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9 Jan

Monday January 9, 2017

by

Good morning,

With the DJIA coming within a whisker of 20,000 on Friday, next week may be the time to pop open the champagne.  I was disappointed, and will explain why later in this report.  

At the close of Friday’s trading:

DJIA: 19,963.80; +1.02%

DJTA: 9,104.08; +1.70%

S&P 500: 2,276.98; +2.45%

Nasdaq: 5,521.06; +0.75

Russell 2000: 1,367.28; +0.67

Aside from the DJIA failing to reach 20,000 after several attempts on Friday, what bothered me most, that otherwise was a great week, was the VIX, which dropped smartly all week to as low as 10.98 on Friday, but wasn’t enough to tip the DJIA above 20,000.  Hmm.

With the percentage-up moves to the averages a bit lopsided, I’ll be anxious to see how stocks open on Monday.  I don’t like to see the Russell lag as much as it did this week, too, and didn’t like to see selling come in on several occasions when it looked like the DJIA was going to crack 20,000.  

Maybe traders were disappointing in the jobs numbers on Friday.  I certainly was.  It’s all about psychology, and Friday’s action in the DJIA disappointed me, although we’re more likely to reach 21,000 than 19,000 at this time.  I predicate that outlook to an assumption that the market is making about the slight advantage a new president has with Congress in the first 100 days of a Trump presidency.  That puts us into April 29, to be exact.

What didn’t disappoint me this week, however, was the action in the bond market.  Ever since my thesis of gauging sentiment in stocks from the action in the bond market and Japanese yen, following the low print of 1.36% on the US Treasury 10-year note in July and the yen’s influence on US stocks, the drop in the yield this week of three more basis points to add to the 15 basis points shed from the prior two weeks relieves me of some fear of the possibility of the bull market derailing from a bond market fiasco.  

Would central banks step in?

Please!  The Chinese aren’t about to sabotage themselves by overwhelming the system with 10-year Treasuries, to paraphrase my parting comment on this subject in last week’s LT Weekly Report.

And get this, apparently Citibank just figured out that central banks are manipulating credit spreads.  Citibank analyst and market bear, Matt King, penned a note to clients this week, and an article about King’s note appeared on Zerohedge.com.

In his report, Citi’s Matt King opines, “nothing sticks to markets,” Zerohedge wrote.

“He [King] proposes one possible reason: perhaps analysts were overly pessimistic going into the election and year end, which is possible considering the ‘most synchronized DM [developed market] upturn in years’…,” Zerohedge added.  

And what ingredient is King missing?  Well, I’ve been telling readers since the summer of last year that central banks have been managing global inter-market interest rates in the US, Europe and Japan since the summer of 2014—in earnest ( see chart, below) due to a funny thing: global currency reserves began to drop.  And that hasn’t happened since the early 1980’s.

ust

“What is the ‘key ingredient’ in the mix that makes sense out of this market chaos?  Simple: according to King, central bank buying of anything that is not nailed down is the ‘missing link,’” Zerohedge ended the article.

Should I comment about the worth of Citibank’s analysis?  No, because I believe it’s better to be late (very late?) than never.

Moving on (as I roll my eyes).

The choir in the financial media about rates spiking too quickly was sure singing when the 10-year note passed 2.50%.  If you remember, as soon as I came out with my call regarding the trouble I saw brewing in stocks if/when rates continued to soar on the 10-year note, dozen of articles were soon published with the same concern.  

My assumption was then and now, that the BOJ and ECB coordinated a carry trade in their respective markets to reflect a better spread between the US Treasury market and Japanese/German markets.  For what purpose?  To provide a safe haven for global money to lift stocks, which in turn provides support for global stocks in a spread/arbitrage scheme.

The only fear I had was the slim possibility of the Chinese upsetting the applecart in retaliation of events surrounding the election of Donald Trump, a fierce and vocal critic of “those Chinese currency manipulators.”  And I won’t get into the proof here, but I can prove that the Chinese are no more currency manipulators than Korea and Taiwan on trade.

Moving on, again.

By the close of the week, the yield spread between the US Treasury 10-year and German 10-year ‘bund’ dropped another 12 basis points to close at 212 basis points, while the yield spread between the US Treasury 10-year and Japanese 10-year note fell another four basis points to 236 basis points.  That’s good for confidence to buy US stocks.

West Texas Intermediate Crude (WTIC) inched up another $0.27 per barrel on the NYMEX this week.  Albeit small rises, the price of WTIC has risen for four consecutive weeks, bouncing back nicely from Tuesday’s 5.6% drop.  OPEC’s jawboning of Saudi Arabia’s complicity with quotas served as a jolt to the oil market.  

And as quick comment about the oil market: I sense that the Trump administration is in the process of proposing a deal with Russia to coordinate an effort to elevate oil prices.  

I know, you would think that an net oil-importing nation as the US is would not want to see firming oil prices, but in this case, the banking industry has a lot at stake in the oil market and has been the bane of the lending industry since the collapse in oil prices from the highs of the summer of 2014.  

For my readers who don’t know, the oil market is today’s 2008/9 housing market and the problem loan associated with an overheated market.  I’ve read a few detailed analytic reports that suggest that WTIC cannot trade too far from $60 per barrel if the banking industry wants to stave off a growing default rate in the  ‘fracking’ space.

In the currency markets, the yen was no help for US stocks this week, as the Japanese currency closed nearly unchanged against the US dollar by the close on Friday.  

The USD Index was little changed for the week.

In the precious metals market, the action this week moved gold and silver prices strongly in the direction to where I believe the metals will go during the first-half of 2017.  And that direction is up.  Gold rose a healthy $21.70 (+1.88%) this week to close at $1,173.40, while silver popped up $0.53 (+3.31%) to close at $16.52 per ounce.  Watch for $1,180 on the gold chart; that’s the first resistance price that needs to be taken out convincingly.  Assuming $1,180 is taken out after three consecutive days of closing prices above $1,180, watch for next resistance at $1,220.  And in silver, $17.50 is the next level of key resistance.

Back to stocks.

Overall, I’d feel a lot better when the DJIA surpasses the psychological 20,000 points mark.  As I stated earlier, the price action in the DJIA on Friday frustrated many traders in that the DJIA’s bounce up to near 20,000 on four separate occasions without a follow through past 20,000.  

It may sound like a trivial matter.  It’s only a number.  Right?  But, trader psychology is critical at this time between the election and the Trump’s cabinet confirmation hearings.  If the market is pricing-in a Reagan-like economic agenda of lower corporate and individual tax rates, along with removing unnecessary regulation imposed upon small businesses, a higher stock market as the fight on Capitol Hill wages on his agenda may put needed pressure on the House and Senate to keep the party in stocks going by not making too much of a fuss about key nominees passing through their committees.  

I feel, that if stocks aren’t on the rise by the time Congress begins its work on the new administration’s economic legislation, the pressure will be far less on Democrats to give the stock market what it anticipates.  

Does any politician want to be blamed for lower stock prices?  No, of course not.  Therefore, I don’t expect any big surprises coming out of Congress and Trump’s nominees.

Okay, let’s get to my positions and Watch List and see what’s brewing there.

This Week’s JBP Stock Ideas

TWITTER (TWTR)

Original report: 11/14/2016

On November 5, I alerted a Call position I took in TWTR at a strike price of $20.

To read my rationale for the Twitter Call, follow the link to my report: ‘Twitter Takeover Play’.

My bet with a Call option includes the possibility a suitor who can fix Twitter’s sluggish attempt to monetize the company may be announced by the expiration of my March 2017 Call.  

At the close of Friday’s trade, the contract settled at $0.73.  The option expires in 67 days.

I’ve been asked, from where do I expect a bidder for Twitter to come: Alibaba (BABA).

ABOUT TWITTER (TWTR)

Twitter, Inc. operates as a global platform for public self-expression and conversation in real time. The company offers various products and services, including Twitter that allows users to create, distribute, and discover content; and Periscope and Vine, a mobile application that enables user to broadcast and watch video live. It also provides promoted products and services, such as promoted tweets, promoted accounts, and promoted trends that enable its advertisers to promote their brands, products, and services; and subscription access to its data feed for data partners.

KANDI TECHNOLOGIES (KNDI)

Original report: 12/17/2016

As I alerted on December 14, I bought 7,000 shares of KNDI at $5.44 per share.

KNDI traded up $0.10 to close at $5.00 on Friday.  

There was no company-specific news this week.

Here’s why I bought the stock.

I have traded KNDI earlier this year for a nice profit.  Since then, the stock has come down significantly from the $6 and $8 range, dropping to as low as $3.40 in mid-November amid concerns of a hold to incentive payments due from the Chinese government.

So, what was the result of the hold on the company’s subsidy payment from the Chinese government?

On November 9, Kandi released a compete earnings report disaster.  Revenue crashed to $6.4 million during Q3, down from $50.5 million, or -87%, from Q3 of last year.  The company cited a freeze of incentive payments as the reason for the decline.

Kandi’s primary business is selling electric-vehicle parts to an electric-car joint venture, Kandi Electric Vehicles Group Co., with automaker Geely Automobile Holdings (NASDAQOTH:GELYF).  The partnership is heavily dependent upon subsidies from the Chinese government, whose economic development plans include the development of electric vehicles.

However, because of nationwide investigates by Beijing into fraud allegations across the industry, incentive/subsidy payments throughout the industry have been frozen until the government completes its investigations.  In the case of Kandi Electric Vehicles Group, without government funding, only 184 units of EV products were sold in Q3, a 96.9% decrease, y-o-y.

In response to the dramatic drop to revenue during Q3, Kandi Chairman and CEO, Mr. Hu Xiaoming, stated, “China’s central government preceded a review on the subsidies paid to all the EV manufacturers, which caused the 2015 subsidy payments remain unpaid industry-wide. The delay in subsidy payment heavily impacted the Joint Venture’s production and sales, which resulted in a significant decrease in our EV parts sales.”

Hu further stated that Kandi had been working with government officials and expressed confidence that the subsidies will be coming “soon.”

Earlier, in September, five of Kandi’s rivals were fined and removed from the list of companies eligible for subsidies.

On 29 November, KNDI announced that its wholly-owned subsidiary Kandi Electric Vehicles (Hainan) Co. Ltd received a subsidy payment of RMB 100 million (approximately US$14.5 million) to support its research and development expenditures for a new model of electric vehicle.  This news of a subsidy payment to one of Kandi’s subsidiary suggests to me that the subsidy payment to the joint venture may in fact be sent “soon.”  Why would Beijing clear a Kandi subsidiary but not the partnership?

News on progress of new factory in Hainan:

In the last earnings call, the company announced the following:

“Our Hainan facility construction proceeds smoothly and we have started to install the equipment as scheduled. We also made progress on the designed product in Hainan’s factory. We expect this product could be well received by the market. With respect to the production license for the new energy vehicle, we have accomplished last or fundamental work. We made our endeavors in the application and hope to opt in the license within 2017.”

This news release clearly indicates progress is being made according to the company’s production plans.  I am expecting news from the company at some time between now and mid-2017 regarding the vehicles expected to be produced at the plant.  

Insider buying:

On five separate days, from November 23 through to December 2, CEO/president Hu Xiaoming, 10% owner of Kandi Technologies Group Inc. (KNDI), purchased a total of 230,000 shares at a total transaction cost of more than $1 million.  Hu’s purchase price range of $4.16 and $4.99 suggests to me the range of support for the stock will fall within this range and strongly suggests to me that Hu really does believe that the frozen subsidy payments due the company are, indeed, on the way.

The Play:

With 15.2% of the stock’s float held short, any positive news may drive the price rapidly higher, similar to the 11% price spike on November 29, the day of the news release regarding subsidy payments received related to the Hainan facility.

Now trading at $5 level, I will be looking for the next move to the $5.50 level.  The next resistance level may be at $6.00.

In the meantime, there’s a lot of time for news to be released about the company’s frozen subsidy payments before the company reports Q4 earnings is released, scheduled for early March.  

My question is: if the CEO has bet $1 million on a favorable outcome to Q4 and/or imminent news regarding the company’s frozen subsidy payments, why wouldn’t you follow the CEO with your own stake?

Update:

There was no change to the stock’s short interest; it remains at a high rate of 16.03% of the stock’s float, up from 15.2% of two weeks ago.  The short ratio has risen to 15.34 days, a very high number of days to cover.

The latest inside purchase was on December 27, when CEO and President, Hu Xiaoming, bought another 57,060 shares at $5.15, for a total purchase price of $293,859.  Xiaoming now holds 12,342,411, according to the SEC.  That’s more good news.

ABOUT KANDI TECHNOLOGIES (KNDI)

Kandi Technologies Group, headquartered in Jinhua, Zhejiang Province, is engaged in the research and development, manufacturing and sales of various vehicle products. Kandi has established itself as one of China’s leading manufacturers of pure electric vehicle (“EV”) products (through its joint venture), EV parts and off-road vehicles.

LIQUIDMETAL (LQMT)

Initial report: December 14

There was no news to report this week, but the stock closed up $0.007 for a 3.27% gain.

As I alerted on Wednesday, December 14, I bought 100,000 shares of LQMT at $0.196, and plan to increase my stake by an additional $30,000 in the future.  

LQMT is a long-term trade, and has been a winner for me in the past.  On November 1, I sold LQMT for a $4,300 profit from a two-month hold.   

I now expect to be holding the newly-acquired shares for at least six months.  My price target is $0.40, at minimum.  

I attended the new CEO conference call on December 8 (after the close), and believe LQMT is a sleeping giant, with the potential to be profitable and to be listed on the AMEX in the coming years.

WHY I’M LONG LQMT

Background:

On March 10, Liquidmetal andDongGuan Eontec Co., Ltd. entered into an agreement, whereby Professor Yeung Tak Lugee Li, Chairman of DongGuan, agreed to purchase up to 405 million shares of LQMT stock for a purchase price of $63.4 million.  

A term of the deal included the purchase of 105 million shares at $0.08 per share for a purchase price of $8.4 million, which did indeed happen on March 10.  An additional term of the deal included the purchase of an additional 200 million shares at $0.15 per share for a purchase price of $30 million, and the purchase of 100 million shares at $0.25 per share for a purchase price of $25 million.  In total, Mr. Li is eligible (board approved the agreement in May) to purchase 300 million shares for a purchase price of $55 million.  

In addition, Liquidmetal issued a warrant for an additional 10,066,809 shares at an exercise price of $0.07 per share.

So, who is Professor Yeung Tak Lugee Li?  He is the Chairman of DongGuan Eontec Co., Ltd., in China.  The company symbol on the Shanghai Exchange is (SHE:300328.SZ), where the shares currently trade at (yuan)14.02, or $2.10 per share.  The market capitalization of DongGuan Eontec is approximately $850 million, and is a highly profitable company, with net profit margins exceeding 10%.  The company manufactures next-generation metals for other commercial enterprises involved with the production of consumer products, just as Liquidmetals is in the business of producing.

In 2012, Li founded Leader Biomedical.  

In 2013, he acquired a majority stake in publicly-traded aap Joints, a division of aap Implantate AG in Berlin, Germany.

In 2014, Li acquired EMCM, a biomaterials contract manufacturer, from aap Implantate.

All of these companies that Li purchased are in the business of developing and manufacturing next-generation metals for commercial products.  Therefore, my stake in LQMT is motivated by the modus operandi of Mr. Li taking control of LQMT with plans to move LQMT onto the AMEX.

On December 14, the company announced that it has named Professor Lugee Li as President and Chief Executive Officer of Liquidmetal Technologies.

“Professor Li has served as a member of the Company’s Board of Directors since March 10, 2016 and is the sole owner of Liquidmetal Technology Limited, a Hong Kong company that is the Company’s largest shareholder,” according to the news release.  “Professor Li will not be taking any compensation as a result of his appointment as President and Chief Executive Officer.”

Now that Li has taken control of Liquidmetals, I expect rapid progress.  This trade idea is very similar to FNMA, in that the stock is at an inflection point. Right now nobody is paying attention to the stock, just as no one was paying attention to FNMA when I bought 40,000 shares of the stock at $1.72.

With Li on board, I’m going to be patient with LQMT, as I expect the stock to start and stop until more news from the company begets more investors and liquidity moves to higher prices during the coming year.

ABOUT LIQUIDMETALS (LQMT)

Liquidmetal® Technologies researches, developments and commercializes amorphous metals. The company’s revolutionary class of patented alloys and processes form the basis of high performance materials in a broad range of medical, military, consumer, industrial, and sporting goods products.  Discovered by researchers at the California Institute of Technology, Liquidmetal alloys’ unique atomic structure enables applications to achieve performance and accuracy levels that have not been possible before.  As the company controls the intellectual property rights with more than 70 U.S. patents, these high performance materials are dramatically changing the way companies develop new products.

Source: Liquidmetals Technologies

FANNIE MAE (FNMA)

FNMA traded up $0.03 this week for a 0.77% gain.  Closing at $3.93 on Friday, the stock still hovers close to the $4.00 mark, and has traded in a relatively loose trade at $4.00 since December 22.

As loyal subscribers know, I made a killing on FNMA after selling out for a $12,800 profit on November 23 on a bet that a Trump victory at the polls would soar the stock.  As a reminder to my long-term subscribers, read my article of a year ago, If Trump Wins The White House, FNMA Soars.  In the article, I suggest that Trump, the businessman, fully understands the wrong perpetrated by the US government against stockholders of Fannie Mae.  That’s not too hard to conclude, and is why the stock soared following his win at the polls.

From the article, follow the links, because if you do and read the supporting documentation of my article, you’ll come away with a firm grasp of the political and legal issues involved with FNMA and the stakes involved to traders of the stock.

Trump takes the oath of office on the 20th, so now what?  As I see it, the issue of Fannie Mae’s future now becomes more of a political than a legal one.

Changing the structure of Fannie Mae may turn into a tough fight for Trump on Capitol Hill.  The idea of a nearly eight-decade-long legacy government GSE being throw to the wolves (as Democrats might see it) will drain a lot of political capital that each president starts with when initially entering the Oval Office.  FNMA is no Social Security issue, but it is huge, especially, with Democrats, and ranks as a high-profile political fight I expect between Trump and Democrats, for sure.

On the Republican side, throwing Fannie Mae to the wolves, if you will, represents the other side of a clear victory for one party over the other.  A Republican dream is to allow the private sector to bid for tranches of Fannie Mae’s $5 trillion mortgage holdings.  That’s huge business!

What would a privatization that do for mortgage interest rates?  

Rates would soar, of course.  In droves, potential homeowners would be shut out of the mortgage market, and the US economy would take a whopping hit.  Oh, and the 30-year mortgage?  Forget about it.  The advent of the 30-year mortgage was facilitated by the mere existence of the GSE in the first place.  Instead, a 15-year loan would probably become the longest fixed-term loan a borrower could achieve.

Now, picture a prospective homeowner, whose principal and interest payment each month would result to as much as 71% leap under a fully-privatized plan?  At a 15-year mortgage term and a, say, 5.5% interest rate on a $170,000 loan, his payment would jump to $1,389 per month, from $811.  

So, forget about that!  A cold-turkey, fully-privatized plan won’t happen.  Even the staunchest anti-Fannies would not vote for such a draconian plan.  Under a scenario, even remotely close to this one, would quickly become Trump’s ‘Obama Care’.

So what is more likely to result as a compromise?

The most likely scenario is one that compromises between upholding stockholders’ rights and a fix to the impediments that already work. That’s where the expertise of Trump’s nominee for Secretary of Treasury, Steven Mnuchin, a Goldman Sachs alumnus, comes in, who stated on November 30 that he would like to see Fannie Mae privatized “reasonably fast.”

“We will make sure that when they are restructured, they are absolutely safe and don’t get taken over again,” he told Fox News.  “But we’ve got to get them out of government control.”

Ah, so what do I read into Mnuchin’s comments?  I think a recapitalization plan may be the settlement Trump and the Republicans hope to achieve, as a first step.  That would delight the Democrats, but tick-off Republicans.  So, what to do?  

To get Republicans aboard a recapitalization plan, Mnuchin and Company may propose a “slow motion” to privatization plan, as I suggested, a plan of which may involve a decade-long unraveling of the implied government backing of mortgages.

A wrinkle to the slow-motion compromise may also involve a slow-motion recapitalization scheme for Fannie Mae, which may actually be the mechanism that facilitates an orderly unwinding of government control, similar to the present FDIC scheme of backstopping the banking system.  

I’m aware that reserves at the FDIC are a joke, but this framework may be in Mnuchin’s head as part of a compromise between political parties and between plaintiffs and the FHFA in the ongoing lawsuits.  Essentially, a deal may come down to a matter of initially and adequately funding an FDIC-like scheme to backstop the mortgage market, while at the same time let the taxpayer off the hook of Fannie’s balance sheet—in theory, of course.  But that may be the pitch Mnuchin can make to both Republicans and Democrats, and may serve, too, as a great talking point for Republicans to make to their constituencies.

As investors of FNMA, there are many more scenarios that involved FNMA stockholders getting paid through a windfall deal (fast or slow) than scenarios that shaft stockholders.

Unlike the financial media hyping the Fannie Mae issue as the next Ali-Frazier fight (Am I showing my age?), as I see the political path to a profit buried in the FNMA trade, a Trump deal to unlock Fannie Mae’s balance sheet to settle lawsuits is doable.  In that case, $4 for FNMA represents a potentially huge discount to its underlying value.  

I’ll let you know what I decide to do about FNMA.

ABOUT FANNIE MAE

The Federal National Mortgage Association (FNMA), commonly known as Fannie Mae, is a government-sponsored enterprise (GSE) and, since 1968, a publicly traded company. Founded in 1938 during the Great Depression as part of the New Deal, the corporation’s purpose is to expand the secondary mortgage market by securitizing mortgages in the form of mortgage-backed securities (MBS), allowing lenders to reinvest their assets into more lending and in effect increasing the number of lenders in the mortgage market by reducing the reliance on locally based savings and loan associations (or “thrifts”).  Its brother organization is the Federal Home Loan Mortgage Corporation (FHLMC), better known as Freddie Mac.

Until next time…

Trade Green!

Jason Bond

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