The "Kitchen Sink" Game

“Once a major asset bubble pops – and the housing bubble was one of the largest asset bubbles of all time – the companies at the center of the mess usually try to take their lumps in a single quarter, often referred to as a ‘kitchen sink’ quarter. By cramming losses and write-offs into a single quarter, they try to give Wall Street the impression that the bad news is out of the way and nothing but blue skies are ahead.

“This game works very nicely sometimes…especially among gullible investors.

“But ‘kitchen sink’ quarters have an inconvenient way of recurring. It is improbable to believe, for example, that banks will be able to cram five years of reckless lending into a single quarter of writeoffs. More likely, this quarter’s write-offs will begin a long-running trend.”

Dan Amoss
October 11, 2007

Read the rest of today’s guest essay here:

The “Kitchen Sink” Game

Now some views from Short Fuse on a rainy day in Baltimore…


Views from the Fuse:

Ah, how quickly things change in the U.S. markets. At the end of trading yesterday, rumors were abound that the S&P 500 companies’ third quarter earnings could go negative for the first time since 2002. “Without major data releases, Fedspeak, or industry news, the Dow and S&P both wandered a bit aimlessly into small losses. The Dow fell 0.6%, and the S&P 500 lost about 0.2%,” report Addison and Ian in today’s issue of The 5 Min. Forecast.

“The NASDAQ registered a small gain of about 0.2%, but is up a surprising 4% in the past month. Most of the NASDAQ’s gains can be attributed to big name tech stocks with overseas influence, but our penny stock man Greg Guenthner notes that a few penny stocks have been riding the tech wave as well.

“‘Techs are prime to stage a turnaround. They’ve essentially been dead for the past 7 years. It’s always small cap companies that produce the biggest gains and lead the way out,’ says Gunner.”

There are already dusty shafts of a light at the far end of the tunnel. Gunner’s voice recognition software pick, for example, is up 46% in 11 months.

But yesterday’s losses are just a distant memory now…the Dow and the S&P hit all time highs this morning. Giving stocks support was news that Wal-Mart raised its outlook; early economic data showed the government reported a drop in weekly jobless claims and the August trade deficit narrowed more than forecast.

We will get the full scoop on the validity of these jobs numbers from Ian tomorrow, but for now, let’s have a closer look at the trade deficit, shall we?

Bloomberg reports: “The trade deficit with China, the second-largest U.S. trading partner behind Canada, narrowed 5.4 percent to $22.5 billion in August as American companies exported a record $5.9 billion worth of goods.

“Demand for American-made goods from South and Central America and from the nations in the Organization of Petroleum Countries also reached records.”

Now…either we are actually making things again – or this could have something to do with a weak dollar. Hmmm…

Of course, the latter has more to do with the narrowing trade deficit, as the dollar’s “rally” came to a halt following the release of the FOMC minutes on Tuesday. And as the dollar continues its slow slide down, commodities head on back up, with gold futures for December delivery at $750.20/ounce and crude oil futures for November delivery at $82.07/barrel.

It’s the norm for a falling dollar to cause investors to hedge their bets – generally in the commodities markets. Now the credit crunch is spurring “investors bitten by the collapse in subprime mortgages [to look] for new opportunities to trade bonds linked to traditionally volatile commodity prices and risky emerging markets.

“The shrinking market is sparking a new migration on Wall Street. Now, in search for higher-yielding assets – and new jobs – an army of structured credit experts is studying products such as Collateralized Commodity Obligations, or CCOs, that are tied to the performance of a portfolio of underlying commodities, such as precious metals or energy prices.”

“Yikes,” says Kevin Kerr, “subprime to commodities, have they learned anything?”

“I expect a big influx of hot money into the commodities market to launch the United States into the next leg of the 10-15 year cycle.

“Those that know how to play in this arena – like we do at Resource Trader Alert – will do just fine.”

Kevin’s readers are doing better than ‘just fine’ in these markets…in September alone, they have racked up 146% gains in wheat in seven days…taken 125% gains in soybean oil in 19 days…and sold half of December gold spread for 100% gain in about eight months.

“This doesn’t make any sense,” said Gabriela.

We stopped ourselves. We wondered whether it was the idea or the way we chose to express it. Spanish is not our mother tongue. In fact, it’s no relation to us at all – not even a distant cousin.

“Una economia es siempre victima de sus proprios ventajes,” we had said.

We hoped it meant what we thought it meant – that an economy is always the victim of its own advantages.

“Oh, I see…it’s a paradox…but what does it mean?” asked our Spanish teacher.

Eduardo Elsztain knew just what it meant. Eduardo is the man behind IRSA and Cresud…Argentine companies that have learned to do business, invest, and profit from Argentina’s many disadvantages. The firms were worth about $150 million during the crisis of 2002. Now, the stock market judges them to be worth about $800 million. Our friend Steve Sjuggerud thinks they’re worth considerably more. Cresud controls 410,000 hectares of farmland in Argentina – and dozens of office buildings and shopping malls. So, yesterday, after our Spanish lesson in the beautiful Galerias Pacificas, we wandered down Avenida Florida to the Plaza Mayor. Eduardo’s handsome office is just off the square.

“You can learn a lot by looking at the Argentine economy,” he said. “You don’t learn anything from watching people who do things right; you learn from watching people who make mistakes. Down here, we make lots of them.”

The most recent lesson is what happens to a country when it borrows too much from foreigners. Back in the ’90s, Argentina was flying. President Menem, with the help of American-trained economic advisors, had pegged the Argentine peso to the U.S. dollar. One to one. No questions. No second thoughts. No need to worry.

Since the U.S. dollar seemed like the safest bet in the world, the Argentine peso seemed like a good bet too. Suddenly, everybody wanted to lend the Argentines money. Why not? The rate of return was good…and the currency was as solid as the U.S. dollar. What a great advantage. All that money coming into the country!

The only little, teeny-weeny worry was that the dollar-peso peg wouldn’t hold…that when it came to take that money back out of the country, it wouldn’t want to leave. That is, there was some lingering doubt about how strong the peso really was. Not long before this, the country had had annual inflation rates over 1,000%. That was why they pegged the peso to the dollar.

But at the time, with the dollar strong and getting stronger…Argentina was expensive. Our friend, Paul Terhorst, told us he had to leave – it was too expensive to live here. Argentina’s exports were suffering too. The nation is one of the top producers of wheat, soy and corn in the world. Not to mention beef. The strong dollar was making the Argentine’s food more expensive than its competitors.

We recall putting the question directly to Carlos Menem himself. We were traveling with a group of American investors in the mid-’90s. Menem agreed to see us…and made a short pitch about what a great place Argentina was for American investors.

“But will you be able to hold the dollar-peso exchange rate at one-to-one?” we wanted to know.

“Yes…of course…” was his answer.

No was the fact of the matter.

On Christmas Eve, 2001, Adolfo Rodríguez Saá was sworn is as interim president of Argentina. His first, and only, important act as president (his term lasted only seven days) was to declare a default on the country’s foreign debt. Then, another short-termer, Ramon Puerta, went home for the holidays and decided not to come back. The crisis deepened until Eduardo Duhalde was elected president – Argentina’s fifth president in 12 days. He promised to save Argentines from the “neo-liberal” policies of his predecessors. Ordinary citizens had become “victims of the financial system,” he said.

(Hillary Clinton ought to go back and read some of the speeches from that era; they could be useful.)

Five days later, the peso was devalued…it subsequently sank to about 3 to 1 with the U.S. dollar – where it remains today. Domingo Cavallo, the economist largely responsible for the dollar peg system was later arrested.

A dollar, is a pound (GBP), is a euro (EUR), is a peso (ARS)…

We had dinner last night at a Spanish restaurant on the Avenida 9 de Julio – Palacio Espagnol. We have always admired the building. It has a marvelous dome on the roof…with a statue of Mercury on top. You can’t miss it. And it’s probably one of the best-known restaurants in town.

A party of four…champagne…hors d’oeuvres…starters…huge chunks of meat…wine…dessert…coffee – the bill came out on a silver tray. It came to 263 pesos.

Ten years ago, that would have seemed like a reasonable price – the equivalent to $263 dollars. Now, it is still 263 but the peso isn’t worth as much on international markets. So, if you’re starting with U.S. dollars or euros or pounds…it seems very cheap. Only about $85.

Wherever you have a meal like that – Paris, London, or Buenos Aires – the bill will come to about 263. But the actual cost will vary with the currency. In London, the actual cost would be over $500. Here, it was a London cab fare.

Eduardo’s stock company had been worth about $800 million before the crisis. Now, it is worth about $800 million again – even though it has added a lot of property. Eduardo used the crisis to expand his holdings.

“Some of these places that we bought were so cheap…they were practically a gift,” he says.

The firm owned seven large farms in 1995. Now, it owns 17. One of the farms in Salta province is 44 times larger than Manhattan. He paid $4 per acre for it.

“I think the whole world’s financial system is headed for trouble,” he says. He’s seen plenty of trouble. We listened. “Many of these hedge funds are going broke. Many of these derivative contracts are going to turn out to be worthless. I’m only interested in investing in things of real value…things that will survive. I only buy land, productive farms, valuable buildings…and gold.”

Back in the late ’90s, the central bank of Argentina was doing, predictably, silly things. For example, the bank had a hoard of gold coins.

“Gold was only about $250 an ounce, back then,” Eduardo explained. “And the central bank wanted to get rid of its gold coins. Who needed gold coins when you had the dollar, right? Well, they put the coins up for auction. No one was especially interested…even though these were valuable coins…mint condition…from the 1880s. So I bought them. I bought all I could. I paid about 52 pesos for each of them…”

We took a look at one of the coins…a pretty thing…about a quarter of an ounce of gold. Let’s see, the gold alone should be worth about $180. And what’s 52 pesos worth? Hmmm…about 16 bucks.

“Good trade,” we commented, making a mental note: Dear Readers might want to make the same trade with their pesos…oops…dollars.

“I’ve done better. I found a gold mine out in Chile. Nobody seemed to be paying much attention to it. I bought it very inexpensively. It has hundreds of thousands of ounces of gold – still in the ground. I could do like you do…buy gold coins and bury them in the ground. Why bother? I just buy them before they ever leave the ground. It’s a very cheap way to buy gold…”

Ah, but we know of a cheap way to buy gold as well, don’t we, dear reader? Even if the price of gold continues heading up, there’s a hidden way to take as big a position in the yellow metal as you like – for the equivalent of less than a penny per ounce.

Our book, Mobs, Messiahs, and Markets, written with co-author Lila Rajiva, hit the New York Times best-seller list again.

“Yeah, I remember when my book hit the NY Times best-seller list,” said old friend Doug Casey last night. “That and $1 would get me a cup of coffee. Now, it’s that and $3.49.”

Most of the reviews haven’t been too painful to read. But occasionally, a reader gets the wrong idea. One actually liked the book until he got to our thoughts on gold. At that moment, he must have gone blind. He completely misread what we had written, imagining that we saw gold as a “solution” to the world’s financial mess. He thought we were urging the world back on the gold standard.

Not at all. We had no part in making the mess; we’re not going to waste our time trying to figure out how to solve it. We’re not world improvers. Besides, who would listen?

We don’t know how to run a monetary system. Given the task, we would do nothing at all and soon be replaced. We only hold gold because we suspect the people who replaced us…and the people who run monetary systems generally…will do an even worse job than we would. That is, we only favor gold for selfish, personal reasons; it allows us to laugh at them.

Until tomorrow,

Bill Bonner
The Daily Reckoning