Connecting The Dots For This Week

Monday, October 24, 2005

Last week's wide market gyrations despite the absence of major economic data lets me gasp for breath for the week to come. Consumer confidence on Tuesday, durable goods orders on Thursday and the GDP figures for Q3 on Friday almost guarantee a continuation of the rollercoaster ride whose new layout seems to bring more downward slopes than upward slowdowns of the ride. For the consensus figures surf to Econoday. Still looking for a website that compiles all public appearances of Fed members I am only able to point out two Greenspan speeches on October 26 and 27 listed on the FRB calendar (can somebody point me to a site that lists all Fed speeches!?). On Wednesday Greenspan will receive the Harry S. Truman Medal for Economic Policy Presentation and on Thursday he is scheduled for some remarks at the commissioning ceremony for the New Houston Branch Building. Market participants will be all eyes and ears for any subtle hints about Friday's GDP growth report which is expected to come in at a real 3.8% with the deflator rising to 3.0%.
Hurricanes Katrina and Rita can be held responsible if we see a negative surprise as I expect it. And with Wilma taking aim at Florida the GDP figures for the current quarter could also see another hit. Is the Kondratieff winter finally dawning?

Real GDP growth Q1 2000 to Q2 2005

GRAPH: GDP growth has been on a downward slide since Q2 2004. Data: Econoday
Public Debt Surpassed $8 trillion last week.
As the coming economic indicators provide enough reasons for some market action last week's new negative milestone was overlooked. On October 18 US public debt surpassed the $8 trillion mark (to be exact: $8,003,897,406,911.24) for the first time in history.

US public debt

GRAPH: US public debt is on an explosive path since president Bush took office. History will attribute him as the biggest ever public spender. The White House has not yet addressed the problem that will aggravate by rising interest rates. Is an AAA rating still justified? See also the post "US AAA rating - how much longer???"
The acting administration has managed to raise its debt by 8.5% since September 30, 2004. Since George Bush has taken responsibility the US public debt has risen an astounding 37.8% or $2.2 trillion. At the end of the fiscal year 2001 the figure was $5.8 trillion. What a comfortable life it must be when you not only have the license to kill, but also the license to print.
Speaking of killing: Secretary of State Condoleezza Rice has again managed to contradict herself within a few sentences concerning Iran and its nuclear aspirations. From a Reuters report:
"Military action isn't on the agenda...The American president never takes any option off the table." I love such contradictions weren't it for the suspicion that the US has no other choice to extend its new oil colonialism if it wants to keep its economy and its war machine going. By the way, I darkly remember that the same language was used before the invasion of Iraq - ahem, I mean the liberation of the Iraqi people who now enjoy a very different standard of living. Yes, I am sarcastic as the US policy and its language leave me with no other option.
At least we can be happy that there will be now war with North Korea. Why? Because there is no oil. It is relatively easy to land tanks on the beaches of Iraq who shoot their way to the next refinery for a fill-up. But in North Korea the US army would have to bring its own diesel/kerosene supplies. And while a tank may be a difficult target for the defenders, an oil-laden supply truck in its tracks can be taken out even with a slightly rusty North Korean rifle. So, peace to North Korea - who has nuclear bombs - and keep the guns aimed at oil-rich Iran. Yes, I am sarcastic as the US policy and its language leave me with no other option.
The Fed-Refco-Austria Connection
In hindsight the summoning of the heads of the 14 biggest derivatives players by the Fed in mid-September also begins to make sense. As the Fed is not only a monetary policy maker but also the banking watchdog I cannot rule out the conclusion that this meeting was a the beginning of a coordinated effort to keep the fallout from the Refco bankruptcy as small as possible. While the big names of Wall Street were being prepared for the things to come, a small Austrian wannabe, Bawag (Bank fuer Arbeit und Wirtschaft) was dealt the big blow. The bank whose CEO is reported to be (have been?) a close personal friend of Refco CEO Bennett got left standing in the rain with a loan to Bennett amounting to more than $450 million, collateralized with Refco shares. That is roughly the profit of two years for Austria's fourth biggest but most profitable bank, wholly owned by the Austrian Trade Union Federation OeGB.
The Wall Street Journal reported on Saturday that Wolfgang Floettl, son of former Bawag CEO Walter Floettl seems to be involved into the Refco disaster. Wolfgang is married to Anne Eisenhower, Dwight D's granddaughter.
Floettl jun. sees himself caught up again in a scandal without any fault on his side.
From the WSJ (which consistently spelled his name incorrectly Flottl - it is Floettl):
Mr. Flottl confirms conducting trades through Refco, but says all obligations to it were paid in full and on time and that he's flummoxed over why his name surfaced in connection with Refco's problems. "It is ludicrous," he says. It's possible the debts were moved on or off Refco's books without the customers' knowledge or even their awareness that the debts still existed.
Mr. Flottl's father for two decades ran a small Austrian bank, Bawag P.S.K. Group, that earlier this month extended emergency loans that Mr. Bennett used to pay off the debts after being confronted by Refco's board about them.
Those loans, uncharacteristically large for a bank of its size, now look pretty risky, given that Mr. Bennett's collateral - Refco stock - has lost 96% of its value since Oct. 7, the Friday before the scandal broke. U.S. investigators are trying to figure out why Bawag was so quick to loan Mr. Bennett such a large sum, and Austrian regulators are looking into it, too. Bawag is listed as Refco's biggest unsecured creditor, with claims of about $451.2 million.
Another tie between Bawag and Refco is Thomas Hackl, who was head of investment banking at the Austrian bank before leaving in 2000 to become the New York-based brokerage's head of global asset management, Refco said in a statement at the time. Mr. Hackl, who is no longer with the brokerage, couldn't be reached for comment.
Mr. Floettl says Ross Capital used Refco as a broker to trade bonds, foreign exchange and futures from roughly the early 1990s to the late 1990s. He also says he traded on behalf of Bawag until 1994, the year his father stepped down from his post there, after questions were raised about the propriety of that trading. Mr. Flottl says his investments made money for the bank. Regulators investigated the matter and issued a confidential report, but the contents remain unknown, a person familiar with the matter says. The episode left Bawag's lenders nervous. The Financial Times reported in 1994 that six banks yanked credit lines from Bawag, citing the close ties between the father and son and other concerns.
In 1999, Bawag acquired a 10% stake in Refco, which it sold in 2004, and securities filings outline other dealings between Bawag and Refco.
Bawag's supervisory board, after meeting Thursday evening, issued a statement yesterday saying that jobs at the bank are safe and that it has adequate reserves even if the loans aren't repaid. Bawag said that it had been lending money to Refco since 1999, though it didn't say how much.
The Flottl family is from Vienna, where his father was known for ruling Bawag with a strong hand. "He was 'Mr. Bawag,' " Alarich Fenyves, a bank consultant in Vienna, says of the now-retired father. Though Walter Flottl was known as a conservative banker, people still talk about the bank's decision to add a penthouse to one of its buildings - an odd move, given the union-owned bank's egalitarian roots.
As a young man, Wolfgang Flottl moved to Boston to earn a degree from Harvard Business School in June 1981 and then established Ross Capital in Bermuda. Arvind Krishnamurthy, who traded U.S. and Canadian bonds at Ross in 1993 and 1994, said Ross Capital gave traders much autonomy to make their own decisions.
"We were organized into small groups of traders, each pursuing their own strategies with capital that had been allocated to us," Mr. Krishnamurthy said in an email. He said he had little interaction with Mr. Flottl beyond occasional group meetings. A spokesman for Mr. Flottl said those traders given autonomy followed strict guidelines.
In the early 1990s, Mr. Flottl began to take a keen interest in art. He reportedly snapped up a Degas in 1991. At a Christie's auction that fall, he was described as the buyer who purchased three pricey works. A spokesman for Mr. Flottl said Mr. Flottl doesn't comment on private matters such as art.
In more recent years, Mr. Floettl has been a seller, accepting an estimated $50 million from Los Angeles's J. Paul Getty Museum for Cezanne's "Young Italian Woman Leaning on Her Elbow." In June 2004, he sold one of his Degas pieces, originally acquired for $9.7 million, for an estimated $7.6 million.
Floettl jun. had made big headlines in Austria more than 10 years ago. Recalling my own reporting from then there was no legal wrongdoing but eyebrows rose in the closely knit Vienna banking circle when it came to light that Bawag's outstanding profitability was not a result of conservative banking policy but a father-son business connection. Floettel sen. had wagered serious amounts of money in bets his son placed on complicated spread and derivative investments. While no money was lost - the bank had been reporting record profits for a period lasting more than 20 years - Floettl sen's reputation got badly dented in the process as he had simply not told the public the truth about the origin of Bawag's high profits.
Floettl jun. is an on-and-off Bermuda resident whose estate in Tuckers Town nestles between the mansions of billionaire Ross Perot and outgoing Italian prime minister Silvio Berlusconi and is highly praised as a big spender by waiters there who remember him not asking for change when he paid with a $50 bill for a coffee. Coffee isn't that good in that particular Bermudian bistro.
As I am deviating into gossip I can also include the story about Ross Perot and the coral reefs of Bermuda, the northernmost living coral reefs in the world, nurtured by the warm Gulf stream.
When Ross Perot bought his multi-million mansion in Tuckers Town he wanted to add a dock for his yacht. Bermudian authorities declined this destruction of the highly praised reefs for environmental reasons. So what did Perot do? He simply blew out the reef and paid a hefty fine. Billionaires can have it their way.
And to add some gossip about Silvio Berlusconi one should not forget that Silvio housed a part of his art collection at his estate in Bermuda's billionaire's corner Tuckers Town. He considered Bermuda such a safe place that he saved in the wrong spot. His mansion lacked a proper burglar's alarm and a caretaker found only empty walls and vitrines on his semi-weekly visit.
OK, I gotta stop the Bermuda gossip here as I still want to be able to visit the blessed island without bodyguards in the future, having lived there for 3 years. No, not in Tuckers Town, but aboard my sailboat moored in Ely's Harbour.
Forecast For The Week
Back to business. See share markets continuing to drift lower as sentiment has certainly turned negative, but watch out for sharp technical rallies taking out shorts. The S&P 500 is poised to test this year's lows if economic indicators are coming in on the weak side.
Gold showed a strong reversal from its recent tectbook correction, rallying $7 in late trading on Friday. I am waiting for a new test of the last high above $481. German news station n-tv had a half hour long report on gold last Saturday. What struck me was the information that industrial demand for gold now tops 200 tons p.a. This goes against the populist myth that there is no use for gold except than for the jewellery industry. A good part of demand comes from electronics producers since the shiny metal has superior qualities as a conductor (as has silver which is much cheaper). OK, so here we go: 200 tons for the industry, 850 tons for Indian gold buyers and 800 tons for the jewellery industry leave only some 650 tons for investment purposes based on data from goldsheetlinks.com. 650 tons translate into a mere 20.8 million ounces left for the goldbugs. Imagine what happens when only 7 percent of the US population decide to put one ounce each in their closets. Imagine what will happen when they decide to do the same with 2 ounces! So better be - and stay - long gold.
Silver also seems to have finished its correction and will take out the $8 mark on the back of a new surge in gold. And for fundamental reasons (growing demand because catalytic converters for diesel engines need more of the metal than catalytic converters for gasoline engines) I am taking a closer look at platinum which has been going sideways for more than a year by now. A breakout could propel it to $1200. Its sister metal Rhodium has already hit an alltime high at $2,930.
Crude oil reversed its recent decline on Friday too, closing above the $60 mark. With the winter season nearing I assume the uptrend will resume on the first set of bad oil data that will hit the market in the next weeks. European consumers still have to fill up their heating oil tanks as they have been waiting for prices to come down. But the window of opportunity may be very short-lived, I fear for all those who warm their homes with hydrocarbons.
The World Is Flat
I will now return to continue reading the thrilling book "The World Is Flat" by Thomas L. Friedman. The history of the 21st century is a must-read for every long-term investor. With every page I become more convinced that shorting the US equity market is the right investment decision. For aditional reasons for this read the book as well as the previous post and follow the links in it.

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