Pivotal Events

By: Bob Hoye | Tue, May 20, 2008
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The following is part of Pivotal Events that was published for our subscribers Thursday, May 15, 2008.


Last Year:

"America sneezed and the rest of the world went shopping."

- Financial Post, May 7, 2007

"Borrowing Binge Fuels U. K."

- Wall Street Journal, May 10, 2007

"Merrill and Morgan Spent Big Money on Subprime Lenders Just Before Slowdown"

- Wall Street Journal, May 19, 2007

* * * * *

This Year:

"They brought aboard the Dream Team, but the result was nightmarish. Looking to charge into the red-hot U. S. business of subprime debt two years ago, Mizuho Financial Group poached 11 bankers, traders and salespeople, headed by structured-finance ace Alexander Rekeda. Nizuho wanted to quickly ramp up its business of packaging mortgage loans into collateralized-debt obligations."

- Wall Street Journal, May 14, 2008 [Sayonara, Alexander]

"Centro Properties Group used a complicated and often-opaque capital structure to grow into one of the world's largest and most debt-laden shopping-center owners.
"But now Centro is in hot water with its lenders."

- Wall Street Journal, May 14, 2008

Centro is based in Melbourne and owns interests in some 670 shopping centers in the U.S. And 130 in Australia. [Guess they shopped until they dropped]

"Vallejo: Poster child of a New Era?"

The article considers the bankruptcy as a turning point as local governments contend with debt as well as "The mountain of pension and retiree health care benefits they've promised but never funded."

- The Bond Buyer, May 14, 2008

Stock Markets: This time last year, all was well in the stock markets if you limited your perspective to stocks, earnings and the abilities of the Fed to keep the sub-prime problem "contained". Now the street has returned to the mode that all is well.

It was in July, last year, that we concluded that the greatest train wreck in the history of credit had begun. The next key call was for the stock market slump into January, which included a 55-trading day plunge in the Nasdaq into late January. As we wrote at the time, that was a typical move that ended big bull markets.

We then expected a rebound for stocks, corporate bonds, commodities, and currencies into March-April. By stages this has worked out, with the action in stocks continuing into a usually favourable month of May.

As with last year, we have been watching for credit conditions to be positive going into May and this has been happening until recently when the sub-prime, for example, has deteriorated a little (we included the ABX charts in last week's Pivot). However, in the face of this traditional corporate spreads have been benign - which was the case last year.

While the market has suffered a couple of panics, much of what we thought possible has been accomplished and we watch for the exit.

Grains have topped, with wheat blowing out at the end of February and rice in the third week of April. Rice then fell 17% and rebounded to 23.5 on Friday. Two down-limit days haven taken out the last low. The rice chart has broken down. While the action has rotated into the meat sector, Ag stocks have seen their best. Rotation is also driving coal stocks again, but this seems tied to crude, which could conclude its blowout within the next few weeks.

Of course, threatening the celebration of the "good stuff" will be more discoveries of bad lending that will prompt sudden dislocations. As with any post-bubble contraction, the key is weakening asset prices, widening spreads and a steepening yield curve. The latter points could become more evident in June.

Sector Comment: Banks (BKX) moved up with Bernanke's widely followed blessing of the markets and reached 88.7. That set the third of a series of descending highs from the rebound out of the January disaster that reached 98. The record high was 121 in 1Q2007.

As noted last week, there has been three lows near the 74 level and with another hit pending to the credit markets this will likely be taken out.

There is the quaint notion that Ben steepened the curve so that the banking system can make some money out of a favourable yield curve. But, the Fed has precious little influence on the curve and throughout financial history the curve inverts in a boom and steepens during most of the consequent contraction, which can be devastating to all who joined the binge of reckless lending.

Taking out 74 will resume the downtrend in banks and financials. This could be anticipated by the "A" sub-prime bond taking out the February low of 14.82. After rebounding to 20.22 in early April, it is at 15.16.

Credit Spreads were also likely to be positive with the revival and junk came in from 1123 bps in mid March to 975 bps. That is quite a change and with this the high-yield came in from 226 bps to 180 bps last week. It is now at 193 bps.

Often spreads narrow into May and this has been the case and the other part of this seasonality is widening. Once turned this could trend towards severe conditions by later in the year.

Gold Sector: As noted last week "The potential low for the sector was expected to be set in the first part of May. Or sometime around now. Investors and traders should begin to position for an intermediate rally."

Senior gold stocks have begun to outperform bullion, which is often a good sign.

Gold's real price has also been expected to correct and our gold/commodities index, which set its high at 230 with the worst of the January financial panic, declined to 194 on May 1. The first bounce was to 201 and the next low was 195 on Tuesday.

Crude oil is an important commodity, and during a boom would naturally outperform gold, and underperform during the contraction. This shows up in the long chart of gold/crude, which is attached.

The ratio is down to 6.86, which compares to the low of 6.36 set in 2005. This could be the limiting level - particularly as the momentum has only been this low two other times on a chart back to 1990.

On the forty-year chart, the gold/crude ratio has hit the downtrending channel only six times. It is there now, and at an opportunistic degree of oversold.

Going back a little further, the ratio set an exceptional low of 7 with the oil crisis of 1920. Phrasing it another way, an ounce of gold would buy only 7 barrels of crude oil. Now it will buy 6.86 barrels. With the 1929 post-bubble contraction, the ratio got out to 36 on annual average prices, and on monthly pricing and at the extreme an ounce of gold would buy 70 barrels of crude oil.

Obviously, a huge paradigm change is pending and resource participants should be making a massive shift from energy exposure to the gold sector.

There were five great financial bubbles since the first big one on 1720 to the example of 1929, which works out to two per century. Typically gold's real price declined with the boom and increased for around three years with the initial contraction. Typically this was within a trend lasting for around 20 years.

Hey - we are talking real history, not theories.


15.94 126.7 ? 695 % ? ? ? ?
March 1986
Oct. 1990
223 % 15.94 1998
May 1973
March 1980
464 % 18.91 1986
May 1933
Jan. 1950
331 % 14.59 1973
May 1915
Dec. 1920
403 % 4.22 1933



Bob Hoye

Author: Bob Hoye

Bob Hoye
Institutional Advisors

Bob Hoye

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