  Additionally, the month of January witnessed extreme volatility in the foreign exchange market as many different currencies underwent severe price fluctuations; most notably the Swiss Franc as the SNB severed it’s peg to the Euro.  Furthermore, interest rates around the world continued to grind lower with some even going negative!  U.S. equities faced strong headwinds this month as multinational corporate companies had to account for an exceptionally strong dollar as they repatriated capital earned overseas.  With so many economic indicators (particularly in Europe) signaling economic contraction, GFC considers it best to limit risk exposure at this time.

The dollar surged higher than we originally expected last month.  We currently view the US Dollar Index as overbought and are expecting a correction to imminently occur.  Additionally, our bullish stance on gold remains intact.  Gold has displayed extremely favorable price action in the face of a strong dollar.  We believe that when the dollar starts to correctively weaken, it should help sustain gold’s current countertrend bounce.  On Thursday of this past week, Gold spiked down $30 only to see the move almost fully retraced on Friday.   The spike down was a mean reversion move to the middle Bollinger band (20) line and also represented a test of the 200-day moving average.  The price action on Friday saw gold move swiftly higher.  GFC is expecting to see gold push higher above $1300 to the cited target range depicted on the chart.  We will keep you abreast of any significant developments related to this forecast.

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Finally, GFC is proud to report that on 29 Jan 2015, our proprietary Crude Contango Index indicator appears to have successfully triggered a buy signal in crude oil.  We subsequently entered into a long position inside our proprietary trading portfolio.  On that day, the Crude Contango Index spiked to a level of $18.33 which implies that banks are keeping oil stored on shipping vessels because they are hoping and waiting to sell at a higher price in the future.  So far, our long position has performed VERY well.  Friday’s price action saw a 7% increase in the price of crude oil.  The decline had become oversold and the RSI was displaying a bullish divergence.  Since the “short oil” trade has become so crowded in recent weeks, GFC expects a classic short squeeze to occur over the coming weeks.  As shorts unwind their positions by covering and taking profit, we expect oil to rebound rather sharply.  The initial target in our intermediate term long position is $51, followed by $59.  Longer term we expect oil to continue its trajectory lower to below $30 an ounce.  The low price of oil is undoubtedly going to have a negative effect on the North American labor force as mass layoffs are just starting to be announced.  Most of the job losses relating to this massive shift in oil prices are likely to be high quality, high paying, middle-class jobs.  Losing these types of productive jobs will be very detrimental to the economy overall, and independently, it will represent yet another notable aspect of the American economy failing to achieve economic viability.

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Tech fatigue

With the beginning of 2015, many tech analyst are salivating at the potential for the new Apple Watch release. Since the release of the original iPod back in 2001, each subsequent new device released by Apple has been a resounding success. Loyal Apply buyers happily lineup at Apple storefronts in droves to get a crack at their most recent releases. But are we getting to a point where consumers are becoming too overwhelmed with technology? At what point will consumers say enough devices is enough?

The original iPod succeeded for a number of reasons, but primarily because it did one thing very well; play digital music. Combined with the iTunes player and market, it quickly gained traction and grounded itself as the de facto MP3 player. And it did it with a recipe of simple, well build hardware. The iPod did little more than play music, with a monochrome screen, a navigation wheel, and not much more. Competitors featured color screens with more functionality, but lacked the minimalistic design and neglected the core function of . . . playing music. Since the iPod what we’ve seen is a convergence of technology rather than widespread diversification. The updated classic “iPod” has since been discontinued, succeeded by a line of iPod touches and iPhones. When the iPhone was released, it combined the functionality of a smart phone with iTunes and the corresponding music store to effectively make the iPod redundant for anyone who owned one. The iPhone was essentially an iPod, PDA, and phone wrapped into one supported by the walled-off ecosystem of iOS and the iTunes music/app store. Later the iPad showed even more device convergence, providing much the functionality of a PC in a smaller package. People could type out emails, browse the web, and play games much as they would have with laptop PCs, and popular add-on keyboards helped with touch screen drawbacks. However both devices continue to be popular and successful (despite recent declines in iPad sales).

Each subsequent device released by apple was a revolutionary product vastly improving on previous technology by at least an order of magnitude. So will the Apple Watch continue this trend? The Apple Watch contains vastly more functionality than its mechanical or quartz counterparts, right? It brings new functionality to a centuries-old device, however attempts in the past to improve on the humble watch have left a trail of failures. Granted, these implementations were not as advanced and many had serious design flaws, but we see a similar trend with each:

These are all hurdles tech devices must overcome, but when marketing a tertiary technology device like a smart watch these challenges are compounded. Who wants to charge yet another device at the end of the day, along with their phone, tablet, and laptop? And with the frightening pace of Apple releases, who will buy a watch with the knowledge that in half a decade (or sooner) their purchase will be essentially useless? High end watch purchases typically fall into the category of buying jewelry, which is expected to have a much longer lifespan and not precipitously lose its value. Typically these are heirloom products meant to be personalized and last a lifetime. The Apple Watch has attempted to address these issues by adding a level of customization to fit the taste of each customer. But these derivatives can only go so far.  The appeal of the device will have a limited audience of Apple customers who are willing to give up their current timepiece.

The Apple Watch is just one example of a recent re-popularized trend of connecting everything to the internet, the so called “internet of things”. This is the idea that everyday “dumb” devices will connect themselves to the internet making our lives easier, and the Apple Watch falls squarely into this category. However the fact is these devices are not new. The technology to, say, connect your fridge to the internet has been around for awhile. LG introduced the first internet fridge back in 2000, more than 14 years ago! The technology never caught on and today we’re stuck with our old dumb fridges, unable to automatically order more milk when we run dry. Yet technology experts are still heralding a new age where everything will be connected to the internet, even your kettle. Keep in mind, when consumers make a purchase of an internet-connected device, they’re also buying the service to make it work. The new-fangled “cloud” is often referenced, but in reality its just a thin veneer representing a proprietary service which might not be around in 5 years. Your smart fridge could end up an expensive dumb fridge in a few years time if LG decided they will only support the most recent models. Furthermore, buying such devices means the consumer has to first utilize their functionality and then take the time to learn the device before they become useful. Is it really easier to make a grocery list on your fridge rather than just writing it down? Do I really need to be notified on my smartphone when hot water is ready for my tea?

 

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“Food Management”?  What happened to the old grocery list?

 

Additionally the industry has yet to standardize a protocol for all these devices to communicate with each other. The market is full of proprietary mechanisms of communication, devices utilize 802.XX, Bluetooth, and a host a host of others. Home automation is a mess, and with no clear market leader consumers are rightfully wary of investing thousands of dollars in their home to find out later the technology they bought went the way of the beta cassette. X10,a home automation protocol that has been around for the better part of nearly two decades, never gained widespread acceptance, even though it provides functionality many new start ups are claiming is novel today. Undoubtedly at some point a leader will emerge and technologies will standardize, but that outcome is still a very long way off.

So what about the Apple Watch? It remains to be seen how the first new device to be released under the guide of Tim Cook will fare. However its good to keep perspective on what the device actually is, and what its trying to replace. Even though it carries the Apple logo, it will still face the same challenges as its smart-watch predecessors. As we move towards more and more devices embedding themselves into everyday appliances, consumers are bound to begin to feel tech fatigue. The stress of having to keep everything plugged in and charged, updated with the latest software release, and knowing that in the not too distant future there will be a newer version making the device you have now obsolete. I doubt consumers will be willing to not only replace their phone every two years, but also every major appliance in their home. Although perhaps the prediction of a luddite, I don’t see the Apple Watch being the revolutionary device some prophesy it to be. I’ll stick with my non-digital timepiece, which does a great job of telling the time.

On the collapse of oil

Speculation regarding the price of oil has been the #1 topic of discussion within financial circles over the past few weeks, and for good reason! Since June of this past summer, the price of West Texas Intermediate Crude Oil crashed just over $107 to $53.60. Oil has experienced a monstrous 50% drop in less than six months! A price drop of this magnitude, especially when occurring in a commodity with such a global importance as oil, is intriguing to say the least. Moreover, drops like these leave many market participants asking hard to answer questions such as “What is causing the price of oil to fall so dramatically?” “How come nobody predicted this?” and “How much further will the price of oil fall?” The goal of this article will be to provide reasonable explanations to all of these questions, and more.

Question #1).  What is causing the price of oil to fall so dramatically?

There are a wide variety of fundamental reasons used to explain why the price of oil has fallen so relentlessly. A few of these explanations hold more credence than others and we will highlight them now. One justification has to do with America’s own oil boom. The Shale oil production in the United States has reportedly grown by 4 million barrels per day (mbpd) since 2008. This has allowed the U.S. to drastically cut its imports from OPEC which has led to OPEC losing considerable revenue and market share. Recently, the Kingdom of Saudi Arabia’s oil minister Ali-al-Naimi went on record saying “It is not in the interest of OPEC producers to cut their production, whatever the price is.” This is an interesting statement considering almost all of the OPEC countries have estimated break even oil price of $90-$120 to finance their 2014 government budgets. Today’s low oil price is undoubtedly negative for governmental finance of OPEC countries, so why is Saudi Arabia’s oil minister so averse to cutting oil production and limiting the market supply? The easiest to explain this is that 75% of the Shale Oil producers in the U.S. are only viable as long as the price of oil remains elevated above $55 a barrel. This means that almost all the oil drilling operations going on in the Bakken shale wells of North Dakota are flirting with economic disaster. As these U.S. shale producers face the challenge of financial viability, OPEC stands to gain back considerable market share as they are able to meet demand by selling cheap oil and still garner profit. This is the most popular fundamental storyline propagated by the media as it fits into a simple “Supply & Demand” storyline template.

More ominous explanations of why oil is falling have to do with realities that are far less palatable to the general public, but are probably much closer to the underlying truth. It is worth remembering that oil is often referred to as a political commodity. It is the one commodity in which many nations around world have staked their independence, wealth, and subsequent influence upon. These nations have come to be called Petro-States because their prosperity stems from the sale and exportation of petroleum. From this lens, it is easy to see how the price of oil can be the ideal tool of leverage (or economic war) when sorting out diplomatic differences with powerful petro-state nations; i.e. Russia. Switching to a macro-view of recent geopolitical developments, the ongoing economic sanctions against Russia over the annexation of Crimea has led to Russia being left economically isolated and more dependent than ever on its oil export revenues.

The recent drop in oil prices has effectively paralyzed the Russian economy and greatly reduced President Putin’s chips at the bargaining table. The US, EU, and NATO have all displayed immense public displeasure with Russia’s annexation of Crimea. Additionally, Saudi Arabia has been outspoken against Russia’s backing of Syrian President Bashar Al-Assad and is in favor of regime change. The Royal House of Saud views Russia as the only entity preventing Bashar Al-Assad from losing power in Syria. In light of these geopolitical circumstances, it is plausible to conclude that this drop in the price of oil represents a coordinated economic hit against Putin, in order to weaken Russia, and arrive at various desired foreign policy objectives.

Question #2) How come nobody predicted this?

You may remember that a year ago almost all Wall Street analysts had been forecasting a gradual increase in the price of oil for 2014. The prevailing rationale was that oil would be supported by ongoing global demand and that oil prices had reached a “New Normal” above $100 a barrel. The main reason Wall Street analysts could not predict a declining oil price is because to do so would be a complete anathema to the general ongoing “Global Recovery” consensus storyline. After all, how could oil fall this much if there truly was a global recovery inherently involving increasing demand for energy? This price drop caught most people off guard because the growing possibility of global deflation hasn’t yet been conceptualized by most economists and forecasters. So predicting a price drop of this extent and magnitude was not even on their radars.

Questions #3) How much further will the price of oil fall?

From both a technical and fundamental perspective, we at GFC believe oil has considerably further to fall. The current prospects for an OPEC cut in production look extremely grim. Again, here is another quote from Saudi Oil Minister Ali al-Naimi; “As a policy for OPEC, and I convinced OPEC of this, even Mr al-Badri (the OPEC Secretary General) is now convinced, it is not in the interest of OPEC producers to cut their production, whatever the price is, whether it goes to $20, $40, $50, $60, it is irrelevant.” So, there you have it from the world’s most powerful oil man, he fully intends to keep producing a lot of oil and seemingly doesn’t care about effect it might have on price.

Collaps of oil

From a Technical perspective, we can see that the price of oil broke a significant 5-year trend line in September and has been in a steep decline ever since. This portends an eventual retest of the 2008 low oil made at $33 a barrel after collapsing from $147. It is important to remember the last drastic collapse in oil prices preceded the worst financial crisis since the Great Depression. Does this decline carry similar implications? Time will tell.
This recent decline in oil has occurred with increasing volume and implies that $33 support level will give way new lows into the $20 handle in the future. If that decline unfolds, then it will be a mind blower to most market analysts. Indeed, it could be the beginning of the real “New Normal” landscape in commodities where global demand and subsequently prices remain suppressed for years to come.

How to run your own bank

Both Prosper and Lending Club have been around for quite a while now and with the recent IPO debut of Lending Club on the NYSE, P2P lending has been getting ample amounts of press coverage.  However, both companies have been steadily gaining ground for a while and now have loan originations in the billions of dollars.  Along with the previous investment of Google in Lending Club, it is clear this new form of retail investing is here to stay.  Most of our readers are likely familiar with the operation of P2P lending, and what Prosper and Lending Club have done for the industry, but are probably less sure about how this type of asset class can be incorporated into their investment strategy – and more importantly the risk dynamic P2P lending adds to one’s portfolio.

Technically speaking, P2P lending falls under the fixed-income bracket of investment vehicles, putting them in the same category of generally boring, “safe” things like bonds.  These securities usually have fairly low returns, but at the same time are assumed to have less risk than equities and more predictable outcomes.  However, with P2P lending you have the possibility of seeing returns far greater than what you would see investing in bonds or CDs.  In fact, it’s possible to even beat out the average return on equities if you pick the right notes.  But does this translate instead to basically holding junk bonds or sub-prime loans?  As with any investment strategy, you need to manage your risk.  With P2P lending there are a few areas where this can be managed and built into your strategy:

Both Prosper and Lending Club both have loan terms of either 36 or 60 months and deal in only unsecured loans at the time of this article.  This means the debit has no collateral, or in other words, no lien on any asset from the borrower as would be the case, for example, in a car loan.  Because of this if a borrower defaults on a note generally it is more difficult to recover the loss.  Both Prosper and Lending Club do have collection services which will contact the borrower and attempt to recover the late loans, however the only real repercussion for a delinquent borrower is a hit on their credit rating.  Notes that have charged off are sometimes passed off to other collections agencies, in which case you might be able to recover some of the loan value (although from my experience this is rare).  Additionally, it should be noted both companies have secondary markets where you can sell notes to other issuers, this gives lenders the flexibility to liquidate their account if they need to, although depending on the number of notes, this may take some time.  There are also limits on what notes can be sold.  Lending Club restricts the sale of notes that are overdue.

So what percentage of my portfolio should consist of P2P Lending?

As with any investment strategy, this depends on a number of factors and the risk appetite of the investor.  Generally I would allocate P2P lending as a subset of my equity holdings but with the caveat that P2P assets are by no means liquid.  It could take months for someone to sell their notes on the secondary market in order to take their account to cash.  With this in mind, P2P lending falls somewhere in between the riskiness equities and fixed income.  Depending on what your current investment strategy is, diversifying your equity exposure into P2P would be my suggestion.  Think of P2P lending as investing in another company within your equities portfolio.

Which notes should I select?

This is the most apparent mechanism to manage your risk and will be covered in a later article in more detail.  There are many great resources that you can utilize to develop your own strategy, or see what others are doing.  Both Prosper and Lending Club publish their historical loan data, this is hugely valuable when designing your own criteria to select notes.  There are dozens of parameters you can use to filter notes, including the industry standard FICO credit scores along with the proprietary rating mechanisms that assign an arbitrary grade to each note.  This data, if analyzed properly, will provide huge benefits.  By filtering and slicing this data, you can develop a note filter that will work for your risk appetite and deliver the highest yielding notes for your portfolio.  Investing time to develop a good filter will pay off dividends as your notes mature.  Also, don’t hesitate to invest in higher risk notes.  Although they obviously do carry a higher risk of default, with the right strategy they will outperform higher note grades.  As an example, below is an outline of one of the filters I use to drill down to the notes I invest in:

So how much money should you invest per loan?  A good rule of thumb is to never invest more than .5% of your total account value.  In fact, I try to invest the minimal amount possible while keeping my percentage of outstanding principal as high as I can.  If there are a lot of notes on the market, I can usually get away with investing the minimum $25 for Lending Club without any problem.  However, if the markets start to get thin, I can increase that amount to keep my money invested instead of sitting idle.

Expected Returns

At this point I’ve been investing in both Prosper and Lending Club for over a year.  As an example, below are the returns I’ve experienced:
P2p Graph

Please note the returns for Propser and Lending Club individually do not take into account charge offs, total rate of return does however.  On average I’ve seen an annual rate of return around 11%-12% which is in-line with the models I used when developing my filters.  I include these figures merely as reference.  Each investor should invest in P2P lending as they see fit, and this type of investing isn’t for everyone. But for those who do, the 15-30 minutes spent each month is well worth it.

Resources

Here are some of the resources I’ve used when researching P2P lending:

http://www.lendacademy.com/ Excellent blog and other resources regarding P2P lending.  They also have an active forum community and put on an annual conference for P2P lending.

https://www.nickelsteamroller.com/ The best site in my opinion for P2P lending analytics.  Their interface allows you to develop your own custom filters and backtest with historical data.

https://www.peercube.com/ Another analytic site which has similar functionality to NSR.

Delta Airlines reduces hedged fuel exposure

During my review of Delta’s investors day presentation, I noticed something that stuck out to me (and probably to many investors) – a $1.2B loss from their hedge book expected for 2015.  When you ask the average retail investor if low oil prices are good for airlines, you will almost certainly get a response of “yes, of course!”.  However when you dig down further you’ll find the answer isn’t as cut and dry as it first sounds and depends greatly on a number of factors, including which airline is being discussed.  In the case of Delta, as apparent in their most recent investor presentation, lower oil prices have lead to a rather large loss and a restructuring of their hedge book.  So how did Delta end up in this situation?

Oil

Oil has become an increasingly volatile commodity which has forced airlines to adopt hedging strategies in order to protect themselves from future price fluctuations.  In the case of Delta, their hedging strategy has been very active as opposed to passive, some might even argue innovative.  Their highly publicized and controversial purchase of the Trainer refinery is probably their most apparent sign of their strategy, although behind the scenes Delta has run a very active desk in house to manage their fuel hedge book.

From the investor presentation this week, however, it is clear this active strategy is starting to show signs of strain.  Along with their projected loss of $1.2B for 2015, they disclosed 65% downside participation for 2015 along with a 100% (“full”) downside participation for 2016.  This suggests a few things, firstly that Delta is expecting the price of oil to stay suppressed into 2016 and large unpredictable drops in the price of oil for the foreseeable future.  Additionally, as they are moving towards full downside participation they are undoubtedly reducing their hedge book overall scope and drastically reducing both swap and collars from their book.  Their increased reliance on call options is a sign they are moving towards a traditional “passive” hedge scenario, where they are simply guarding themselves on a steep increase in oil prices.  The cost of these options however are not insignificant, and as they become more dependent on them they will have to reduce the overall scope of their hedge book compared to their overall fuel strategy.  Delta has had issues with its oil hedging in the past, it seems they’ve assessed the losses associated with their swaps and collars were too great and exposed them to too much risk going into 2015 and onward.

But what does this mean for Delta’s venture into refining?  For Delta, their fuel hedging is broken out into two general areas, the crack spread and the cost of raw materials (oil) for refinement into Jet A.  There exists very few financial instruments to hedge against Jet A which is why airlines tend to hedge using more liquid commodities such as oil and kerosene.  The other side to the hedging strategy involves the crack spread – the cost per barrel it cost to convert crude oil to refined Jet A.  Delta’s refinery fits right into this part of its hedging strategy as they expect to see the crack spread continue to increase.  By owning and producing its own Jet A, Delta can limit its exposure to sharp increase in the crack spread.  Although the refinery has a large initial capital investment on the part of Delta ($150M, plus cost of refurbishment), in the long run this will most likely continue to be part of its long term hedging strategy.  Delta said the refinery will produce $75M  in profit for this quarter alone, which is a marked improvement from the $41M loss in the first quarter of this year.  They are specifically looking for the refinery profits to now offset the losses being incurred by its hedge book.  It is unclear however as to how the refinery will continue to perform going forward.  The increased downward pressure of oil should in theory help the refinery profits, however in time the crack spread will begin to shift to take into account the depressed cost of raw materials.  Although Delta would like to tout its relatively new refinery as an easy money maker, the refinery business is a crowded and competitive market, and a costly one to run especially for an airline whose core competency doesn’t reside in oil refining.  Its not as easy for Delta to dump an entire refinery as it is for them to rearrange their hedge book.  Plus, from a PR perspective, offloading their refinery would cause unwanted negative press and probably spook their investors.  I see Delta holding onto their refinery for the foreseeable future as they continue to explore how they can leverage it to mitigate their crack spread exposure.  Other airlines will be closely watching how Delta fares with their relatively new venture, and might outline strategies other airlines could try to replicate in the future.

Delta is a unique example compared to other airlines.  Southwest for example, which famously hedged all of their fuel buys and recorded $221M market to market loss when fuel prices rose in 2012, is proof in point that a hedging strategy from one extreme to another isn’t a good idea.  It will be interesting to see how Delta continues to adapt their fuel cost management, however it is clear they are expecting continued depressed oil prices for the foreseeable future, and have reduced their hedge book accordingly.

Imminent top in the dollar

For anyone who’s been in possession of the world’s reserve currency, 2014 has been an awesome year!  Since bottoming out near the 79 handle in early May, the dollar has staged a relentless 8-month rally.  Some of the big fundamental storylines that contributed to the relentless surge in the US dollar index were weakening economic data from the Eurozone, the collapse of the Japanese Yen due to Japan’s extreme (and verifiably insane) monetary policies, and general geopolitical developments concerning regional instability in places like Ukraine and Iraq.  All of these precarious developments served to send capital from around the world rushing into the U.S. dollar due to its perceived status as a safe-haven.   Recently however, the dollar has been signaling that the strong bull trend that has characterized much of the past year is reaching a point of exhaustion.

dollar

As the above chart shows, the US Dollar Index has recently encountered long term resistance in the 89.63 area dating back to March of 2009.  The dollar has initially backed off upon reaching this area 3 days ago.  Additionally, there is a secondary long term resistance level 3 handles higher at 92. 63 which dates all the way back to November of 2005.   If the dollar is able to break through the 89.63, the 92.63 would most likely cap any additional gains.  From a very long-term macro-view, GeoFront Capital believes an eventual retest of the 120 area is possible, but the dollar first needs to catch its breath here in the short term

dollar2

Drilling down onto the daily chart, the 2014 rally is prominent displayed.  As shown, it is possible to count a completed 5 wave Elliott-wave-sequence which began back in early May.  Since Elliott wave theory is fractal in nature, these 5 waves are together the first initial wave of an even larger wave sequence.  According to the Elliott wave model, once 5 waves are complete, a corrective retracement of the previous wave will commence.  Wave 2 will be a partial downwards retracement and will likely bring prices back to at least the 84.50 area which is the “previous 4th wave of one lesser degree” which is a common location for waves to retrace.  Additionally the 50% fibonacci retracement level resides in this area as well, making it a compelling target zone.

The Relative Strength Index, which indicates price momentum, is showing what is referred to as a bearish divergence.  The price of the US dollar index has continued to make higher highs, but the RSI has been registering a series of lower highs since September, with each high since then registering lower the previous one.  This says that the advance has grown tired and is due for a reversal.  Another item of note is the fact that the RSI chart itself is getting close to breaking its own upward sloping support line. Breaks of this kind on RSI charts can be indicative of significant trend reversals, and should be taken into consideration, especially when the RSI support line is well defined like it is here.

So how and more importantly when, will we know for sure that the US dollar index has topped?  Well, when analyzing the USDX, it is important to know that the USDX itself is composed of nothing more of a basket of difference currencies.  Knowing what these currencies are, how they are weighted inside the index, and where they are trending can provide solid clues to the future direction of the USDX.  The Euro accounts for a 57% weighting. Over half of the index is tied to this one currency!  So, it behooves savvy currency traders to look closely at the Euro to get an idea of where the dollar is likely headed.  Now let’s take a look at what the EURUSD has been doing lately.

dollar 3

Unsurprisingly, this chart is almost an exact mirror opposite of the USDX.  The EURUSD pair has been in a severe downtrend since early May of this year.  It has also completed a 5 wave Elliott Wave sequence and it is already showing signs of having put in a potential bottom.  Contrary to the USDX which is showing a BEARISH divergence, the EURUSD pair is showcasing a textbook BULLISH divergence.  This is a strong warning that the lower lows the pair has been making since September should be considered suspicious because they have gone unconfirmed by momentum. Furthermore, it is probable that this entire stretch from September will be fully retraced which would amount to a 50% upward Fibonacci retracement of the previous 8 month decline. Additionally, RSI looks like it is breaking through its downward sloping resistance line.

Finally, speaking of downward sloping resistance lines, EURUSD is sporting a very, VERY, well defined downward sloping resistance line dating back to the 15th of October.  Even though it is drawn on the chart, it is important to keep in mind that we at GFC did not draw this line, the market did. This resistance line has 6 separate touch points.  This many touch points dramatically increases the validity and the implications of what this line portends.  A solid daily close above this line today would provide strong confirmation that the downtrend has ended and a substantial upward retracement has begun. One should expect additional upward follow through in the weeks ahead.  To conclude, it is extremely like that U.S. dollar index is topping at this specific juncture.   The recent price action in the foreign exchange markets is signaling a significant trend reversal that will consequentially produce a tailwind for bullish price behavior in the precious metals.  If you haven’t seen GFC’s latest analysis on Gold,  be sure to check out “A Nice Time to Be Bullish on Gold” now.

A nice time to be bullish on gold

One of the most intriguing assets that you can trade right now is gold.  It order to have a proper perspective on where the price of gold is going, one should possess an acute awareness of where the price of gold has been.  It is important to know that gold WAS in a virtually uninterrupted bull market from late 1999 to 2011 where it rose from below $250 an ounce to an intra-day high of $1,921.  You may remember a few years ago when many Wall Street pundits and commentators were saying gold was going to cruise to $5,000 an once and that easy monetary policies instituted by central banks around the world would surely drive gold to $5,000 per ounce.  As it turns out, ALL these pundits were wrong.

Gold

Since 2011, Gold has been in a consistent downtrend which saw the price drop from $1,921 to 1,130.   A drop of over 41%! Over the past 3 years many gold bulls have been flushed out and many analysts have finally recognized the bearish trend in play.  Right on cue, they have linearly extrapolated this downtrend and put forth bearish calls like “Gold to $800 before $1,500”  and  “Gold for sure on its way below $1,000”.   The main problem these analysts have is their assumption that they can confidently extrapolate linear trends.  Markets are not linear, but in fact non-linear, dynamic, and fractal in nature.   Gold prices are most likely in a multi-year “A-B-C” correction and retracing a fraction of the previous 12-year bull run.

Gold has recently completed the initial 5 waves down in the Elliott Wave sequence which represents wave A of a multi-year A-B-C structure.  The sentiment readings (consisting of overwhelming bearishness) toward gold in the previous months has been congruent with an intermediate term bottom.  Gold day gold hit $1130, the market was full of short positions and almost everyone in the market was expecting gold to continue lower.  Since that time, some very interesting technical and fundamental developments have occurred.

In November, the price action in the gold market was characterized by much speculation of the Swiss Gold Referendum which was a vote taking place in Switzerland which would have forced the Swiss Central Bank to back the Swiss currency by 20% with gold reserves.  More importantly if this referendum would have passed, it would have restricted the Swiss Bank from selling its current supply of gold reserves.  As you can imagine, the prospect of this legislation passing generated a very bearish backdrop for gold.  And as such gold traders bid the price of gold up consistently for most of the month in the hopes the gold referendum would pass.  On Sunday, Nov 30th, the gold referendum failed spectacularly with 78% voting against the gold referendum.  This sent the price of gold crashing Sunday night down to $1,140.  Technically this price action served as a ‘test’ of the November 7th low at $1,130.  Since this price action occurred outside of London and New York market hours, the accompanied volume on the move was relatively light.  Prices did not have enough energy to break to new lows and immediately reversed on Monday from the $1,140 low and surged above $1,220 an ounce on monster buy volume.  This price action also created a massive bullish engulfing pattern on the daily candlestick chart which closed at $1,212 above the previous swing high of $1,208.

To a market technician, it is fairly obvious that there is a significant short squeeze going on right now in the gold market and should continue indefinitely.  If wave “A” down in gold is over, then this is most likely the start of a significant wave “B” up in gold and it should be an enduring multi-month move.  GeoFront Capital is expecting the price of gold to eventually move into the $1,400-$1,500 area some time in 2015 to complete wave “B”.  It is in this area where we will be looking for signs of a wave “B” termination and potential opportunities to go short.