Trial By Fire

The Daily Reckoning PRESENTS: We all start somewhere, and for Kevin Kerr, ‘somewhere’ was with a philosophy degree and a lack of funds. Until one day, a simple question changed his life forever. Read on, and see what it’s like to be an inexperienced trader in a world of frenzied finance.

TRIAL BY FIRE

It seems that everyone, at one time or another, asks you, “What was your major in college?” When I would answer, “philosophy”, people would often look puzzled. Quite frankly, I felt the same way. I mean, what do you do with a philosophy degree anyway? The listings for philosophers in the want-ads section are thin at best. Funny enough, years later I would come to find out that many of my colleagues in the trading and publishing businesses had been philosophy majors, too. So I guess law schools, trading floors, and publishing houses are where former philosophy majors end up.

Anyway, I graduated from the University of Southern California with my shiny new philosophy degree and promptly left for Europe for three months with my best friend. When I got back, I realized that my already strained student budget was even more threadbare. I had no desire, nor the LSAT score, to attend law school. But I was fond of eating. One day my friend Tim Butler mentioned to me that his brother David needed an arbitrage clerk on the trading floor. I said, “What trading floor?” This question changed my life.

Up until that point the only exposure I’d had to commodities was back when I saw the movie Trading Places. I truly didn’t know livestock from preferred stock. Well, when I asked what an arbitrage clerk did, my friend said, “I don’t know, but he’ll pay you $22,000 a year.” Now, for someone just out of college without two nickels to rub together, $22,000 a year sounded like a great job.

So there I was on a warm August morning in New York City, ready to launch my career on Wall Street. I headed downtown on the number four train, cramped as always, decked out in my best suit and tie. I got off at the Fulton Street station and took the short walk over to the World Trade Center. There I searched for 4 World Trade Center, which housed all four New York exchanges at the time: The New York Mercantile Exchange, COMEX for the precious metals, the Coffee Sugar and Cocoa Exchange (CSCE), and my destination, the New York Cotton Exchange.

The six-story black building was dwarfed by the Twin Towers, and few noticed the buildings that sat at the base of the towers. I found the elevators and pushed the button for the fifth floor. It was very early – around 6:15 AM. I was eager to make a good impression. Unfortunately for me, nobody was there yet. As I got off the elevator, the first thing I saw was the letters “CEC” directly on the wall in front of me. They stood for Commodities Exchange Center. I walked up to the guard and he looked at me strangely as I told him I was here to be an arbitrage clerk in the Dollar Index.

He must have thought I was nuts, dressed in a suit and tie and trying to get in at 6:00 AM. He took pity on me and issued me a visitor’s badge and told me I would need to get my credentials later. He then directed me to the entrance to the trading floor and said that nobody was in yet but I could go straight through that entrance. I headed over that way; the quiet darkness inside intrigued me.

As I approached the top of the entrance I could hear the hum of all of the equipment. There were numerous television monitors; some telephones were ringing, but most just had red lights flashing above them. Ticker tapes (electronic ones) on the walls were flashing quotes and news into the dark, empty room. I remember in the darkness hearing a big thump every once in a while. Later I found out it was the time-stamp clocks – hundreds of them-making the loud thumping noise.

The monitors hung from large poles in the center of the trading pits. The pits were all different sizes and shapes; the majority were octagons, but some, like the orange juice pit, were just circles with a wooden ring. The room itself was cavernous – almost three stories high, I found out later – although it was so dark that I couldn’t really tell then. I remember the floor was very clean-not one bit of paper or anything else. I wouldn’t realize how clean it was until later in the day.

When I found my way over to where I was supposed to be meeting David Butler, my friend’s twin brother, I sat down on the edge of the pit and just looked around. Suddenly the lights came up and it was as if someone had turned on the sunshine in a huge stadium. Now I could see just how big this trading floor was. It was enormous-like nothing I had ever seen before.

Even though I had no clue about what to do, I was put straight to work. I was shown where the phones were. Then I quickly took off my jacket and tie and was handed a trading clerk’s jacket, green with blue trim. Our clearing firm was Gelderman, and green and blue were their colors. Anyway, I was quickly shown that the phones didn’t ring; even if they did, you couldn’t hear them, so above each phone was a light. The lights indicated the phone was ringing, and when it was busy all of the lights were flashing. This was when I realized that I had stumbled into no ordinary job.

The Dollar Index market was a small pit with about 50 people, if that. To me at the time, it seemed like a very tiny, crowded space. People were coming in with their multicolored trading jackets, holding their trading cards, and nobody really said much – certainly not to me. I was instantly initiated into the fraternity once the bell rang and the frenzy in the pit began. I was overwhelmed – the noise, the kaleidoscope of multicolored jackets, the sheer volume of paper everywhere, all made my head spin.

When the closing bell rang at the end of the day I felt as if I had been through a war. Most of the time throughout the day I’d had no idea what was going on and I felt totally lost, but I stuck it out. I remember a trader, whose badge read “GAMA,” asking me, “Are you coming back tomorrow?” He must have seen the forlorn look on my face. But come back the next day I did, and every day since. And while I wouldn’t trade (pardon the pun) my experience for anything, I hope I can help you learn and understand the commodities markets from an insider’s perspective without having to go through all the turmoil I did (unless, of course, you want to!).

Regards,

Kevin Kerr
for The Daily Reckoning
February 22, 2007

P.S. I have been on the “grain train” since the beginning of the year. Wheat, cotton, soybeans, and let’s not forget corn, all continue to look very good. In fact, according to Bloomberg, corn farms are more precious than apartments in Manhattan. So the next time you stop by a roadside produce stand, don’t just buy a few ears…buy the farm.

Editor’s Note: The above was taken from Kevin’s soon-to-be-released book, A Maniac Commodity Trader’s Guide to Making a Fortune. In the book, Kevin dispels the common myths and misconceptions about these markets, offering an insider’s view of what he calls “the last bastion of pure capitalism on Earth.” Whether you’re a novice or an experienced trader, Kevin’s down-to-earth, clear-cut guidance will make you more savvy, more confident, and more able to jump right in and grab those profit opportunities that are waiting for you.

Kevin Kerr is the editor of two highly successful and acclaimed financial advisory newsletters, Resource Trader Alert and Outstanding Investments. A veteran commodities trader, Kevin uses his irreplaceable experience to advise his readers on a variety of commodities investments on a daily basis. Widely considered one of the nation’s top commodities gurus, Kevin’s expert opinions are routinely featured in the country’s premier media outlets.

All over the planet, paper is still what they are buying.

Even though the Bank of Japan took its first, tiny baby step towards normalizing interest rates (when it doubled its overnight lending rate from 0.25% to 0.5%) the yen fell on the news, because the BOJ had showed, once again, that it was ready to keep supplying the financial trade with all the low-cost credit it wanted, and that nothing much would change.

Of course, speculators could still borrow yen, trade the currency for, say, New Zealand dollars, buy NZ bonds and make a cool 5% gain. Leveraging their capital 20 times, they could double their money in a year. The hedge fund manager who put $10 million into this ‘yen carry trade’ could borrow $200 million worth of yen, invest the proceeds in New Zealand bonds, make a net profit of about $10 million (after paying interest on the yen loans), then take 20% off the top for himself, giving him compensation of $2 million on this trade alone.

The carry trade keeps everyone happy. The Japanese are happy because they believe their low lending rates help keep their economic expansion going. GDP growth in Japan is running at 4.8% – not bad at all. And Japanese stocks are trading at a 15-year high (although that is not saying much, since they crashed 18 years ago and still have a long way to go before they get back to where they were in 1989). The hedge fund investors are happy because they’ve made an 80% gain. And all other investors are happy because the Japanese are helping to pump the great flood of liquidity that is making them rich…or at least, making them look rich.

All over the world, the tide of easy money is pushing up asset prices. Democracy and capitalism are supposed to be the big victors of the post-Cold War period, but the hottest markets are neither democratic nor really capitalistic. China is soaring, of course. But so is the nation that kicked out U.S. troops 35 years ago so it could enjoy its own miserable system of misgovernment – Vietnam.

The Financial Times reports: “After watching the formal stock market’s main index soar by 249 [percent] over the last 13 months, Vietnam’s emerging middle class is in the throes of stock market mania and students, civil servants and state enterprise managers with cash to spare are all rushing to buy shares and dreaming of windfall profits.

“The recent bull-run on the formal exchange, with 107 listed companies, has been propelled partly by foreign investors, eager for exposure to one of Asia’s fastest-growing economies.”

Why is the Vietnamese stock market manic? Part of the answer is that Vietnam is privatizing and embracing elements of the western, capitalistic system. But the more important part of the answer is that there is a lot of money around and it will go anywhere where the going is good.

The Financial Times continues: “‘It’s a frenzy,’ says Jonathan Pincus, the U.N.’s chief economist in Hanoi. ‘All the chatter in Hanoi is about people investing in the market. I don’t know if anyone knows what these companies are worth, but they are buying the paper.’

“Until recently, Vietnamese tended to put what savings they had into more traditional assets such as gold or real estate. But in the past year the number of trading accounts in the Vietnamese stock market has almost quadrupled from 32,000 to about 120,000.”

Who knows how to say ‘bubble’ in Vietnamese? The callow Vietnamese traders probably haven’t learned yet. Perhaps they have no word for ‘crash’ yet either?

We don’t know, but we will bet that the Vietnamese lexicon will be enriched by these two words just at the moment that Vietnamese investors are impoverished by millions of disappearing dollars’ worth of paper assets. Then, the Vietnamese who were once buying gold and real estate will probably start buying gold and real estate again.

But that is all in the future. And if you believe the cover story in this week’s Economist, the future may be in the past. “The End of the Crash Era,” is the headline; the picture above shows dinosaurs with coins on their bodies. You may no longer need gold coins, says the article, because the things they were supposed to protect you against are things of the past. In this new era, no crashes means no need for crash protection. No need for crash protection means no need for gold.

But wait, what’s this? The price of gold shot up $23 yesterday to $684. This is telling us something. What?

Gold is what you buy when you worry that the paper is not necessarily as valuable as other investors think. What you get at the top of a credit expansion is a lot of financial assets – paper assets – bid up to prices that they don’t deserve.

Just look at the Vietnamese market. A company that makes copper cable just went public at a market capitalization of $140 million. The company makes only $1.1 million in profit, giving a P/E ratio well over 100. Making copper cable is not exactly a high-tech high growth business. So, we can just imagine that investors are getting carried away and that the paper they are buying is not worth as much as they believe.

Of course, what happens next is just what you’d expect. The price of the paper goes down. Gold, which tends to hold an intrinsic value no matter what, will be a relatively better place for an investor’s money.

Every era has its endangered species, but we doubt that gold is today’s dinosaur. We would guess that it is the credit expansion that faces extinction, not gold. And when it does, people will look to gold for safety.

More news:

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Chuck Butler, reporting from the EverBank world currency trading desk in St. Louis…

“I couldn’t get through this without talking about the $22 increase in gold yesterday! WOW! With all the Fed Head talk about ‘inflation pressures’ and ‘rising prices’, gold traders finally pushed the shiny metal past the $670 level…”

For the rest of this story, and for more market insights, see today’s issue of The Daily Pfennig

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And more thoughts:

*** Our Maniac Trader has done it again! In an interview on the FOX News program Bulls and Bears on Saturday, our very own Kevin Kerr picked Whole Foods Inc. as one of his best performing stocks for 2007.

Well, guess what happened. In a late move yesterday, MarketWatch reports, “Whole Foods said that it would gobble up Wild Oats Markets for about $565 million in cash, beefing up its store base as it grapples with competition from larger conventional supermarkets.” As a result, “Whole Foods’ shares were up 7.6% in morning trading.” And that was just this morning. As this is being written, it’s up almost 6% from that, to 13.2%.

We don’t like to brag, dear reader, but this is just par for the course for Kevin, whose portfolio consistently shows great returns.

Read more from Kevin in an excerpt from his upcoming book below.

*** Finally, after two days, the power came back on. We checked the freezer. Miraculously, the food was still good.

Of course, we didn’t suffer without electricity. Far from it. The weather has been perfect – warm and breezy. We swam in the cool Pacific waters, dined by candlelight, and were abed by 9 pm.

So when the lights came back on about 8 pm last night, not only in our condo but all down the coast, we were almost sorry to see them. All of a sudden, the spell was broken and the stars had competition. As usual, for every foot of progress, we yield up an inch or two of satisfaction.

This brief sojourn in the days before Edison recalled an earlier period in our lives. We had inherited an old family farmhouse in Maryland – a modest place…so modest, in fact, that it had no electricity, no running water and no heat.

What’s more, it was a wreck. Abandoned for years, it was overrun by wisteria vines that crept between the clapboard siding and intruded into the house itself. In springtime, wisteria would even bloom in one of the bedrooms. More sensible people would have called in a wrecking crew. But the place had a certain charm, and since we had no money at the time, we ignored its defects, brought in some modern conveniences, and made it our home.

But between the time of moving in and the time when electricity and running water were installed, there were several months in which we had to live like our great grandparents. Our light came from kerosene lamps with the same basic mechanism as today’s camp lamps. But the old lamps were elegant, with a brass base that held a kerosene reservoir and a tulip-shaped glass flame protector. You could adjust the flame, too, by raising or lowering the wick – which gave off a soft, golden, flickering light.

We would light the lamps after dark and carry them from room to room. From the kitchen, where dinner was prepared, to the dining room, where it was eaten and then up to the bedroom. It was there that we came to appreciate our old lamps. We had no air-conditioning, not even a fan, so in summertime, we propped the window screens open and let in the smooth, rich, moist air. It seemed to mix with the light itself and rolled against the old lime-washed walls until the whole room was warm, fragrant, and languorous. Afterwards, we blew out the light and slept the sleep of the innocent…and the brain-dead.

*** Henry and Edward have been taking surfing lessons. After two days, they were able to get up on the boards and ride them like real surfers. We tried it too. Except, we figured we didn’t need no stinkin’ lessons. A natural athlete in the prime of his life ought to be able to do this sort of thing without instruction. We got on the board, paddled out and then when a whopper of a wave came our way, we got in position, paddled hard, and sure enough, we were surfing! Piece of cake.

Then, we tried to stand up. We must have been too far to the front of the board, because the nose went into the water and…eeyoow! We pitched under the water too. Fortunately, we had our surfboard tied to our ankle, so instead of making a clean getaway, it hit us in the head once or twice before we resurfaced.

“Are you all right, Dad?” Henry asked after we shook the sand out of our ears.

“Yes – of course, what did you think?”

“Well, you don’t look so good.”

“I always look this way.”