Friday, December 31, 2010

Black Swans for 2011

The hardest trick is to predict the onset of a black swan event.  Yet I have been pretty good at it for a single reason.  The serious black swans are able to take advantage of preexisting conditions in the market and accelerate them

I anticipated the market meltdown in 1987 which was completely unexpected at the time.  I understood that the market before 9/11 was specifically vulnerable to such an event (it did not really affect the market itself but the signals were red flagging) and was not surprised but stunned at how large the event itself and the reaction became.  I also anticipated the crisis of 2008, but that one was patently obvious to all but the willfully blind.

This writer tries to list several prospective black swans, most of which are not.  In the list, please pay attention to China construction, national defaults, and fossil fuel production.  The rest are not significant enough for the present.  My first comment unbelievably is that they are not important enough, although they certainly can create headlines.

China is converting internal currency into non producing capital stock in the form of housing and is using it as a stimulus program to sustain the development of the economy.  I hope that there are better solutions developing, but we can live with this.  In the meantime China continues to own a ton of US currency which is been converted into assets as quickly as they can which is great for the global dollar cased economy.  It is not going to stop soon, although inflation is chewing things up now.

Spain et al will be patched in the same way the rest was patched.  Again, the money has long since been spent and the printing press is covering the losses.

Energy is the big story and it is not known which way the press will run with it.  A major loss of conventional production would cause a price burst that will give us a rerun of 2008 of a gentler nature.  The real story is that we can use fresh oil production to keep the US on an oil diet for some years to come, but this is not obvious yet.  Most important all that new production is coming on stream internally and we are about to begin displacing imported oil in its entirety over the next decade as external production continues to face serious declines.

So yes, these are all plausible sources of market shocks during 2011, but not in the form of a serious black swan unless we have a major oil production crisis somewhere.  That could be a sharp loss in Saudi production.  I still do not think the vulnerability is that particularly high.

The big black swan would be for Focus Fusion to announce a major economic success in the production of fusion energy at an obviously cheap price structure.  Such could be rolled out at great speed and the entire global energy industry becomes terminally obsolete.  Equally plausible is the ultracapacitor business emerging this year making the E car truly viable.  Both are now possible and increasingly probable.  Both are capable of replacing and dominating their sectors extremely fast.  Everything else is a side show.

On the front of bad black swans, we really have nothing to worry about economically, because all the excess is sorting itself out.  It could be better and much faster but it is at least sobering and perhaps we can avoid a repeat for another eighty years or perhaps forever.  We remain on track to establish a modern middle class global civilization and we are already past the fifty percent mark and are now starting to quickly chew up the balance.  We may reach the ninety percent mark inside of as little as twenty years and by that I mean everywhere at the same level as China today.

Politically is another issue.  I think that Iran is ready to collapse and end its problem.  I also think North Korea is presently terminal.  No one else particularly matters and will disappear in the mopping up that will take place over the next two decades.  That leaves us with the question of how those two plan to die.  Obviously all are focused on arranging a soft landing for both.

As an aside, ongoing Islamic economic failure is steadily undermining Islamic extremism and we are now experienced in confronting it.  They will continue to trash around for some time longer until they grow tired of been the ditch diggers to the rest of the world.

In whole I am an optimist for the coming year and think that we will continue to muddle along quite well.

Ten Black Swans for 2011

By Christian A. DeHaemer | Thursday, December 30th, 2010

On April 17, 1793, three French soldiers broke into the tomb of Michel de Nostredame, a man we know as Nostradamus.
Legend has it that one man, a Corporal Adelaide, picked up the skull in an attempt to gain the power of the long dead seer.
His fellow soldiers bore witness that his eyes opened wide as he gained full knowledge, then was immediately struck down and killed by an errant bullet, fired from the nearby riots.
A plaque around the neck of the corpse read 1793.
It is by channeling the ghost of Nostrodamus — as if drinking blood from the very skull itself — that I give you my Black Swans for 2011.

Black Swans
For those of you who don't know, Black Swans are unpredictable events that destroy prediction models.
After 20 years in the derivatives industry, Nassim Taleb created the Black SwanTheory to explain:
  • The disproportionate role of high-impact, hard to predict, and rare events that are beyond the realm of normal expectations in history, science, finance, and technology.
The non-computability of the probability of the consequential rare events using scientific methods (owing to their very nature of small probabilities).

The psychological biases that make people individually and collectively blind to uncertainty and unaware of the massive role of the rare event in historical affairs. In other words, you can't create a mathematical certainty in the market. Long Term Capital Management taught us that. Computer models and base probabilities on bell curves... Yet it's the three percent on either end that makes all their algorithms fail. And by the very nature of statistics, an event that's 1% likely to happen will happen— if you wait long enough. Today I bring you ten events that could be that unpredictable, disruptive long shot for 2012.

1. China real estate bubble pops
Hedge Fund Manager Jim Chanos said the following about China on CNBC:
Construction is 60-plus percent of GDP, compared to exports of 5 percent... The problem is that consumption as a percentage of Chinese economy has declined in the last 10 years, from 40 to 35 percent. It’s all real estate...When construction is 60 percent of your economy, and you are building lots of things that people don’t need, the state may let this get out of control... It’s hard to manage this type of bubble.
China Business Insider estimates there are 64 million vacant homes in China. If the Chinese real estate bubble pops, commodities such as copper, iron, and moly will crater.
2. Spain defaults
High national debt, high inflation, high unemployment, plummeting housing prices, and a second round of bank failures coupled with political mismanagement sends Portugal into insolvency, followed quickly by Spain.
This overwhelms the EU's 440 Euro bail-out fund and sends U.S. Treasury yields into the negative as investors flee to safety.
3. Decade of natural gas
The U.S. Department of Energy (DOE) more than doubled its estimate of unproved, technically recoverable shale gas reserves from 347 trillion cubic feet to 827 trillion cubic feet for its 2011 Annual Energy Outlook. This means lower natural gas prices — and twice the production for shale gas.
Furthermore, you should expect an additional twenty percent increase in U.S. natural gas production through 2035 than was predicted last year.
The national leadership won't take advantage of the opportunity to end our dependency on imported oil due to the combined lobbies of big petroleum and green energy.
In any event, natural gas storage facilities and pipelines will continue to grow until there is a global network of ports and facilities to transport natural gas in much the same way we transport oil. Right now, natural gas is around $4 in Texas but $12 inJapan. Obviously, there are opportunities here.
4. Uranium companies surge
Last year, I predicted uranium would surge to $90 a pound.
That didn't happen. Instead, it went from $40 to $65. I predict uranium in the $90s again based on the continued building of nuclear plants around the world.
If you'd listened to my prediction last year and bought uranium miners, you'd have doubled your money:
5. China clings to dollar, riots ensue
China links its currency to the dollar. The dollar is in a state of decline as a policy move to inflate away U.S. debt.
This means that everything in China is going up in price. The official rate in China is 5.1% for November — but food inflation is running at 11.7%. The last time food prices jumped in 2007, there were riots at supermarkets.
6. Farm land jumps in price
According to a survey by the Chicago Federal Reserve Bank: “Farmland in Iowa increased in value by 13 percent between the fall of 2009 and fall 2010. Our survey for Indiana shows that farmland values since 1985 have gone up about 270 percent, or 5.5% per year."
Farmland prices are increasing at more than twice the historical average. This will continue, despite the fact that all other real estate prices are falling, and create a bubble. Farmers will overextend themselves, crop prices will fall, and we'll have a raft of farm foreclosures.
Willie Nelson and John Cougar will go on tour for Farm Aid VII. The national leadership will continue to squeeze food prices through subsidies for ethanol... After all, you can't be president without a strong showing in the Iowa caucus.
7. Dow has four 10% correction in 2011 — ends the year up 9.7%
Volatility is down to pre-crisis levels. Bernanke has set a paperweight on his laptop number pad. It is adding zeros to the national debt as fast as his Lenovo will allow.
Last year I wrote: “No one is talking about an extended bull market... The money that is currently being produced by the Treasury and hoarded by the banks could flow to equities and launch another bubble."
I predicted Dow 20,000. This didn't happen — but the DJIA did climb 18% on pure liquidity from the Fed.
Judging by how few bargains there are out there, I'd say that the market has gotten ahead of itself. The Bernank will continue with its flood of cash, but expect a lot of mixed signals and volatility...
8. The Year of the Electric Car
Look for EVs to sell out this year. The Nissan LEAF, the Chevy Volt, and the Fisker Karma will hit the ground rolling, giving early adopters all sorts of smug happiness.
Charging stations are springing up in downtowns everywhere. You will be able to buy them at Best Buy. The Geek Squad will hook them up in your garage.
9. Dead tech revival
Old companies like Intel (NASDAQ: INTC) (which had its best year ever), Cisco (NASDAQ: CSCO), IBM (NYSE: IBM) and Corning (NYSE: GLW) will break out of their ten-year sideways range based on the revival of business spending. These companies are all trading at small P/E ratios and sitting on large amounts of cash... Intel has $20 billion; Cisco has $38 billion.
10. Fidel Castro dies
Cuban Dictator Fidel Castro finally kicks the bucket. His brother Raúl makes overtures by allowing free speech and releasing all political prisoners. He seeks to open trade talks with the United States.
The State Department continues to spurn all advancements. Leaders in both parties do nothing because you can't be president without Florida, and you can't win Florida without the Cuban vote.
Have a great New Year,

Christian DeHaemer
 Energy and Capital

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