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« Agnico-Eagle: Reserves at Record Levels | Main | Gold: The HUI does not want to play! »

A Bet Against The Banks

Aside from our main investments in gold, silver and uranium, we have take a speculative position on the US financial sector.

IYF 130208

The problems of the financial sector begun with the sub-prime crisis but we believe it will spread to all areas of real estate and this will have a massive impact on a myriad of financial sectors, such as bond insurance companies, all across the world.

It is clear to us that this Bernanke led Fed committee is nothing but a one trick pony when it comes to solving economic turmoil. The base rate is already below the rate of inflation and although the Fed can continue to cut interest rates as much as they like, the question is: Will banks lend money below the rate of inflation?

In reality this would be equivalent to throwing away money; blatant, deliberate loss of wealth.

We don't see how the banks can escape more massive write downs and gigantic losses. If they lower the interest rates on their loans as the Fed cuts rates, the rate will drop below the rate of inflation, and so the banks will be losing money hand over fist (in real terms) everyday. If they choose to hold their loan rates as the Fed lowers the base rate, then they will be faced with more loan defaults and repossessions by people who cannot afford the payments. These repossessed properties will not fetch nearly as much needed to cover the reckless loans made the banks in the first place. So either way, they loose.

The bottom line for these reckless financial companies cannot be avoided. The bottom line is that they have made bad loans and risky investments which have turned against them and they will lose money. Big time. There is no coming back for the financial sector, not for a long time.

But its not just the banks that made bad loans that are suffering. These loans were packaged up into separate entities and then sliced up into bonds. These bonds were insured by companies such as Ambac and MBIA against default, insurance companies with AAA ratings from agencies such as Standard and Poors. As these “bonds” were insured by AAA rated bond insurance companies, rating agencies automatically gave the bonds AAA ratings. So investors and investment banks across the globe saw these AAA rated high yielding bonds and jumped at the chance to get aboard the doomed ship.

Then the music stopped.

Home-owners started to default on their loans, which meant the insurance companies were forced to pay out on the home loan backed bonds they had insured. A multitude of pay-outs meant these insurance companies didn't look as healthy on paper so the rating agencies started to question their AAA ratings. As the bond insurers get downgraded from AAA, so do the bonds they have insured. Therefore these bonds are far less attractive to investors, who stop buying them, sending the value sharply south. In addition to this, many investment funds are forced to dump the bonds as soon as they are downgraded from AAA, as their brief only allows them to hold AAA rated investments. This sends their value even further down and so the balance sheets of every bank, investment bank and investor who bought into this dream money machine, get extremely ugly.

Taking a look at the financial sector as a whole via the chart of Financial iShares above we can see that it is not a pretty picture. Financial iShares is an ETF (Exchange Traded Fund) that tracks the progress of the US financial sector. The MACD and moving averages have given bearish crossover signals and the STO, as well as other technical indicators, are heading south in a determined downtrend. The represents what has happened across the board in the financial stocks with exposure to the crisis.

This crisis is far from over. This is why we have begun to build a speculative short position on US financial stocks. We bought a position in an ETF called Ultra Short Financials ProShares, (AMEX:SKF) today at US$110.36. We have had an eye on shorting US financials for some time now, but we were waiting for the right opportunity. However the STO is heading higher and the MACD has given a bullish signal for SKF after the ETF corrected from making a high of around US$130.

SKF 130208

We are comfortable with buying an initial position at these levels and we may increase this position if the opportunity presents itself. For those not familiar with these financial instruments, an ETF trades exactly the same as any other stock. Each share represents a holding in the fund, and the share price varies depending on the value of the fund's holdings. In this case the fund's holdings are designed to offer an inverse relationship to the Dow Jones US Financials Index with leverage of 200%. So if the Dow Jones US Financials Index falls 10%, SKF should rise 20%, in theory. In practice the ETF will never follow its underlying index exactly, nor trade at the NAV of its holdings 100% of the time, but it is usually close. It should be noted that at any one time this fund holds a variety of options and futures contracts and also has the right to hold derivatives in order to meet its brief of providing an inverse relationship with the Dow Jones US Financials Index with leverage of 200%.

The top holdings of the Dow Jones US Financials Index include names such as; Bank of America Corp. (7.08%), JPMorgan Chase & Co. (5.63%) and Citigroup Inc (5.58%). We feel that with the continuing credit crisis and severe recession that will set in this year, these companies and this index will suffer greatly, which will push SKF much higher. In fact in our opinion this “credit crisis” is not about credit at all, it is about solvency, and many financials are simply going bankrupt and so we have begun to build a short position to profit from this.

You can stay updated on our investment decisions, trading signals and market commentary by subscribing to one of our FREE emailed newsletters, click here for more information.

As this is not an investment in gold, silver or uranium, it will not feature in any of our free online model portfolios, although we will provide updates on this investment and the situation in the financial sector as it affects the entire market.

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Reader Comments (7)

The SKF, ETF sounds like a logical deal and it looks like you have done your homework and due diligence. We plan to take a position also, and ask that you keep us apprised of developments and particularly of any changes in your feeling about this investment. Thank you.


February 14, 2008 | Unregistered CommenterJohn Ell

wow... you have some brass ones. That is a tough call to make. I wish you best of luck with that trade and will keep my eye on it - SKF is going into my watch list for sure.

I guess my question regarding this is - what is the reporting calendar looking like for the next wave of financials? Do you think they'll announce any further writedowns in their quarterly reports announcements or will they wait until their next annuals?

Because if they come out with billions more in writedowns it's going to kill any rallies in gold or uranium for sure.

February 14, 2008 | Unregistered Commenterjgr

Your position in SKF is sound.

I have been in Ultra short real estate (SRS) since Oct and done very well.

Dan K

February 14, 2008 | Unregistered CommenterDan K

re: jgr comment -- uranium already depressed so downside should be minimal, just a longer wait until it comes into its own, but other than temporary static for gold stocks, the gold bull should be invigorated by bad news on the financials.

February 14, 2008 | Unregistered CommenterJim Smith

I have been in and out of skf and have done well. I am looking to get back in under 105. my puts on jpm, bac, mer have done ok but news comes out daily to counter any down trend. My best short has been mastercard. I cannot find out if they hold much of their own paper. I would appreciate any information on their debt quality.

John Connelly

February 14, 2008 | Unregistered Commenterjohn c

Thanks for the input Jim, hope you are right about the downside pressure being minimal, but I suspect the summer may have a surprise in store for us. And investor confidence is fragile, so a blanket profit-taking day like today can have more negative impact than usual I worry.

In any case, my question is more about the financials and their reporting habits. Will banks announce further writedowns when they announce quarterly results, or do they only announce writedowns with their annual results?

If they only do so annually, we may have some breathing room to grow without as much fear-based selling as we've had in the past bit here.

Shorting Mastercard isn't a bad idea. I would look at shorting some of those Solar companies as well if you have the risk tolerance.

February 15, 2008 | Unregistered Commenterjgr

I would be careful on this one.If we go into hyper-inflation which I believe we will, a lot of new "Cheap" and "Foreign" money will pour into the financials because they are perceived as "Bargains".
During the Weimar Republic the stock market went up to infinity, not down.
I am sticking with gold buillion, gold majors, juniors, OIL ETF,

February 15, 2008 | Unregistered CommenterRollo

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