NY Times: “When you buy protection against an event that you have a hand in causing, you are buying fire insurance on someone else’s house and then committing arson.”

Mr. Lippmann made his pitch to select hedge fund clients, arguing they should short the mortgage market. He sometimes distributed a T-shirt that read “I’m Short Your House!!!” in black and red letters.

While the investigations are in the early phases, authorities appear to be looking at whether securities laws or rules of fair dealing were violated by firms that created and sold these mortgage-linked debt instruments and then bet against the clients who purchased them,

Editor’s Note: It would be wise to pay careful attention to news reports and press releases from investigating agencies and to track the discovery in class action and other cases filed. A lot of your work might already be done, right down to the same lender you are  dealing with.

Banks Bundled Bad Debt, Bet Against It and Won

In late October 2007, as the financial markets were starting to come unglued, a Goldman Sachs trader, Jonathan M. Egol, received very good news. At 37, he was named a managing director at the firm.

Mr. Egol, a Princeton graduate, had risen to prominence inside the bank by creating mortgage-related securities, named Abacus, that were at first intended to protect Goldman from investment losses if the housing market collapsed. As the market soured, Goldman created even more of these securities, enabling it to pocket huge profits.

Goldman’s own clients who bought them, however, were less fortunate.

Pension funds and insurance companies lost billions of dollars on securities that they believed were solid investments, according to former Goldman employees with direct knowledge of the deals who asked not to be identified because they have confidentiality agreements with the firm.

Goldman was not the only firm that peddled these complex securities — known as synthetic collateralized debt obligations, or C.D.O.’s — and then made financial bets against them, called selling short in Wall Street parlance. Others that created similar securities and then bet they would fail, according to Wall Street traders, include Deutsche Bank and Morgan Stanley, as well as smaller firms like Tricadia Inc., an investment company whose parent firm was overseen by Lewis A. Sachs, who this year became a special counselor to Treasury Secretary Timothy F. Geithner.

How these disastrously performing securities were devised is now the subject of scrutiny by investigators in Congress, at the Securities and Exchange Commission and at the Financial Industry Regulatory Authority, Wall Street’s self-regulatory organization, according to people briefed on the investigations. Those involved with the inquiries declined to comment.

While the investigations are in the early phases, authorities appear to be looking at whether securities laws or rules of fair dealing were violated by firms that created and sold these mortgage-linked debt instruments and then bet against the clients who purchased them, people briefed on the matter say.

One focus of the inquiry is whether the firms creating the securities purposely helped to select especially risky mortgage-linked assets that would be most likely to crater, setting their clients up to lose billions of dollars if the housing market imploded.

Some securities packaged by Goldman and Tricadia ended up being so vulnerable that they soured within months of being created.

Goldman and other Wall Street firms maintain there is nothing improper about synthetic C.D.O.’s, saying that they typically employ many trading techniques to hedge investments and protect against losses. They add that many prudent investors often do the same. Goldman used these securities initially to offset any potential losses stemming from its positive bets on mortgage securities.

But Goldman and other firms eventually used the C.D.O.’s to place unusually large negative bets that were not mainly for hedging purposes, and investors and industry experts say that put the firms at odds with their own clients’ interests.

“The simultaneous selling of securities to customers and shorting them because they believed they were going to default is the most cynical use of credit information that I have ever seen,” said Sylvain R. Raynes, an expert in structured finance at R & R Consulting in New York. “When you buy protection against an event that you have a hand in causing, you are buying fire insurance on someone else’s house and then committing arson.”

Investment banks were not alone in reaping rich rewards by placing trades against synthetic C.D.O.’s. Some hedge funds also benefited, including Paulson & Company, according to former Goldman workers and people at other banks familiar with that firm’s trading.

Michael DuVally, a Goldman Sachs spokesman, declined to make Mr. Egol available for comment. But Mr. DuVally said many of the C.D.O.’s created by Wall Street were made to satisfy client demand for such products, which the clients thought would produce profits because they had an optimistic view of the housing market. In addition, he said that clients knew Goldman might be betting against mortgages linked to the securities, and that the buyers of synthetic mortgage C.D.O.’s were large, sophisticated investors, he said.

The creation and sale of synthetic C.D.O.’s helped make the financial crisis worse than it might otherwise have been, effectively multiplying losses by providing more securities to bet against. Some $8 billion in these securities remain on the books at American International Group, the giant insurer rescued by the government in September 2008.

From 2005 through 2007, at least $108 billion in these securities was issued, according to Dealogic, a financial data firm. And the actual volume was much higher because synthetic C.D.O.’s and other customized trades are unregulated and often not reported to any financial exchange or market.

Goldman Saw It Coming

Before the financial crisis, many investors — large American and European banks, pension funds, insurance companies and even some hedge funds — failed to recognize that overextended borrowers would default on their mortgages, and they kept increasing their investments in mortgage-related securities. As the mortgage market collapsed, they suffered steep losses.

A handful of investors and Wall Street traders, however, anticipated the crisis. In 2006, Wall Street had introduced a new index, called the ABX, that became a way to invest in the direction of mortgage securities. The index allowed traders to bet on or against pools of mortgages with different risk characteristics, just as stock indexes enable traders to bet on whether the overall stock market, or technology stocks or bank stocks, will go up or down.

Goldman, among others on Wall Street, has said since the collapse that it made big money by using the ABX to bet against the housing market. Worried about a housing bubble, top Goldman executives decided in December 2006 to change the firm’s overall stance on the mortgage market, from positive to negative, though it did not disclose that publicly.

Even before then, however, pockets of the investment bank had also started using C.D.O.’s to place bets against mortgage securities, in some cases to hedge the firm’s mortgage investments, as protection against a fall in housing prices and an increase in defaults.

Mr. Egol was a prime mover behind these securities. Beginning in 2004, with housing prices soaring and the mortgage mania in full swing, Mr. Egol began creating the deals known as Abacus. From 2004 to 2008, Goldman issued 25 Abacus deals, according to Bloomberg, with a total value of $10.9 billion.

Abacus allowed investors to bet for or against the mortgage securities that were linked to the deal. The C.D.O.’s didn’t contain actual mortgages. Instead, they consisted of credit-default swaps, a type of insurance that pays out when a borrower defaults. These swaps made it much easier to place large bets on mortgage failures.

Rather than persuading his customers to make negative bets on Abacus, Mr. Egol kept most of these wagers for his firm, said five former Goldman employees who spoke on the condition of anonymity. On occasion, he allowed some hedge funds to take some of the short trades.

Mr. Egol and Fabrice Tourre, a French trader at Goldman, were aggressive from the start in trying to make the assets in Abacus deals look better than they were, according to notes taken by a Wall Street investor during a phone call with Mr. Tourre and another Goldman employee in May 2005.

On the call, the two traders noted that they were trying to persuade analysts at Moody’s Investors Service, a credit rating agency, to assign a higher rating to one part of an Abacus C.D.O. but were having trouble, according to the investor’s notes, which were provided by a colleague who asked for anonymity because he was not authorized to release them. Goldman declined to discuss the selection of the assets in the C.D.O.’s, but a spokesman said investors could have rejected the C.D.O. if they did not like the assets.

Goldman’s bets against the performances of the Abacus C.D.O.’s were not worth much in 2005 and 2006, but they soared in value in 2007 and 2008 when the mortgage market collapsed. The trades gave Mr. Egol a higher profile at the bank, and he was among a group promoted to managing director on Oct. 24, 2007.

“Egol and Fabrice were way ahead of their time,” said one of the former Goldman workers. “They saw the writing on the wall in this market as early as 2005.” By creating the Abacus C.D.O.’s, they helped protect Goldman against losses that others would suffer.

As early as the summer of 2006, Goldman’s sales desk began marketing short bets using the ABX index to hedge funds like Paulson & Company, Magnetar and Soros Fund Management, which invests for the billionaire George Soros. John Paulson, the founder of Paulson & Company, also would later take some of the shorts from the Abacus deals, helping him profit when mortgage bonds collapsed. He declined to comment.

A Deal Gone Bad, for Some

The woeful performance of some C.D.O.’s issued by Goldman made them ideal for betting against. As of September 2007, for example, just five months after Goldman had sold a new Abacus C.D.O., the ratings on 84 percent of the mortgages underlying it had been downgraded, indicating growing concerns about borrowers’ ability to repay the loans, according to research from UBS, the big Swiss bank. Of more than 500 C.D.O.’s analyzed by UBS, only two were worse than the Abacus deal.

Goldman created other mortgage-linked C.D.O.’s that performed poorly, too. One, in October 2006, was a $800 million C.D.O. known as Hudson Mezzanine. It included credit insurance on mortgage and subprime mortgage bonds that were in the ABX index; Hudson buyers would make money if the housing market stayed healthy — but lose money if it collapsed. Goldman kept a significant amount of the financial bets against securities in Hudson, so it would profit if they failed, according to three of the former Goldman employees.

A Goldman salesman involved in Hudson said the deal was one of the earliest in which outside investors raised questions about Goldman’s incentives. “Here we are selling this, but we think the market is going the other way,” he said.

A hedge fund investor in Hudson, who spoke on the condition of anonymity, said that because Goldman was betting against the deal, he wondered whether the bank built Hudson with “bonds they really think are going to get into trouble.”

Indeed, Hudson investors suffered large losses. In March 2008, just 18 months after Goldman created that C.D.O., so many borrowers had defaulted that holders of the security paid out about $310 million to Goldman and others who had bet against it, according to correspondence sent to Hudson investors.

The Goldman salesman said that C.D.O. buyers were not misled because they were advised that Goldman was placing large bets against the securities. “We were very open with all the risks that we thought we sold. When you’re facing a tidal wave of people who want to invest, it’s hard to stop them,” he said. The salesman added that investors could have placed bets against Abacus and similar C.D.O.’s if they had wanted to.

A Goldman spokesman said the firm’s negative bets didn’t keep it from suffering losses on its mortgage assets, taking $1.7 billion in write-downs on them in 2008; but he would not say how much the bank had since earned on its short positions, which former Goldman workers say will be far more lucrative over time. For instance, Goldman profited to the tune of $1.5 billion from one series of mortgage-related trades by Mr. Egol with Wall Street rival Morgan Stanley, which had to book a steep loss, according to people at both firms.

Tetsuya Ishikawa, a salesman on several Abacus and Hudson deals, left Goldman and later published a novel, “How I Caused the Credit Crunch.” In it, he wrote that bankers deserted their clients who had bought mortgage bonds when that market collapsed: “We had moved on to hurting others in our quest for self-preservation.” Mr. Ishikawa, who now works for another financial firm in London, declined to comment on his work at Goldman.

Profits From a Collapse

Just as synthetic C.D.O.’s began growing rapidly, some Wall Street banks pushed for technical modifications governing how they worked in ways that made it possible for C.D.O.’s to expand even faster, and also tilted the playing field in favor of banks and hedge funds that bet against C.D.O.’s, according to investors.

In early 2005, a group of prominent traders met at Deutsche Bank’s office in New York and drew up a new system, called Pay as You Go. This meant the insurance for those betting against mortgages would pay out more quickly. The traders then went to the International Swaps and Derivatives Association, the group that governs trading in derivatives like C.D.O.’s. The new system was presented as a fait accompli, and adopted.

Other changes also increased the likelihood that investors would suffer losses if the mortgage market tanked. Previously, investors took losses only in certain dire “credit events,” as when the mortgages associated with the C.D.O. defaulted or their issuers went bankrupt.

But the new rules meant that C.D.O. holders would have to make payments to short sellers under less onerous outcomes, or “triggers,” like a ratings downgrade on a bond. This meant that anyone who bet against a C.D.O. could collect on the bet more easily.

“In the early deals you see none of these triggers,” said one investor who asked for anonymity to preserve relationships. “These things were built in to provide the dealers with a big payoff when something bad happened.”

Banks also set up ever more complex deals that favored those betting against C.D.O.’s. Morgan Stanley established a series of C.D.O.’s named after United States presidents (Buchanan and Jackson) with an unusual feature: short-sellers could lock in very cheap bets against mortgages, even beyond the life of the mortgage bonds. It was akin to allowing someone paying a low insurance premium for coverage on one automobile to pay the same on another one even if premiums over all had increased because of high accident rates.

At Goldman, Mr. Egol structured some Abacus deals in a way that enabled those betting on a mortgage-market collapse to multiply the value of their bets, to as much as six or seven times the face value of those C.D.O.’s. When the mortgage market tumbled, this meant bigger profits for Goldman and other short sellers — and bigger losses for other investors.

Selling Bad Debt

Other Wall Street firms also created risky mortgage-related securities that they bet against.

At Deutsche Bank, the point man on betting against the mortgage market was Greg Lippmann, a trader. Mr. Lippmann made his pitch to select hedge fund clients, arguing they should short the mortgage market. He sometimes distributed a T-shirt that read “I’m Short Your House!!!” in black and red letters.

Deutsche, which declined to comment, at the same time was selling synthetic C.D.O.’s to its clients, and those deals created more short-selling opportunities for traders like Mr. Lippmann.

Among the most aggressive C.D.O. creators was Tricadia, a management company that was a unit of Mariner Investment Group. Until he became a senior adviser to the Treasury secretary early this year, Lewis Sachs was Mariner’s vice chairman. Mr. Sachs oversaw about 20 portfolios there, including Tricadia, and its documents also show that Mr. Sachs sat atop the firm’s C.D.O. management committee.

From 2003 to 2007, Tricadia issued 14 mortgage-linked C.D.O.’s, which it called TABS. Even when the market was starting to implode, Tricadia continued to create TABS deals in early 2007 to sell to investors. The deal documents referring to conflicts of interest stated that affiliates and clients of Tricadia might place bets against the types of securities in the TABS deal.

Even so, the sales material also boasted that the mortgages linked to C.D.O.’s had historically low default rates, citing a “recently completed” study by Standard & Poor’s ratings agency — though fine print indicated that the date of the study was September 2002, almost five years earlier.

At a financial symposium in New York in September 2006, Michael Barnes, the co-head of Tricadia, described how a hedge fund could put on a negative mortgage bet by shorting assets to C.D.O. investors, according to his presentation, which was reviewed by The New York Times.

Mr. Barnes declined to comment. James E. McKee, general counsel at Tricadia, said, “Tricadia has never shorted assets into the TABS deals, and Tricadia has always acted in the best interests of its clients and investors.”

Mr. Sachs, through a spokesman at the Treasury Department, declined to comment.

Like investors in some of Goldman’s Abacus deals, buyers of some TABS experienced heavy losses. By the end of 2007, UBS research showed that two TABS deals were the eighth- and ninth-worst performing C.D.O.’s. Both had been downgraded on at least 75 percent of their associated assets within a year of being issued.

Tricadia’s hedge fund did far better, earning roughly a 50 percent return in 2007 and similar profits in 2008, in part from the short bets.

Gold is getting a nice little pop this morning and the ABX trade is working nicely.  Here’s another chart with a pretty little pattern and possibilities –

This will be the last post unless I see something amazing in the market.  Enjoy some holiday time and I’ll see you Sunday p.m.

Merry Christmas!

If there was a single trading event for investors, traders, and speculators from early October to early December, it was not stocks and was not bonds.  It was not even the bet against the US Dollar.   It was the bright shiny yellow stuff… Gold.  Gold rose by over 20% in dollar-terms.  The DJIA is up close to 10% since then and the S&P is up almost 8% in the same period.  Longer-dated Treasury notes and bonds have not made any real money in that time.  Yet gold has pulled back now that the US Dollar has gotten off its back, and the pullback from the highs is now at about 10% in price.  We took a look at many issues to see if a top has been put in or if this pullback is a significant buying opportunity.

On top of tracking the key ETF, the SPDR Gold Shares (GLD).  We also wanted to take a look at the Market Vectors Gold Miners ETF (NYSE: GDX) and its three key components of Barrick Gold Corporation (NYSE: ABX), Goldcorp Inc. (NYSE: GG), and Newmont Mining Corp. (NYSE: NEM).  Even the Market Vectors Junior Gold Miners ETF (NYSE: GDXJ) is worth noting here.

The first issue is the chart and what the technical patterns are saying.  Adam Hewison, a well-known technician and an affiliate of ours at INO, has provided a quick audio-video chart analysis.  His take is that gold has entered the silly season now that we are outside of the bands and on the backside of December 15.

We wanted to take our own look at this on the charts, and it seems very much a similar case.  After looking at the charts going back a year, gold could go back down to $1,050.00 or even closer to $1,000.00 per ounce before any long-term uptrend on the chart is violated.  Near-term is entirely different.  The bullish pattern has definitely been violated, and frankly this is what we’d refer to as a technical No Man’s Land.

Then there is the fundamental issue about gold and the ties to the Dollar and to interest rates.  It is true that the United States has been an outright violator of trust with our new deficit path and violations of the old debt ceiling.  We have billions, if not trillions, of dollars that may come into the money supply over the coming years.  The Chinese and the Middle East obviously want a hedge on protecting themselves from a weakening dollar.  The saving grace for the US greenback is Europe and the E.U. via the Euro.  Greece is in trouble with the ratings agencies.  Ireland, Spain, Austria, and other locales in Eastern Europe are potentially on the ropes.  The Brits are not a part of the Euro, but the Pound Sterling is at risk if it can’t quell the recent fears brought in by the ratings agencies.  Not everyone can hide in commodities, so any further developments in the E.U. would effectively take away the risk that the U.S. Dollar would further lose its position as the world’s reserve currency.

Then there is the notion of what will happen to US interest rates.  As of yesterday, the belief is that a Fed Funds hike will come in the summer of 2010.  That is too late if you take a snapshot today, but it is still now more likely.  A personal take is that this generally ramps faster and faster if strength or less weakness can remain.  The US Dollar Index may not be out of trouble entirely, but any rise in rates in the U.S. should offer at least a temporary floor to the US Dollar.  When was the last time you saw an interest rate cycle change and end on a “one and done” move by central banks?  If the US Dollar strengthens after a multi-year slide south, that will take away one of the major catalysts for gold bulls.

The recent pullback in gold has been seen in the gold miners and producers.  We usually take a look at the components inside the Market Vectors Gold Miners ETF (NYSE: GDX) to get a feel for the move between spot gold prices and the producers of gold.  That ETF is now down 18% from recent highs if you count the 5% slide today.  Barrick Gold Corporation (NYSE: ABX) is the largest component, Goldcorp Inc. (NYSE: GG) is the second largest component, and Newmont Mining Corp. (NYSE: NEM) is the third largest component.  The total ETF weighting for those three alone is almost 34%.  Here is the percentage price drop seen in each from recent highs: Barrick down almost 20%, Goldcorp down 18%, and Newmont down almost 16%.  Keep in mind that this is after large losses today.

Then came the launch of the Market Vectors Junior Gold Miners ETF (NYSE: GDXJ) in November.  This has been actively traded as traders look for leveraged bets on gold, and surprisingly it is only down about 16% from its post-launch highs.  ETFs of this cult caliber would be like having the second or third solar ETF or alternative energy ETF.  They may not mark a top, but they rarely come at any market or sector bottom.

There is a huge wild card for the gold sector which has yet to gather any steam.  Whether you like the CFTC or the administration of today, the reality is that its new directive is likely to be in force until the end of 2012 and it will not be even up for debate as to whether any real regime change in the U.S. is possible until after Congress’ mid-term elections.  That being said, imagine if the SPDR Gold Shares (NYSE: GLD) is deemed too large by regulators similar to what we have seen in energy ETF products, or even worse that it is an outright direct influence on the price of gold…. and therefor a direct cause of inflation.  Suddenly, there could be billions and billions worth of dollars in gold bullion hitting the market as the GLD is one of the top holders of gold in the world.  For the gold bulls, the good news is that this is not an alarm being sounded elsewhere by other market observers and it may never even come up as an issue.

Unfortunately this still leaves a question mark for beyond what is just the rest of 2009.  If you rate what economists, traders, and analysts all say on interviews and television report now compared to a month ago, that field is now looking just as split.  Dennis Gartman even sounded mixed in his latest call.  A final bit of insight here is that when these choppy patterns go into the technical no man’s land, it requires being right every day to be profitable.  What seems obvious now is that the straight line to $1,300.00 or $1,400.00 in gold is no longer one that is put in as a “definitely until told otherwise” status.

JON C. OGG

These are Monday’s top ten analyst upgrades, downgrades, and initiations seen from early Wall Street research calls:

Agrium Inc. (NYSE: AGU) Raised to Buy at UBS.
Barrick Gold Corporation (NYSE: ABX) Cut to Neutral at Credit Suisse.
Brocade Communications (NASDAQ: BRCD) Raised to Outperform at Oppenheimer.
DuPont (NYSE: DD) Cut to Neutral at Credit Suisse.
Juniper Networks Inc. (NASDAQ: JNPR) Cut to Sell at Auriga.
Marsh & McLennan Companies, Inc. (NYSE: MMC) Cut to Neutral at Goldman Sachs.
Potash Corp. of Saskatchewan (NYSE: POT) Raised to Buy at Goldman Sachs; Target raised to $120 at UBS.
SunPower Corporation (NASDAQ: SPWRA) Raised to Overweight at Barclays.
Suntech Power (NYSE: STP) Raised to Overweight at Barclays.

You can join our open email distribution list to hear more news on key analyst calls, top day trader alerts, mergers and acquisitions, Buffett and other investment gurus, IPOs, secondary offerings, private equity, and more.

Jon C. Ogg

Well Friday was certainly not what I expected. It felt like during the week that perhaps we would roll over much earlier than I had anticipated; but now it feels like we might move up some more. Hence I thought Friday might just be that day. As Yoda would say ” conflicted am I”. I still think we are in for a nice down move , and it may begin this week, but the key will be when we hit those shoulder resistance lines and whether they hold or give way. It looks to me like most of them are leaning to acting as resistance.

We don’t have news like we did last week, just Thursday and Friday so it will be earnings and surprise news that will move us. I am still convinced that the v shows us that the institutional sellers have not yet stepped in, and when they do I think we will see a sell off like we did last Friday. So keep on eye on the VIX, all the indexes and the UUP, which had some massive buying this week. I am seeing weakness in AAPL and RIMM two of the NASDAQ big boys, so I may continue to use the QQQQ as my trading venue. Now onto this week’s video:

Tidy up time

After another gruelling week in Snorestore’s own version of la la land, today has been a much more relaxed affair. No postal strikes for a change, bonfire parties to look forward to at the weekend, and lots of messing about on Twitter to fill in the gaps.

In an idle moment, we asked what items were on your desk that didn’t ought to be there. For us it was simple: lego, an electric toothbrush manual and a loo roll. Other people owned up to wine bottle corks, stones, mini screwdrivers and berets.

What’s on your desk which should not strictly be there?

Yesterday’s surprise move from India that sent gold through the roof to almost $1,085.00 per ounce was a game changing event in gold.  Many technical analysts and chartists were looking for, or at least hoping for, a further consolidation in the price of the shiny yellow stuff.  Yet now that appears to not be the case.  This has broad ramifications for the SPDR Gold Shares (NYSE: GLD) and for Market Vectors Gold Miners ETF (NYSE: GDX); and it also of course will help push top-line and bottom line improvements to the likes of two of the huge players of Barrick Gold Corporation (NYSE: ABX) and for Goldcorp Inc. (NYSE: GG).  This morning we received an audio-visual slide show technical analysis presentation from one of our affiliates INO.  This was by Adam Hewison, who we have noted was making a big gold call for a move to $1,100 and then $1,200 or even higher back when gold prices were consolidating and well under the $1,000 mark.

With gold now right at the $1,095.00 mark, that video adds more outlook and data about what to expect.  Particularly considering that the $1,100 level may be a psychological figure.

All the gold plays we track as the go-to instruments are chasing the metal higher this morning.  The SPDR Gold Shares (NYSE: GLD) is up 0.85% at $107.36 and the new intra-day and all-time high for the instrument is $107.50.

The Market Vectors Gold Miners ETF (NYSE: GDX) is up 2.1% at $47.15, yet this is short of the early 2008 highs when this went briefly above $50.00.  Its two largest components are Barrick Gold Corporation (NYSE: ABX), up 1.5% at $39.76 (year high is $42.10), and then Goldcorp Inc. (NYSE: GG) is up only 0.2% at $40.21 (year high is $43.41).

India’s play yesterday was a potential game-changer and is a move into hard assets rather than into US Dollar assets.  The timing was probably well off, and many traders and investors are hoping that India caught the top or at least that will mark a key event in the currency. Unfortunately that charts are saying something else now.

JON C. OGG

Pts with corneal abrasions should receive Pseudomonas prophylaxis if:

1. Organic FB
2. Contact lens users
3. Acrylic nails

The guys over at The Hood Internet posted their 300th track earlier this week, ABX’s mash-up of Biz Markie, Phoenix and Classixx. It’s amazing, which is what you should always expect from The Hood Internet. Check it out below.

To celebrate the posting of their 300th track, the duo will release The Mixtape: Volume 4 on November 9th. Be prepared.

These are today’s unusual options trading patterns seen late in the afternoon.  We have provided links over to VSInvestor.com for more details on each situation:

• There have been two large options transactions in Barrick Gold Corporation (NYSE: ABX).
• Caterpillar Inc. (NYSE: CAT) is seeing some longer-term bullish recovery bets that may have been profit taking on a prior trade.
• Someone is making a big pre-earnings options trade in Expedia, Inc. (NASDAQ: EXPE).
• Traders are placing bets both for and against a Sun Microsystems Inc. (NASDAQ: JAVA) buyout by Oracle Corp. (NASDAQ: ORCL) now that there are 3,000 more layoffs after the company keeps losing more and more money while the kids running the European Commission figure out that a money-losing company should not require a deep review of this sort for anti-competition.
• OptionsHawk.com notified us of nine-times options volume in Credit Suisse Group (NYSE: CS).

You can join our open email distribution list to get updates on top analyst upgrades and downgrades, top day trader alerts, IPO’s, secondary offerings, Warren Buffett and other guru activity, M&A and more.

JON C. OGG
OCTOBER 21, 2009

By Charles Rotblut
October 21, 2009

As gold sets new highs, it would only be natural to assume that profit forecasts for gold mining companies would be soaring too. Surprisingly, profit forecasts are not jumping.

Though some brokerage analysts have raised their full-year projections in recent weeks, the Zacks Consensus Estimate is not moving higher for most gold miners. Rather, it is essentially unchanged for Barrick Gold (ABX – Analyst Report), Eldorado (EGO – Snapshot Report), Goldcorp (GG – Snapshot Report) and most of their peers.

Where are we seeing increases are for companies that are significantly dependant on other metals, such as copper or silver. For example, the 2009 Zacks Consensus Estimate for Freeport-McMoRan (FCX – Analyst Report) has risen 67 cents over the past 30 days to $3.79 per share. (This morning, FCX reported third-quarter profits of $2.07 per share, topping forecasts for $1.14 per share). Analysts hadPan American Silver (PAAS – Snapshot Report) is also seeing expectations rise with the Zacks Consensus now at 75 cents per share, versus 70 cents a month ago.

Ore Quality Is An Issue
A big reason why the gold miners are not shining as brightly as the precious metal is the quality of the ore being mined. There is a general school of thought that the miners are digging up ore that is more difficult to process. As result, this is adversely impacting costs. When miners dig up gold, they are effectively taking rock out of the ground. Though the goal would be to just dig up gold, the actual rocks contain various other metals and minerals. This means the mining company has to separate the gold from the other metals. Ore is considered to be higher quality when there is a greater concentration of gold in the rocks. Conversely, ore is considered to be of lower quality if the rock contains less gold.

Obviously, it is in every miner’s best interest to dig up higher quality ore. However, as more and more gold is dug up, the quality of the ore decreases, hurting margins. It is this concern that has many analysts unwilling to raise their profit forecasts. Investors should note that this is not dissimilar to what is occurring with oil. Many of the newly discovered oil fields are in areas where it is expensive to drill in. An example is Brazil’s Tupi field, which lies several miles below sea level.

Not The First Time Analysts Have Been Cautious
What’s interesting about the lack of estimate revisions is that this is not the first time it has happened. Back in February, when gold broke above $1,000 for the first time this year, I pointed out that brokerage analysts were not raising their forecasts. (Read Why Gold Miners Are Not Glittering.) Rather, analysts were cutting forecasts at that time.

Since then, gold mining stocks have rallied with Market Vectors Gold Miners (GDX) gaining about 43%. However, had you invested in a fund that tracked the S&P 500 instead, you would have realized an approximate 42% return. In other words, you could have gotten a similar return with considerably more diversification by buying S&P 500 SPDR (SPY) instead of GDX. (An investment in gold, via Gold SPDR (GLD) would have only earned you an 11.2% return over the same period of time.)

As you can see, while gold has been rallying, it has not given investors the best opportunities to profit. The mixed earnings estimate picture for gold miners suggests that the risks of investing in these companies remains elevated. Though gold mining stocks could still go higher, especially if third-quarter margins are better than expected, there are industries whose short-term prospects are brighter.

Warren Buffett

Warren Buffett is a strictly a long-term investor with a holding period of “forever”. The fact that he is an investor prevents him from investing in gold. Gold will never earn any money, nor will it ever pay out dividends to its holders.

The only thing gold can do is precisely why I have been buying; it works extremely well as a store of value. An average automobile in 1950 would have cost the equivalent of approximately 30-40 ounces of gold. The same holds true today at the recent spot gold prices above $1000. Had you instead decided to hold cash, you would not even have enough money to pay for the down payment.

The most common reason cited by people bullish on gold is inflation and although it is certainly a contributing factor, I do not feel that this is the most important issue affecting gold prices. Instead, I believe that there are three other overarching trends taking place right now that are exerting much more upward pressure on the price of gold.

1.) Overall Depreciation of Currency
Normally if one government prints a lot of money, the currency will drop relative to other currencies. However, in situations like we have today when many governments are printing money (and some are managing their currencies to subsidize exports like the Chinese), you get a situation where fiat currencies as a whole become worth less relative to other stores of value such as gold and other commodities. There is only so much gold on this planet and it is usually pretty hard to get to which helps fundamental elements of supply and demand.

2.) Excess Liquidity and a Truly Damaged ‘Real Economy’
Despite the recent stock market rally, the real economy is still hurting badly and even though unemployment has been improving, we are still a long long long… pause… long way from adding jobs. Governments are also intervening in the markets in very unprecedented ways in the form of legislative overhauls, a massive stimulus bill that served mostly pork-barrel interests and the new role of the Government/Federal Reserve as the biggest lending facility in the world.

The poor state of the economy, along with the extreme uncertainty regarding the future business landscape and poor availability of lending facilities, it is not surprising that investors and entrepreneurs aren’t rushing into the real economy. They are instead putting their money into stocks, bonds, gold and commodities hoping to make at least modest return while also preserving the value of their money as central banks around the world flood the markets with liquidity.

3.) There is no Price Ceiling on Gold Prices
People in general don’t buy gold as an investment. They buy it because they feel they need to in order to avoid losing something; in this case, it is to protect investors and central banks from depreciating global currencies, inflation and political instability. The price they pay for this protection is simply whatever they can buy it for.

David Goldman (ironic last name) pointed out in a piece from a few weeks ago that Central banks alone own about 4.8 million tons of gold. The world produces about 2,200 tons. If central banks were to increase their gold holdings by just one percent, it would require approximately 48,000 tons which is more than 20 times annual mining production.

If the planet is about to be hit by a meteor and there is only enough room for 100 people in an underground bunker; the people who have the most cash (or the biggest guns unfortunately) are going to end up in the bunker.

I don’t think gold will begin to fall again until we have incontrovertible evidence that the situation in the real economy is on the mend. Until then, I will try to have at three to eight percent of my portfolio in gold through the actual commodity (GLD, purchased @$99.65 on 10/5) and gold miners (GDX, purchased @$48.64 on 10/8). I hold a small legacy position in Barrick Gold Corp. (ABX) that I see no reason to sell, but I also see few reasons to buy it. I will be doing further research into gold mining stocks in the future.

Gold is very volatile and I recommend gradually easing into positions on dips if you are going to play in this area.

-MJB

Disclosure: Long: GLD, GDX and ABX

These are this Wednesday’s early upgrades and positive research calls which we have seen out of Wall Street firms this morning:

AMR Corp. (AMR) Raised to Overweight at Barclays.
Answers Corp. (ANSW) Raised to Buy at Canaccord.
Barrick Gold (ABX) Raised to Overweight at JP Morgan.
Cisco Systems (CSCO) Started as Outperform at Wells Fargo.
Continental Airlines (CAL) Raised to Equal Weight at Barclays.
Computer Sciences (CSC) Raised to Neutral at Goldman Sachs.
EMC Corp. (EMC) Raised to Overweight at Thomas Weisel.
Goldcorp (GG) Raised to Overweight at JP Morgan.
Harley-Davidson (HOG) Raised to Outperform at Wells Fargo.

You can join our open email distribution list to get updates each morning on analyst upgrades and downgrades, top day trader alerts, IPO’s and secondary offerings, Warren Buffett and other guru activity, M&A and more.

JON C. OGG
October 14, 2009

The Hood Internet – A Meatysauce Review Playlist

Click here to Download

Even though I am not necessarily an expert on what makes a good mash-up or even a good DJ for that matter, I certainly DO know what I like and don’t like.  I found The Hood Internet by chance one day and I immediately started to download their mixes.  Some are a lot better than the others but on the whole it is a pretty amazing collection of music with some very interesting song sampling.  Hailing from Chicago, The Hood Internet is composed of Aaron Brink (aka ABX) and Steve Reidell (aka STV SLV).

For your listening pleasure, I have taken a few of my favorite mixes and turned them into an extended mix of my own.  It runs about 30 minutes long and is certainly worth a listen.  If you like what you hear then you might like their website.  Make sure to click here for the link…have fun!

Consider double coverage when pt has:

S erratia
P seudomonas
A ctinobacter
C itrobacter
E nterobacter

This morning’s reports on unemployment (up), manufacturing (down), housing (sort of up), and consumer spending (up a little) have pushed the market down. Out of the gate this morning, gold miners and spot gold prices followed the market down, but as trading has increased the spot gold price has recovered about half its early losses and the gold miners are coming back too.

Barrick Gold Corp. (ABX) fell more than a dollar in the first hour, but has since regained about a third of that. Kinross Gold Corporation (KGC), Gold Fields Ltd. (GFI), and the Market Vectors Gold Miners ETF (GDX) have followed roughly the same pattern. Spot gold opened above $1,009/oz this morning, fell to about $1,002/oz, and has since recovered to about $1,004.50/oz. Royal Gold, Inc. (RGLD), which owns royalty shares in metals miners, has followed the miners’ trend. The SPDR Gold Shares ETF (GLD) has followed the spot price.

All that commotion is pretty much what one would expect as markets swirl around. But gold itself, and the mining of gold, face a couple of fundamental issues. First, demand for gold jewelry fell 22% from the first quarter of 2009 to the second quarter. Even recycled gold sales have softened, from 566 metric tons in the first quarter to 334 metric tons in the second.

Second, sales to the ETFs have also dropped. In the second quarter of 2009, demand from ETFs fell to 56.7 metric tons, from 465.1 metric tons in the first quarter of the year. That is not a typo. And expectations for third quarter ETF purchases remain weak.

As for mining, Gold Fields Ltd. confirmed today that it expects production and costs for its first fiscal quarter of 2010 to be in line with previous guidance. Gold Fields expects its notional cash expenditure (all-in costs) to be $835/oz. If gold prices remain around $1,000/oz, the company and other gold miners will do nicely, thank you. But reining in production costs has been difficult for all mining companies, and the third quarter may be no different.

Paul Ausick

A Canadian friend told me that he was thinking about taking a long position in GE.  It was at an all time low and evidently oversold at the time (under $7).  I warned him that stocks held in US currency were risky for Canadians because they would have to buy US currency at a high price but that, with the Obama government overspending and all, the US dollar was going to lose its value quickly.

GE hit its low in early March, and let’s say that my friend bought at $6.66, its closing price on March 6.  On that day, he would have paid about CDN $1.27 for every US $1.  So 100 shares would have cost him $6679.99 (which is inclusive of the $19.99 commission), or CDN $8483.59.  GE today is selling at $16.52 today.  If you add the three quarterly dividends (ex dividend date 17 Sept, 17 June, 17 March), he would be looking at a total of $16.82 per share or a phenomenal 152% rate of return.  But what is that today in Canadian funds?  $16820 = $17755 (1.056)  That is today in Canada, his investment has 109% rate of return, which is still wonderful, but as a result of the diminished power of the US dollar, much less than 152%.  But in the likely event that the US dollar continues to plummet, his return on investment will continue suffer in Canadian value.

I’ve taken short positions against the dollar by keeping borrowing funds to buy Canadian oil and gold companies (erf, abx: NY) in US funds.  Also, I will convert every penny of US funds that come in into Canadian until the currencies reach par.

Yesterday I learned that many investors are beginning to use the US dollar as the new “carry trade currency”.  I didn’t know what that meant so I looked it up.  It is a reference to borrowing currency that has a low interest rate, changing into a foreign currency and making investments in that currency (such as GICs or buying stocks).  Well, I guess my investment strategy is a trend rather than idiosyncratic.  I was basing this strategy on the fundamental conviction that US dollar, despite the current deflationary tendency, would suffer because of the Obama budget deficit.

Links:

Dollar is the ‘New Peso’

Is the Dollar Set to Become the new yen?

Now that Barrick Gold Corp. (NYSE:ABX) has raised $4 billion or so to buy out its hedges, the company is set to enjoy an expected run-up in gold prices. In early trading today, Barrick shares were up about 1.5%, AngloGold Ashanti Ltd. (NYSE:AU) shares were up slightly, and Newmont Mining Corp. (NYSE:NEM) shares were up about 1%.

Share prices for these and other gold mining shares have been on the rise for the past few weeks. The Market Vectors Gold Miners ETF (NYSE:GDX) peaked at $48 a week ago, a new 52-week high. SPDR Gold Shares ETF (NYSE:GLD) also flirted with a new 52-week high today. Spot gold prices have been as high as $1,015/oz today, but are moving back down at just $1,001.79.

The better-than-expected US unemployment data released today raised equities a bit at market opening, but early gains have been given back already. The gold miners too, have given back most of their early gains.

In the near-term, mining stocks could continue to rise given the relatively short supply of scrap gold now available. Also, Barrick’s timing on buying back its hedges could also affect the near-term spot price of gold. Inflationary fears, real or imagined, will also hit spot prices, but for now at least, the miners look pretty solid.

Paul Ausick

These are this Wednesday’s top pre-market analyst downgrades and cautious research calls we have seen from Wall Street firms:

Adobe Systems (ADBE) Cut to Hold at Jefferies.
Barrick Gold (ABX) Started as Reduce at Nomura.
Coventry Health (CVH) Cut to Sell at Goldman Sachs.
Felcor Lodging (FCL) Started as Sell at Citigroup.
Martha Stewart (MSO) Cut to Underweight at JPMorgan.
Mirant (MIR) Cut to Sell at Citigroup.
Sprint Nextel (S) Cut to Market Weight at Thomas Weisel.
Verizon Communication (VZ) Cut to Neutral at UBS.

JON C. OGG

So wait a second, let me get this right. A company pays billions of dollars to buy insurance, and then decides to sell $3.5 billion in dilutive ownership rights (current stockholders losing more than 10% of their ownership) so that they can pay somebody else another $5.6 billion to take that same insurance they previously loved away. In my book, I call that lunacy. This madness is exactly what Barrick Gold (ABX) just decided to do. The world’s largest gold miner issued approximately 95 million common shares at $37 per share to remove gold price hedges (used to lock in gold prices at a certain level) so if gold prices spike Barrick will now be able to participate fully without the drag of the hedges.

Effectively, management has decided to turn the mining company into a Vegas casino, where shareholders can now freely speculate in the price of gold without the volatility reducing hedges in place. Does this outlandish behavior signal a top in gold prices (now hovering around $1,000 per ounce)? I’m not stupid enough to call the end of frothing, speculative behavior – just witness Alan Greenspan’s “irrational exuberance” speech in 1996 when the NASDAQ traded at 1,300 (then went on to peak above 5,000). But what I am bold enough to do is call a spade a spade and to point out how ridiculous this reverse hedging activity is.

Other signs of speculation beyond the 4x price increase over the last 8 years or so, is the fact that gold prices have risen in the face of incredibly weak gold jewelry demand, -22% year-over-year globally in Q2 according to the Gold Demand Trends. This leaves the remaining demand coming largely from speculators and global central banks. If you need more evidence for the gold speculation, just turn on your local AM radio station and listen for the endless number of get-rich-quick on gold advertisements – some stations need to fill the gaping hole once held by those advertisers hawking mortgages.

From a gold investors’ perspective, I would say I fall more into Warren Buffett camp of thinking. Unlike other commodities (some of which I believe will be driven upwards by my emerging market demand and other forces) , gold is something dug up from the dirt in South Africa, melted, transported to another hole, buried in the ground (central bank), and then costs are incurred to guard the shiny metal. Sure, jewelry and small commercial applications are drivers for real demand, but the majority of demand is derived from intangible desires. Other commodities, for example oil, copper, uranium, and natural gas offer a lot more utility.

So what’s next when it comes to the price of gold? Peter Schiff an uber-gold bull broker at Euro Pacific Capital believes Armageddon is coming for the U.S. economy and hyper-inflation will drive gold upwards to the $4,000 per ounce price range (See How Peter Schiff’s Other Forecasts Have Performed). Another possibility to consider is a complete collapse in gold prices (and surge in the dollar) like we saw in the early 1980s after Paul Volcker raised interest rates and gold prices did not appreciate for a 25 year period. Hmmm, I wonder what direction interest rates are going next with the Federal Funds rate currently at effectively 0%? Could we see a repeat of the early ‘80s? Seems like a possibility to me. Certainly if you fall into the civil unrest, soup kitchen, and bread line camp, like Schiff and other U.S. bears, then piling into the diluted Barrick Gold shares may not be a bad strategy.

Inflation

Given the massive stimulus, debt loads, money supply growth and legislative agendas currently in place, inflation is a major medium and long-term concern. My remedy is government guaranteed Treasury Inflated Protection Securities (TIPS) that not only compensates investors with interest payments (unlike gold), but will also see principal values increase in tandem with principal if inflation indeed rears its ugly head. For those conspiracy theorists that believe the Consumer Price Index (CPI) is rigged, there are alternative international flavors of TIPs that reset according to other inflation benchmarks. As a kicker, some of these particular securities offer a hedge against a sliding U.S. dollar, which may or may not continue.

So as I lie in my recliner with my popcorn and TIPs, I’ll watch Barrick and other speculators continue the gold buying frenzy, wondering when and how ugly the gold finale will be?

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

DISCLOSURE: Sidoxia Capital Management and client accounts do not have direct long or short positions in ABX or gold related securities at the time the article was published. Sidoxia Capital Management and its clients do have long exposure to TIP shares. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

Barrick Gold Corporation (NYSE: ABX) is going to be taking an action which has mixed implications for shares of Barrick versus the overall gold play now that the shiny yellow metal is hitting $1,000.00 an ounce.  The company has engaged a large syndicate of underwriters to raise billions in cash.  This is not to make an acquisition, but rather to remove gold hedging contracts.  With gold hitting $1,000.00 today, it seems that management does not want to leave major upside here in case the gold run-up is just starting.

The underwriting syndicate will be led by RBC Capital Markets, Morgan Stanley, J.P. Morgan Securities Inc. and Scotia Capital Inc.  This is public offering for gross proceeds of approximately $3.0 billion.  This represents 81.2 million common shares of Barrick at a price of $36.95 per share.

Barrick said that intends to use $1.9 billion to eliminate all of its fixed priced gold contracts within the next 12 months and approximately $1.0 billion to eliminate a portion of its floating spot price gold contracts. Raising this cash is showing how much pain out there might be in the company’s past gold hedging.  Barrick will record a $5.6 billion charge against earnings in the third quarter due to a change in the accounting treatment for the contracts.

Barrick called this a strategic decision to gain full leverage to the gold price on all future production.  However, our discussions we have had is that certain contracts were getting underwater and that a huge hedging position from one of the producers might have been what is accounting for the run up in gold to $1,000.00.

Barrick is acting like most gold companies when prices get high as it noted “an increasingly positive outlook on the gold price.”  The company also expects “global monetary and fiscal reflation” to be necessary for years to come and sees “continuing robust gold supply/demand fundamentals.”

For 2010, Barrick expects production to grow to 7.7 million to 8.1 million ounces at lower total cash costs than 2009.  The company noted that as of yesterday its gold sales contracts came to a total of 9.5 million ounces with a mark-to-market position of negative $5.6 billion.

Barrick is a $34+ bllion gold miner and producer, so we are not going to accuse it of catching the top of the market.  In fact, one of our affiliates has a video demonstrating the possibility of $1,200.00 gold.  But there is one thing that has happened before… gold miners (and many commodity producers) have dropped their hedges right at a time when the run-up is getting close to an end.

JON C. OGG

Bug: Pasteurella multocida: Gram -ve coccobacillus. Penicillin sensitive.

Rx: Amox-Clav (bites are typically polymicrobial…must cover for anaerobes)