Thursday, September 18, 2008


During the turn of 1973, there was trouble in the financial stocks and trouble in the Middle East. During the turn in 1990-91, there was trouble in the financial stocks and trouble in the Middle East. During the turn of 2008, there is trouble in the financial stocks and trouble in the Middle East.

Yesterday, 5 bombs went off near the US Embassy in Yemen; sixteen people were killed. Yesterday, UN inspectors presented evidence that Iran has secretly tried to alter the nose cone designs of rockets they possess. The modifications were for the purpose of replacing conventional war heads with nuclear war heads.

The market did not take kindly to the news. The price of gold jumped by the largest margin in recorded history. The price of oil jumped by $5 per barrel.

When did the US know and when did the UN know about the modifications to the missiles? I suspect this information has been known for some time. Over the past couple of months, speculators, well aware of the world wide economic slowdown, have become oil and gold sellers. Speculators in commodities tend to trade on extreme leverage, yesterday, they got their heads handed to them.

The obvious risk is that there is going to be a strike on Iranian nuclear facilities. I believe the odds are less than 20% but the latest international news, coupled with an outpouring of liquidity from central banks and treasury departments caused fear to rumble. The outpouring of liquidity, including from bankers in Australia and Japan, was enough to cause the fear of inflation to reignite. The reality is that inflation expectations are being decimated by the collapse of US financial institutions. These US institutions hold trillions of dollars worth of mortgage backed paper that has been written down to extreme levels. The heads of these institutions understand that the survivors will make trillions of dollars when the value of these securities bounce. The last bank to be sold out will be the poster child for coming close to making big money. In the case of AIG, it is known that the sub-prime portion of their portfolio is being carried at 20 cents on the dollar. A rebound in the housing market would cause these securities to quickly double and to likely double again. In a good market, these securities are worth 80 cents on the dollar.

One thing very different about yesterday's trading was that the bond market did not "suck the air out". The ten-year has been on a big roll but yesterday it was pretty stable. The implication being that the big bond rally is getting very long in the tooth. Yesterday, the short end of the curve collapsed, implying that some bond traders are now selling long paper and implying that the FOMC may cut short rates again. In the "normal cycle", the rally in the bond market should continue well past the market bottom and the big V in financial stocks should occur before the market bottom. The market is currently "testing" the previous bottoms.

There is always turmoil at the turns. It is common to see international tension at the turns. These can be the most confusing of times.

The House passed a silly posturing bill yesterday. Democrats are now on record for having voted for an oil drilling bill; a bill that will not pass the Senate or the pen of the President and a bill that if passed would prevent drilling from taking place.

The Congress has 12 days to get serious. Investors should take advantage of the confusion in the market place. Few people realize how little the wiggle room of congress. Should the international tensions cool about the same time that the drilling bans expire, the price of gasoline could rapidly fall to $2.50 or below.