Category Archives: Market Manipulation

Gold Is Historically Cheap To The Stock Market

“The monetary authorities running the paper-money schemes of the present are anxious to forestall significant rises in the paper price of gold, because such rises would diminish confidence in the lasting value of the paper money in use today.”Hugo Salinas Price

The price of gold was victimized by yet another raid on the Comex paper gold market on Friday. The pattern has been repetitive over the last 15-20 years:  hedge funds push the price of gold higher accumulating a massive net long position in gold futures while the Comex bullion banks feed their appetite, building up a mirror-image large net short position.

A raid is implemented typically on a Friday after the rest of the world has shut down for the weekend, the Comex banks begin bombing the Comex with paper, which in turn sets-off hedge fund stop-losses set while the market is moving higher. This triggers a “flush” of hedge fund long positions which the banks use to cover short positions, booking huge profits.

As evidence, the preliminary Comex open interest report based on Friday’s activity shows the gold contract o/i dropped 14,316 contracts. For the week, gold contract o/i is down over 26,000 contracts representing 2.9 million ozs of paper gold. This is 8x the amount of “registered” – available for delivery – gold in the Comex gold warehouse.  I call this “a Comex open interest liquidation raid” by the bullion banks.  When the CFTC finally releases a COT report to reflect Comex trading activity for this past week, it will likely show a large drop in the net short position of the banks and a concomitant large drop in the hedge fund net long position.

Trump was out flogging the Fed on Friday for holding the dollar up with interest rates – interest rates that the Emperor of DC has declared “too high.” This likely signals a political campaign to drive the dollar lower, which will be bullish for gold.

Trevor Hall and I discuss on our Mining Stock Daily podcast why we believe the current sell-off in the price of gold will lead to higher prices. I also present a couple junior mining stocks I believe will be acquired in the escalating wave of gold mining company M&A transactions (click on the image or HERE to listen to the podcast):

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You can learn more about the highly undervalued junior mining stocks mentioned in the podcast plus many more in the Mining Stock Journal:  Mining Stock Journal information

Tesla: Enron Status Secured

Elon Musk a has long track record of being long on promises and short on deliveries – literally and figuratively.  His motive, as has been self-professed repeatedly on Twitter,  is to torment short-sellers by driving the stock higher with fraudulent tweets.  But underlying Musk’s garish bravado and overtly fraudulent financial reports is a business operation that, by all indications, is slowly disintegrating.

Musk has ushered in the long-awaited introduction of the $35,000 Model 3 with a tweet two days earlier aimed at pushing the stock higher to squeeze short-sellers. Musk’s highly questionable tweet tactic drove the stock price up $21 over two days. The stock did a $10 belly-flop when the Model 3 announcement hit the tape, accompanied by an announcement that Tesla was cutting the size of the workforce for the 3rd time this year and would transition the sales operation to online-only.

While Musk spends an inordinate amount of time scheming to squeeze short-sellers, Tesla’s business operations and financial flexibility is getting squeezed by reality. All Ponzi scheme’s eventually fall prey to the laws of economics. Musk’s Ponzi has been proliferated by a financial system flooded with printed money  and by a Government that no longer applies the Rule of Law to billionaires with the ability to buy protection from regulatory enforcement.

Arcadia Economics‘ Chris Marcus and I spent some time on Wednesday discussing the similarities between Tesla and Enron and Elon Musk and Bernie Madoff:

The Stock Market Is Back In Idiot-Mode Again

I don’t know if it was the intent of the Fed, but Jerome Powell has managed to trigger a rush into stocks more frenzied than the one that engulfed the last days of the dot.com/techbubble. The vertical ascent since Christmas in the Dow/SPX is unprecedented on a percentage basis over an 8-week period of time. All sense of logic, sound analysis and fear of risk has disappeared. I don’t know how much longer this move will last, but it will likely be followed by a spectacular reversal.

What I can say with 100% certainty is that the stock market continues to dislocate from economic reality. This is a situation that will be corrected sooner or later, with the stock market re-pricing significantly lower to a level that better reflects the deterioration in both the global and U.S. economy.

A perfect example of this is housing starts, which were released today for December and showed an 11.2% drop from November. The better comparison is the 11% plunge from December 2017, as “seasonal [statistical] adjustments” are used to obfuscate the real data trends month to month. The year/year comp is somewhat “cleansed” from “seasonal” manipulation adjustments.

The mainstream media is already putting a positive spin the starts number by explaining that permits rose. A permit is not indicative of a future start. Homebuilders have been loading up on land, as tends to happen at the end of housing cycles. A permit is a cheap “option” to initiate a start if the market picks up. In fact, starts should be increasing right now. It takes 3-5 months to build the average priced new home. If homebuilders truly thought that the market was going to improve, housing starts should be increasing in November/December in anticipation of peak selling season in June.

Funny thing about the housing starts commentary.  Most homebuilders are sitting on a record level of inventory.  An example is LGI Homes, which just reported this morning.  LGI’s  year-end inventory soared 34% from year-end 2017.  The Company financed most of this with debt.  Home closings for 2018 were up 11% but decelerated during the year and new orders were down in January 2019 vs 2018.  Given the big jump in existing home inventory during the 2nd half of 2018, it’s safe to say that most homebuilders will likely try to work off existing inventory before starting new homes in excess of what is sold.

The housing market and all the related economic activity connected to building, selling, and financing home sales represents  20-25% of the GDP.  Inflating the money supply and dropping interest rates is not a valid method of stimulating economic activity when most households are over-burdened with debt, living paycheck to paycheck and depleting savings just to remain on the gerbil wheel.

Notwithstanding the propaganda coming from policy makers, Wall Street and the hand-puppet mainstream media, the economy is sinking.  The current spike in the stock market is nothing more than a rabid bear market rally of historic proportions. The stock market is not trading higher on fundamentals or hedge funds plowing investment capital back into the market (away from algo-based momentum trading).

According to data tracked by Goldman Sachs, hedge fund exposure to the stock market is well below levels registered during the last 18 months. As it turns out, corporate stock buybacks and short-covering are driving stocks higher. Buybacks YTD are tracking 91% higher than the same period last year. Short interest in the S&P 500 is now at the lowest level since 2007. The stocks that have performed the best since Christmas are the most heavily shorted stocks.

We’re not hearing anymore whining about the hedge fund computers dictating the direction of the market as was commonplace during the December sell-off. But when this market rolls over and rips in reverse, the Leon Cooperman’s of the world will be spilling tears all over the Wall Street Journal and CNBC complaining about hedge fund algos driving stocks lower. Funny thing, that…

The commentary above is partially excerpted from the latest Short Seller’s Journal. This is a weekly subscription service which analyzes economic data and trends in support of ideas for shorting market sectors and individual stocks, including ideas for using options. You can learn more about this here: Short Seller’s Journal information.

Just How Indebted Is Elon Musk?

Tesla continues to head south since hitting its post-earnings high of $321. It’s down nearly $100 from the $380 post “funding secured” tweet all-time high close on August 7th. The stock has diverged negatively from the SPX since mid-January. By all accounts the order-rate and delivery rate of Tesla’s 3 models is dropping quickly. While there may be a brief boost in sales from  Model 3 deliveries into Europe and China in Q1, it looks like Model 3 orders and deliveries in North America have slowed to a trickle. Complaints about the poor quality of the Model and poor service from Tesla are already populating European automobile forums.

There have been wide-spread reports from people who are having trouble getting canceled $1,000 reservation deposits on Model 3’s refunded. Several have reported receiving the refund only to have the check bounce after it’s deposited. Consumer Reports removed its highly sought recommendation rating from the Model 3 after citing poor quality control and reliabity. This past Wednesday Tesla’s General Counsel, who left his Washington, DC law practice and took the job two months ago, announced he was leaving the Company. The stream of high-level c-suite departures has been nearly continuous over the last year.

Tesla is staring at the $920 million convertible bond maturity due next Friday (March 1st). I have no idea how Tesla will address this, as it seems by many indicators that the $3.9 billion in cash Tesla posted on its year-end balance sheet may not be accurate, in addition to showing negative working capital of $1.7 billion. That said, I would not bet that Tesla will default this soon on its debt.

On Friday it was reported that Elon Musk took out $61 million in mortgages on his five California mansions, $50 million of which was new funding and $11 million was refinancing (note:  rumor of this deal was in the market a week earlier). Morgan Stanley underwrote the mortgages. I would suggest that Musk possibly needed the money to meet margin calls on his stock-holdings, against which Musk has borrowed heavily. Otherwise it makes no sense to me why an alleged billionaire would need to trifle with $61 million in mortgages. Morgan Stanley is one of Musk’s primary stock custodians. In that regard, I’m wondering if Morgan Stanley forced the issue.  It’s a good bet that Musk has pledged and hypothecated most of his assets as collateral against indebtedness. I have no doubt that when Tesla hits the wall, Musk’s wealth will largely vanish.

Elon Musk’s Legacy Of Unchecked Fraud Continues

At 5:15 p.m. on February 19th, Elon Musk tweeted that Tesla would produce 500,000 cars on 2019.  The headline hit news terminals globally. The stock jumped over $1 in after hours trading.  Four hours later Musk tweeted that he meant Tesla would be producing cars at an annualized rate of 500,000 by the end of 2019.  After-hours trading was closed when that “correction” hit Twitter.

The next morning the Wall Journal reports that Tesla’s General Counsel, Dane Butswinkas, is quitting Tesla to return to his law practice in DC – two months after he took the job. Butswinkas’ role at  was widely regarded to be Musk’s highly compensated Twitter babysitter per the terms of Musk’s SEC settlement related to Musk’s securities fraud “420 secured” tweet.

Tesla will rival Enron as the biggest stock fraud in this century, if not U.S. financial history.  To be sure it sells cars that generate revenues.  But the alleged profitability shown in Q3 and Q4 financials is likely nothing more that the product of GAAP accounting manipulation.  Elon Musk has been making promises and performance projections which fall miserably short of reality for several years.  He overtly violated securities laws with the $420 secured” tweet, which cost investors $10’s of millions of dollars – longs and shorts.

Tesla stock jumped on Monday, February 11th after analysts from Canaccord and Wedbush issued strong buys based on “strong demand for the Model 3,” putting absurd price targets on the stock. While both analysts’ analysis and opinions can be summarily dismissed based on gross negligence in presenting facts, you should be aware that the Canaccord analyst had a buy recommendation on Solar City stock from $53 in February 2015 all the way down to down $19.60 in May 2016. Tesla acquired Solar City in the summer of 2016 in a highly controversial deal,  likely fraudulent,  that has turned out to be an unmitigated  disaster.

I suspect the motive for both analysts’ arguably fraudulent stock reports is to generate demand for Telsa shares that can be used to unload shares on behalf of a large seller through both brokerage firms’ retail stock distribution network (brokers and investment advisors). T Rowe Price, formerly the largest shareholder outside of Musk,  cut its position in half during Q4, unloading 8.4 million shares. Insiders have been unloading shares non-stop, with not one insider purchase in the last 3 months.  Two of the most respected investors on Wall Street – Stanley Drukenmiller and Jim Chanos – are short Tesla.

With the tax credit cut in half January 1st and a growing reputation for poor quality control and even worse service, Tesla’s deliveries of all three models have literally plunged off a cliff since Q4. Officially Model 3 sales have dropped 60% for Q4. But sources that keep track of the numbers separately from the Company show a steeper drop-off in sales. As an example, the Marina Del Rey service center previously had been Tesla’s premier delivery center. But deliveries have dropped from average of 16 deliveries per day in Q4 to less than 1 per day in February through February 11th (2.1 deliveries per day in January). Sales in China and Europe have also fallen off a cliff, as superior competing EVs are becoming available.

The latest “500,000 production in 2019” tweet is the just latest in a long list of stunts pulled by Musk in an attempt to pump up the stock price. The departure of the General Counsel is one of many high level executive departures to leave in the last two years after spending just a brief tenure at the Company. Remarkably, the main stream financial media has little to no interest in investigating the nature of the circumstances of the executive departures or the unwillingness of regulators to keep Musk in check.

Tesla is perhaps the most egregious fraud in U.S. financial history.  It has been allowed to unfold out in the open, enabled by the complete lack of regulatory enforcement. Tesla and Elon Musk are emblematic of the unmitigated corruption that has engulfed the U.S. political, financial and economic system. Tesla’s saga represents the Government’s total disregard for Rule of Law. The message sent is that it is now open season for any person or entity with enough money to buy political protection to grab as much wealth as possible before the system collapses

More Accounting Games At AMZN

On January 31st, Amazon reported an expected “beat” for Q4 revenue and net income. After the headline report hit the tape, the stock soared $59 to $1777 from the closing price ($1718) minutes earlier. But then the stock began plunging. It closed the after-hours session at $1635, down $142 from the earnings headline spike and down $83 from the NYSE close. The Company guided Q1 revenues down below the consensus estimate. Amazon’s Q4 numbers also reflected a slow-down in revenue growth.

I predicted Q4 would show slowing growth based on the fact that AMZN enjoyed four quarters of year-over-year comparisons which included Whole Foods numbers for Q4 2017 to Q3 2018 vs comparable year-earlier quarters which did not include Whole Foods numbers (A GAAP rule-change allows companies to avoid restating historical numbers after a big acquisition – this enabled AMZN to report 3 quarters in 2018 with WF numbers but leave WF numbers out of historical financials). Q4 2018 is the first year-over-year quarterly comparison which was an “apples to apples” comparison of the numbers. And AMZN did not disappoint me by disappointing.

If the AMZN Einsteins on Wall Street are aware of the Whole Foods accounting gimmick, they certainly never mentioned it in their analysis, which probably explains why AMZN’s stock is down 6.4% since reporting Q4 while the SPX is up 2.6% in the same time period.

AMZN’s year-over-year revenue growth rate for Q4 came in at 19.7%, the slowest growth rate since Q1 2015. If AMZN revenue comes in at the mid-point of Q1 2019 guidance ($58 billion), it would represent a year-over-year growth of rate of 13.6% – the slowest revenue growth rate since 2001.

I noticed an interesting development in AMZN’s numbers which the analyst community will no doubt overlook or fail to see. AMZN’s gross margin jumped from 37.1% in 2017 to 40.3% in 2018. This made no sense given that Whole Foods’ gross margin was running about the same as AMZN’s prior to the merger. The obvious place to look for gross margin accounting manipulation (understating cost of goods sold) is the balance sheet. Property, plant and equipment jumped 27% from 2017 year-end, or $13 billion. This increase is not attributable to the WF acquisition because the 2017 year-end balance sheet would reflect the WF acquisition. I also noticed a 27% jump in “other assets.” Other assets contains the “intangible” value of video content acquired.

While I can’t prove this without seeing the inside books, I would suggest that the likely explanation is that AMZN is capitalizing costs that should be expensed in the year the costs are incurred. I would also bet that AMZN has slowed down the rate at which it depreciates its media content. This is the primary source of accounting manipulation utilized by Netflix. Capitalizing expenses and slowing down the rate of depreciation has the effect of reducing cost of goods sold and increasing gross profit, thereby increasing the gross margin.

A counter-argument would be that AWS continues to grow at 40% and is a high margin business. However, AWS revenues have been running about 10% of AMZN’s revenue base for quite some time. Thus, while AWS’ business might contribute to a small improvement in AMZN’s gross margin, a 300 basis point jump in one year is too good to be true.

I would suggest that AMZN altered its cost recognition accounting in order to offset slowing revenue growth with a higher reported gross income, which translates into higher operating and net profits. This enables AMZN to “beat” earnings estimates – at least in the short run.

As I’ve detailed in the past and in the Amazon dot Con report (available to Short Seller’s Journal subscribers), AMZN presents its “free cash flow” in a non-GAAP format in order to make it look like the business model generates a lot of free cash flow. As AMZN discloses in a footnote buried in the 10Q/K, its presentation for free cash flow is non-GAAP. At the bottom of its statement of cash flows from operations is a section titled, “supplemental cash flow information.” This section includes “property and equipment acquired under capital leases” of $10.6 billion and “property and equipment under build-to-suit leases” of $3.6 billion. Together, this is cash spent during 2018 of $14.2 billion.

These expenditures have been growing annually for many years and should be netted out from AMZN’s “investing activities” section in the statement of cash flows. Subtracting the $14.2 billion from the cash used or provided by operations, investing and financing yields negative $3.4 billion. This is the actual “free cash flow” generated by AMZN’s operations in 2018 vs. the  positive $11.6 billion “free cash flow” number shown on page 1 of AMZN’s Q4 earnings presentation.

One last point. My biggest contention is that AMZN’s revenues are driven primarily by the attraction of 2-day free delivery for Prime members. Stripping away AWS from AMZN’s revenues and operating income gives AMZN a 2.5% operating margin. This is about half of the operating margin generated by AMZN’s comparable competitors like Walmart, Target and Best Buy. Most of that 2.5% operating margin is attributable to Whole Foods. AMZN’s cost of fulfillment (the cost of getting a product from the “shelf” and delivered to the buyer), surged to 25.6% of revenues from 22.8% in 2017. In 2010, before Prime really began to take off, AMZN’s cost of fulfillment was 13% of revenues.

AMZN’s e-commerce business barely generates an operating profit (international e-commerce generated a $2.1 billion operating loss in 2018). If we could calculate a net income for just e-commerce, it’s likely that AMZN would show a net loss. As the rate of AMZN’s revenue growth slows, the cost of fulfillment is going to consume AMZN’s operating margin.

My point is that AMZN stimulates e-commerce sales with the allure of free 2-day shipping. AMZN’s stock price keys off revenue growth. Unless AMZN can keep revenue growing at historical rates, the stock price is going to reprice down to a multiple based on a hybrid cloud computing services and retail business. The growth rate in Prime subscriptions has been the “holy grail” of AMZN’s revenue growth rate. But the growth rate in Prime memberships plummeted to 26% year-over-year in Q4, down from 50%+ growth rates historically.

AMZN’s stock trades at an eye-watering 65x operating income. It trades at 76x trailing EPS. Keep in mind that there’s a good argument to be made that AMZN stretched its GAAP income measurements with accounting games that reduced cost of goods sold and increased operating/net income. The jump in gross margin is a one-time event and likely not sustainable. Perhaps Bezos will plan another big acquisition in order to keep kicking the accounting indiscretions down the proverbial road.

Regardless, the stock remains insanely overvalued. As a comparison, Walmart trades at 22x operating income and a P/E of 18. Target trades at 9x operating income and a P/E of 11. AMZN’s stock price could get cut in half and it would still be overvalued relative to retailer comps. That said, AMZN’s stock price will likely trade directionally with the stock market, although it will outperform to the downside when the bear market resumes.

If you are looking for ideas for shorting the stock market, try out my Short Seller’s Journal. Each week I review the key economic data and provide analysis like AMZN analysis above plus offer suggestions for using options to short stocks.  Learn more about this newsletter here:  Short Seller’s Journal information

A Financial System Headed For A Collision With Debt

The retail sales report for December – delayed because of the Government shut-down – was released this morning. It showed the largest monthly drop since September 2009. Online sales plunged 3.9%, the steepest drop since November 2008. Not surprisingly, sporting goods/hobby/musical instruments/books plunged 4.9%. This is evidence that the average household has been forced to cut back discretionary spending to pay for food, shelter and debt service (mortgage, auto, credit card, student loans).

I had to laugh when Trump’s Cocaine Cowboy – masquerading as the Administration’s flagship “economist” – attributed the plunge in retail sales to a “glitch.” Yes, the “glitch” is that 7 million people are delinquent to seriously delinquent on their auto loan payments. I’d have to hazard a wild guess that these folks aren’t are not spending money on the latest i-Phone or a pair of high-end yoga pants.

Here’s the “glitch” to which Larry must be referring:

The chart above shows personal interest payments excluding mortgage debt. As you can see, the current non-mortgage personal interest burden is nearly 20% higher than it was just before the 2008 financial crisis. It’s roughly 75% higher than it was at the turn of the century. The middle class spending capacity is predicated on disposable income, savings, and borrowing capacity. Disposable income is shrinking, the savings rate is near an all-time low and many households are running out of capacity to support more household debt.

I found another “glitch” in the private sector sourced data, which is infinitely more reliable than the manipulated, propaganda-laced garbage spit out by Government agencies. The Conference Board’s measurement of consumer confidence plunged to 120.2 from 126.6 in January (December’s number was revised lower). Both the current and future expectations sub-indices plunged. Bond guru, Jeff Gundlach, commented that consumer future expectations relative to current conditions is a recessionary signal and this was one of the worst readings ever in that ratio.

This was the third straight month the index has declined after hitting 137.9 (an 18-yr high) in October. The 17.7 cumulative (12.8%) decline is the worst string of losses since October 2011 (back then the Fed was just finishing QE2 and prepping for QE3). The expectation for jobs was the largest contributor to the plunge in consumer confidence. Just 14.7% of the respondents are expecting more jobs in the next 6 months vs 22.7% in November. The 2-month drop in the Conference Board’s index was the steepest 2-month drop since 1968.

This report reflects a tapped-out consumer. It’s a great leading economic indicator because historically downturns in this report either coincide with a recession or occur a few months prior.

Further supporting my “glitch” thesis, mortgage purchase applications have dropped four weeks in row after a brief increase to start 2019. Last week purchase applications tanked 6% from the previous week. The previous week dropped 5% after two consecutive weeks of 2% drops. This plunge in mortgage purchase apps occurred as the 10yr Treasury rate – the benchmark rate for mortgage rates – fell to its lowest level in a year.

Previously we have been fed the fairy tale that housing sales were tanking because mortgage rates had climbed over the past year or that inventory was too low. Well, mortgage rates just dropped considerably since November and home sales are still declining. The inventory of existing and new homes is as high as it’s been in over a year. Why? Because of the rapidity with which number of households that can afford the cost of home ownership has diminished. The glitch is the record level of consumer debt.

The parabolic rise in stock prices since Christmas is nothing more than a bear market, short-covering squeeze triggered by direct official intervention in the markets in an attempt to prevent the stock market from collapsing. This is why Powell has reversed the Fed’s monetary policy stance more quickly than cock roaches scatter when the kitchen light is turned on. But when 7 million people are delinquent on their car loan and retail sales go straight off the cliff, we’re at the point at which stopping QT re-upping QE won’t work. The stock market will soon seek lower ground to catch down to reality. This “adjustment” in the stock market could occur more abruptly most expect.

As The Fed Reflates The Stock Bubble The Economy Crumbles

I get a kick out of these billionaires and centimillionaires, like Kyle Bass yesterday, who appear on financial television to look the viewer in the eye and tell them that economy is booming.  Kyle Bass doesn’t expect a mild recession until mid-2020. Hmmm – explain that rationale to the 78%+ households who are living paycheck to paycheck, bloated with a record level of debt and barely enough savings to cover a small emergency.

After dining on a lunch fit for Elizabethan royalty with Trump, Jerome Powell decided it was a good idea to make an attempt at reflating the stock bubble. After going vertical starting December 26th, the Dow had been moving sideways since January 18th, possibly getting ready to tip over. The FOMC took care of that with its policy directive on January 30th, two hours before the stock market closed. Notwithstanding the Fed’s efforts to reflate the stock bubble – or at least an attempt to prevent the stock market from succumbing to the gravity of deteriorating fundamentals – at some point the stock market is going to head south abruptly again. That might be the move that precipitates the renewal of money printing.

Contrary to the official propaganda the economy must be in far worse shape than can be gleaned from the publicly available data if the Fed is willing to stop nudging rates higher a quarter of a point at a time and hint at the possibility of more money printing “if needed.” Remember, the Fed has access to much more detailed and accurate data than is made available to the public, including Wall Street. The Fed sees something in the numbers that sent them retreating abruptly and quickly from any attempt to tighten monetary policy.

For me, this graphic conveys the economic reality as well as any economic report:

The chart above shows the Wall Street analyst consensus earnings growth rate for each quarter in 2019. Over the last three months, the analyst consensus EPS forecast has been reduced 8% to almost no earnings growth expected in Q1 2019. Keep in mind that analyst forecasts are based on management “guidance.” The nearest next quarter always has the sharpest pencil applied to projections because corporate CFO’s have most of the numbers that go into “guidance.” As you can see, earnings growth rate projections have deteriorated precipitously for all four quarters. The little “U” turn in Q4 is the obligatory “hockey stick” of optimism forecast.

Perhaps one of the best “grass roots” fundamental indicators is the mood of small businesses, considered the back-bone of the U.S. economy. After hitting a peak reading of 120 in 2018, the Small Business Confidence Index fell of a cliff in January to 95. The index is compiled by Vistage Worldwide, which compiles a monthly survey of 765 small businesses. Just 14% expect the economy to improve this year and 36% expect it to get worse. For the first time since the 2016 election, small businesses were more pessimistic about their own financial prospects than they were a year earlier, including plans for hiring and investment.

The Vistage measure of small business “confidence” was reinforced by the National Federation of Independent Businesses confidence index which plunged to its lowest level since Trump elected. It seems the “hope” that was infused into the American psyche and which drove the stock market to nose-bleed valuation levels starting in November 2016 has leaked out of the bubble. The Fed will not be able to replace that hot air with money printing.

I would argue that small businesses are a reflection of the sentiment and financial condition of the average household, as these businesses are typically locally-based service and retail businesses. The sharp drop in confidence in small businesses correlates with the sharp drop in the Conference Board’s consumer confidence numbers.

The negative economic data flowing from the private sector thus reflects a much different reality than is represented by the sharp rally in the stock market since Christmas and the general level of the stock market. At some point, the stock market will “catch down” to reality. This move will likely occur just as abruptly and quickly as the rally of the last 6 weeks.

Tesla: Can You Smell The Blood In The Water?

“The demand for – the demand for Model 3 is insanely high. The inhibitor is affordability. It’s just like people literally don’t have the money to buy the car. It’s got nothing to do with desire. They just don’t have enough money in their bank account.” – Elon Musk on the Q4 earnings conference call

The following commentary/analysis is from the February 3rd issue of the Short Seller’s Journal.

Tesla’s Failed Business Model – The statement above is an actual comment from Elon Musk on the earnings call. I literally had to ask a couple of people who were on the call if I had misread the transcript or if it was a mistake in transcription. I’m not sure if Elon erringly thought he was sharing profound insight into the laws of economics or if the relationship between price and demand eludes his understanding.

It was announced in late January, before Tesla posted earnings, that the Saudi Public Investment Fund had hedged its 4.9% investment in Tesla’s stock (8.33 million shares). It accomplished this via a structured note (OTC derivative) created by JP Morgan. In exchange for downside price protection, the Saudis gave up participation in any gains should Tesla’s shares rise in price. My guess is that the Saudis also paid a hefty transaction fee to JP Morgan on the order of 3-4% on the market value of the shares hedged.

It did not take long for the Saudi fund to abandon its investment in Tesla. The Saudi stake in Tesla was announced shortly after Tesla’s Q3 2018 earnings release. Musk’s infamous “funding secured” tweet was issued right after the Saudi stake was revealed to the public.

My best guess is that the 8.3 million shares where accumulated during July around an average price in the low $300’s. It’s also possible that one of the large U.S. fund holders sold a big block of shares that was crossed into the Saudi fund. Hard to say for sure but I would surmise that JP Morgan and/or Goldman Sachs (Tesla’s primary investment banks) know the truth.

If the hedging derivative was structured during the month before it was announced, the average price of the hedge is likely $320. Let’s assume the Saudis locked in a $20/share profit – $166 million. Netting out all trading and transaction fees (at a 3.5% fee, the derivative hedge would cost $93 million) the Saudi fund maybe netted about $60 million on the trade. But why did the Saudis bail on the investment after less than six months?

For me the demand/price comment exemplifies the Tesla tragicomedy. The Company reported its Q4 on Thursday after the market closed. Until the 10-K is release (40-60 days), I can not layout a detailed dissection of Tesla’s accounting games. But needless to say it appears as if Tesla’s CFO employed all of the same accounting schemes as were used in Q3 in order to manufacture a GAAP “net profit.” Notwithstanding this, the Company “missed” the Wall St consensus estimate and warned that it may or may not generate a profit in Q1 2019.

Speaking of the CFO, it was announced at the end of call – literally before the Company hung up the phone in order to avoid questions on the matter – that the CFO would be leaving the Company sometime in early 2019 though no specific date was set. He is to be replaced by a little-known 34-year old VP in the finance department, Zach Kirkhorn. Kirkhorn prior to Tesla was a “business analyst” McKinsey & Co. This is a fancy term for someone who helps design computerized enterprise applications for McKinsey clients. Prior to McKinsey, Kirkhorn worked at Microsoft.

Kirkhorn was a curious choice becasue he stunningly has little apparent experience in accounting and finance. Typically CFO’s have either worked their way up the accounting/controller side of a company or are hired from a similar role from the outside. This move left everyone scratching their head but reflects the general dysfunctionality that pervades the Company.

Telsa has experienced a stunning drop-off in orders since the end of 2018 that appears to have begun during late December. The $7500 tax credit was cut in half starting January 1st. Data from Europe show that EV sales fall off a cliff when the tax credit disappears. The chart to the right illustrates this by showing Tesla’s Model 3 sales over the last 12 months (from @TeslaCharts).

The jump in December M3 sales is a product of huge incentive programs Tesla implemented to stimulate sales ahead of the cut in the tax credit. As you can see, since July TSLA has averaged 20,000 unit sales per month. The January number is largely the expected cliff dive related to the drop in the tax credit. However, the large drop-off is also likely attributable to potential EV buyers waiting for the spring roll-out of the Audi E-Tron and Porsche Taycan. Porsche announced in January that it was doubling production in response to demand.

Briefly on Tesla’s numbers. Taking $139 million of net income attributable to stockholders at face value – i.e. assuming the accounting is 100% clean – nearly $100 million of that is from Tesla’s sale of greenhouse gas and zero emission vehicle credits. If we assume just $39 million worth of GAAP manipulation used to generate “income” (the real number is multiples of $39 milion) small amount of accounting games were used to generate GAAP “income,” reversing out the GHG/ZEV credits takes Tesla’s actual net income to zero. This means that the ability of Tesla’s business model to generate actual cash income is based solely energy credit sales. This is not a valid sustainable business model.

In the short term, the next big event is the maturity of the $920 million convertible bond due in March. It looks like Tesla’s stock price will be below the price at which bondholders will want to convert. Additionally, the deadline to reset the conversion price lower has passed. This suggests that Tesla will use cash to pay off the converts.

But here’s the problem:  At quarter end, Tesla’s balance sheet showed a working capital deficit (current assets minus current liabilities) of $1.7 billion.  Of the $8.3 billion in current assets, $3.6 billion is cash. However, of the $9.99 billion in current liabilities, $3.4 billion is accounts payable. It would appear that Tesla will be stiffing its suppliers, vendors and service providers if it uses the cash, as reported, to pay the converts.

I don’t know how Tesla will resolve this issue but I suspect the maturing bond will paid. Otherwise the Company will be forced to file for bankruptcy of some flavor. I don’t see this event happening until at least the end of 2019. This is why I moved my long-dated Tesla OTM puts out to June 2020.

Regardless of this immediate issue, I expect to see continued deterioration in Tesla sales across all three of its models. Snapshots from around the country from major metropolitan areas show lots full of unsold Teslas – all three models – with the inventory stored in these lots growing by the week.

Since I wrote the above analysis for the Short Seller’s Journal issue released this past Sunday, it was reported that Tesla has not received EU approval to sell Model 3’s with autopilot installed. Most of the Model 3’s pre-ordered in Europe were for the Model 3 with autopilot. This little factoid was in direct contradiction to the Company’s announcement, reiterated by Musk in the earnings letter to shareholders, that the Model 3 was fully approved in Europe.

There’s clearly something amiss with Tesla’s liquidity. It’s been reported by customers in Germany that Tesla is demanding full payment for Model 3’s ordered before the Company will deliver the vehicle. Perhaps a tempest in a teapot? A Model S owner who had canceled his Model 3 order and requested a refund of the $1000 deposit posted a copy of the refund check on Twitter – only Tesla had placed a “stop payment” on the check:  LINK

Meanwhile the Company has been laying of workers and cutting prices on feverishly on the Model 3. This is in response to a cliff-dive in demand since January 1st, especially in China. Based on this new evidence, I don’t know if Tesla will be able to make the $920 million convertible bond payment. I would seem possible, given the anecdotal evidence, that Tesla has misrepresented the cash balance on its year-end financials (unaudited as of December 31st). No one knows the answer to that question right now except the banks holding the alleged cash as shown on Tesla’s year-end balance sheet.

Whether or not Tesla can complete a financial hail Mary and address the convertible bond repayment, this company is circling the drain. As far superior competitive models hit the market, demand for Teslas could possibly disappear completely. The stock will drop to zero and the creditors will be left to fight for standing and priority in bankruptcy. I can smell that blood in the water.

In the Short Seller’s Journal I cover economic analysis combined with ideas for shorting the stock market, including market timing, capital management and the use of options.  In the latest issue I presented ideas for using puts to short Tesla, including full disclosure of my trades in the name.  You can learn more about this newsletter here:  Short Seller’s Journal.

Why Housing Won’t Bounce With Lower Rates

“Our advice is to own as little exposure U.S. equity exposure as your career risk allows.” – Martin Tarlie, member of portfolio allocation at Grantham, Mayo, Van Otterloo investment management

The following is an excerpt from the latest Short Seller’s Journal:

Economy is worse than policy makers admit publicly – Less than four months ago, the FOMC issued a policy statement that anticipated four rate hikes in 2019 with no mention of altering the balance sheet reduction program that was laid out at the beginning of the QT initiative. It seems incredible then that, after this past week’s FOMC meeting, that the Fed held interest rates unchanged, removed any expectation for any rate hikes in 2019, and stated that it might reduce its QT program if needed. After reducing its balance sheet less than 10%, the Fed left open the possibility of reversing course and increasing the size of the balance sheet – i.e. re-implementing “QE” money printing.

Contrary to the official propaganda the economy must be in far worse shape than can be gleaned from the publicly available data if the Fed is willing to stop nudging rates higher a quarter of a point at a time and hint at the possibility of more money printing “if needed.” Remember, the Fed has access to much more detailed and accurate data than is made available to the public, including Wall Street. The Fed sees something in the numbers that sent them retreating abruptly and quickly from any attempt to tighten monetary policy.

Housing market – As I suggested might happen after a bounce in the first three weeks of January, the weekly purchase mortgage index declined three weeks in a row, including a 5% gap-down in the latest week (data is lagged by 1 week).  This is despite a decline in the 10-yr Treasury rate to the lowest rate for the mortgage benchmark Treasury rate since January 2018.

Not surprisingly, the NAR’s pending home sales index – released last Wednesday mid-morning for December – was down 2.2% vs November and tanked nearly 10% vs. December 2017. Pending sales are for existing home sales are based on contracts signed. This was the 12th straight month of year-over-year declines. Remarkably, the NAR chief “economist” would not attribute the decline to either China or the Government shutdown. He didn’t mention inventory either, which has soared in most major metro areas over the past couple of months.

For me, the explanation is pretty simple: The average household’s cost to service debt has reached a point at which it will become more difficult to find buyers who can qualify for a conventional mortgage (FNM, FRE, FHA):

The chart above shows personal interest payments excluding mortgage debt. As you can see, the current non-mortgage personal interest burden is nearly 20% higher than it was just before the 2008 financial crisis. It’s roughly 75% higher than it was at the turn of the century.  Fannie Mae raised the maximum DTI (debt-to-income ratio – percentage of monthly gross income that can be used for interest payments) to 50% in mid-2017 to qualify for a mortgage. This temporarily boosted home sales. That stimulus has now faded. And despite falling interest rates, the housing market continues to contract.

That said, the Census Bureau finally released new home sales for November. It purports that new homes on a seasonally adjusted, annualized rate basis rose a whopping 16.9% from October. I just laughed when I saw the number. The calculus does not correlate either with home sales data reported by new homebuilders or with mortgage purchase applications during that time period (new home sales are based on contract signings). 90% of all new home buyers use a mortgage.

The November number was a 7.7% decline from the November 2017 SAAR. According to the Census Bureau, the months’ supply of new homes is at 6, down from October’s 7 but up from November 2017’s 4.9. A perusal of homebuilder balance sheets would show inventories near all-time highs (homebuilders do not always list finished homes on MLS right away if a community already has plenty of inventory). The average sales price of a new home dropped to 8.4% from $395,000 in October to $362,000 in November. Anyone who purchased a new home with a less than 9% down payment mortgage during or prior to October is now underwater on the mortgage.

Absent more direct Government subsidy and Fed stimulus, the housing market is going to continue contracting, with prices falling. Anyone who bought a home with less than a 10% down payment mortgage over the last 3-5 years will find themselves underwater on their mortgage.  I expect home equity mortgage delinquencies and default to begin rising rapidly in the 2nd half of 2019.

In the last issue of the Short Seller’s Journal, I presented my favorite homebuilder shorts along with put option and short selling call option ideas. You can learn more about this newsletter here:   Short Seller’s Journal information