[rseiser]

One of these days I am gonna write a summary on my shorting experience. But regarding setting a stop-loss, you have to practice this and see if you can do it. It is not easy since you might lose 80% of the time just because of short-term volatility. That means you have to make really good gains on the winners, which is not easy either in an inflationary environment. If you miss your stop and it goes against you, where do you pull the trigger? At 5%, 10%, 20%, 50%? I for one am completely useless in that regard as I have proven to never cover unless I admit that my fundamental analysis was wrong. And that’s a guy talking who shorted TOL years ago at $25 and again at $40 just to see it go to $50. I guess I finally made some money now, but this was not for the faint of heart.

[rseiser]

I think this is a very relevant comment. It just shows that banks are getting desperate and try to borrow money cheaper wherever they can, no matter the risk. This is the same as when interest rates are low and everybody buys junk-bonds because they have a higher yield. This is the wrong move, since they are also more risky, especially in these times. Just because interest rates are lower in Europe totally overlooks the higher risk. In interest rates one has to look at their level compared to the equilibrium level. If a country keeps its level artificially lower than the market would demand, then it would be a good deal to borrow, since the rates are low AND their currency will lose somewhat due to the credit created. But Europe might not be in that situation. They might have interest rates low, because they are justified by the market, i.e. less money printing and lower trade deficits. In that case it might be better to borrow in the U.S. Does it matter for WM? Maybe. $20 billion seems like a large amount, and if they just lose 1% annually that would be $200 million. Quite significant compared to earnings of $3 billion.
Good luck with your short Poway. I haven’t gotten enough information on this, but the long-term chart sure looks like bearish flag if it cracks. Wonder what ChrisJ has to say to this.

[rseiser]

Poway, thanks for digging this up, as it is another nugget I didn’t know about at all. I suppose, one would have to be intimately familiar with the banks’ practices to paint a full picture of what is going on in their balance sheets. All these little things together might absolutely be capable of putting the nail in some of the banks’ coffins. I heard another thing on an older Jim Puplava show, that I don’t know if it has been discussed before. Despite selling off their mortgages as packaged instruments on wall-street, the guest claimed that banks end up buying these back as a way of investing their reserves. According to him 60% of some banks’ reserves are sitting in these mortgage backed securities. As discussed on another thread, these MBS could be in some mid-range of risk, e.g. A or AA, but that hardly makes them bullet proof. The guest also claimed that the worse slices were still held by the banks, since they couldn’t be sold off so easily.

[rseiser]

leung, yes, that is what the broker generally wants to tell you, i.e. that you have to pay interest to borrow stock, and get interest from the cash raised, and that they cancel each other, and therefore you get nothing. I don’t believe this is true, since LTCM did it (“no hair-cut”), and I read that if you are a good client then you would have these better conditions (i.e. getting cash credited and not pay for borrowing stock). Also, quite frankly, who would get paid interest if your broker lends your MRK stock to some guy for short-selling? You don’t get anything, you only get the dividends, and when you sell your stock, you get the proceeds. So, on lending your MRK stock to a short-seller, the broker charges him the self-proclaimed “interest”. The broker doesn’t really deserve this interest, but it is a free-bee for him. I heard they are making good money from this.

Part two:
In-the-money puts have larger intrinsic values, i.e. the difference between strike price of the option and market price of the stock. They have nearly zero risk premiums since they are likely to end in-the-money as well. They do have, however, something I call “dividend premiums”, and (in the case of calls, mostly) “interest premiums”, since you are spared these extra expenses as opposed to shorting. Let’s take a random example: WM jan2008 $45 put. It currently trades at $5.80 and the stock is $41.90. Assuming these quotes are correct, I estimate that the option price (per share) is roughly composed of:
$3.10 intrinsic value,
$2.30 dividend (est. for the next 5 quarters)
$0.40 risk premium (for the risk of the stock rising above $45)
This seems like a better deal than shorting WM. When you short it, you have infinite risk, you have to pay the dividend, and you kind of have to pony up some cash to fund you margin account that you could otherwise use elsewhere.
With the option, your risk is only $5.80 (even if the stock goes up to $60), and that is all you have to send in to your broker. Assuming the stock doesn’t come your way and stays at $41.90 by Jan 2008, your option would be worth $3.10, and you lost $2.70 per share ($5.80-$3.10), so $270 for a contract of 100 shares. This $270 loss is a short-term capital loss subtracted from your short-term capital gains on Schedule D. Assuming you are net positive for the year you will save on some taxes. If you were short the stock, it would be more complicated to itemize your margin interest and your paid dividends.

[rseiser]

barnaby,
I don’t quite understand what you mean with shorting using TDAmeritrade. One time you mentioned that it was difficult, the other time you mention “short LEND and TDWaterhouse”. I am short all kinds of stocks in my TDWaterhouse acount, and it works very well. I never have to call them. I was even able to short rare stocks like “CLM” (not for the faint of heart). The only problem I found is that when shorting I don’t get credited the dollar amount versus my stocks on margin. So I still have to pay margin interest for some of my longs, and don’t get any interest for my shorts. This makes me tend to use in the money puts, that have another advantage for the small investor that premiums are automatically deducted from your profits, so your tax is reduced without itemizing.
I read that most retail-brokers don’t credit the short-balance against your margin (or pay interest). This puts you in a hole by 5% annually versus the professional. Does anyone know a broker that would credit the short-balance?

[rseiser]

I think these opposite views on the stock market over the next months are really interesting. Just from that we can confirm that indeed nothing is a sure thing. It will be interesting to revisit this in a few months after we know how it has played out.
While everything is possible due to short-term fluctuations or sentiment, investors would probably avoid highly priced stocks, while traders might as well go for it. Then there is of course a third group trying to short stocks. Everyone has to set his priorities, time-frame, conviction, and risk (e.g. stop-losses).
One thing I am always looking for are inconsistencies in the popular opinion. This is certainly the notion that money will now flow out of real-estate into stocks. What money, I would ask. It already has been flowing out of real-estate, with lower and lower payments and cash-out refinancings. Chances are that money has to start to flow into real-estate to bring up people’s equity or get out if they are under water.

[rseiser]

Everything is possible, so diversifyyyy!
Regarding the liquidity there are two schools of thought:
1) Those who believe that creation of dollars just devalue the dollar, and prices of everything will go up. They adhere strictly to the definition of inflation as the “supply of money and credit”.
2) Those who believe that money and credit creation props up certain assets for which they were created for.

I believe that it is probably to some extent both. If say the government prints money for a war, military companies (their shares and employees’ salaries) will go up most. While they in turn spend the money on raw materials and other goods, some of that (but not all) money will slowly flow through the economy and to some extent drive up other prices.
If say the government creates credit by lowering interest rates, they also influence a little what credit is created for (by all these little regulations, 401k rules, margin rules, GSEs, etc.). People since 1995 took credit mostly for houses or cashed out for consumer items, and few people took a loan to buy gold.
Creation of money always leads to driving up the price of gold, since money rarely gets removed from the system. Creation of credit has hardly helped buying of gold as we saw where it went in the 90s. If credit contracts, it is therefore unlikely that gold gets sold either. In a severe depression it could do worse than cash, but way better than the other assets. And in that case people might still buy gold as flight to safety. So, yes, if the government would insist on contracting credit, gold could go down. But how likely is that?

[rseiser]

I don’t think the government would purposely want to start a speculation in gold, since it wouldn’t impress the people (voters). Governments hate gold anyways, since they can’t tax and monitor the people if everyone avoids using his bank account and starts using gold. Also, they want to pay their government bills and salaries, and by buying gold, they would have to print even more money for themselves to offset the money they already printed for gold. And last, the US doesn’t produce as much gold as South-America/Africa/Australia, so a high price would benefit those countries. Even in good faith, gold doesn’t really create any productive capacity or jobs, at least in the stock and RE bubble the beneficiaries were in the US.
There could be, however, inadvertent buying of gold by the government if things get really bad, and the dollar collapses. To restore faith, or later to be able to sell bonds, the government might slowly accumulate gold to have something real after the crash. This is in my opinion the reason why they don’t sell any now.

[rseiser]

I just watched both shows that my friend recorded for me. Rich is excellent. Jolly is a loser.
We were cracking up on his last comment: “Buy a house in San Diego, and your children and grand children will thank you.”
My response: “Yes, I also think the drop will be so severe that it will take 1-2 generations to break even again!”, haha.

[rseiser]

So I guess 1:0 for RightSide. I am also short it since April and will cover some tomorrow.

[rseiser]

Here are some excerpts from the Jim Puplava show. It makes you think that the government really doesn’t want housing to drop and rather print money. I am surprised that Bernanke seems to be the most reasonable, since he at least tried to rase rates. (At least so far)

[rseiser]

I think the government will probably try to go the middle road: Basically print enough money to partially offset the credit contraction. Like you say, it won’t be enough to keep housing or the stock market elevated, but other prices will still rise. Necessities will rise, and gold and agricultural commodities might rise the most. By being in the middle of the two evils, they upset the least voters. Houses drop 30% and gasoline rises 30%? Wouldn’t you try to do the same if you were Bernanke?

[rseiser]

PS, let me answer and let’s see if jepsd comes up with the same.
-Yes, they can lower interest rates to some extent using the slowing economy (falling asset prices) as an excuse.
-Yes, we will be fine ultimately, just have to work hard and enjoy very little for a while.
-Yes, they print the difference only. (Plus what the US prints I guess)
-It is currently a loss to China, since they could also give the printed money (or the exported product) to their citizens. It’s like lending a relative money (you don’t really expect it back, since he is a nice guy)
-When people expect bad times they will not buy, no matter how much money or incentive you give them, except they might buy for hoarding (e.g. gold). This was the Depression and Japan.
-China wants to stop at some point, but according to them doesn’t want to upset the system. So they take the loss to try and build a world-wide customer base, good political relations, a good banking system, infrastructure, etc.

[rseiser]

Well, call me skeptical, but I haven’t been in China, only in India, so I might not know enough. Obviously, Jim Rogers thinks they are the greatest economy of the future, since he even teaches his daughter Chinese. What worries me is this hype connected with China. Sure they produce real things, but nothing grows to the moon that fast. They had phenomenal growth and it might need a pause. A stop of the frenzy in the US might do it to them. Readjust some of their mal-investments. This costs a lot of money. It reminds me a lot of Silicon Valley. Yeah it was the greatest, and then suddenly all buildings and freeways were empty. I would never invest from a value stand-point in something that already has gone that far, and where everyone talks about it. It could, however, happen that they have a stumble, and after that they continue as the winner.
I think you should research the 1921 recession. It was the same with the US and Europe, where Europe was sucking up debt, and the US was providing it, and when it stopped the US went into a severe recession. They recovered very quickly though. jepsd knows more about it.

[rseiser]

sfobserver is right on, and I also agree that equity was not double counted in the initial example. But there are many other costs that make up for the accumulated equity. I mean, the example was for 30 years, and don’t tell me it doesn’t cost continuously more than a few hundred dollars per month if you include occasional remodeling. I have never owned a house, but it is apparent to me what some friends spend time and money on their houses.

REGARDLESS OF ALL THAT:
The main point I think is the one Rich points out in his bubble primers: Houses do occasionally trade at bottoms in terms of mortgage/rent or price/income. You just can’t afford to buy at the top of the range and then see it drop to the bottom. The loss is just too great (unless you don’t care about the money), and will be there regardless of most twists of comparing costs.

[Author]

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