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Paper vs Physical Gold And Silver And Why The Precious Metals Sector Should Rally

I had an interesting dialogue with a couple of long-time colleagues about this commentary by Wall Street On Parade.  The Martens do an admirable job exposing the corruption on Wall Street, the Fed and Congress. But they exhibit a profound misunderstanding of the architecture of the global market for gold and silver. In the title to that article, the Martens suggest that “the typical safe havens of gold and t-notes are losing money.”  Well, yes all flavors of fixed income securities are losing money because that’s how bond math works when interest rates and bond yields rise. However, the Martens fail to understand that the gold and silver market is bifurcated.

One side of the market is the paper derivatives markets on the Comex and LBMA as well as OTC derivatives. These markets are opaque, fraudulent and a source of fantastic profitability for the banks that use the products to manipulate the prices of gold and silver. For now, the paper market is dictating most of the price-action. And it’s not just the banks. The hedge funds have been dumping tens of thousands of gold and silver paper contracts on the Comex. This can be seen in the weekly COT reports, which show that the hedge funds (Managed Money segment) are increasingly adding to their gross short position and reducing their net long position.  The hedge funds have been net short paper silver for several weeks. Their recent net short positioning in paper gold is the largest in memory.  Conversely, the Comex banks (Swap Dealers segment) have swung from a big net short position to a net long position in paper silver and they are aggressively covering their short position in paper gold.

The other side of the gold and silver market is the physical market. By this I mean the market in which large buyers – primarily eastern hemisphere buyers – are accumulating vast quantities of physical gold and silver and require that the metal is physically delivered to their possession/custody rather than remain in allocated and unallocated vaults in London and New York (Delaware, actually).  Central Banks, sovereign entities and the Indians are hoovering physical gold right now. Unlike the paper markets, in which Comex contracts and LBMA forward agreements can be printed as easily as digital currencies and Treasury bond certificates, there are not any large sellers of physical gold and silver that are identifiable. To be sure, gold and silver is brokered from producers to buyers via the bullion banks. And when delivery short-falls occur, the unallocated GLD and SLV accounts (sub-custodian accounts) are pilfered by the banks and shipped to buyers. But there are not any transactions globally in which a big holder of physical gold or silver is selling its holdings to the buyers.

The banks are not bidding aggressively to cover their short  positions. Rather, shrewdly let the hedge funds drive the price lower with an avalanche of selling/shorting and using that opportunistically to cover their short positions as the price falls. Shrewd gamblers know that when the “house” – or the dealers – are taking all bets placed in one direction for their own account, the game is rigged. What do the banks know that we do not yet?  This is a similar set-up to the final bottom of the precious metals sector in late October 2008, when the precious metals sector turned on a dime and shot higher while the stock market continued to head south quickly for six more months.

As mentioned above, the set-up in the markets is startlingly similar to that of late September and early October 2008.  Something stopped the selling of paper gold and silver back then – some trigger event – and the paper shorts scrambled to start covering, driving the market higher and setting off a 2 1/2 year bull move in the precious metals sector.  Whatever that catalyst was – and it was connected to the de facto credit market/banking system collapse – will be triggered again. It’s a matter of timing. The credit markets are melting down as evidenced by the devastation in the various fiat currencies.  Review  a historical chart of the dollar to see that the dollar soared – like it is now – in the summer of 2008, just before the financial system implosion. Based on behavior of the credit and currency markets, along with the glaring repositioning of paper gold and silver between the banks and the hedge funds per the COT report, I believe that a similar trigger event will occur in the coming months, possibly before Christmas.

The Housing Market Continues To Crater

The following commentary is an excerpt from the latest issue of my Short Seller’s Journal. In addition to my analysis, I provide my subscribers with specific short ideas, including the use of options. In the housing sector, my recent home run short ideas include Zillow $Z, Opendoor Technologies $OPEN and Anywhere Real Estate $HOUS (formerly Realogy), among others.

Housing market update – There’s nothing like grass roots data from Main Street as opposed to the gaslighting propaganda from the perma-bullish mainstream media. A subscriber emailed me to tell me he talked with two window manufacturers. Anderson said they are down 60% in requests for quotes [from builders, primarily but also replacement window resellers]. A higher end company to which he spoke wouldn’t give him a number but did not argue when he mentioned the 60% number. Both companies are still working through their back-log of orders.

The mortgage purchase index last week dropped to 197.8. This is the fifth week in a row of declines. The index has fallen 10 of the last 11 weeks. Outside of the lockdown period, the purchase index is at its lowest level since late 2016. It has plunged 43% from its peak in early 2021. Note that the purchase index continues to decline despite that fact that 30-year mortgage rates slipped below 6% last week.

Recall that I’ve been discussing the record level of homes under construction by new homebuilders. This chart was posted on Twitter last week:

The number of housing units sitting in various stages of work-in-process inventory on homebuilder balance sheets is at an all-time high of 1.678 million – 50% of which is single-family homes. It’s 18% higher than the peak in the previous housing bubble. Homebuilders are beginning to release a massive backlog of finished homes on to the market at discounted prices.

According to the Census Bureau data, this is the first time in history that the number of single-family homes being built exceeds the run-rate of single family homes that are being sold. Note that the run-rate (SAAR) is declining and will continue to decline per the mortgage purchase index and pending home sales data.

In my opinion, the homebuilder/home construction-related stock valuations are significantly overvalued relative to the industry fundamentals and outlook.

The chart above from the Fed shows the single family new home sales monthly SAAR over the last ten years. The current level is back to where was in the 2015-2016 time period.

This chart is a 10-yr weekly of the DJUSHB (Dow Jones Home Construction index):

In the 2015-2016 time period, the DJUSBH was trading between 500 and 600 vs Friday’s close at 1,190. This means that home builder/home construction stocks are trading currently at two-times the value per home sold now as in the 2015-2016 period. This is despite the fact that mortgage rates (6%) currently are nearly 200 basis points (2%) higher than the average rate in 2015-2016 (4%).

To be sure, profit margins over the last year have been higher than they were in 2015-2016. But that’s “rear-view” mirror data. With inventory soaring and sales plus prices dropping, the profit margin differential will quickly disappear. In addition, in coming quarters homebuilders will be forced to take big inventory valuation write-downs. This fact is not remotely priced into the stock valuations yet. I am going to increase my capital allocation to homebuilder puts.

The homebuilder stocks have been holding up better than I would have expected given the significant decline in new orders that they have been reporting over the last couple of quarters. This is particularly true of TOL, which showed a 60% YoY drop in new orders in its latest quarterly report. I don’t expect this to last much longer. In fact, I expect home prices to begin to decline in step-function fashion, which what happens when a relatively illiquid market goes from a big demand imbalance to a large supply imbalance, as is happening now.

You can learn more about the Short Seller’s Journal here: Short Seller’s Journal subscription information

How And Why QE Becomes Printed Money

There’s an egregious misperception that QE is merely an “asset swap” with banks that simply creates reserves – that the Fed is not printing money with its QE operations. This view is seeded in ignorance about the monetary system as operated by the Central Banks, particularly the Fed. My good friend and colleague, John Titus, in a series of videos shows how, using the data and research papers freely available on the Fed’s website how the bank reserves leak (or have gushed) into the real economy, thereby creating spendable money from QE. Note: it is highly recommended that you watch the series of videos referenced in this video:

The Housing Market Appears To Be In Free Fall

The following is an excerpt from the latest issue of the Short Seller’s Journal.  I have been hitting doubles, triples and home runs with my housing market-related stock shorts, like $OPEN, $HOUS, $Z, $PSA, $REZ plus homebuilder stocks. You can learn more about this weekly newsletter here:  Short Seller’s Journal information.

Housing market update – The Homebuyer Affordability Fixed Mortgage Index from the National Association of Realtors has plunged to its lowest level since 1989:

The late 1980’s experienced what was back then considered a housing bubble, though it was much smaller in scale than the two housing bubbles this century. But here’s the kicker: back then the average rate for a 30-yr fixed-rate agency mortgage was nearly 10%. Price inflation and deteriorating household conditions has turbo-charged the prospective homebuyer’s sensitivity to small changes in interest rates relative to 33 years ago.

This explains why the July new home sales report was a complete disaster. The headline SAAR (seasonally adjusted annualized rate) was down 12.6% from June. The SAAR of 511k homes sold was below Wall Street’s forecast of 520k. The YoY SAAR plunged 29.6% and the rate of home sales is at its lowest since January 2016.

However, the YoY unadjusted monthly sales showed July new home sales collapsed 32.2% from July 2021. The unadjusted number is much “cleaner” statistically than the SAAR, as it is not subjected to seasonal adjustment modeling errors – only to data collection estimation errors. The months’ supply jumped from 9.1 months in June to 11.2 months in July. This chart should terrify anyone who recently overpaid for a new home or was thinking about buying one:

The supply of new homes is nearly as high as it was at its highest after the previous housing bubble popped. The “low inventory” narrative was never completely valid but now it is preposterous.

Pending home sales for July fell 1% from June and 20% YoY. On a monthly basis, pendings have dropped 8 of the last 9 months and 9 of the last 12 months. On a YoY basis, pendings have dropped every month for over a year. Not including the pandemic lockdown period, the pending home sales index is at its lowest level since October 2011. Needless to say, the July pending home sale data suggests that August will show another monthly decline in home sales.

The mortgage purchase increase declined 0.5% from a week earlier. Not including the pandemic lock-down period, the mortgage purchase index dropped to its lowest level in nearly six years.

In a recent issue, I mentioned that Wall Street/corporate home buyers have been rapidly pulling back from the housing market. This past week, Blackstone announced that its Home Partners of America buy-to-rent subsidiary will stop buying homes in 38 cities as of September 1st. It will stop buying in an additional 10 cities on October 1st. In addition to Blackstone, Invitation Homes (INVH), American Homes 4 Rent (AMH) and My Community Homes (owned by KKR) announced that they have slowed considerably their home purchases.

Up until recently, buy-to-rent or flip homebuyers represented well over 20% of all home sales over the last couple of years. Zillow (Z) shut down its home flipping operations in late 2021. It’s only a matter of time before Opendoor (OPEN) stops buying homes. One of the differences between the 2008 bubble and current bubble is that the corporate buyers largely were not prevalent until after the 2008 bubble had collapsed. However, the corporate home buyers were one of the primary drivers of the housing bubble. Removing the corporate demand from the market equation will accelerate the downward momentum of the market and it’s one of the reasons I believe this housing collapse will be worse than 2008.

The chart below makes a compelling argument that home prices are going to go into free fall:

The light blue line is the Case-Shiller average home price. The dark blue line is a regression metric composed of the current mortgage rate and months supply. The two lines are highly correlated going back to 1998, the start date of the study. I do not foresee a scenario which prevents the light blue line from “catching down” quickly with the dark blue line. The 60% decline YoY new orders in its FY Q3 reported by TOL (see below) is an indicator that a price collapse is coming.

This chart solidifies that argument:

Unfortunately, the chart from Redfin only goes back to 2015. But the chart shows the percentage of active listings nationwide with price cuts. In some of the biggest bubble cities (Boise, Austin, Denver) the number of active listings with price cuts are in excess of 50%.

A long-time colleague of mine knows the CEO of a large excavating company in Colorado. They primarily do “dirt work” for new homebuilders. They are busy finishing existing projects. However, they do not have any new business on the books for 2023 or 2024. The CEO said “it’s like somebody just turned off the fountain.” If the Fed sticks to the message delivered by Jay Powell at Jackson Hole on Friday just for the next four to six months, the carnage to the housing market will be Biblical.

The Housing Crash Will Be Worse Than 2008

“The buyers just disappeared off the face of the earth.” – Shauna Pendleton, a Boise real-estate agent for Redfin

Over the course of the summer, there’s been a stunning collapse in home sales. For July, new home sales fell 12.9% from June (seasonally adjusted annualized rate) and 29% YoY. However, the Census Bureau includes the “unadjusted” monthly data – this is a metric that is based on the Census Bureau survey of homebuilders – though the media ignores it. On a YoY basis for July, new homes sales plunged 32%. Toll Brothers’ FY Q3, reported earlier this week, experienced a 60% decline in new contracts.

Based on all of the data available currently, I can say with confidence that it is starting to look like the coming housing bubble collapse will be considerably worse than the one in 2008. Because of the financial condition of the majority of prospective homebuyers, a Fed pivot will not revive the housing market – it’s headed into a severe crisis:

I have been focused in my Short Seller’s Journal on finding short ideas to take advantage of the stocks that are not remotely pricing in the coming housing market depression. I recommended Opendoor Tech ($OPEN) at $21 in November 2021; Realogy ($RLGY – now called $HOUS) at $16 early in 2022; Zillow ($Z) well before the stock price collapsed; and a plethora of homebuilders plus a couple real estate REITs (Public Storage $PSA at $400 earlier this year). There’s a lot more wood to chop from the short side. You can learn about my newsletter here: Short Seller’s Journal info

Fortuna Silver – A True Value Stock

Arcadia Economics hosted a podcast with Fortuna Silver CEO ($FSM), Jorge Ganoza, to go over the Company’s Q2 earnings report and discuss the remarkable effort by management to contain costs and build value that is yet to be recognized by the stock market:

The following analysis of Fortuna Silver was featured in the last issue of the Mining Stock Journal. I believe Fortuna offers the stability and growth of mid-cap gold and silver producer as well as the upside optionality of a junior development stock with its Seguela and Boussoura assets. You can learn more about my news letter here: Mining Stock Journal information

Fortuna Silver (FSM, FVI.TO) – Fortuna released its Q2 results Wednesday evening. At first blush, the numbers looked disappointing, which apparently was the market’s view because the stock is down over 8% from Wednesday’s close. However, after going through the numbers thoroughly and attending the earnings conference call, FSM’s management did a great job managing the operations through a quarter in which the cost of mining was substantially higher than Q2 2021 and the average price of silver was lower YoY by approximately 16%.

Sales rose 39% YoY but cost of sales rose 63%, in part because of increasing production at Lindero and in part because of the inclusion of Yaramoko. Sales at San Jose declined 23% (lower output and grade per guidance). Gold production more than doubled YoY while silver production fell 13% – again this is in-line with the Company’s guidance at the start of 2022.

Mine operating income declined 33%. Most of this is attributable to the lower cost of silver. However, consistent with guidance, production and head grade at San Jose declined YoY. Operating income declined 71%. Again, 40-50% of this decline is attributable to the drop in the price of silver. But SG&A was also a factor, rising 62% YoY. Of the $14 million incurred in Q2, $1.5 million is non-recurring and related to the Roxgold acquisition. I had a brief conversation with the CFO, Luis Ganoza, who said he expects SG&A to be about $12mm per quarter going forward.

Now for the good news. First, the Company’s mine operating costs have remained in-line with the guidance that it provided at the beginning of 2022. This is a remarkable feat given the considerable price inflation experienced by the industry, particularly with respect to diesel fuel, cyanide and mine explosives. The expenses connected to the development of Seguela continue to remain on target with the cost budget released last September.

$4 million (22%) of the variance in operating income is attributable to a non-cash write-down of low grade ore stockpile at Yaramoko. Many companies would overlook making this adjustment to manage GAAP earnings but it’s a non-cash event. Furthermore, assuming the price of gold rises going forward, that write-down will be more than reversed because the ore can still be profitably processed. If the price of gold continues to rise, the size of the non-cash write-down will be more than offset by real cash income.

Cash provided by operations (from the statement of cash flows) was $47 million, up 61% from Q1 2021. Free cash flow derived from the statement of cash flows, was $6.4 million. For this I added back the $3 million used for share buybacks. This compares with negative $23.2 million (-$23.2mm) free cash flow in Q2 2021. Despite the capex involved with building Seguela plus tweaking production at Lindero, FSM is generating free cash flow. Furthermore, there’s still progress being made with lowering the overall costs at Lindero.

Seguela is 66% complete, with the first gold pour expected in mid-2023. Using the mid-point of FSM’s full-year production guidance, the Company is tracking to produce roughly 340,000 ozs of Au-Eq in 2022. This does not include zinc and lead production. When Seguela is fully ramped-up, FSM will be producing between 420-450k ozs of gold-equivalent, not including lead and zinc.

In my view, the stock market is substantively undervaluing FSM. To begin with, most companies producing in the range of 400k-500k ozs of gold per year are valued, minimally, north of $1 billion. At the extreme end of the range is Alamos, which has a $4 billion market cap on 460k-500k ozs of gold expected in 2023. Interestingly, the average grade of the resource at Alamos is similar to that of FSM. I’m not saying FSM deserves the same market cap as $AGI, but either AGI’s market cap is far too high or FSM’s market cap is far too low.

With most of the variance in operating income attributable to a lower price for silver, a one-time non-cash write-down of low grade ore stockpile at Yaramoko – that likely will be recovered in cash in the future – and $1.5 million of non-recurring SG&A, if you believe that the price of silver and gold – especially silver – is headed higher over the next 12 months, the sell-off in FSM post-earnings is a gift.

FSM has demonstrated that it can manage its operations efficiently in an environment of rising costs and falling precious metals prices. When the price of gold and silver move higher, FSM will experience growth in its income and cash flow generation that is not even remotely priced into its current stock price. On top of this, the market is not giving any credit to the huge resource upside and grade potential that is being demonstrated currently with the drill program at Sequela or to the considerable “optionality” upside potential with Boussoura.  In a bullish environment for the sector, I would expect FSM to more than double from the current level (12-18 months).

While The Economy Tanks And Gambler’s Chase Meme, Gold, Silver & Miners Are Historically Cheap

Despite the highly massaged CPI report last week, inflation remains entrenched and persistent at a historically level. Meanwhile, the economy continues to contract, average household real earnings become more negative and the housing market is in a slow motion collapse that will accelerated in the coming months. It’s impossible to predict when the Fed will be forced to rip-in-reverse its monetary policy, but the precious metals sector (gold, silver and mining stocks) are as undervalued at any time since the early 2000’s vs the rest of the stock market.

Jason Burack invited me onto his Wall Street for Mainstreet podcast to discuss why the Fed is trapped and why it’s time to start accumulating more precious metals and mining stocks:

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The precious metals sector looks like it’s ready for a major move higher, especially the junior exploration stocks – you can learn about my Mining Stock Journal here: MSJ information; and my Short Seller Journal subscribers have made a small fortune on the ideas I present weekly in my short seller’s newsletter: SSJ information.

Will The Fed Pivot And Do Gold And Silver Care?

“[T]he Committee decided to raise the target range for the federal funds rate to 2-1/4 to 2-1/2 percent and anticipates that ongoing increases in the target range will be appropriate. In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities.” – July FOMC Policy Statement

The FOMC voted unanimously in favor of the Policy Statement and related actions released last week. While the Fed indicated that “ongoing increases” will be data dependent, the key data points consistent with the alleged Fed mandate are CPI inflation and the unemployment rate. Both are phony numbers but if the Fed thinks it can attack inflation by attacking consumer demand, it will need to continue hiking rates for now and it can point to a sub-4% unemployment rate, as fictitious as that number may be, to justify continued rate hikes.

That said, the precious metals sector at this point will not care whether or not the Fed pivots. Real interest rates are still extremely negative – meaning monetary policy continues to devalue the dollar – and there are many indications that the precious metals sector may be forming a tradeable bottom.

Chris Marcus of Arcadia Economics and I discuss the implications of the Fed’s latest episode of “FOMC Kabuki Theatre” and why the current policy as well as possible pivot is bullish for gold, silver and mining stocks:

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The precious metals sector looks like it’s ready for a major move higher, especially the junior exploration stocks – you can learn about my Mining Stock Journal here: MSJ information; and my Short Seller Journal subscribers have made a small fortune on the ideas I present weekly in my short seller’s newsletter: SSJ information.

Shopify Remains Insanely Overvalued ($SHOP)

The analysis below is from the latest issue of the Short Seller’s Journal. This is a weekly subscription newsletter that offers economic commentary and short-sell ideas based on fundamental analysis, as well a ideas for using puts to express a bearish view on insanely overvalued companies. You can learn more here:  Short Seller’s Journal information

Shopify ($SHOP) posted a $1.12 billion net loss for Q2. To be sure, $1 billion of that was a non-cash write-down of the Company’s equity investments. However, once all of those crappy little companies go out of business, it will be an economic loss of the cash used to invest in them. But even adding that write-down back, SHOP lost $190 million on an operating basis vs $139 million of operating income in Q2/2021.

For the 1H of 2022, SHOP posted an operating loss of $288 million vs $258 million in operating income in 1H 2021. The surge from the pandemic in online buying died in late 2021 and now a large portion of consumers no longer have the disposable income needed to buy the garbage sold on SHOP’s platform. SHOP’s operations burned $177 million in cash in the 1H 2022 vs providing $202 million in cash in 1H 2021.

The Company said that it will generate an operating loss for the 2H of 2022 and it expects the Q3 operating loss to increase “materially” over the second quarter’s $190 million loss. It sounds like the operating loss in Q3 will be quite large as management goes on to say “we expect an adjusted operating loss in the fourth quarter that is significantly smaller than in the third quarter, but larger than in the second quarter.”

About the only positive in SHOP’s earnings report is that it has roughly $5.50/share in cash and marketable securities. However, based on the 2H guidance, the Company likely will burn around 10% of the $6.65 billion in cash plus marketable securities.

Giving SHOP the benefit of simply doubling the 1H revenues to come up with a full-year estimate, SHOP is trading at 9x revenues. We can’t gauge operating and net income valuation ratios because the Company will be losing money, and the rate of loss will increase, for at least the next two quarters.  Thus, on both a trailing four quarter and six month forward basis, SHOP loses money. To put the 9x revenues metric in perspective, AMZN trades at 2.9x sales while most other retailers – all of which have big online businesses (WMT, TGT etc) trade between 0.5-0.8x sales trailing sales.

SHOP did a 10-for-1 stock split on June 29th. Pre-split it had run up to as high as $1700 at the frenzied top of the stock bubble. It’s back down to $340 pre-split. Post-split the all-time high was $170. The current stock price is $34 and the 5-yr low is just below $12:

Assume SHOP does $6 billion in revenues in 2022 – this gives SHOP the benefit of revenue growth in the 2H though it will still lose $600-$700 million on an operating loss basis. If SHOP breaks that line of support, which extends back to the March 2020 lows. I believe SHOP could see $12 before year-end but for sure within the next 12 months.

At a share price of $12, the price/sales ratio using my 2022 estimated full-year revenues is still 2.5x. This would correct SHOP’s valuation down to AMZN’s level. But unlike AMZN, SHOP loses a lot of money. If it corrects down to the average P/S ratio for big retailers with online operations, the stock price will fall to $3/share (this is based on a PSR of 0.65 and $6 billion in revenues). By the time SHOP might fall to $3, its cash hoard – at $5.50/share now – will be well below $5/share. Maybe the cash on hand will prevent it from falling to $3 for a couple years.

When the market rolls back over, which I expect to happen anytime between now and Labor Day weekend, I think SHOP will fall to the $20-$25 range. On that basis, I think the September 16th $30 puts are quite interesting. I may buy some of those. However, for the purposes of the valuation analysis I laid out above, I like the March 2023 $20 puts (traded at $1.75 on Friday) and the January 2024 $15’s (traded at $1.80 on Thursday) or the January 2024 $12’s (lowest strike offered, traded at $1.20 on Friday). A continued rally in the market that takes SHOP higher will help make the 2024 puts less expensive.

Rising Financial And Economic Uncertainty: Watch Big Pension Funds

After a decade of deranged monetary policies that ultimately amplified speculation beyond 1929 and 2000 extremes, we are so far from “normal’ that arriving anywhere near that neighborhood will be a journey. The recent market decline has simply retraced the frothiest portion of the recent bubble, bringing the most reliable market valuation measures back toward their 1929 and 2000 extremes – John Hussman, Hussman Funds

Calpers, the California public state employee pension fund, unloaded $6 billion worth of private equity holdings at discounts to where the positions were marked at the end of Q1. The discounts ranged anywhere from the high single-digits to as much as 20%. On the surface this may not seem like a big deal, as the $6 billion represents just 1.4% of Calper’s asset base. However, private equity investments are likely somewhere between 15-20% of Calper’s holdings.

The same is true for most pension funds. When the returns available on Treasury bonds and investment grade debt went below 1%, approaching zero for short duration Treasuries, public pension funds across the country ratcheted up their fund allocations to stocks, junk bonds and private equity. I know from insiders that some public funds increased the allocation of private equity to 20%.

The valuations of private equity positions are based on theoretical “mark-to-model” pricing. The new valuation of each company increases when the successive round of capital raises place a higher valuation on the equity of these companies. And the valuation models are based on where “comparable” companies trade in the stock market. The scheme worked great for generating higher mark-to-market rates of return each quarter and boosting the overall ROR on the fund during the years when the stock market bubbled up.

As long as the stock market was pushing the publicly traded “unicorns” higher (stocks like Peleton, Teledoc, etc), the private equity fund managers could apply rising revenue multiples to the valuation of the privately held equities. See the problem? The investment strategy at its core is a Ponzi scheme. This was being done by pension boards and managers in order to justify the payouts to current-pay beneficiaries despite the fact that the current payout stream of cash exceeded the cash inflow from investment gains and capital contributions from future beneficiaries.

The returns generated for pension funds on these positions each quarter and annually continued to rise with the stock market. But it was fool’s gold. Now all of the pension funds that jumped on the private equity bandwagon are faced with the prospect of having to write-down the valuations of most if not all of their private equity holdings. Many of the companies funded by the easy money during the bubble years will disappear, in which case private investments will have to be written-off completely.

This is an issue faced by States and pension beneficiaries that is not getting any air-time. But the report about Calpers caught my attention. I would bet that the positions that were sold by Calpers were cherry-picked because those positions had the highest bids from the buyers. Remember, these private equities trade over-the-counter in the private market, which is opaque and becomes extremely illiquid during a bear market. I am certain that many of Calpers positions had bids that were well below 50% of the price mark at the end of June and some had no bids.

As the bear market progresses, it will become apparent to many that big pension funds are in serious trouble. This in turn ratchet up the degree of financial and economic uncertainty, which will put further downside pressure on the stock market.

The commentary above is from the July 17th issue of the Short Seller’s Journal. Each week I provide analysis of the weekly key economic data plus provide short sell ideas and related put option suggestions. Currently I’m focused on the housing market, which is entering a bear market that will be worse than the 2007-2010 housing bear. You can find more information on this newsletter here: Short Seller’s Journal