Markets Going Forward
Friday, February 8, 2008
For months now we have been stating that the mortgage
market can go lower and lower as many people thought that the problem could be
over in a matter of months. It is a situation we find very interesting as well
as quite frightening at the same time. Recently we could not help but to chuckle
at the predicament some of the smartest men in the world find themselves stuck
in. Not only have they had to bail themselves out by selling large chunks of new
equity in their companies to foreigners, face mounting lawsuits, but to top it
off they now must bailout the leading bond insurers! It seems that everyone
involved in the mortgage securities business has fallen out of favor, and
rightfully so, with investors.
When you look at the cycle of how these securities came to
life, you get a picture which follows these steps:
- The banks originate or buy thousands and thousands of
mortgages, most which are really subprime.
- Banks begin to securitize the mortgages and sell off
“risk” in packages to investors. The investors get a percentage of the deal at
a “discount” price and they assume a certain percentage of the first defaults
up to a specified level.
- The credit agencies then issued ratings for these
packages before they were sold to the public, institutional investors and
other financial institutions.
- Many of these securitization deals were insured by the
bond insurers to guarantee them in the future.
- The securities were then finally sold into the market to
At this point, everyone seems to be upset (to put it
kindly) with the banks, and we now see a flow where the banks are having to go
backwards through this web and support the securitization market for themselves
as well as their partners in crime. If supporting the market here by stepping in
and giving money to the bond insurers keeps their credit ratings at AAA level or
equivalent, then that will solve one of their problems, but many more loom on
the horizon. What will be very interesting going forward will be our first
chance to look into the books of these companies and see how they are accounting
for their securities. More important will be how the accountants view the assets
on their books. The accountants should state the truth, which is that these
securities are not worth very much, but most likely they will not and will be
but another party sucked into the subprime mortgage debacle.
This is something that we will be looking at more in-depth
at later on, but shall be very important for the market going forward. Many of
the financials are up over at least 20% since the Federal Reserve cuts at the
end of January, but we see more storms over the horizon.
Getting back to mining, we are beginning to do our forensic
research on many uranium companies to see where the real value is. We have found
a few companies which are quite intriguing, however we are taking note that
should the market continue to fall rather than bounce then putting new capital
in at this time might be out of the question (We are not a Wall Street bank mind
We also like the potash companies at this time with Potash
of Saskatchewan Corp. being our favorite, as it has been for years. What is of
interest to us is that should BHP Billiton be unsuccessful in its bid for Rio
Tinto, then it very well could make a go at POT. This would give it a
controlling stake in the world potash production market and give it control of
much of the world’s available reserves for development.
The Mosaic Company is another potash producer we like,
although it does have exposure to other fertilizer components and less exposure
to potash than POT. One thing we would caution investors about is that as
Agriculture ETFs rise, MOS rises quickly with a standard deviation greater than
others in the space such as POT, AGU and the like. The downside to this is as
the ETFs sell off, MOS falls harder than its siblings and thus the losses can be
far greater than the industry. This is simply a case of the tail wagging the
dog, because as the ETF money rolls in and out it creates an imbalance in buyers
and sellers in the market for MOS shares.
Compared against the Market Vectors
Global Agribusiness ETF (MOO), MOS shareholders feel more pain in good times and
more gain in good times. Something to keep in mind when trading in today's
Agrium Corporation is a company which should be owned if
you want to be involved in the entire fertilizer cycle. The company mines,
refines, creates, markets, and then sells at its retail locations fertilizer to
farmers. The company has been aggressively expanding its retail locations
through acquisitions which should help in bad times as they have a relationship
built up with the end-user, the farmer.
Agrium is a much less volatile stock than
MOS due to its retail unit, which has lower margins than the mining part of
their business, but may be key in the future when fertilizer prices may not be
as high and personal relationships with the end user become ever more important.
Food demand is rising, and agriculture is in a bull market
which appears as though it will last through at least the next five years. The
fertilizers which allow the high yields of crops are in short supply and thus
should stay in a bull market longer than the next five years as it takes 10
years to open new potash mines and currently the next capacity additions
probably will not be online for two years. Like uranium, supply needs to catch
up to demand and even after the demand market levels off, supply will remain in
a bull market until it reaches equilibrium with demand.
Finally, regarding markets, the Nasdaq actually closed
below a yearly low and to make matters worse it was a close below previous
intraday lows for over a year! It seems to have bounced off of that low
and is struggling to stay in the positive as any rally appears to experience
strong selling into it. The Dow Industrials and S&P 500 have both been able to
stay above their lows, but should one of them fall below theirs and have a close
below those lows, that would spell some serious trouble for markets moving
forward. Personally we think that markets need to go lower to solve some of our
long-term problems and shake out the weak hands holding shares, but with all of
the bailouts looming in the months ahead and the possibility of further Fed rate
cuts, we very well could be up big in the months ahead.
The real question is whether the recent
rally which started intraday during trading Thursday was a dead cat bounce or
the bottom of a correction which had taken the Nasdaq market down 20%. Time will
However, always keep in mind the fact that many more of
these mortgages are going to go bad regardless of rates because housing prices
have collapsed and you cannot refinance something that has fallen in value
without covering your loss first. Quite honestly this is not an option for many
Americans who totally depleted their buying power buying the huge house and are
now faced with the option of foreclosure or bankruptcy.
We continue to nibble here, but certainly not using any
margin, and are keeping in mind that we may experience losses before any gains
going forward. As always good luck (its better to be lucky than good) and happy