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We checked in with our Macau sources recently and came away a little more constructive on LVS’ near-term credit situation there. As we wrote about in our 3/1/09 post “MACAU: A SENSE OF OPTIMISM”, we think investors should begin to look past the tough Rolling Chip comparisons of the first 3 quarters of 2009. Relief on the near-term covenant issues would provide the second punch of a solid one-two shot in the arm for LVS.

Our 2/23/09 post, “LVS: RESIDUAL VALUE RESIDING IN MACAU”, outlined possible remedies for the potential leverage covenant breach on the Macau credit facility. Two of these remedies appear more likely since we wrote about them last week. First, it appears LVS is making progress on selling their mall there. A net sales price of $800 million looks reasonable. Second, our sources indicate the Macau government is becoming more agreeable to approving residential sales at the Four Seasons Macau. While previously speculated sales prices at $1,500 per square foot are unlikely, we think investors would still cheer the more likely prices of $800 per square foot, or $600-650 million in proceeds. These transactions would go a long way to curing the 2009 covenant issue.

Other remedies include selling off a portion of the equity in the Macau operations to the public and amending the leverage covenant. We believe both of these options are on the table.

The upshot here is that the market continues to price LVS as an option yet there are a number of equity enhancing levers the company can pull. These levers do not appear to be well understood by investors. Of course, LVS management has a history of disappointing when it comes to asset sales, development projections and timelines, etc. Thus, investors are likely to be skeptical until the company can put something on the tape. If and when they do, look out.

SP500 Levels Into The Close...

Nasty day out there, and whenever we get oversold like this, this is exactly how it should feel…

Right here and now, my buying the SP500 on the 715 line looks like it was 1% too early, but I am rarely accused of moving “too late” - closing prices are what matters here, and anything south of 708 is a 3 standard deviation move on the immediate term duration model that I am using. Unless something catastrophic happens overnight (oil wouldn’t be trading down like this if there was a terrorist attack in the works), there is a very high probability that we see a meaningful bear market bounce in the coming hours of trading.

Below I have outlined the line that I think we can bounce too first – 757 (dotted red). That would be +7% from the 705 we are currently trading at. That’s plenty enough for me to be buying SPY here.

Let me be clear - oversold immediate term bear market bottoms should be rented, not owned.

Keith R. McCullough
CEO & Chief Investment Officer


The chart below analyzes the Q4 promotional environment as measured by promotional allowances as a percentage of gross revenues. Not surprisingly, each operator spent a higher percent of gross revenues in giveaways. However, with the exception of the Las Vegas operators, the year over year increases were not as great as I would have expected for the rest.

Despite the awful consumer environment, the regional operators managed to keep promotional expenses in check. The promotional percentage increased 1% or less in Q4 2008 in these markets.

One standout of note is Boyd Gaming. BYD’s promotional percentage barely increased despite operating in everyone’s favorite punching bag market: Las Vegas. The Las Vegas locals market is BYD’s largest. Thanks to a severely capital constrained Station Casinos (the largest play in the LV locals market), the promotional environment remained somewhat tame, despite a pretty dreadful top line performance. We are not so negative on the 2010-and-beyond outlook for the Las Vegas market (See “THE LAS VEGAL LOCALS MACRO MODEL”) due in part to Station’s demise. Imagine if BYD could walk away with some of the Station assets?

The situation is much more dire for the other major Las Vegas market, the Strip. As can be seen in the chart, LVS and WYNN saw their promotional percentage increase significantly. MGM hasn’t reported but we expect to see an increase there as well.

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EYE ON EASTERN EUROPE: A Facelift of Funds, Hungary Wants More

It’s old news now that the Central and Eastern European patient is sick. We’ve been writing about the estimated $1.25 Trillion exposure of euro-region banks over the last weeks. Austrian banks alone (Raiffeisen and Erste Group banks in particular) have some $280 Billion of exposure to E. European countries, or 64% of the country’s GDP.

On Friday the World Bank, the European Bank for Reconstruction and Development, and the European Investment Bank took action to address the region’s ails, providing a 24.5 Billion Euro relief package to Central and East European banks and businesses. Collectively, the aid will take the form of equity and debt financing, credit lines and political risk insurance.

Bailouts are nothing new in this region. The IMF has already bailed out Latvia, Hungary, Serbia, Ukraine, and Belarus. Yet Europe’s lagging financial crisis (with reference to the US) is finally calling policy makers to action. On Thursday we reported on the UK’s establishment of a Bad bank for toxic assets and the Treasury’s guarantee of some 325 Billion Pounds ($462 Billion) for mortgages and loans to middle to lower income earners.

Friday’s aid to Central and East European countries comes in the face of the horrendous economic numbers we’ve been sorting through over the last weeks. Some of the outliers include: Latvia, a country that saw its GDP contract -10.5% in Q4 ’08 and is forecast to fall to -12% this year and the Ukraine, which saw industrial output plummet -34% in January. Both countries recently had their credit ratings downgraded to BB+ and CCC+ respectively as fear of default on their debt becomes a looming proposition.

In aggregate Central and East European GDPs, currencies, exports, outputs and credit ratings have plummeted while unemployment and bond yields have increased; looking forward the IMF forecast that GDP in Central and Eastern Europe as a whole will shrink 0.4% this year. That’s a very aggressive estimate. Much of the initial boom in the region was funded by “Western” banks like Raiffeisen in Euro and Swiss Franc denominated loans. With the severe devaluation in currencies (see below) like the Polish Zloty at -11.8% versus the Euro, default risk has risen.

Other confirming negative data points include the contraction in capital flow, estimated to fall from $254 Billion in 2008 to $30 Billion in 2009, or -88.2%. We’re also seeing current account deficits (for 2008) rocket upward.

One of the main risk factors that nations have wrestled with —will the European Union be able to afford to help their Eastern neighbors?

Hungarian Prime Minister Ferenc Gyurcsany announced on Friday that he wants the European Union to arrange a package of as much as 180 Billion Euros to help Eastern European economies, banks and companies. He presented the plan formally yesterday at a EU summit in Brussels, and it was outright vetoed. The package was aimed specifically at Bulgaria, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland and Romania (EU members); Croatia and Ukraine (non-EU states); and Slovakia and Slovenia (Euro-region economies).

Gyurcsany’s plan calls into question the willingness of Europe’s stronger nations to bail out the weaker ones. While German Finance Minister Peer Steinbrueck stated on 2/17 that euro-region countries may be forced to bailout other members of the Union that face problems refinancing their debt, it appears unlikely the German opinion would support such a measure when Germany is dealing with its own severe contraction. German unemployment rose to 8.1% in February from 8.0% M/M and recently released data shows that Q4 ’08 GDP fell 2.1% and Exports declined 7.3% on a quarterly basis. And similar stats could be listed for Italy and France. The European Commission predicts that the EU’s $17 Trillion economy will shrink 1.8% this year.

The large nations of Europe may need to decide quickly. Recently, Romanian central bank advisor Eugen Radulescu said Romania needs 10 Billion Euros to cover its current account and budget gaps.

We haven’t been long anything in Europe in 2009, and we remain bearish on Europe as a whole. Sunday’s veto by EU leaders of Hungary’s proposed Eastern European bailout signals that more may not be in store for the region.

Matthew Hedrick

Andrew Barber

Eye on Re-Regulation: Where There's Smoke...

The Citi Never Sleeps*
But can trade and standards of living continue to increase indefinitely? Yes. That is the gift of competitive free markets and the irreversible accumulation of technology.
- Alan Greenspan, “The Age of Turbulence”

We nominate Bloomberg Inc for the Excellence in Journalistic Subtlety Award. The headline that popped up on the television screen on Sunday was “Citi Increases Government Stake with $25 Billion Swap.” Remembering that it is the equity holders that get wiped out first, we agree with the nuanced conclusion: Citi has increased its control over the Government, in return for which it was paid twenty-five large.

That headline was followed by an interview with Cal Ripken, including the inevitable questions about Alex Rodriguez. Meanwhile, it is now clear that our own MLB – Major League Bankers (“Merrill Lynch Blackguards”?) – have been on fiscal steroids for many seasons. Our question: should past years’ earnings numbers have an asterisk?

Ken Lewis showed up to more cameras than Bernie Madoff, and left his sit-down with Andrew Cuomo having proffered nothing more than Name, Rank and Serial Number. Meanwhile, well known banking sector analyst Richard Bove, interviewed on Bloomberg Radio on Sunday morning, pointed out that Bank of America currently holds one out of every nine deposit dollars in the US banking system. Who do you think blinks first? Our guess: not the one with the money.

The broader dialogue is sadly lacking the insightfulness of the anonymous Bloomberg headline writer: the bigger they are, the harder we fall. Treasury Secretary Paulson glommed $350 billion, cast hastily into his hands by a cowardly Congress, and handed it out with no strings attached. What recourse do we have now that only 5% of Paulson’s billions are accounted for? Should we have been worried that Paulson, without any vetting process, put one of his junior cronies in charge of the biggest corporate welfare fund in our history? And that this child was permitted (instructed?) to hand the money out without even obtaining an IOU?

Today we do not even have a list of who got what. Follow The Money meets Cover Your Tracks.

These institutions are not Too Big To Fail. They are too big to regulate.

Today’s quote, from Chairman Greenspan’s memoirs, reveals the profound disconnect underlying this insanity: for years our elected leaders, blinded by science, have abdicated responsibility to academic theory. President Bush was the butt of ridicule for making the statement: “I am the decider”, yet the test of leadership has little to do with being right, and everything to do with being decisive.

America’s Lost Decade lies not so much ahead of us, as behind, when all the world did obeisance to Chairman Greenspan. The fact that he could state openly – and with a grin – to Britain’s Central bankers, that European insurance companies had taken the losses on billions of dollars of failed swap instruments is the hubris of one who is either convinced that he is right, or that he is untouchable.

The Chairman’s theoretical statement of endless growth is perhaps true in the vacuum of theory, yet it disregards the way the world works. Incessant growth can occur, but under the constraints of human society it is localized, as someone pays the price. In the debacle of the ‘nineties, it was the European insurers. Before that it was Russia, Mexico, Brazil, etc. And at every turn, the average investor has taken a drubbing. Meanwhile the big market players have taken increasing fees on all manner of transactions.

We decry the political climate that progressively dismantled the regulatory system, but we recognize that market participants are so clever, so powerful, and so well advised by all manner of senior-regulators-become-lawyers, that they will always find the lucrative margin of the law and reap billions before the public – and the legislators – figure out what they are about. One creative market participant exploits a loophole. Once the majority of participants undertake the same activity, it is no longer a loophole but a sinkhole. Commerce and crime lie along a continuum and, while the question of critical mass is a matter for philosophers to debate, the nature of this phenomenon is well known to all who practice government and law, and studiously ignored in practice.

At this remove, and in light of the events that have unfolded since the Maestro shared his nasty little secret with England’s bankers, it is clear that Chairman Greenspan knowingly disregarded, or was reckless in not knowing, the fact that the investing public was suffering with every gyration in the markets.

The Dismal Science also knows the fundamental rule of What Goes Around, Comes Around. How did the Maestro think we were going to announce to the world’s bankers that we were stealing from them, and that it would not come back to affect us directly?

The inescapable conclusion is that we have been consistently lied to by those on whom we have relied most, and that there is no reason to believe the set of principles at work today are any different.

We would put our money in a mattress, if only we could find an honest mattress manufacturer.

The Gold-Bug
It may well be doubted whether human ingenuity can construct an enigma... which human ingenuity may not, by proper application, resolve.
- Edgar Allen Poe, “The Gold Bug”
It seems the dancing-madness does not need the tarantula’s bite to pass like cholera among the susceptible, but on all sides one sees the living descendants of William Legrand, all in search of fabled riches. Indeed, we wore out our fingers counting the number of times the word “gold” was mentioned in one week in the financial press.

The game is afoot. As witness the Wall Street Journal of February 23 (“Gold’s ‘Perfect Storm’ Rages On”). The headline reads: “Experts See A Rise To $2,000 As Investors Seek Safe Haven.” Like the famous Business Week cover story, “The Death of Equities”, this has the pungent reek of a turning point in the market.

The “Experts” who predict $2000 / oz. for the yellow metal are the managers of: the Global Resources Fund (PSFX: price on 29 February, 2008: 17.71. Price on 25 February 2009: 4.98); the Tocqueville Gold Fund (down 34.94% last year); and USAA Precious Metals & Minerals Fund (down 34.99% last year). The article does not mention the performance of the managers quoted – we had to look that up ourselves.

Which underscores the quote from Poe’s famous story: a little digging can yield a truly wondrous result. Poe’s tale was highly popular in its day, not just as a yarn of greed, but because it played on the popular fascination with ciphers and cryptography. Of finding something precious – in Poe’s case, the fabled treasure of Captain Kidd; in our case, transparency to understand who is trying to sell us what, and why they need us to buy it.

When oil was trading at above $140 a barrel, the media were alive with frenzied talk of $200 oil, $300 oil. The sky was the limit. Beneficiaries of the price frenzy included sellers of inflation hedges, alternate energy sources, and energy sector investment products.

Now that oil suffers shortness of breath every time it crosses forty dollars, how clever do those folk appear who loaded up on the energy exchange traded funds and notes (ETFs and ETNs) at the peak?

The question that went unasked was: whose narrative is this supporting, and why? As to the Experts quoted by the WSJ, they are in the business of investing other people’s money in gold. And, while these three funds have reasonable long-term track records, if you bought into them in 2008, hoping for a safe haven to balance your equities exposure, you suffered the double indignity of being very right – to take money out of your equities portfolio – and quite wrong, to believe these precious metal managers could provide any safety.

It is not clear to us why the article refers to these folks as the “Experts”, when they are getting smoked. We wonder why the Wall Street Journal has run a panic headline and backed it up by quoting money managers who have destroyed their portfolios in the last twelve months. It seems such blatantly irresponsible journalism that we wonder what’s in it for the Journal to be on the sell side of this story.

And just who is selling gold these days, anyway? And why are they getting written up all over Creation? Well, for one, the managers of the precious metals funds, who today look pathetic. Why should they suffer the indignity of massive withdrawals, just because they turned in a rotten year? And of course, the gold and silver ETFs.

By the way, we do not pretend to expertise in this market, but it is striking that the Tocqueville fund was down 34.94%, while the USAA Precious Metals fund lost 34.99%. Two independently managed funds, both suffering major double-digit declines, and their performance differs by only five basis points. Kind of makes us think there’s precious little independent thinking going on in precious metals these days. As one of our old neighborhood wags would say, “You notice you never see the two of those guys together at the same time. Coincidence? I think not!”

We believe we are witnessing a bubble in the ETF/ETN markets. We also suspect that the ETF and ETN market will soon face a double bombardment of regulatory action, and investor lawsuits.

Exchange Traded Funds purport to be a way for the average investor to trade like a professional by buying a single instrument that represents a basket of securities. ETFs originated as an institutional product. Where no pre-packaged exchange-sponsored index existed, basket traders would pay a trading desk to create a custom exchange-traded index security for them to arbitrage against.

The firms that were in the ETF creation business were servicing multi billion-dollar desks running high velocity trading algorithms where it was not uncommon for tens of thousands of trades to go off in a day versus a single ETF.

Having developed a new expertise, the major firms were eager to capitalize on it. In a textbook-perfect example of how institutional tools become retailed, the ETF was soon being flogged as a way for the average investor to trade like a pro. We believe the fall from favor will be equally paradigmatic – and is likely to happen with lightning speed.

Underlying the retail pitch to Trade Like A Pro is the acknowledgement that the individual investor does not understand instruments like index futures or options on the futures, and does not have access to the venues where they trade. Now, by buying one hundred shares of an ETF that tracks the index, you are trading Like A Big Boy.

The underlying fallacy is so blatant, it’s a wonder to us the regulators ever permitted these instruments to be marketed to the public. A retail customer is given access to an instrument that mirrors the behavior of a set of instruments to which the investor has no access, and which the investor does not understand. The instrument is then sold to the investor by a sales professional who is not qualified to understand or explain the investment, and who takes a commission on the trade.

This approach may have made some sense for ETFs that track a basket of equities by sector – energy or housing, for example – there is no logic to permit stockbrokers to market ETFs based on commodities or futures. The suitability requirements for a customer to participate in the futures and commodities markets are different from those that prevail in the equities market, and the licensing requirements for brokers are completely different. The Series 7 Exam, administered to Registered Representatives, enables them to sell securities investments and get paid commissions. Commodities and futures brokers are required to pass the Series 3 exam, which covers Futures Contracts and Options, Theory of the Futures markets, Hedging Theory and Strategies, Settlements, Margin Practices, and rules of the CFTC and NFA. None of which is addressed in the Series 7 exam.

In other words, the major brokerage firms have taken the much more complex product line of commodities and futures out of the hands of the professionals licensed to deal in them, and have placed them in the hands of individuals whose training does not even touch peripherally on the underlying instruments.

One reason the CFTC may want to stay far away from the mooted merger with the SEC is their reluctance to inherit the class action lawsuits waiting to explode when thousands of individual investors figure out they were sold investments that were not suitable for them, by people who were not licensed to understand them.

Here are the two most popular oil ETFs, for example: the DBO and the USO. Both of them trade on the NYSE, both are nondiversified oil portfolios that trade futures on West Texas Intermediate sweet light crude oil. Both ETFs are regulated like stocks, and sold to investors as though they were equities.

Here is what they say about themselves, as quoted from Yahoo! Finance.

DBO: Powershares DB Oil – “The investment seeks to track the price and yield performance, before fees and expenses, of the Deutsche Bank Liquid Commodity Index - Optimum Yield Oil Excess Return. The index is a rules-based index composed of futures contracts on Light Sweet Crude Oil (WTI) and is intended to reflect the performance of crude oil. The fund is nondiversified.”

USO: US Oil Fund – “The investment seeks to reflect the performance, less expenses, of the spot price of West Texas Intermediate (WTI) light, sweet crude oil. The fund will invest in futures contracts for WTI light, sweet crude oil, other types of crude oil, heating oil, gasoline, natural gas and other petroleum based-fuels that are traded on exchanges. It may also invest in other oil interests such as cash-settled options on oil futures contracts, forward contracts for oil, and OTC transactions that are based on the price of oil. The fund is nondiversified.”

These funds look very alike, if not fungible. True, one fund uses more diversified instruments, but the average investor nonetheless expects both funds to pretty much track the price of oil. In fact, these funds are managed differently and their performance diverges, both over time, and intraday, creating ongoing arbitrage possibilities. This is primarily because one fund trades near-month contracts, one trades year-to-year contracts, a fact not mentioned in their thumbnail portraits.

Just as an exercise, call your stockbroker – you know, one of those tens of thousands of guys who is getting 80% payouts to churn your account so that Bank of America can pay the legal bills to defend Ken Lewis for not answering Andrew Cuomo’s questions – and ask him which of these ETFs will better take advantage of backwardation in the oil market. Or does your broker think the trend is towards contango? We predict the answer will be: To be on the safe side, you should buy some of each.

On Friday, February 13th, Senator Carl Levin proposed to amend the Commodity Exchange Act “to prevent excessive price speculation with respect to energy and agricultural commodities.” Speculative position limits have been implemented from time to time in the commodities markets, and we believe the Levin bill could force a return to this type of regulation.

The fact is that purchasers or producers of the underlying asset are never the natural traders of the ETF. No physical market participant would use an equity look-alike with its constraints of size and composition, and its exposure to tracking error, to manage actual physical commodity price exposure. And it is that tracking error that makes ETFs a valuable tool for large institutional traders.

Tracking error creates the possibility of arbitraging the components against the basket. When exchanges create indexes, the arbitrageurs trade the components against the index, taking advantage of the inherent tracking error to scalp profits. When no index product exists, the arbitrageurs create their own tracking-error-producing index. Since index arbitrageurs structure the ETFs themselves, what odds would you give that the arbitrage program already knows where the tracking error is likely to arise? Does it make you feel better, knowing you just bought a synthetic instrument created to give an arbitrageur an all but guaranteed trading profit?

The CBOE will not comment publicly on their treatment of individual market participants, but they categorize ETF managers in general as speculators. Thus, commodity ETFs and ETNs are an obvious target of Senator Levin’s bill. The added benefit is “collateral regulation” as stockbrokers find their ability to pitch this product class to retail customers curtailed. There will be hue and cry from the banks who issue ETFs, but Congress will have to weigh this against the public rage and bad press once the plaintiffs’ bar figures out what the real story is on ETFs and ETNs.

Game on!

O Ye Of Little Faith!
Kool Aid, Kool Aid – Tastes Great!
Wish we had some. Can’t wait!

The headline reads “Merrill’s Losses Rise by $500 Million” (WSJ, 25 February, page C7). The story relates a half-billion dollar earnings miscalculation that has only now surfaced, forcing a surprised Bank of America to draw down another $20 billion in taxpayer money. Not to worry, assures B of A CEO Ken Lewis, on his way to stonewalling New York Attorney General Andrew Cuomo, B of A will do fine. (Remember that they are holding over 11% of the nation’s cash deposits.)

Right under that is a story announcing that veteran regulator Richard G. Ketchum has been selected to replace Mary Schapiro as CEO of FINRA which, together with the SEC, was responsible for oversight of Merrill’s internal controls.

The item quotes Mr. Ketchum as saying that FINRA is “an effective entity that doesn’t need to be fixed in any way.”

Words fail us.

DECK: Oversold

The DECK sell-off last week into the $40s was notable. Check out my post. Keith's models said that it would pay to be patient and wait for $39. Now it's oversold under the $38.49 line.

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