This is the opening commentary in the December 14th issue of my Mining Stock Journal. I also the updates on two my portfolio stocks (I also reviewed Franco Nevada in the issue). To learn more, follow this link: Mining Stock Journal information
Yesterday (Wednesday, December 13th) the Fed signaled the end to interest rate hikes and, in so many words, implied that now the timing of rate cuts is being informally discussed. While stocks and bonds staged a rally, the precious metals sector sprinted higher. Gold and silver rose 2.4% and nearly 5%, respectively, while the mining stocks as represented by GDX soared over 6%. Across the board, the precious metals sector and mining stocks in terms of percentage price gains ran circles around the rest of the stock market. This should be the start of a long, sustained bull cycle in the precious metals sector that could take even seasoned gold bugs like me by surprise with the size of the moving coming.
Based on the FOMC policy statement from the December FOMC meeting, combined with what I believe are the key comments from Powell’s post-FOMC media circus, for all intents and purposes the Fed has pivoted toward easing with respect to its interest rate policy. In addition, I believe there was a subtle signal – intentional or not – that points to the potential for an eventual pivot from QT to more QE. As such, I believe the Fed has triggered the next big move higher in the precious metals sector.
As an aside, I have to believe in order for the Fed to lay itself out like it did Wednesday, it must be seeing highly adverse events unfolding “behind the curtain” in the banking and economic system.
Here are the salient comments from Powell (sometimes my English major comes in handy):
“Policymakers are thinking we have done enough.” Translation: “put a fork in the rate hikes”
“We haven’t worked out if we will follow a threshold-based path for cutting rates.” Translation: “We’re already discussing the implementation of rate cuts.”
“You need to reduce restriction on the economy well before 2%.” This last statement is measured confirmation that the Fed will soon start to cut rates. But the term “restriction” is intentionally nebulous. The meaning can encompass both rate hikes and the expansion of the money supply. Rate cuts in 2024 are a foregone conclusion. However, based on the Fed’s actions this year in response to the banking crisis, I believe “reduce restriction” means that the Fed will take further action in 2024 to increase banking system liquidity though it will likely be forms that are different from overt QE.
Though the Fed reaffirmed that QT program will remain intact (for now), it has used other means to inject liquidity into the banking system. In March the $400 billion it printed to prevent even more regional banks from collapsing is one example. The Bank Term Funding Program, which increases in size almost weekly, hitting an all-time high last week, is another form of QE (the Fed takes long-maturity fixed income assets at par value from the banks in exchange for giving the banks capital – that’s QE).
In addition, the Reverse Repo Facility has declined from $2.55 trillion in December 2022 to $823 billion, or $1.7 trillion as of December 13th. While this does not affect the size of the Fed’s balance sheet, it has enabled the dissemination of that $1.7 trillion into the financial system. The facility served as a “holding tank” for a couple trillion dollars worth the over $4 trillion the Fed printed during the pandemic period.
The facility was a way to withhold that money from the financial system and real economy in order to avert even worse inflation. The Fed could incentivize the retention of funds in that facility by raising the rate it pays. Instead it has let it leak out over the last 12 months because it is needed either to help fund new Treasury debt issuance or shore up banking system liquidity. Though the CPI will be rigged to hide it, this liquidity will stimulate price inflation.
More opaque is a $500 billion bailout facility created in 2021 called the Standing Repo Facility. This facility was the successor to the repo operations that began in September 2019. Establishing it in 2021 was done to make sure that the start of bailout measures are already in place when the next big bank crisis hits. This is different from the BTFP because the BTFP is open to any and all banking institutions. The Standing Repo Facility is limited to the list of primary dealers, which are the big banks, domestic and foreign, that have been approved to help underwrite and fund Treasury debt auctions. The SRF is, in effect, a ready-made QE facility the banks determined to be systemically important.
The Fed thus has in place a couple different avenues available by which it can inject liquidity into the domestic and international banking system as needed and it can direct this liquidity at specific banks. Just recently, a little-known bank outside of Japan was added to the list of banks on the Standing Repo Facility. This is why I maintain the view that the Fed has already been engaged in subtle forms of quantitative easing.
The point I’m making is that, despite the FOMC’s affirmation that it will continue with its balance sheet reduction plan, it’s an optical illusion. The next phase of quantitative easing, also known as “money printing,” has begun and precious metals investors have been given the green light to invest aggressively in the sector.
For point of note, I don’t necessarily expect the junior project development stocks to take off all at once. In fact, I hope they lag the larger cap stocks for a while. I also expect that large moves in micro-cap juniors will occur at any given time to specific individual stocks based on individual company news releases or positive events. Twenty-two years ago I likened this aspect of junior stock investing to watching popcorn pop. You don’t know when a specific kernel will pop but you know most of them will eventually. My point here is don’t be discouraged if some positions lag. At some point any stocks with merit – and many without merit – will make big moves when you least expect it.
In brief: Cabral Gold (CBGZF, CBR.V – US$0.11) released more drill results from the oxide material at the Central Gold deposit. The assays show that drilling continues to hit wide intervals of high-graded gold mineralization. One intercept showed 6.5 gpt over 2 meters within 28 meters of 1.2gpt. The results are important because they demonstrate and confirm continuity and confidence in the oxide blanket mineralization as well as help optimize the resource model for the PFS the eventual mine operation. Cabral continues to be egregiously undervalued. I added shares today. Alan Carter (CEO) told me that his excitement about this project keeps him up at night!
i-80 Gold (IAUX, IAU.TO – US$1.70) released more drill results from Granite Creek. Ordinarily I have not been updating every drill result release because there’s been so many, especially from Ruby Hill and Granite Creek (this is a good thing because it shows the Company is serious about aggressively and expeditiously advancing both projects). But today’s results stand out because of the high grades encountered underground. Just one example is 31.1 gpt over 21.9 meters. The stock jumped 8% on the news.
This degree of high-grade is why big companies like Barrick and Newmont spend a lot of capital developing and processing Carlin Trend underground high-sulphide ore. It’s what makes access to an autoclave so valuable. It’s why I think IAU, currently valued at $500 million, will eventually be worth over $1 billion.
The following commentary and analysis is from the December 17th issue of the Short Seller’s Journal. To learn more about this newsletter, follow this link: Short Seller’s Journal information
The stock market, led by the Dow, is going parabolic as it inflates on helium forced into the financial system by the Fed. The bubble has become more manic and all-encompassing than the late 1990’s dot.com/tech bubble, which was led by the Nasdaq. This time around the Dow is leading the pack and has become irrationally exuberant.
While this could become even more insane to the upside, the sentiment and level of speculative activity are back to levels historically indicative of a top. Yesterday’s (December 20th) sudden, sharp reversal in the stock market is likely a warning shot – tremors before a bigger earthquake. Retail trading accounted for 30% of the total trading volume on Friday, compared to the 30-day average of 10%. Volume in sub-$1 stocks is surging, reflecting an extreme degree of risk-taking. But it’s not just the penny stocks. The meme stocks like CVNA and SNAP are going parabolic.
A long-time subscriber asked me how I explain the big move higher in CVNA because it’s pretty clear CVNA will eventually have to file bankruptcy. I asked him to look at this chart to tell me:
The chart plots CVNA (candlesticks) vs the MEME stock ETF (blue line). Note the strong correlation between MEME and CVNA. In fact, what does it say about CVNA that it has been underperforming MEME in the move higher that began in early November. Every retail idiot trading this market is chasing the worst garbage stocks higher. Most of the stocks in MEME have a very high short-interest. Most will be bankrupt within the next three years.
Long positioning by CTAs is at its most extreme level in at least eight years. Extreme long or short positioning by CTAs is a highly reliable contrarian indicator. The VIX is at its lowest level since mid-January 2020. Also, the weekly survey by the Association of American Individual Investors (high net worth, retail) shows that bullish sentiment jumped up to 51.3% through Wednesday, its highest level since July 19th. At 19.3%, the percentage of bears is at its lowest over that same period.
No one can say for certain when this madness will reverse. But we can say for certain that it will and when it does the ensuing sell-off will likely be brutal. Though I took a beating over the last three weeks in my put portfolio and closed out most of the positions. I continue to hold January CVNA $50 puts, AN January $125 and $130 puts, NVDA March $435 puts and TSLA April $220 puts. In addition, on Friday I started a position in IWM (Russell 2000 ETF) late December $195 puts. Earlier in the week I started buying late January SNAP $16.5 puts. Take a look at SNAP’s chart [next page] to understand why. Oh, I also hold January GDDY $100 puts.
C’mon, man. For its Q3, SNAP’s operations lost $380 million. Through 9 months it’s incurred a $1.14 billion operating loss. The only reason this Company is still in business is that the capital markets have enabled it to raise over $4.8 billion via convertible bonds between 2019 and 2022. It did not issue any debt in 2023. But the only thing keeping SNAP from going out of business is the $3.4 billion in cash it had at the end of Q3 2023.
The stock gapped up on November 14th when it was reported that SNAP signed a deal with AMZN that enables AMZN to run ads on SNAP which let SNAP users shop on AMZN and check out without exiting the SNAP app. The economic terms connected to the agreement were not disclosed, which means that the terms do not directly generate revenues from the agreement for SNAP. In terms of the financial benefit of this deal for SNAP, the only thing I could dig up after scouring articles and reports is that the deal might increase average user time on the SNAP app which might enable SNAP to charge higher advertising rates.
In my opinion, SNAP is worth no more than the value per share of the cash on its balance sheet, which will deplete over time. Currently it has $2.42/share in cash. At some point I plan to increase my capital commitment to SNAP puts beyond the January $15.50 puts I have now.
Housing market update – The homebuilder and home construction stocks have gone absolutely parabolic:
The Dow Jones Home Construction Index has soared 17% since the end November. The MACD momentum indicator is by far at its most over-bought reading in the history of the index (2000).
But while the homebuilders have been increasing deliveries via the use of heavy price discounts and other incentives, they are not reporting record levels of revenues and profitability. And the contract value of their order backlogs is plummeting. And here’s the 10-year picture of the monthly seasonal adjusted annualized rate for new home sales:
While new home sales bounced after declining for nearly two years, overall the rate of new home sales has been in a steep downtrend since late 2020. In other words, the differential between the market cap of the homebuilders and their profitability may be at the widest in stock market history. The DJUSHB is 2.4x higher that it was at the peak of the early 2000’s housing bubble while the SAAR peaked at over 700k back them compared to the current SAAR of 679k. I believe that reality will hit the stock market hard in 2024 accompanied by a swift sell-off in the homebuilder stocks.
Lennar (LEN – $149) reported its FY Q4 and full-year numbers on Thursday after the close. Despite “beating” revenue and EPS consensus, as well as the expected FY Q1 2024 forecast, the stock dropped 3.6% Friday. This is because it was apparent to the market that LEN sacrificed margins by cutting prices and offering fat incentives.
While Q4 revenues rose YoY 7.9%, operating income rose just 4.8%. Ordinarily in a healthy operating environment, homebuilders would benefit from economies of scale and operating income would rise percentage-wise more than revenues. But the ASP declined 8.7%. This does not include incentives like rate buy-down loans and architectural upgrades.
LEN’s share price has soared 42% since the end of October. I would be an idiot if I didn’t admit that I wish I had bought calls 7 weeks ago. But the increase in market cap is not in any way remotely justified by fundamentals.
The value of LEN’s backlog, despite a 4.3% increase in new unit orders, plunged 24%. The ratio of LEN’s market cap to the value of the backlog is 6.4. A year ago this ratio was 2.98. This illustrates the degree to which LEN’s market value has become completely unhinged from reality.
While the builders enjoyed a bounce in sales during 2023 thanks to rate buy-down gimmicks as well as other tweaks to mortgage terms that lower the cost for the first two years, with the “savings” added to the back-end cost of the mortgage, plus huge price and upgrade incentives, I have no doubt that homebuilders face a tough 2024.
Most sectors of the economy are already in a recession and the Fed has already started to ease monetary policy. But when will the Fed cut rates? I think it will take the onset of a banking system crisis or a steep decline in the stock market, or both, before the Fed cuts rates.
Craig “Turd Ferguson” Hemke invited me back onto his Thursday Conversation podcast to discuss the economy and precious metals sector as well some specific mining stocks. You can access out conversation from his website: TFMR – Thursday Conversation or from the MP3 below:
You can learn more about my Mining Stock Journal and Short Seller’s Journal newsletters via the links at the top of this website.
The Conference Board’s Consumer Confidence for November is 102; 101 was expected. However, the big story is that October was revised to 99.1 from 102.6! The November Present Situation is 138.2. October was revised to 138.6 from 143.1. The November Expectations is 77.8; October was revised to 72.7 from 75.6. Why did Conference Board statisticians botch October metrics so badly? Why have there been so many downward revisions to US economic data? Qui bono? – The King Report, November 29, 2023
The following commentary is the opening salvo of my December 3rd Short Seller’s Journal newsletter. Follow this link to learn more about SSJ: Short Seller’s Journal info
Many of the Government and some non/quasi-Government association economic reports are being released with suspiciously bullish data only to be revised lower in subsequent months. But the revisions are buried in the reports and never make the headlines. The Conference Board’s Consumer Confidence survey is one of the examples just from this week. Typically parallel data from the private sector do not corroborate the data from these reports.
The Chicago PMI on Thursday morning, released by the Chicago Institute of Supply Management, spiked up to an index level of 55.8 from 44 in October and vs 45.4 expected by Wall Street. The report triggered a 1.47% manic rally in the Dow, though the SPX closed up 0.38% and the Nasdaq was red. The big jump in “measured” economic activity was one of the biggest “beats” in the history of the index, with a 13-sigma beat (i.e. the probability that the reported result is the actual result is near-zero).
I think the explanation for the unexpected spike in the Chicago PMI data is attributable to the fact that auto labor union strike was resolved in November. The Chicago Fed region hosts a large number of automotive OEM parts suppliers and many other businesses related to the manufacturing of automobiles. All of the sub-index components of the Chicago PMI, in my opinion, reflect the surge in orders, shipments and other economic activity related to the post labor settlement ramp-up of automotive manufacturing.
The Chicago PMI likely does not have a methodology to adjust, or “smooth out,” the data points connected to the post-strike ramp-up in automobile production. Thus, I am confident that this particular economic report does not support the “recession avoided” narrative promoted by the Biden people, the Fed and Wall Street. In fact, a day later S&P Global reported its Manufacturing PMI and it showed a decline to 49.4 from 50 in October, driven by a decline in new orders and employment. A reading below 50 indicates contraction in business activity.
Speaking of the Fed, the Fed’s Beige Book for November said the economy continued to show a slowdown in activity from the October report. The October report basically said that economic activity stagnated. The point here is that the Chicago PMI in all probability does not at all reflect economic reality. This is particularly true given that the other major Fed regional bank economic indices, as well as the leading indicators, point to a continued contraction in economic activity.
The ISM Manufacturing PMI for November was reported at 46.7, unchanged from October, but was expected to improve to 47.6 by Wall Street. All sub-indices contributed negatively (new orders, production, employment, inventories and supplier deliveries). However, contrary to the Chicago PMI which said that prices paid moderated, the ISM prices paid jumped higher. Some of the respondents to the survey described their business sector (fabricated metal products, chemicals) as in recession.
Further reinforcing the recession view, the Cass Transportation Index shows continued contraction in shipping and freight transportation activity. The shipments index fell 4.7% MoM and 9.5% YoY; the The expenditure index declined 2.2% MoM in October and 23% YoY; and the truckload linehaul index fell 0.6% MoM and 8.3% YoY. The timeline charts for all of these indices are down considerably from the peak in early/mid-2022 and down to their respective levels in late 2020/early 2021. Freight transportation directly reflects the level of economic activity at all levels of the economy.
The Cass metrics thereby do not corroborate the heavily massaged Government and trade association economic reports. Certainly the Leading Economic Indicators, reported in mid-November, having declined for 19 straight months indicates that the U.S. economy is in recession.
The reason I’m hammering on this is that another stock market “echo bubble” has reinflated, particularly in the cyclically sensitive Dow Jones Industrial, fueled by a dovish pivot by the Fed and hyperinflated market expectations of rate cuts and money printing in 2024. In fact, the Dow appears ready to go parabolic:
The Dow is just 1.6%, or about 600 points, from the all-time high close on January 4, 2022. In comparison, the Nasdaq is still 12.5% away from its ATH while the SPX is 4.6% below its ATH. Speculative frenzy, momentum-chasing and outright gambling have engulfed the stock market, fueled by a Federal Reserve that has stealthily, or maybe so stealthily, ushered more liquidity in the financial system while financial condtions since the last FOMC meeting per the various financial conditions indices (Goldman, for instance) have eased at the fastest rate in four decades. The most overvalued shitco garbage stocks have soared like dot.com stocks during the tech bubble (CVNA and SNAP, for instance). CVNA likely will be in bankruptcy sometime within the next 24 months. It’s high-coupon debt still trades at a big discount to face, which means the bond market believes the equity is a bagel.
I have to believe that this echo bubble will soon quickly deflate, as did the echo bubble that inflated earlier in 2023. Though this market insanity could last for a few more weeks, certainly all of the signs of a top are present. Any fear of risk has evaporated from the market. The VIX has melted down to a level not seen since early February 2020, when the market at the time hit an all-time high. Retail investors have been furiously piling back into the stock market. For the weekly period ending November 22nd (a week ago Wednesday), retail investors net bought $4.8 billion in cash equities. This is 2.3 standard deviations above the last 12-month weekly average and the highest weekly inflow since April 2022.
In terms of sentiment, the CNN Business Fear & Greed index is almost back to extreme greed. But even more telling is the American Association of Individual Investors (retail, high net worth) sentiment readings. The percentage of bullish respondents hit 48.8%, its highest reading since August 2nd (the stock market started a 3-month decline in early August) while the percent of bearish respondents fell to 19.6%, the lowest level since January 3, 2018. The spread between the bullish and bearish respondents, at 29.2 points, is more than four times higher than the historical average for the differential.
Finally, sentiment and investor positioning is getting “stretched” again to extreme bullishness. As an example, a sentiment indicator compiled by Goldman Sachs measures stock positioning across retail, institutional and foreign investors versus the past 12 months. Readings below -1.0 or above +1.0 indicate extreme positions, long or less long and very short. The indicator is a reliable contrarian signal. Currently the indicator shows extreme long positioning. Part of this is the automatic algo positioning of CTA funds. They have piled head-first into long positions. It could unwind at any moment.
Circling back to the integrity of Government economic reports, the differential between the Gross Domestic Income (GDI) measurement and the Gross Domestic Product (GDP) measurement is the widest in the history of the two data series. The differential in the YoY% between the two metrics is 3 points, with the GDP three points higher than the GDI. The GDI measures the total income generated by all sectors of the economy including wages, profits and taxes (tax revenues have been declining, by the way).
The Government (BEA) claims that two metrics conceptually are equivalent. However, conceptually, the level of corporate revenues, income and tax revenue generated is a more accurate measure of wealth output and it can be measured more accurately than the GDP variables, which are estimated/ guesstimated and statistically massaged (GDP = consumption + investment + Government spending + exports – imports).
The point here is that, based on the GDI rather than the GDP, the economy is not generating the level of wealth portrayed by the quarterly GDP calculus. In fact, in Q3 the GDI registered a slight YoY percentage decline. 2001 and 2007 were the only other times going back to 1971 the GDP was positive YoY while GDI was negative. In both cases the economy spiraled into tough recessions.
Speaking of the economy, Best Buy and Lowes both cut their forecasts and warned that shoppers were pulling back on big-ticket items like appliances ahead of the holiday season. This is particularly true for higher income demographics. According to a report from Bloom-berg, foot traffic at shopping malls that serve higher income areas is starting to decline for the first time since the pandemic. In October, 21 of the 25 shopping areas surveyed across the country posted declines in foot traffic, with overall foot traffic down 3.3% YoY for the latest three-month period. I have been making the case that household disposable income is tapped out. Further, based on early holiday spending reports, use of buy now/pay later credit is soaring.
Most people do not understand that the Fed supposedly is the “safekeeper” of the gold allegedly owned by the
U.S. Treasury Department Taxpayers. But in all likelihood most if not all of that gold has been hypothecated, leased or sold outright in the Fed’s effort to remove bona fide price discovery from the gold market. As fact, the gold said to be owned by the Treasury has not been subjected to a formal and rigorous independent audit since Eisenhower occupied the White House.
GATA’s Chris Powell submitted some interesting questions – questions that should be answered but is not legally required because the Fed is a privately-owned entity, the fact of which most Americans are unaware. And, as it turns out, the NY Fed refuses to say if it been repatriating or intervening in gold. The post below was dispatched by GATA on December 2nd. I would love to know the answers to these questions but I’m not holding my breath…
Dear Friend of GATA and Gold (link):
With repeated telephone calls and e-mails, for three weeks your secretary/treasurer has been trying to get the Federal Reserve Bank of New York to answer two simple questions about its gold responsibilities — questions the New York Fed has answered for others in years past — but has been unable to get any form of acknowledgment.
Would you be kind enough to help?
Here are the questions.
1) Does the New York Fed’s statement of November 9 asserting that the Federal Reserve and U.S. Treasury Department did not intervene in the foreign exchange markets during the July-September 2023 quarter —
— cover the gold market as well?
2) Has the New York Fed repatriated any gold to foreign nations this year? If so, how much and to which countries, and how much was repatriated in each month?
Answers to these questions might illuminate how the gold market is being directly if surreptitiously influenced by central banks quite apart from any announced purchases of gold for reserves.
You can help in two ways.
First, try putting the questions directly to the publicists for the New York Fed as your secretary/treasurer has been doing. A list of the New York Fed’s publicists with their telephone numbers and e-mail addresses can be found at the bank’s internet site here —
— when you click on the “Media Contacts” line in the middle of the right column. If you have time, try both a telephone call and an e-mail.
Second, call or write to your members of Congress and ask them to get the answers for you from the New York Fed.
Contact information for U.S. representatives is available here:
Contact information for U.S. senators is available here:
And of course if you get any response, please let your secretary/treasurer know.
Your secretary/treasurer will bring these questions to the attention of a large number of reporters for mainstream news organizations and some financial letter writers, just in case any are ever allowed or inclined to put critical questions to central banks, the institutions that determine the value of all capital, labor, goods, and services in the world but seldom are asked to answer for what they do.
CHRIS POWELL, Secretary/Treasurer
Gold Anti-Trust Action Committee Inc.
With respect to the economy, the hard reality on Main Street is the opposite of the propaganda and lies pitched at us by Wall Street, Capitol Hill and the mainstream financial media. Most sectors in the economy are in recession. At some point the Fed will either have to let financial and economic system implode or it will be forced to crank up the money printing press again. In some ways this has already occurred in response to the regional bank crisis last spring. Kai Hoffman and I discuss economic reality and the precious metals sector.
If you are interested in learing about some junior project development stock ideas with 5-10x upside potential, click here to learn more about my Mining Stock Journal
Liquidity in the primary dealer Treasury market is drying up. Deposit outflows from the big banks continue unabated. The outflows at the small, regional banks haveg abated but some banks continue to draw on the Fed’s Bank Term Funding Program, which hits a new high almost weekly. The facility matures in March but it’s doubtful the debtor banks will be in a position pay back the loans. Just like the “temporary” repo program that began in September 2019, the BTFP will continue to hit ATH’s and the Fed will extend the maturity of the facility. This is de facto QE.
In my bi-weekly Arcadia Economics podcast, I discuss the indicators that point to a large-scale banking crisis percolating. The day after I recorded the podcast, Citigroup announced 10’s of thousands of layoffs – another sign of the onset of financial distress.
The mining stocks are historically undervalued relative to the price of gold and to fraudulent, fiat securities, especialy in the junior microcap project development stocks. If you interested in ideas to capitalize on the re-instatement of QE, check out my mining stock newsletter: Mining Stock Journal information
The following analysis is from my latest issue of the Short Seller’s Journal. Follow this link if you would like more information on this newsletter: SSJ info
Carvana (CVNA – $31.96) – CVNA reported its quarterly numbers Thursday after the close. Of course the headline report announced that the Company beat the Street. But as is always the case with CVNA, a look under the hood reveals both heavy use of accounting gimmicks and the continued deterioration of CVNA’s business model. This includes a 52% plunge in the number of vehicles listed on the website at the end of the quarter and a 28.6% decline in average monthly unique visitors to the website vs Q3 2022.
Revenues declined 18% YoY and 6.6% from Q2. Retail vehicle unit sales plunged 21% YoY for Q3. YTD thru nine months revenues are down 22.4%. While the Company was boasting about a big jump in the gross profit per vehicle sold, a significant contributor to the reduced cost of sales was the result of the Company playing games with the auto loan volume it originates and sells. CVNA reported $5.95k GPU (gross profit per unit), an increase of $2.45k GPU vs Q3 2022. But of this $2.45k, $1.8k (or 73.5%) is attributable to the gain on loan sales that resulted from an unusually large reduction in auto loans held for sale. In all probability, this source of GPU benefit will be non-recurring or greatly reduced going forward. In addition, it admitted in the footnotes that it took a non-recurring accounting “allowance,” meaning a non-cash credit applied to the cost of sales.
In reality, CVNA lost $108 million for the quarter:
Moreover, this gain is fictitious. It provides zero economic benefit to the Company other than two years of reduced cash interest expense. However, as I detailed in the July 23rd issue of SSJ after the transaction was announced, after two years of the PIK feature the amount of debt will be back to where it was before the exchange and the rate of interest on the debt will be higher:
CVNA also announced a debt restructuring that will involve exchanging $5.6 billion in debt that matures between October 2025 and May 2030 for $4.3 billion of new notes that mature in December 2028 through June 2031. The new notes have a PIK feature for up to two years (pay-in-kind, meaning the Company can pay the interest expense for up to two years in more bonds rather than cash).
However, the PIK feature comes at a steep cost. The existing debt carries an average coupon roughly of 8.9%. One tranche of the new notes has a PIK coupon rate of 12% and 9% cash thereafter while a second note tranche carries a PIK coupon of 13% and 11% cash thereafter and the third new tranche has a 14% PIK and 9% cash thereafter. The weighted average cost of the PIK debt payments is roughly 13.1%. If CVNA chooses to PIK the notes for the first two years, after two years there will be roughly $5.6 billion in notes outstanding ($4.3 billion compounded 13.18% over two years). The same amount of debt outstanding before the debt restructuring!
The reason CVNA is able to claim that it produced positive net income is because the Company reduced the total outstanding amount of bonds via the debt exchange along with the issuance of $452 million in stock. Because of this, GAAP entitles the company to recognize a one-time non-cash gain of $878 million, which represents the amount of the discount to par value of bonds that were eliminated from the debt exchange.
Ironically, the one-time “gain” from the extinguishment of debt will be erased after two years. The problem with the GAAP treatment of this matter is that CVNA gets the optical benefit of the “gain” but will not have to reverse that “gain” despite the fact that the debt level will be back to where it was before the exchange.
One skeleton that will pop out of the closet for CVNA is its liquidity. Cash at the end of Q3 was $616 million, down slightly from the end of Q2. But this included the $453 million from the sale of shares during Q3. $213 million of the cash provided by operations in Q3 was the result of inventory drawdown (i.e. selling more inventory than was replaced). CVNA can’t continue with this rapid inventory reduction much longer or it risks the loss of potential sales.
Another $500 million of the cash provided from operations came from selling more car loans than originated. In most quarters, the amount of proceeds from the sale of loans is roughly equivalent to the amount originated. As with the inventory drawdown, this is not a sustainable source of cash. The amount of finance receivables held for sale declined to $650 million by the end of Q3 vs $1.098 billion at the end of Q2 and $1.334 billion at the end of 2022. There may be a little more “juice” to squeeze out of the sale of finance receivables in excess of originations, but it becomes more difficult as unit sales continue to decline. Also, the credit quality of some percentage of these loans is likely to be too low to dump into ABS bond trusts.
I wanted to show the comparison of the Q2 and Q3 asset side of the balance sheet because it’s a good visualization of what I mean when I say that CVNA’s business model is deteriorating in size. CVNA’s cash provided from operations was $599 million. But $713 million is attributable to the extraordinary reduction in finance receivables and inventory. This means that, on balance, the cash provided from operations outside of those two items was negative $114 million.
As mentioned earlier, the overall scale of CVNA’s business model is contracting. At some point in the next couple of quarters, CVNA will need to raise cash. It is authorized to sell up to $547 million more worth of shares via at-the-market offerings. This means that the Company can sell shares at any time without announcing it to the market until after the shares are sold.
Carvana is insanely overvalued on its own but also relative to Autonation and Carmax (note: I think AN and KMX are also good shorts). It’s tough to do a full comparison of the respective valuation metrics because both AN and KMX generate operating and net income while Carvana generates neither. But CVNA trades at a price/sales ratio of 0.32x. KMX trades at a P/S of 0.39x and AN trades at a P/S of 0.22x.
Carvana is much smaller in terms of revenues, which means its business risks are higher. And of course there’s the debt load, which substantially increases CVNA’s riskiness as an investment. The amount of debt CVNA has outstanding and the cost of that debt is obscenely higher than the amount of debt, and the cost to service that debt, that is carried by KMX and AN relative to the size of their revenues, profitability and total assets. As such, CVNA should trade with a P/S that is lower than the P/S’ of KMX and AN.
Applying Autonation’s P/S ratio of 0.22 to CVNA’s trailing twelve month revenues of $11.18 billion results with an implied market cap of $2.46 billion, or roughly $1 billion lower than the current market cap. That translates into an implied price per share of $22.85. But that’s just a starting point. CVNA’s revenues are quickly trending lower and will for the foreseeable future as household finances become increasingly strained and the economy continues to atrophy. In addition, based on CVNA’s current level of cash flow generation and likely further reduced cash flow from operations, at some point the Company will be unable to service its debt. The bondholders kicked the can down the road with the last debt exchange.
Given the continued deterioration in CVNA’s operations, it is likely that the bondholders will not tolerate another deferment of bankruptcy while the assets depreciate in value. In a strict bankruptcy restructuring scenario, CVNA’s equity is worthless, though the court would likely toss warrants to the shareholders. In a strict liquidation scenario, CVNA’s equity is completely worthless.
CVNA, which is heavily shorted (38% of the float was short at the beginning of November), experienced a sharp bounce along with the stock market on Thursday and Friday. I am also certain that there was some momentum-based price-chasing as well as panic-short covering on Friday in response to CVNA’s headline “beat.” Unless the market rally continues, I plan to press my short positions in CVNA over the next few weeks. Ultimately I believe CVNA will trade under $5 within the next 12 months.
The prices of gold and silver and the valuations of mining stocks – from the largest cap producers to the cash-consumer junior project developers – will go parabolic along with the money supply and issuance of Treasury debt. Holding dollars will be the equivalent of financial suicide. Converting cash into physical gold and silver will be the most effective hedge against hyperinflation. The Central Banks will be powerless in their effort to control precious metals prices.
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Anyone who does not admit that the Central Banks actively manage the price of gold is ignorant of the facts. If they are ignorant of the facts, they are too lazy to look for the truth. But GATA makes it easy. Robert Lambourne is a GATA consultant who scrutinizes everything published by BIS.
(the graphic is from a BIS presentation to Central Banks that advertised the BIS’ services)
“As far as we can determine, only one person in the world outside central banking — GATA’s consultant Robert Lambourne — reviews the BIS monthly reports and does the calculations necessary to discover what is happening. The interventions, accomplished in large part through gold swaps and leases, are not stated plainly in the BIS monthly reports, though they easily could be. The interventions are stated plainly, if obscurely, only in the bank’s annual report. But recent BIS annual reports have confirmed the stunning accuracy of Lambourne’s monthly calculations.” – Chris Powell, GATA
From Lamourne’s dissection of the latest BIS monthly report:
The BIS’ gold swaps had fallen to zero as of December 31, 2022, and reached their peak for 2023 so far of 188 tonnes as of May 31.
It remains likely that the BIS has entered these swaps on behalf of the U.S. Federal Reserve. There is no evidence to suggest that any other major central bank is actively trading this much gold, and so far in 2023 many central banks have been accumulating physical gold.
The basic transaction that the BIS is believed to undertake is to swap dollars for gold transferred from a bullion bank, then to deposit this gold in a gold sight account at a central bank, presumed to be the Fed but almost certainly being the central bank that is using the BIS to execute the gold swap on its behalf.
The basic transaction that the BIS is believed to undertake is to swap dollars for gold transferred from a bullion bank, then to deposit this gold in a gold sight account at a central bank, presumed to be the Fed but almost certainly being the central bank that is using the BIS to execute the gold swap on its behalf.
Given the recent volatility in the levels of BIS gold swaps, it seems likely that most are of short duration. Why a central bank needs the BIS to undertake gold swaps isn’t clear, but the swaps are likely connected with short-term trading needs, which could include suppressing the gold price.
Read the full GATA dispatch here: BIS gold swaps fell in September as bank’s substantial trading continued