John Tuld, CEO: “We are selling to willing buyers at the current market price.”

John Tuld: “So that we may survive.”

                                                            “Margin Call”

If you ever wondered where you stand on Wall Street, the op-ed opinion piece in yesterday’s New York Times is a must read. The fall out from the words of a 12-year veteran of one of the world’s most prestigious investment firm is resonating around the world.

Watch your Wallet

It is not necessary for me to identify either the firm or the writer, since just about everyone now knows who I am talking about it. Yesterday, my inbox was deluged with readers who forwarded me the piece. Most readers are aware that I have a huge beef with the ethics on Wall Street and what I see as the ‘customer comes last’ attitude that is prevalent within that sector.

As has happened in the past, I’m sure that after this column runs I will receive a flurry of hate mail from those in the financial community, who believe I am attacking them personally. I’m not. Most individuals in this business are decent folks who do care about their clients –when they are allowed.

Unfortunately, they work for firms that cannot put the interests of their clients first or even in the top ten of their business objectives. These firms are just too big, too short-term and too focused on next year’s bonuses to afford the luxury of putting their clients first.

Now, I know for the most part I am preaching to the choir at this moment. As the facts have come out about just how duplicitous these companies and their managements have been in creating, exacerbating and finally being rewarded for the financial crisis they engineered. Is it any wonder that very few Americans trust Wall Street?

Despite financial legislation and promises of a new ethic by those caught with their hand in the cookie jar, it is very much business as usual on Wall Street. It cannot be otherwise. When I first got into the business in the early 1980s, the big names on the Street were largely partnerships with long-term relationships with their clients. It was a world where trust among your clients was your most valuable asset.

The shift from private to public companies, the end of fixed commissions, the dawn of proprietary trading (firms trading their own capital), the escalation of risk and with it much greater rewards, altered the ethics of finance. These new masters of the financial universe embraced greed and abandoned the old ways. As a result, they saw their total pay skyrocket 70% above average paychecks in all other industries in the last decade.

Big became not only beautiful but mandatory in this new high stakes area. The bigger you are, the more muscle you can throw around, not only with your competitors but with your customers as well. Clients become numbers to be crunched. Today, these firms are so big that they truly are “too big to fail.” And because they are, they are largely immune from retribution or legislation.

I say we should salute this middle-management executive and his op-ed piece. He most likely will face legal and monetary retribution from his ex-firm. You see, almost everyone on Wall Street must sign both a non-compete contract as well as agree not to say anything disparaging about their firm upon departure (whether voluntary or not). If you violate these agreements, the company will and does come after you with the full weight of their legal departments.  It is one of the reasons that so few ex-employees actually “tell all” when they quit.  Although this guy’s opinion will amount to no more than a cry in the darkness, he should be commended and remembered for his courage and honesty.

Their forecasts are being extrapolated from the present price of gasoline which averages $3.52 per gallon. That is high for this time of year, since February is usually a period of low gasoline demand. You might think that this year is a bit different since the mild winter and absence of snow throughout much of the country might bolster driving. But demand nationwide is down to 15-year lows.

What has propped up oil prices so far this year is continued instability worldwide. The financial crisis and subsequent recession in Europe, which should have reduced energy demand has been counterbalanced by events in the Middle East. The real culprit in the oil patch appears to be Iran.

The world wants Iran to cease and desist developing nuclear weapons or else. In response, Iran has been threatening to close a key oil avenue through the Strait of Hormuz, if the U.S. and the EU deliver on their intent to apply economic sanctions to their country. As a result, the price of oil has been flirting with $100/BBL level over the last few months and is presently trading above $102/BBL for West Texas crude. The threat of higher oil prices if Iran were to embargo Europe or the U.S. is real. Iran boasts the world’s fourth-largest proven oil reserves and the world’s second largest natural gas reserves.

Middle East tensions are nothing new. The oil market periodically moves up and down with unfolding events in that region. Spikes tend to be short-lived but everyone from the Fed on down pays attention to trends. What makes this situation a little different than usual is that the tensions are occurring just at the moment when the U.S. economy appears to be picking up some speed.

The last thing this country needs right now is for oil/gasoline prices to trend higher. I have written at length on how energy prices are another form of tax on American consumers. Although energy prices account for only 5% of our overall spending, it is spending that cannot easily be cut back. If the experts are right and gasoline prices move higher as a result of a stronger demand and the continuation of political tensions, then consumers might be paying a few hundred dollars more this summer for gasoline.

That is a lot of money when multiplied by the number of Americans driving cars, trucks, buses and motorcycles. If past behavior is any guide, consumers will fork over the extra money for gas but at the same time cut spending on other things like restaurants, vacations, and shopping at the mall. Higher energy prices will also take a bite out of profits in Corporate America. It will also mean higher prices from everything from diapers to tires as companies attempt to pass on the higher energy costs to consumers.

Unfortunately, higher energy prices are here to stay as long as this country fails to develop a comprehensive energy plan that will reduce our dependency on oil. Until then, we will remain hostage to every two-bit, oil-rich dictator or wanna-be nation that takes a swipe at us.

Oil and gas decline has silver lining

The power and abruptness of the decline caught the majority of investors unaware. After all, commodity stocks have led the market for well over a year. Stock investors were piggy-backing on what was happening over in the commodity pits. Up until last week, commodity speculators were minting money. They were able to borrow short term money for practically nothing (courtesy of the Fed’s QE 2) and were buying commodities, such as silver and gold, with the proceeds. Over time, as more and more traders jumped on board, commodity prices across the board spiked into the “bubblesphere”.

Silver for example, from $36/ounce to almost $50/ounce rose in less than two months. At that point the Commodities Mercantile Exchange (CME) decided (or was prodded) that enough was enough. On April 25th they raised the amount of money that investors had to put down as collateral (margin requirements) to guarantee their silver trades. It took five margin hikes in a row (an 87% increase in margin requirements) before speculators admitted defeat. And what worked to rein in the price of silver is now being applied to other more important commodities like oil and gas.

The Federal Reserve Bank has been targeting asset classes, such as the stock market, in their effort to spark a long-lasting economic recovery in this country. One fly in the ointment has been the spike in commodity prices, especially oil and food, as speculators borrowed money from the Fed at very low prices and made millions by betting on higher commodity prices.

Oil had reached as high as $112/bbl. and gas prices at the pump were skyrocketing in response. A similar trend was underway in food. The Fed is under increasing pressure and criticism as core inflation remains quite moderate, but consumers and corporations were paying more and more for energy and food (two non-core inflation items). The Fed’s Chairman, Ben Bernanke, has argued that prices for these non-core items are beyond their control. But are they?

Is it beyond reason to speculate that the CME may have received a call from Big Ben over at the Fed? If the Fed can target an upturn in the stock market, how difficult would it be to engineer a deflating of the commodity bubble through the stiffening of margin requirements?

Whether the CME decided on their own or had a little help, the downdraft in commodity prices has removed that problem from the Fed’s agenda. It will also produce an immediate and automatic boost to the economy across the board. Gasoline futures are already heading down on the back of a 21% margin hike on NYMEX gasoline futures. Corn was limit down (-5%) on Tuesday as well. Speculators are selling positions in anticipation that margin hikes on other commodities are just around the corner.

Over time, I believe commodity prices will stabilize and even rise, although not at the rate of the past. As the speculative froth comes out of this asset class, the real values will be set by supply and demand and not speculators. Many of these commodities are becoming increasingly scarce, whether in the energy, food or metals space, so the investment case is still viable. In the meantime, as prices come down to earth, I expect investors will begin to realize that this down draft is actually a windfall in disguise.

Recently, the data in the real estate markets has been confusing, even contradictory, which is what one would expect in a bottoming market. For example, the National Association of Realtors said that 2010 was the weakest year for home sales since 1997 and the number of foreclosures in 2011 will continue to weigh on home prices, which are expected to fall even further in the next six months.

Given these somber statistics, why would anyone want to invest in real estate? As a contrarian, I often like to invest in markets that most others shun, especially when I believe the worst is just about over. Over the last few months, certain housing statistics indicate a bottom is forming in this sector, in my opinion.

For example, existing home sales hit their low in July, 2010 and have steadily increased each month since then (with the exception of October). For December, sales were up in all parts of the country with the strongest gain coming from the west with a 16.7% increase. Sales rose 13% in the Northeast, 10.1% down South and 11 % in the Midwest.

Many bearish forecasters, however, point to the rising tide of housing inventory as a reason to stay away from the sector. The more inventory there is to sell, the more prices must go down, and the more time it will take before supply and demand of houses is back in equilibrium. Last month, the inventory of unsold homes stood at an 8.1 month supply, down from 9.5 months in November. The trend looks good but unfortunately it is still far from normal since the historical average of normal inventory is 4.5 months supply.

In September, 2010 there were 3,585,000 homes for sale. However, lurking out there are all those houses whose mortgages are in default called “shadow inventory”. That represents another 3,776,200 units that could possibly be dumped on the market. If we assume that 50% of them will ultimately be added to the national housing inventory, then it could take as much as two years to work off (sell) this entire inventory, assuming that no new inventory came on the market.

New inventory (housing starts) will continue to grow at the same time, but the data indicates housing starts are growing at a declining rate. Since March we’ve experienced a 20% decline is the issuance of building permits. Housing starts dropped an additional 4.3% in December. It appears that the big national homebuilders will be cautious for the foreseeable future in building new homes until a recovery begins.

Of course, the real key to the housing market is the growth rate of employment. Without a job, there is little one can buy, regardless of how low housing prices or mortgages rates go. There again the data points to an uptick in employment and the Fed and government are doing everything they can to boost that number.

Most people I talk to have nothing positive to say about the real estate market. Some investors actually hate it, especially if they suffered major losses in REITs or other real-estate related securities. That’s the time when many smart people start paying attention. Two men I respect, Warren Buffet and hedge fund manager, John Paulson, are predicting the housing market will bottom this year. I agree.

Remember too, that in this era when so many investors are concerned about future inflation, real estate has provided a suburb hedge against inflation along with other commodities. If you are an investor with a short-term horizon (the next 3-6 months), then real estate is not for you, but if you have the patience to invest now and hold for a few years, I believe now is the time to buy. Please call or write for my specific recommendations.