Energy speculation vs. hedging - regulate it all, ask questions later

From Bloomberg:

U.S. regulators say they may clamp down on oil and gas price speculators by limiting the holdings of energy futures traders, including index and exchange-traded funds.

The rationale is that speculators artificially inflate energy prices. So where is the evidence that "speculators" control energy prices? There is more money under management in energy index and exchange-traded funds now than there was a year ago, while oil price is now less than half.

The argument is that oil speculators hurt the consumer. Then why stop at oil and gas "speculators"? Why not hit property speculators? Treasury bond speculators? Stock market speculators? The stock market was the largest speculative bubble out there, but nobody was proposing regulation to stop the speculators because we call them "investors".

Gensler said the CFTC is reviewing exemptions from position limits for “bona fide hedging,” after seeking public comment on whether the exemption should continue to apply to traders who are in the market for financial reasons, rather than those that actually use the commodity.

"Bona fide hedging"? How do you define that? If someone owns a large airline/transportation portfolio of stocks, would buying gasoil or crude to hedge fuel price exposure be a "bona fide" hedge? How about a REIT that owns properties and wants to buy heating oil or natural gas forward to hedge against heating expenses spiking in the winter? What about a pension fund that wants to hedge against inflation by buying crude (as many pensions and endowments do)? Where do you stop?

There are two ways to address the energy price spiking issue:
1. keep the dollar stable to avoid a run-up in commodity prices due to inflationary fears
2. diversify away from crude oil as the key energy source

Sounds as though the US is not seriously interested in either one. The proposed regulatory measures will destroy liquidity and reduce companies' and institutions' ability to manage risk. But they do present an excellent opportunity for politicians and bureaucrats to make a name for themselves.

India's budget takes the wrong turn

The word "pork barrel" is probably inappropriate for India, but that's exactly what's in the new government budget. From "fertilizer subsidy" to "welfare of workers in the unorganized sector". All useful stuff, but will force India into a serious budget deficit.

From the Government of India (Union Budget):

To counter the negative fallout of the global slowdown on the Indian economy, Government responded by providing three focused fiscal stimulus packages in the form of tax relief and increased expenditure on public projects along with RBI taking a number of monetary easing and liquidity enhancing measures.

Fiscal accommodation led to an increase in fiscal deficit from 2.7 per cent in 2007-08 to 6.2 per cent of GDP in 2008-09.

Learning from the US to spend money one doesn't have is probably not the right direction to take. In the long run this will hurt India, because once something is in the budget, politicians will have to keep it in to get re-elected. If the economy doesn't grow at the rate they forecast, India can get caught in a deficit spiral.

For now India's government will find numerous buyers for the new debt, but that may not always be the case. The market immediately signaled it's disappointment:

Sensex:


INR vs. USD:

Venture Capital - some revealing facts

Deloitte recently published their "Global trends in venture capital 2009 global report", a survey of venture capital firms. Here is a quote that sets the stage:

In short, the tourists have left, explained Mark Heesen, president of the NVCA. “Young entrepreneurs who thought they could get rich quickly with just a good idea are now gone and those now left standing recognize the challenges and tenacity needed to establish and build a sustainable business,” he said. “Those out on the hustings trying to get funded are much more astute about the globalization of the economy and worldwide competition. They understand that the value of their company today is not what it will be six months from now and that if they want to be funded, it will likely be at a lower valuation than in the past.”

With depressed valuations on established firms, early stage venture is completely out of favor.



Semiconductor companies are out of favor and "clean technology" is in.



Asian firms will be getting an increased allocation.



The only investor allocation increases are expected to come from governments. Everyone else's VC allocations are expected to shrink. Not surprising.



When asked "Top five locations viewed as having the most to lose in terms of overall economic stature, over the next three years", this is the response.



When asked what governments can do to stimulate innovation, guess what pops up on top. Taxes: it's a sure way to either stimulate or hurt small business.







The overall issue with the VC industry is the length of time to monetization, which has been increasing. LPs just don't have the stomach to wait 10 years for the portfolio companies to be monetized. With the entrance of secondary investment funds, who buy firms from other VCs, the time to monetize a good investment may shorten. Here is a bit of background on this from Business Week:

Longer waits are bad not just for the VC calculating the return on investment (ROI). They also result in impatience on the part of limited partners such as university endowments that invest in venture firms. It's also demoralizing for individual venture capitalists. There are many well-regarded VC partners that have never had an exit. Some venture capitalists are leaving the profession altogether and firms are shrinking.

Here's where secondary VCs can play a vital role. These firms, most of which did not exist 10 years ago, specialize in buying stakes in private companies from VC firms. Some examples include Saints Ventures and W Capital Partners, which are among the most successful firms this decade. Secondary firms now account for roughly 3% of the VC market, but their clout is increasing as they do more deals. San Francisco-based Saints now has more A-list portfolio companies than most traditional VC firms. Its investments include Facebook, eHarmony, and QuinStreet.

Need cash? Will buy your California IOU.

From Craig's List - LA:

Getting I O U & need Cash. Sell Your Gold & Silver Jewelry to me

But why sell your gold if you can sell the California IOU itself? Wherever there is an instrument with an expected payout, there will be a market. Here is another one from Craig's list:

In fact the guys from SecondMarket are getting in on the game. If SecondMarket can accumulate a portfolio of IOUs, they can auction it off to investors for a quick return. They specialize in auctioning off illiquid assets, but in this case will need significant volume to make IOU auction worth while. The discount may only be a few percent, so the fees for SecondMarket will be tight. They usually take a 5-10% commission on their auctions.

Here is what the return will look like, assuming California will pay on time (Oct. 2nd with 3.75% annualized interest):



But it remains to be seen if the state will have the resources to pay on the IOUs by October. The IOUs also subordinate the existing CA bonds. Not good news for the CA muni market.

So where is the TARP money and all the other cash?

We've been getting numerous e-mails questioning what has happened to the TARP funds the banks still hold. Plus what about all the new debt banks have issued including the FDIC guaranteed debt. What happened to recent earnings? Why aren't banks lending? Where's the cash?

Let's see if we can shed some light on the issue using some data from the Fed. TARP funds (though helped add equity to banks) are actually a drop in the bucket in comparison to the overall deposits at banks, which continue to grow. Deposits are now at some $7.5 trillion:



What about the lending then? How have bank assets grown to date? Here is a chart that shows all the loans historically outstanding on banks' balance sheet:



The lending has leveled off at about $7 trillion. This includes corporate as well as residential and consumer loans. But relative to deposit growth one would expect to see more lending. Here is the total loan-to-deposit ratio:



So where are the banks placing all their cash? And NO it's not in the treasury certificates the two guys caught in Italy were carrying as many have suggested.

One place to look is at bank holdings of government or agency bonds - liquid paper held for emergency purposes that would not require significant amounts of capital. The amounts of liquid paper held. actually took a nose dive last year as banks were selling all liquid securities to raise cash. But now this is where some of the bank cash is going:



The most striking change however is the cash banks hold at the Fed. Banks are required to always hold some amount at the Fed as reserves (reserve requirements). But now banks use the Fed as a parking place for their cash, holding far more than the reserve requirements. It's about $800 billion in total vs. under $60 billion required, as the chart below shows:



Now that the Fed pays interest on cash deposits (a recent change), this in fact is the ultimate safe place to dump cash. It's a riskless deposit without any capital requirement that pays some interest. The Fed now pays 0.25% (annualized - which is better than T-bills) to banks, and the banks pay their depositors probably half that (unless a bank wants to grow deposit base and set an attractive rate).

So why hoard all that cash? Here are 3 reasons:

1. The demand for loans is actually not that great - at least for loans the banks want to underwrite. Companies that are profitable don't have immediate growth plans and don't want increase leverage. Why would they in this environment? Those who can issue bonds and pay down their loans have been doing so. Consumers who qualify for a mortgage are not in a hurry to buy either. Without the securitization market, banks have a limited appetite for other consumer loans unless they get TALF help (which they have been utilizing somewhat).

2. Banks are still paranoid about deteriorating assets and any unexpected growth in balance sheet. For example here is a chart that shows home equity loans on banks' balance sheets. Desperate consumers are drawing on home equity lines as they too try to hoard cash or just trying to survive (sometimes trying to get ahead of their bank cutting the line.) This is a scary trend for banks and they need to reserve for it to avoid finding themselves overleveraged again.



3. Banks are trying to deleverage. They are trying to raise new equity and a nice helping of cash on the balance sheet makes it easier for them do that. Here is a chart of overall bank net equity. It had an ugly dip last year and banks just don't want to be near there again. It's a race against time: recapitalization vs. asset deterioration.

The anti-dollar rhetoric is meant to boost oil prices

From Bloomberg:

Russian President Dmitry Medvedev has repeatedly called for creating a mix of regional reserve currencies as part of the drive to address the global financial crisis, while questioning the dollar’s future as a global reserve currency. Russia’s proposals for the Group of 20 major developed and developing nations summit in London in April included the creation of a supranational currency.

China and now India have chimed in to support this call to move away from the dollar as the primary reserve currency. But the Russians have been the most vocal about it. Why? The can just as easily shift to the Euro as the primary reserve currency. Why make a big stink out of it?

The answer is actually simple. The Russians are trying to accelerate dollar devaluation by creating an anti-dollar chorus (which is not necessarily unwarranted). Here is the reason:

Oil prices respond strongly to dollar weakness


OPEC has been unable to get the oil price back up above $100. Demand just isn't there (as we discussed.) So talking down the dollar may create a nice spike in energy prices as we had a year ago. Russia is headed for a devastating economic contraction unless oil prices recover. It's a short sighted, desperate strategy, as a weak dollar may cause an even weaker demand for crude in the long run. Realizing that, Russia's Finance Minister Alexei Kudrin was recently allowed to make this statement: "It is hard to say that in the next few years this [dollar based reserves] system will change significantly."

So if bringing down the dollar doesn't work, let's try some geopolitical shenanigans such as the Nigeria oil platform attack a few days back. Doesn't cost much to pay a few guys to fire some shots at an oil platform.

Expect to see more of this.

Amory Lovins wants to win the oil endgame

The numbers seem to make sense. The technology is already here. The goal of US independence from foreign oil just doesn't look that daunting.



This lecture was given in 2005. What happened?

Construction weakness drives US job losses

When the payrolls number came out on Thursday morning, the market was taken by surprise. The sell-off in the equity markets was reminiscent of the poundings the market was taking early in the year.

From FT:

The data hurt US and European equities, put pressure on commodity prices, while government bonds, the yen and the dollar were boosted by the rise in risk aversion. "If you were banking on the US driving a vigorous recovery, think again," said Alan Ruskin, strategist at RBS Securities.

The larger-than-expected 467,000 decline in June payroll employment and the rise in the unemployment rate from 9.4 per cent to 9.5 per cent, poured cold water on hopes that the US was poised for recovery.

But this really should not have been a surprise. Jobs changes in the US are now driven by construction. Construction spending data a day earlier showed a 0.9% decline, which translated in nearly half a million jobs lost.



Mass media is not reporting on this relationship for some reason, but that shouldn't be a surprise either. Housing recovery will be key to any significant economic improvements, just as it's decline had led to the recession.