Is Barrick Gold Signaling Peak Gold?

Barrick Gold’s hostile takeover offer for Newmont Mining likely signals “peak gold.” Barrick claims the shareholders would benefit from over US$7 billion in NPV of “real synergies.” These “synergies” would primarily be derived from proposed cost-savings by combing the Nevada operations of both companies. As it turns out, footnoted in Barrick’s presentation is the disclosure that the proposed $7 billion NPV represents the projected cash flow benefit of the merger over a 20-year period discounted at 5%.

If I were a NEM shareholder, my answer would be “no thanks.” First, it would be more
appropriate to use a 15-20% discount rate to better represent the probability that Barrick’s
projections over 20 years are even remotely accurate. Second, given the poor track record
over the last 20 years of Barrick’s management, I would be skeptical of any representations
and projections made by the Company. Barrick’s stock has substantially underperformed the  HUI index over the last 20 years. This is significant because Barrick carries a 13.8% weighting in the HUI. While some type of joint venture or merger of the two companies’ Nevada operations makes sense, I do not believe that Barrick will achieve the synergies as presented.

I believe Barrick’s move to buy Randgold and its attempt to acquire Newmont is a desperate attempt to accumulate as much gold reserves as possible to replace the depletion rate of Barrick’s reserves. The most cost effective way with the gold price at its current level to build a large gold resource base is to buy it. Acquiring Newmont would double Barrick’s  proven/probable reserve base and double its annual production.

In my opinion, Barrick’s acquisition of  Randgold and its attempt to acquire Newmont signals both “peak gold” and an outlook for a much higher gold price. There has not been a major gold deposit discovered in  several years. A five million oz discovery used to be considered “major.”  While I don’t know if this is still the case, a former Newmont geologist who now runs a junior mining company told me 10 years ago that NEM wouldn’t even consider a project unless the geologists thought it had a least 5 million ozs of gold.

Those days are probably over. It’s likely that Barrick’s management does not believe the Company has a major discovery to be made in its future. However, the strategy of buying large gold reserves does not make sense unless the Company believes that the depletion rate of gold in the ground is going to exceed the amount of gold found in new deposits going forward.  It also suggests that Barrick believes in the eventuality of a much higher gold price.

On another note, since August 12th, the price of gold has outperformed all of the major stock indices plus Tesla stock (TSLA):

If you are looking for ideas in junior mining stocks to take advantage of the coming bull move in the precious metals sector, try out the Mining Stock Journal:  Mining Stock Journal subscription information (there’s no minimum commitment beyond the first month).

Trump’s Trade War Tweets, Buybacks And A Short-Squeeze

Someone last week suggested that Trump sees the stock market as the barometer measuring the success of his Presidency. I think his behavior, tweets, press comments, etc with respect to the stock market validates that assertion.

The Dow trended lower all week last after Monday’s close. Whenever the stock market faded from an early run-up or began a rapid sell-off, a Trump tweet or press statement would pop up proclaiming that the trade war negotiations were “progressing.” It seems, though, this manipulation tonic is starting to lose strength. The index of stocks with large buyback programs actually finished the week lower. But the “most shorted” stock index closed higher on the week again. This is why the SPX, Naz and Russell outperformed the Dow this past week.

Market tops are a process – While I’m getting impatient for this market to rollover, market tops are a process. This chart certainly provides something to contemplate:

The chart above overlays the SPX from April 2018 to present on top of a chart of the SPX over a similar period in 1936-1937. The correlation is surprisingly high up to this point. No one can predict if the SPX will follow the same path for the rest of 2019 that it took in 1937, but the two periods of time have many economic, financial and geopolitical similarities. There’s certainly a case to be made that the current stock market might unfold in a manner that “rhymes” with the large decline that occurred in 1937.

Another interesting indicator is the AAII Sentiment Survey. The AAII is the American Association of Individual Investors. The weekly survey measures the relative bullishness and bearishness of individual investors. Retail investor sentiment is considered a fairly reliable contrary indicator. Currently the bullishness is now over the 40% level and the bearish level is 20% (the rest are “neutral”) – a level of bullishness that has signaled a market top in the past. In contrast, a bullish level of 20% and a bearish level of 49% on December 13th was registered nine days before the stock market bottomed.

The highest the bullish sentiment level has reached in the last 5 months was 45% in the first week of October (25% bearish). The stock market entered a big decline on October 3rd. In isolation, this indicator may or may not be reliable. But given the number of other indicators associated with a market top, now would be a good time to take profits on any long positions you might have put on in the last 2 months. Given the deteriorating fundamentals of the economic and financial system, the probability that the market will rise a meaningful amount from here is quite low.

The “US Macro” index measures the difference between consensus expectation vs the actual number reported for a wide array of economic reports. As you can see, the stock market has dislocated from economic reality by a substantial margin. At some point, unless the economic reports begin to improve, the stock market will “catch down” to reality. How long it will take for this to occur is anyone’s guess, but it is likely that the “adjustment” will be abrupt.

Many indicators are reflecting a sharp fall-off in consumer demand. Wholesale inventories are soaring and the inventory to sales ratio is significantly higher than a year ago. The CEO of a logistics warehouse in California remarked in reference to the inventory stored in company warehouses, “in 30 years I’ve never seen anything like this.” This includes inventories of durables and non-durables targeted for domestic distribution.

Confirming the pile-up in manufactured goods relative to demand, the Cass Freight index has declined on a year-over-year basis two months in a row. The index had been rising each on month on an annual comparison basis since Trump took office.

Consumer sentiment is also falling. The latest U of Michigan consumer sentiment survey fell well below the Wall St consensus expectation, with some components falling to their lowest level since the 2016 election (recall that hope soared after the election). Apologists are blaming the trade war and the Government shutdown. However, historically there’s a near-100% correlation between the directional movement of the stock market and consumer sentiment. Any negative effect from the shutdown should have been offset by the sharp rally in the stock market. Contrary to the obligatory positive spin put on the data, the sentiment index likely reflects the fact that the average household has largely tapped out its ability to take on more debt in order to keep spending on anything above non-discretionary items.

Insider selling during February has accelerated. Insiders sold more shares in the first half of February relative to shares purchased than at any time in the last 10 years. The size and volume of insider stock sales the last three days of February – per SEC filings – was described by one analyst as “off the charts.” The Financial Times had an article discussing the fact that America’s CEOs are leaving their posts at the highest rate since 2008. It’s likely the departures reflect a bearish outlook by insiders both for business conditions and the stock market.

Homebuilders, despite the small rise in homebuilder optimism, must be sensing the fall-off in the economy and a decline the pool of potential new homebuyers. Housing starts in December dropped 11.2% from November. The decline would have been worse but November’s number was revised lower. The number reported for December was 14.4% below the consensus estimate. The numbers are SAAR (seasonally adjusted annualized rate) in case you were wondering about seasonality between November and December. But just to confirm, the December 2018 number was 11% below December 2017. Also, the Census Bureau releases the “unadjusted” monthly numbers, which showed a 12% drop in starts year-over-year.

Over the next several weeks there will be a lot of excuses for the deteriorating economic fundamentals:  trade war, Government shut-down, cold weather in January and February, low inventory in low-price homes, the dog ate my homework.

But the truth is that the average household in the U.S. is running up against debt limitations – the ability to take on and service additional debt.  Just one indicator of this is rising credit card and auto loan delinquencies.  The U.S. economy for the last 8 years has been primed and pump with printed money and debt.  Debt at every level of the system is at all time higher – both nominally and as a percentage of GDP.

The next round of QE, regardless of the scale, will do nothing to re-stimulate economic activity unless the money is used to re-set (i.e. pay-off) creditors on behalf of the debtors. This was how the last reset was engineered after the financial crisis but this time it will have to be a bailout in size that is multiples of the last one.

The stock market is beginning to rollover again, as the gravity of economic fundamentals begins to exert its “pull.”  I’m sure it won’t take long before we start to hear complaints about the hedge fund computer algos again.  But the best advice is to take your money off the table and get out of the way.

MMT (Modern Monetary Theory) Thoroughly Disemboweled

The best I can figure is that some very liberal, trust-fund Phd Sociologist professors at Bennington hooked with a group of radical Public Policy students from Harvard somewhere in a cabin in Vermont and did a group analysis of John Maynard Keynes’ “The General Theory of Employment, Interest and Money” after ingesting copious quantities of LSD. From out of that drug-addled assemblage, MMT sprung to life in “socially correct” political circles in NYC and DC.

Short of that explanation for the current obsession with MMT – also known as “Magical Money Tree” –  among the elitist intellectual trust-fund liberal political class, I have a hard time explaining the enthusiasm for this comic book version of economics.

A good friend of mine, who happens to be highly intelligent and obsessive about research, is thoroughly confounded by the idea anyone in their right mind would consider MMT as a serious policy tool other than as a mechanism to accelerate the confiscation of wealth and liberties from the public.

The best I could offer is that legitimizing MMT with academic endorsements is a precursor to the next round of QE, which will have to be Weimar in scale.  Occam’s Razor applies here. It’s that simple.  A Government unable  slow down its spending deficit has no other means of paying its bills other than to raise taxes to a level that will trigger mass revolt or use its printing press.  You see where this is going…

Interestingly, a writer/analyst who springs from the left, and who otherwise I would have thought to have been a proponent of MMT, thoroughly explores and disembowels the concept.  You can literally sense the author’s struggle to find a use for MMT:

We have a private economy driven by exploitation, overwork, asset stripping, and ecological destruction. MMT has little or nothing on offer to fight any of this. The job guarantee is a contribution, though a flawed one, and it’s not at the core of the theory, which proceeds from the keystroke fantasy. That fantasy looks like a weak response to decades of anti-tax mania coming from the Right, which has left many liberals looking for an easy way out. It would be sad to see the socialist left, which looks stronger than it has in decades, fall for this snake oil. It’s a phantasm, a late-imperial fever dream, not a serious economic policy.

Ordinarily I would have briefly skimmed through this essay. But if you are making an effort to be open-minded and understand the genesis, history and follies of MMT, it’s worth spending the time to read this piece in its entirety – then you can have a good laugh:  Modern Monetary Theory Isn’t Helping by Doug Henwood

Modern Monetary Theory isn’t just an insult to one’s intelligence, it’s a complete affront to common sense.

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.