Saddle Point Asset Management LLC. is a start-up Hedge fund in Beverly Hills, California that manages funds for its partners and investors.
Saddle Point Asset Management’s primary investment objective is to appreciate capital through an opportunistic investment and trading strategy that emphasizes the exploitation of major macro economic trends and special situations. Through the deployment of this strategy, the Partnership seeks to generate risk-adjusted returns that substantially outperform The Treasury Bill Rate, regardless of the economic and market environment.
The short-term objectives of the blog are simple: to create an online public community of investors who share ideas on our site.
Wednesday, January 6, 2010
Investment Letter December 7, 2009
To Our Friends,
The Dollar and Asset Inflation
Before we review the markets, a couple observations to share:
1) While lunching a couple weeks ago with one of the smartest value
investors we know, a person who has literally made a fortune as a public market investor over the past 30 years, we asked what he was doing in
the markets, and his response was: “I’m just trying to get out of dollars.”
This reminds us that excessive monetary stimulation and currency creation
lead directly to inflation of other assets. Investors do not want to get caught
holding a depreciating asset, so they try to diversify out of it. In the case of the
dollar, one is holding Treasury Bills that pays little or nothing in a currency
that is depreciating. To do nothing is to sit idly by while one’s purchasing
power continuously erodes. The process by which our friend and the rest of
the world “get out of dollars” is a secular trend that we call a “bear market on
the US Dollar”, and this is a continuing theme that is not going away soon.
We have been bearish on the dollar for some time and expect to be so for
sometime into the future.
That said, there is currently a rally underway in the dollar, which is in our
opinion, primarily due to technical factors, but cannot be ignored. Since this
rally has been different in character from other recent dollar rallies we must
consider the possibility that it will carry on for longer. This dollar rally has
played a major role in creating a short-term top in the gold and commodities
market. We will be monitoring this vigilantly as any protracted rally in the
dollar will tend to be negative for gold and other commodities where we are
bullish. On the other hand, in 2005 the dollar and gold both rallied
significantly so we will need to monitor this relationship carefully.
Pending resolution of this dollar rally and related gold correction, we have
reduced our gold position to the smallest level since the inception of the fund.
With less bullishness at the top, the last gold high at 1030+ in 2007 was
followed by a 30% correction. While we believe this correction will be much
shallower and that gold will make new highs by a considerable margin, at this
time we think caution is warranted. We will vigilantly watch for an opportunity
to rebuild our position in this market.
To keep the big picture in perspective, the current correction in the gold
market is setting up for a major up leg that will carry gold far higher than
Saddle Point Capital Partners, LP
9601 Wilshire Boulevard, Suite 736, Beverly Hills, CA 90210
people imagine. In a world of rapid currency creation, gold creation is
constrained (by Mother Nature as well as mining challenges) and so it
becomes an accepted form of money and store of wealth that cannot be
debased by incompetent politicians and central bankers. In a world in which
financial assets total hundreds of trillions, few investors understand that the
entire value of all the gold ever mined in the world is less than $10 trillion. The
upside potential of gold is breathtaking. We believe the bull market in gold will
not be over until gold is over $3000/oz and the Dow:Gold ratio (which is
currently about 9:1) will be close to 1:1.
2) Some very smart strategists have suggested that the Fed is not only
buying hundreds of billions of mortgage debt and Treasuries, as they have
made known publicly, but that they are also coordinating the purchase of
public market equity -- to improve consumer balance sheets, confidence and
spending. You read that right; the Fed is more or less “buying” the stock
market either directly or by coordinating the purchase of the equities by other
central banks and key financial institutions.
The notion that the Fed is operating in equity markets or influencing the market is
not that farfetched. The existence of an emergency “team” of Fed and Treasury
and other key market participants, the Plunge Protection Team, has been well
known for some time. But given that Bernanke has admitted that they don’t want
banks to make bad loans, and given that everybody knows the economy is not
strong enough to support a lot of loan demand and banks are upping credit
standards, the Fed chief has precious little tools left to assist the real economy.
The famous Bernanke reference to dropping money from helicopters is easier
said than done it turns out. So Helicopter Ben, unable to actually drop money
onto Main street from choppers, and unable get banks to use excess reserves,
may have turned to the financial markets to help improve the economy. This
hypothesis would make sense for an administration willing to spend trillions to get
the economy turned around, and for Bernanke given the situation with the banks.
It also tends to explain the decoupling between equity market valuations and
activity in the real economy.
The question becomes how high do financial assets and the stock market have
to go before some of the gains begin to bleed over into the real economy, and
how does the Fed deal with the obvious unevenness of a recovery where only
Wall Street and big banks make money in the market but the rest of the economy
goes nowhere? Bernanke testified a week ago that US stock prices were not
overvalued depending on your assumptions for the recovery, which was a
backhanded way of saying there is no asset bubble in US stock prices. I am not
sure that the market believes this -- and the numerous statements by US
government officials that there is “no asset bubble” in US stock prices reminds
me of the famous quote that is attributed to Bismarck: “Nothing is true until
officially denied.”
Saddle Point Capital Partners, LP
9601 Wilshire Boulevard, Suite 736, Beverly Hills, CA 90210
Whether the Fed is assisting the equity market more or less, directly or indirectly
or not at all, is really only a way of making sense of some of the behavior of the
markets. Regardless of why, the fact is that this most hated bull market of all time
continued to crawl higher during most of November and early December, and did
so again on mostly light volume with low volatility. The market seems to shrug off
everything, including the failure of the Dubai city state to make interest payments
on its $100 billion of debt, an event which would have surely cratered the market
a year ago. Scary thing is most people we talked to concluded that “It was only
$100 billion.” Hmmm... talk about complacency. That is a red flag for us, and
suggests that perhaps the thus far toothless Dubai incident may yet prove to be a
milestone of some kind that will take time to be fully reflected in the markets.
We continue to believe the equity market is distributing and trying to top, though
the action of the market has prevented us from building any kind of significant net
short position.
Summary Overview:
We continue to believe that the primary trends we have identified in the past
remain intact:
1) Global wealth has bounced back with the rally in financial assets but
overall it is way down from 2007 as are incomes and employment. Global
income is barely budging the needle.
2) Balance Sheet de-leveraging is continuing.
3) Central bank reflation is still going at top speed, and any discussion of
tightening and exit strategies is self indulgent on the part of the financial
media and premature given the income and employment backdrop.
4) The US Fed and Treasury continue to pursue a three pronged strategy to
stimulate the economy: a) they are keeping short term rates as low as
possible, b) they are allowing the dollar to weaken and thus far have
managed this in an orderly manner, c) they are trying to support key asset
prices – bonds, housing, equities?
5) In this type of money creating environment we believe that paper
currencies and financial assets in general will lose value against hard
assets, and that the dollar specifically is in the process of losing value
against other currencies and that within five or ten years will no longer be
the reserve currency of the world. This has dramatic implications for your
dollar based wealth and purchasing power.
6) Given the weak economy and the massive efforts of the government to
support every aspect of our society with other people’s money, the federal
deficit will continue to swell and this will continue to weigh on the dollar,
and eventually on interest rates. The only way that interest rates will
remain low would be in a total meltdown of the global economy which
Bernanke/Geithner and friends will clearly not allow.
Saddle Point Capital Partners, LP
9601 Wilshire Boulevard, Suite 736, Beverly Hills, CA 90210
7) The dollar has continued to generally move inversely to US stock prices.
We have continued to expect the falling dollar to eventually correlate with
falling bond and equity prices, but this has yet to occur. Logically, we are
simply expecting that a protracted decline in the value of a national
currency will be associated with falling financial asset prices that are
denominated in that falling currency. Recently, there was an interesting
development in this regard, as the dollar experienced a rally which did not
coincide with an equity decline, though commodities declined across the
board including gold. It is possible that the dollar is beginning to shift its
correlation to equity/growth, which would be very bearish for the US
financial assets, given our expectation of a continuing downtrend in the
greenback. It is too early to say at this time if this shifting correlation will
be sustainable, but we are watching it on a daily basis.
8) We believe the best ways to protect wealth in this environment is to be
short the US dollar, long gold and commodities, short equity and short
bonds. We are following these guidelines in our portfolio.
Performance Review:
Both our macro and stock specific positions have worked very well for us lately,
and combined to generate a turnaround in the portfolio from a month ending low
of about -12.5% at the end of August, to a +12.5% year to date at the end of
November. This performance is even more impressive when you consider that
the portfolio has never been leveraged more than 2:1 and is normally less than
1.5:1, and that it is hedged as to net long or net short exposure. Our portfolio is
also characterized by some position concentration, which means we have
several larger positions in excess of 10% of the portfolio, including a long stock
(VRMLQ) and a short stock (AMED) both in the health care area, as well as gold
(which has been our biggest position). Strong movements in these key positions
at the same time contributed to the gains through November, but these positions
do not go straight in our favor and tend to ebb and flow. In early December we
have thus far seen some correction in these positions. We are not in the
business of trying to trade in and out of our key positions frenetically, expecting
that our underlying thesis will continue to work over time, so some drawdown or
correction in performance must be tolerated to allow the positions to mature and
fulfill their potential. Therefore we are expecting our performance to consolidate a
bit in the next month or so, though we are highly confident that our position book
has significant upside potential over time relative to the capital risk. For example,
while we would be very surprised to see our portfolio finish the first year down
10% we would not be surprised to see it up 30% or more.
As always, please feel free to call us if you have any specific questions or
comments. We believe in transparency and communication with our investors,
and we thank you for your continuing support.
The Dollar and Asset Inflation
Before we review the markets, a couple observations to share:
1) While lunching a couple weeks ago with one of the smartest value
investors we know, a person who has literally made a fortune as a public market investor over the past 30 years, we asked what he was doing in
the markets, and his response was: “I’m just trying to get out of dollars.”
This reminds us that excessive monetary stimulation and currency creation
lead directly to inflation of other assets. Investors do not want to get caught
holding a depreciating asset, so they try to diversify out of it. In the case of the
dollar, one is holding Treasury Bills that pays little or nothing in a currency
that is depreciating. To do nothing is to sit idly by while one’s purchasing
power continuously erodes. The process by which our friend and the rest of
the world “get out of dollars” is a secular trend that we call a “bear market on
the US Dollar”, and this is a continuing theme that is not going away soon.
We have been bearish on the dollar for some time and expect to be so for
sometime into the future.
That said, there is currently a rally underway in the dollar, which is in our
opinion, primarily due to technical factors, but cannot be ignored. Since this
rally has been different in character from other recent dollar rallies we must
consider the possibility that it will carry on for longer. This dollar rally has
played a major role in creating a short-term top in the gold and commodities
market. We will be monitoring this vigilantly as any protracted rally in the
dollar will tend to be negative for gold and other commodities where we are
bullish. On the other hand, in 2005 the dollar and gold both rallied
significantly so we will need to monitor this relationship carefully.
Pending resolution of this dollar rally and related gold correction, we have
reduced our gold position to the smallest level since the inception of the fund.
With less bullishness at the top, the last gold high at 1030+ in 2007 was
followed by a 30% correction. While we believe this correction will be much
shallower and that gold will make new highs by a considerable margin, at this
time we think caution is warranted. We will vigilantly watch for an opportunity
to rebuild our position in this market.
To keep the big picture in perspective, the current correction in the gold
market is setting up for a major up leg that will carry gold far higher than
Saddle Point Capital Partners, LP
9601 Wilshire Boulevard, Suite 736, Beverly Hills, CA 90210
people imagine. In a world of rapid currency creation, gold creation is
constrained (by Mother Nature as well as mining challenges) and so it
becomes an accepted form of money and store of wealth that cannot be
debased by incompetent politicians and central bankers. In a world in which
financial assets total hundreds of trillions, few investors understand that the
entire value of all the gold ever mined in the world is less than $10 trillion. The
upside potential of gold is breathtaking. We believe the bull market in gold will
not be over until gold is over $3000/oz and the Dow:Gold ratio (which is
currently about 9:1) will be close to 1:1.
2) Some very smart strategists have suggested that the Fed is not only
buying hundreds of billions of mortgage debt and Treasuries, as they have
made known publicly, but that they are also coordinating the purchase of
public market equity -- to improve consumer balance sheets, confidence and
spending. You read that right; the Fed is more or less “buying” the stock
market either directly or by coordinating the purchase of the equities by other
central banks and key financial institutions.
The notion that the Fed is operating in equity markets or influencing the market is
not that farfetched. The existence of an emergency “team” of Fed and Treasury
and other key market participants, the Plunge Protection Team, has been well
known for some time. But given that Bernanke has admitted that they don’t want
banks to make bad loans, and given that everybody knows the economy is not
strong enough to support a lot of loan demand and banks are upping credit
standards, the Fed chief has precious little tools left to assist the real economy.
The famous Bernanke reference to dropping money from helicopters is easier
said than done it turns out. So Helicopter Ben, unable to actually drop money
onto Main street from choppers, and unable get banks to use excess reserves,
may have turned to the financial markets to help improve the economy. This
hypothesis would make sense for an administration willing to spend trillions to get
the economy turned around, and for Bernanke given the situation with the banks.
It also tends to explain the decoupling between equity market valuations and
activity in the real economy.
The question becomes how high do financial assets and the stock market have
to go before some of the gains begin to bleed over into the real economy, and
how does the Fed deal with the obvious unevenness of a recovery where only
Wall Street and big banks make money in the market but the rest of the economy
goes nowhere? Bernanke testified a week ago that US stock prices were not
overvalued depending on your assumptions for the recovery, which was a
backhanded way of saying there is no asset bubble in US stock prices. I am not
sure that the market believes this -- and the numerous statements by US
government officials that there is “no asset bubble” in US stock prices reminds
me of the famous quote that is attributed to Bismarck: “Nothing is true until
officially denied.”
Saddle Point Capital Partners, LP
9601 Wilshire Boulevard, Suite 736, Beverly Hills, CA 90210
Whether the Fed is assisting the equity market more or less, directly or indirectly
or not at all, is really only a way of making sense of some of the behavior of the
markets. Regardless of why, the fact is that this most hated bull market of all time
continued to crawl higher during most of November and early December, and did
so again on mostly light volume with low volatility. The market seems to shrug off
everything, including the failure of the Dubai city state to make interest payments
on its $100 billion of debt, an event which would have surely cratered the market
a year ago. Scary thing is most people we talked to concluded that “It was only
$100 billion.” Hmmm... talk about complacency. That is a red flag for us, and
suggests that perhaps the thus far toothless Dubai incident may yet prove to be a
milestone of some kind that will take time to be fully reflected in the markets.
We continue to believe the equity market is distributing and trying to top, though
the action of the market has prevented us from building any kind of significant net
short position.
Summary Overview:
We continue to believe that the primary trends we have identified in the past
remain intact:
1) Global wealth has bounced back with the rally in financial assets but
overall it is way down from 2007 as are incomes and employment. Global
income is barely budging the needle.
2) Balance Sheet de-leveraging is continuing.
3) Central bank reflation is still going at top speed, and any discussion of
tightening and exit strategies is self indulgent on the part of the financial
media and premature given the income and employment backdrop.
4) The US Fed and Treasury continue to pursue a three pronged strategy to
stimulate the economy: a) they are keeping short term rates as low as
possible, b) they are allowing the dollar to weaken and thus far have
managed this in an orderly manner, c) they are trying to support key asset
prices – bonds, housing, equities?
5) In this type of money creating environment we believe that paper
currencies and financial assets in general will lose value against hard
assets, and that the dollar specifically is in the process of losing value
against other currencies and that within five or ten years will no longer be
the reserve currency of the world. This has dramatic implications for your
dollar based wealth and purchasing power.
6) Given the weak economy and the massive efforts of the government to
support every aspect of our society with other people’s money, the federal
deficit will continue to swell and this will continue to weigh on the dollar,
and eventually on interest rates. The only way that interest rates will
remain low would be in a total meltdown of the global economy which
Bernanke/Geithner and friends will clearly not allow.
Saddle Point Capital Partners, LP
9601 Wilshire Boulevard, Suite 736, Beverly Hills, CA 90210
7) The dollar has continued to generally move inversely to US stock prices.
We have continued to expect the falling dollar to eventually correlate with
falling bond and equity prices, but this has yet to occur. Logically, we are
simply expecting that a protracted decline in the value of a national
currency will be associated with falling financial asset prices that are
denominated in that falling currency. Recently, there was an interesting
development in this regard, as the dollar experienced a rally which did not
coincide with an equity decline, though commodities declined across the
board including gold. It is possible that the dollar is beginning to shift its
correlation to equity/growth, which would be very bearish for the US
financial assets, given our expectation of a continuing downtrend in the
greenback. It is too early to say at this time if this shifting correlation will
be sustainable, but we are watching it on a daily basis.
8) We believe the best ways to protect wealth in this environment is to be
short the US dollar, long gold and commodities, short equity and short
bonds. We are following these guidelines in our portfolio.
Performance Review:
Both our macro and stock specific positions have worked very well for us lately,
and combined to generate a turnaround in the portfolio from a month ending low
of about -12.5% at the end of August, to a +12.5% year to date at the end of
November. This performance is even more impressive when you consider that
the portfolio has never been leveraged more than 2:1 and is normally less than
1.5:1, and that it is hedged as to net long or net short exposure. Our portfolio is
also characterized by some position concentration, which means we have
several larger positions in excess of 10% of the portfolio, including a long stock
(VRMLQ) and a short stock (AMED) both in the health care area, as well as gold
(which has been our biggest position). Strong movements in these key positions
at the same time contributed to the gains through November, but these positions
do not go straight in our favor and tend to ebb and flow. In early December we
have thus far seen some correction in these positions. We are not in the
business of trying to trade in and out of our key positions frenetically, expecting
that our underlying thesis will continue to work over time, so some drawdown or
correction in performance must be tolerated to allow the positions to mature and
fulfill their potential. Therefore we are expecting our performance to consolidate a
bit in the next month or so, though we are highly confident that our position book
has significant upside potential over time relative to the capital risk. For example,
while we would be very surprised to see our portfolio finish the first year down
10% we would not be surprised to see it up 30% or more.
As always, please feel free to call us if you have any specific questions or
comments. We believe in transparency and communication with our investors,
and we thank you for your continuing support.
November 6, 2009
Inflation v Deflation – The Binary Dilemma
In our last investor letter, we made the observations, some of which are
reiterated below for further discussion:
1) Considering the amount of money that the government has provided it is
remarkable how little benefit the real economy has experienced, in terms
of income or employment, financial market rallies notwithstanding.
2) The basic bull/bear debate is now focused on whether the financial market
rallies are forecasting a better economy or are simply a liquidity bubble
fostered by an extremely low interest rate environment. We suspect that it
is more the latter than the former, and we are structuring our portfolio
accordingly.
3) We suspect that there is some kind of tail event lurking, and that the
markets have become complacent and are vulnerable to any kind of tail
event shock.
4) We believe that there are going to be some paradigm and correlation
shifts in the near future, and that these will mainly be focused around the
dollar, as the continued bear market in the greenback begins to bleed over
into equity and fixed income markets in addition to the commodity markets
(where it is already being felt as investors worldwide seek to diversify out
of dollars into other assets like gold, copper and crude oil).
Regarding the correlation shifts, it is noteworthy that in the past week we have
had some brief bouts of equity market declines in which gold actually firmed up
and rallied. This is a harbinger of our future.
The market as defined by the Dow Industrials has not quite hit our 50%
retracement target of 10330, having put in a high so far of 10,119. We will note
that our experience is that the markets usually don’t reach the targets when you
are right and when you are wrong they blow right through them, but that said, the
fact remains that we appear to be in a dynamic binary situation in the global
macro market environment.
The binary options we face are basically inflationary growth vs deflationary
contraction. At this stage the equity market is the battleground since it is the
floppy tail of still overleveraged global balance sheets. It is critical to note that the
hyperinflation scenario while almost inconceivable becomes more possible as a
chapter following a deflationary contraction due to the inevitable response of the
current US political leadership.
Saddle Point Capital Partners, LP
9601 Wilshire Boulevard, Suite 736, Beverly Hills, CA 90210
The Dow is a good benchmark (or the SP 500) and right now, this market is
consolidating and will likely break out to the upside or reverse and test the
downside. The likelihood of going sideways for an extended period at these
levels is fairly remote. We believe that a recent pick up in volatility is a harbinger
of even more volatility; increasing volatility is not healthy for markets as we have
discussed before. We believe that this period since the March lows will
historically be viewed as the eye of the hurricane, where there was a calm that
engendered a false sense of security.
It is really impossible to know what will happen because it is impossible to predict
money velocity, however, the two alternatives and scenarios seem fairly clear: a)
the asset markets continue to rally off of the central bank accommodation and
this will eventually lead to higher growth and higher inflation, or b) the asset
markets will roll over and do so sharply because they are complacently bullish
and very long, and this rolling over will lead inevitably to more desperate
government attempts to revive it, which will increase the chances of even higher
(ie. hyper) inflation.
What is knowable is that given the level of money creation, and the fact that any
weakness in the economy and/or markets is going to be met by more money
creation, we do know that equity prices must decline relative to the price of gold
and hard assets.
Our portfolio is structured to benefit from a decline in the price of equity relative
to gold, and we believe this narrowing will occur regardless of whether we have
an inflationary or deflationary resolution to the current situation. We are also
structured to benefit from increased volatility, whether it comes from an up equity
market or a down equity market.
Our opinion is that it is hard to keep focused on the big picture but we are
reminded of the old French saying: “Plus c’est change, plus c’est meme chose”...
which translates into “ the more things change the more they stay the same.”
This seems like a modern version of the early 1930’s and the resolution is not
going to be tame. We believe it is still possible that this rally since March will
prove to be just a great bear market rally, just like what followed the stock market
crash of 1929.
We discussed “tail events” last month, and so in keeping with that theme we will
postulate that the market is absurdly complacent and that the resolution will find
itself in the tail of expectations rather than in the belly of the curve. What does
this mean, obviously it is impossible to know, but expect the unexpected. That is
how our portfolio is structured, to expect the unexpected. We think there is a
chance the market is set up for a vicious downside reversal that will take it much
lower than imaginable as the financial world sits complacently in the eye of the
hurricane, but at the same time, if we are wrong and the resolution is to the
Saddle Point Capital Partners, LP
upside it will come with much higher inflation, possibly hyperinflation, sharply
higher interest rates and a set of problems not seen since the late 1970’s.
Building on our initial small position from last month we have added to our short
in US government bonds, as we believe over the next four to six months there
will be upward pressure on the long end of the global yield curve, especially with
regards to 30 year US Treasuries. This pressure will be greatest if the resolution
of things is to the upside, due to inflation expectations rising, however, even if the
economy doesn’t take off as the bulls hope, there will still be upward pressure on
rates as the US issues more and more bonds with the Fed running out of money
designated to support this market. If the markets resolve strongly to the
downside, this would likely create conditions for a final attempted bond market
rally, and so our short bond position is in the form of put options that allow us to
quantify our risk as a small fraction of our potential upside.
In a world where we anticipate increased volatility and potential binary outcomes,
we have structure our portfolio accordingly.
In our last investor letter, we made the observations, some of which are
reiterated below for further discussion:
1) Considering the amount of money that the government has provided it is
remarkable how little benefit the real economy has experienced, in terms
of income or employment, financial market rallies notwithstanding.
2) The basic bull/bear debate is now focused on whether the financial market
rallies are forecasting a better economy or are simply a liquidity bubble
fostered by an extremely low interest rate environment. We suspect that it
is more the latter than the former, and we are structuring our portfolio
accordingly.
3) We suspect that there is some kind of tail event lurking, and that the
markets have become complacent and are vulnerable to any kind of tail
event shock.
4) We believe that there are going to be some paradigm and correlation
shifts in the near future, and that these will mainly be focused around the
dollar, as the continued bear market in the greenback begins to bleed over
into equity and fixed income markets in addition to the commodity markets
(where it is already being felt as investors worldwide seek to diversify out
of dollars into other assets like gold, copper and crude oil).
Regarding the correlation shifts, it is noteworthy that in the past week we have
had some brief bouts of equity market declines in which gold actually firmed up
and rallied. This is a harbinger of our future.
The market as defined by the Dow Industrials has not quite hit our 50%
retracement target of 10330, having put in a high so far of 10,119. We will note
that our experience is that the markets usually don’t reach the targets when you
are right and when you are wrong they blow right through them, but that said, the
fact remains that we appear to be in a dynamic binary situation in the global
macro market environment.
The binary options we face are basically inflationary growth vs deflationary
contraction. At this stage the equity market is the battleground since it is the
floppy tail of still overleveraged global balance sheets. It is critical to note that the
hyperinflation scenario while almost inconceivable becomes more possible as a
chapter following a deflationary contraction due to the inevitable response of the
current US political leadership.
Saddle Point Capital Partners, LP
9601 Wilshire Boulevard, Suite 736, Beverly Hills, CA 90210
The Dow is a good benchmark (or the SP 500) and right now, this market is
consolidating and will likely break out to the upside or reverse and test the
downside. The likelihood of going sideways for an extended period at these
levels is fairly remote. We believe that a recent pick up in volatility is a harbinger
of even more volatility; increasing volatility is not healthy for markets as we have
discussed before. We believe that this period since the March lows will
historically be viewed as the eye of the hurricane, where there was a calm that
engendered a false sense of security.
It is really impossible to know what will happen because it is impossible to predict
money velocity, however, the two alternatives and scenarios seem fairly clear: a)
the asset markets continue to rally off of the central bank accommodation and
this will eventually lead to higher growth and higher inflation, or b) the asset
markets will roll over and do so sharply because they are complacently bullish
and very long, and this rolling over will lead inevitably to more desperate
government attempts to revive it, which will increase the chances of even higher
(ie. hyper) inflation.
What is knowable is that given the level of money creation, and the fact that any
weakness in the economy and/or markets is going to be met by more money
creation, we do know that equity prices must decline relative to the price of gold
and hard assets.
Our portfolio is structured to benefit from a decline in the price of equity relative
to gold, and we believe this narrowing will occur regardless of whether we have
an inflationary or deflationary resolution to the current situation. We are also
structured to benefit from increased volatility, whether it comes from an up equity
market or a down equity market.
Our opinion is that it is hard to keep focused on the big picture but we are
reminded of the old French saying: “Plus c’est change, plus c’est meme chose”...
which translates into “ the more things change the more they stay the same.”
This seems like a modern version of the early 1930’s and the resolution is not
going to be tame. We believe it is still possible that this rally since March will
prove to be just a great bear market rally, just like what followed the stock market
crash of 1929.
We discussed “tail events” last month, and so in keeping with that theme we will
postulate that the market is absurdly complacent and that the resolution will find
itself in the tail of expectations rather than in the belly of the curve. What does
this mean, obviously it is impossible to know, but expect the unexpected. That is
how our portfolio is structured, to expect the unexpected. We think there is a
chance the market is set up for a vicious downside reversal that will take it much
lower than imaginable as the financial world sits complacently in the eye of the
hurricane, but at the same time, if we are wrong and the resolution is to the
Saddle Point Capital Partners, LP
upside it will come with much higher inflation, possibly hyperinflation, sharply
higher interest rates and a set of problems not seen since the late 1970’s.
Building on our initial small position from last month we have added to our short
in US government bonds, as we believe over the next four to six months there
will be upward pressure on the long end of the global yield curve, especially with
regards to 30 year US Treasuries. This pressure will be greatest if the resolution
of things is to the upside, due to inflation expectations rising, however, even if the
economy doesn’t take off as the bulls hope, there will still be upward pressure on
rates as the US issues more and more bonds with the Fed running out of money
designated to support this market. If the markets resolve strongly to the
downside, this would likely create conditions for a final attempted bond market
rally, and so our short bond position is in the form of put options that allow us to
quantify our risk as a small fraction of our potential upside.
In a world where we anticipate increased volatility and potential binary outcomes,
we have structure our portfolio accordingly.
Investment Letter: October 26, 2009
In our last update dated October 5th, we were bearish but expected the market
momentum to continue. On that day the Dow Jones opened at 9500 more or
less, today it is trading at about 1000, and we have a small short position in
equity, net of our long equity, gold and related positions. We still believe that the
Dow will attempt to reach the 10300-level as discussed in our last update, but we
have begun to deploy our short positions now. If the Dow reaches 10300 we will
likely look for a reversal to sell short.
Our thought is that the government, financial sector and the press, acting more or
less with the same agenda will manage to set the market up for a “good”
Christmas, in which expectations will be sufficiently low to further any market
rally; however, between now and the end of the year, we believe that there is
room for a correction of up to 10%. This would qualify as a trade-able correction
and we would not be surprised if it were very sharp and swift. The market
sentiment increasingly needs to be rebalanced, and any correction of 5% or more
would set the market up for a much stronger year-end rally.
At the same time, our hedges are interesting in that we are hedging a large
position in gold with equity put options, and there is always a possibility that in a
falling dollar environment, a decline in equity prices might result in a rally in gold.
If this were to happen we would benefit quite nicely, while if gold were to trade
down with the stock market we would be protected. Since a large portion of our
short position is in puts, this quantifies our risk, and allows for the portfolio to
generate positive returns even if the market rallies.
In addition, we have long exposure to the crude oil market, which has recently
broken out of a trading range banded by $75/barrel on the upside. Our exposure
is in the form of crude ETF options and stock in Conoco Phillips.
We have also initiated a small position short the US Treasury bonds, as we
anticipate that interest rates may begin to increase as the Fed runs out of money
to support the market.
As always, please feel free to call us with any questions or updates.
Thank you for your continued support.
Warm Regards,
momentum to continue. On that day the Dow Jones opened at 9500 more or
less, today it is trading at about 1000, and we have a small short position in
equity, net of our long equity, gold and related positions. We still believe that the
Dow will attempt to reach the 10300-level as discussed in our last update, but we
have begun to deploy our short positions now. If the Dow reaches 10300 we will
likely look for a reversal to sell short.
Our thought is that the government, financial sector and the press, acting more or
less with the same agenda will manage to set the market up for a “good”
Christmas, in which expectations will be sufficiently low to further any market
rally; however, between now and the end of the year, we believe that there is
room for a correction of up to 10%. This would qualify as a trade-able correction
and we would not be surprised if it were very sharp and swift. The market
sentiment increasingly needs to be rebalanced, and any correction of 5% or more
would set the market up for a much stronger year-end rally.
At the same time, our hedges are interesting in that we are hedging a large
position in gold with equity put options, and there is always a possibility that in a
falling dollar environment, a decline in equity prices might result in a rally in gold.
If this were to happen we would benefit quite nicely, while if gold were to trade
down with the stock market we would be protected. Since a large portion of our
short position is in puts, this quantifies our risk, and allows for the portfolio to
generate positive returns even if the market rallies.
In addition, we have long exposure to the crude oil market, which has recently
broken out of a trading range banded by $75/barrel on the upside. Our exposure
is in the form of crude ETF options and stock in Conoco Phillips.
We have also initiated a small position short the US Treasury bonds, as we
anticipate that interest rates may begin to increase as the Fed runs out of money
to support the market.
As always, please feel free to call us with any questions or updates.
Thank you for your continued support.
Warm Regards,
Investment Letter: October 5, 2009
WHEN IS “ENOUGH” LIQUIDITY NOT REALLY ENOUGH?
In our last investor letter, we postulated that the deflationary cycle was broken by
the massive liquidity efforts of the central banks. We had shifted from bearish to
market neutral in June 2009 when the Dow Jones Industrial Average was about
8400. The question is now whether or not the liquidity provided to stabilize the
system was enough to generate growth, and more importantly, enough growth to
satisfy the expectations of the market. We think not. However caution is still
warranted as it will likely take some time for bullish momentum to dissipate. So while liquidity is king, at this point we believe that not enough was done, and
that the economy is going to sink from its own weight; the weight of debt, the
weight of persistently low velocity, the weight of a bailout that preserved large
zombie institutions at the expense of the small business entrepreneurial
backbone of job creation in the US and the weight of a president whose frenetic
policy mix has (on top of all the other problems) served to confuse and paralyze
business investment.
As the disconnect between the stock market and the real economy widens, we
are again becoming bearish. Very bearish. As for how we might play this, we are
looking for a test of the 10300 level of the Dow Jones Industrial Average. How do
we get to that number? The 10300 level represents the 50% retracement of the
entire bear move from 14000+ to 6600. Very often major moves are followed by
large retracements. At this point, heading into the third quarter earnings season
we find as of last week that there were an inordinate number of parties in the
short or correction camp for the market, and the bearishness was building as it
often does as the market falls. However, we suspect that this bearishness will be
wiped out by another upsurge in the market, taking it toward the 50% retrace
level mentioned above. We have started to deploy some short positions, but our
short is relatively modest at this stage. We will short more if/when the market
rallies and we see sentiment turn more bullish. Speaking of bullish sentiment we find the bond market sentiment to be extremely
conducive to shorting. The government has been buying more and more
Treasury and related debt securities in an attempt to keep rates down, and this
has created a bull market that is now sucking in the public into bond mutual funds
at a rate almost equivalent to tech buying in the late 1990’s. No doubt this bond
market bubble will end badly for the public, as they are typically last in and end
up holding way too long. The only question about shorting bonds is when and
how much?
Regarding gold, we find the market action to be extremely bullish, as the
gradually but inexorably falling dollar is driving gold higher. Interestingly, gold is making new highs in almost all currencies which shows that paper money creation is eroding purchasing power around the world, not just in the US, though
we are the worst culprits.
By the time you read this you should have received your September
performance. You will see that we have recovered all of our losses and that our
fund is now positive. Part of this performance is due to the rise of gold and
precious metals stocks in which we have a core investment, but a good portion of
the performance is also due to two special situations we have invested in:
Vermillion (VRMLQ) and Design Within Reach (DWRI). Vermillion is a small medical diagnostics company that was sitting in bankruptcy expecting a protracting approval process for their Ovarian cancer blood test,
when they unexpectedly received FDA approval. We were fortunate enough to
learn of the situation relatively early after the approval through our network of
health care contacts, and we accumulated a decent sized position at an initial
price under $5. At this time we have in excess of 10% of the portfolio in this
security, and it is trading in excess of $15. We believe that the potential news
flow and earnings potential for this company is dramatic and that the stock has
limited downside and significantly more upside. We continue to hold this position,
but are not adding because we do not want too much concentration in any one
name.
Design Within Reach is a promising furniture retail brand that suffered a
deterioration in their business as a result of the recession. Through a combination of circumstances we were able to purchase a significant position in
the company at a price that we believe to be 50% below the liquidating value of
the business. We believe that the downside is limited from these levels (our cost
is $0.20/share) but that there are numerous positive scenarios that would cause
the stock to move higher in both the short and intermediate term. This position
has appreciated about 20% for us so far, and currently constitutes a little more
than 10% of our portfolio.
At present we maintain a slight short on the equity market (that we plan to
increase) and a sizable long position in gold.
We continue to look for
disappointing growth and greater money creation by the government.
We believe that stocks are overpriced and gold is underpriced and have structured
our portfolio accordingly. We are short the dollar by virtue of our gold position.
We believe that bonds are in the later stages of a generational bubble and we
are bearish over time, but we do not have a short position at this time.
In our last investor letter, we postulated that the deflationary cycle was broken by
the massive liquidity efforts of the central banks. We had shifted from bearish to
market neutral in June 2009 when the Dow Jones Industrial Average was about
8400. The question is now whether or not the liquidity provided to stabilize the
system was enough to generate growth, and more importantly, enough growth to
satisfy the expectations of the market. We think not. However caution is still
warranted as it will likely take some time for bullish momentum to dissipate. So while liquidity is king, at this point we believe that not enough was done, and
that the economy is going to sink from its own weight; the weight of debt, the
weight of persistently low velocity, the weight of a bailout that preserved large
zombie institutions at the expense of the small business entrepreneurial
backbone of job creation in the US and the weight of a president whose frenetic
policy mix has (on top of all the other problems) served to confuse and paralyze
business investment.
As the disconnect between the stock market and the real economy widens, we
are again becoming bearish. Very bearish. As for how we might play this, we are
looking for a test of the 10300 level of the Dow Jones Industrial Average. How do
we get to that number? The 10300 level represents the 50% retracement of the
entire bear move from 14000+ to 6600. Very often major moves are followed by
large retracements. At this point, heading into the third quarter earnings season
we find as of last week that there were an inordinate number of parties in the
short or correction camp for the market, and the bearishness was building as it
often does as the market falls. However, we suspect that this bearishness will be
wiped out by another upsurge in the market, taking it toward the 50% retrace
level mentioned above. We have started to deploy some short positions, but our
short is relatively modest at this stage. We will short more if/when the market
rallies and we see sentiment turn more bullish. Speaking of bullish sentiment we find the bond market sentiment to be extremely
conducive to shorting. The government has been buying more and more
Treasury and related debt securities in an attempt to keep rates down, and this
has created a bull market that is now sucking in the public into bond mutual funds
at a rate almost equivalent to tech buying in the late 1990’s. No doubt this bond
market bubble will end badly for the public, as they are typically last in and end
up holding way too long. The only question about shorting bonds is when and
how much?
Regarding gold, we find the market action to be extremely bullish, as the
gradually but inexorably falling dollar is driving gold higher. Interestingly, gold is making new highs in almost all currencies which shows that paper money creation is eroding purchasing power around the world, not just in the US, though
we are the worst culprits.
By the time you read this you should have received your September
performance. You will see that we have recovered all of our losses and that our
fund is now positive. Part of this performance is due to the rise of gold and
precious metals stocks in which we have a core investment, but a good portion of
the performance is also due to two special situations we have invested in:
Vermillion (VRMLQ) and Design Within Reach (DWRI). Vermillion is a small medical diagnostics company that was sitting in bankruptcy expecting a protracting approval process for their Ovarian cancer blood test,
when they unexpectedly received FDA approval. We were fortunate enough to
learn of the situation relatively early after the approval through our network of
health care contacts, and we accumulated a decent sized position at an initial
price under $5. At this time we have in excess of 10% of the portfolio in this
security, and it is trading in excess of $15. We believe that the potential news
flow and earnings potential for this company is dramatic and that the stock has
limited downside and significantly more upside. We continue to hold this position,
but are not adding because we do not want too much concentration in any one
name.
Design Within Reach is a promising furniture retail brand that suffered a
deterioration in their business as a result of the recession. Through a combination of circumstances we were able to purchase a significant position in
the company at a price that we believe to be 50% below the liquidating value of
the business. We believe that the downside is limited from these levels (our cost
is $0.20/share) but that there are numerous positive scenarios that would cause
the stock to move higher in both the short and intermediate term. This position
has appreciated about 20% for us so far, and currently constitutes a little more
than 10% of our portfolio.
At present we maintain a slight short on the equity market (that we plan to
increase) and a sizable long position in gold.
We continue to look for
disappointing growth and greater money creation by the government.
We believe that stocks are overpriced and gold is underpriced and have structured
our portfolio accordingly. We are short the dollar by virtue of our gold position.
We believe that bonds are in the later stages of a generational bubble and we
are bearish over time, but we do not have a short position at this time.
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