RealMoney Silver - Get Set for Coming Mark-to-Market Pain

Get Set for Coming Mark-to-Market Pain
By Cody Willard
RealMoney.com Contributor
8/31/2007 1:30 PM EDT

The volatility's been volatile again this week. Expect much more volatility in coming weeks because the financial markets remain full of air pockets between what's being reported as market prices vs. the real value of much of those real estate assets. Here's what this trader will be pondering on the beach this weekend.

Starting next week and continuing through the end of this quarter, we're going to see a lot more "mark to market" updates. That's going to result in a lot more pain for hedge funds and brokerages.

Almost any real estate-related asset is at least somewhat overvalued relative to the actual prices it can be sold for. Many assets, whether subprime-related or not, are worth a fraction of the worth still being reported.

As the owners of these assets (and I'm thinking mostly of the major brokers and hedge funds) start getting more serious about making sure every asset on their balance sheets is being valued relatively accurately, a mass repricing of assets will probably result in a lot more dislocations and freeze-ups in the financial markets. When the bids -- many of which are at, say, 60% of the reported worth -- start getting hit, nobody will be able to claim that their assets are worth 100% of what they've been saying.

Mark to market is a theme we're still going to be hearing a lot more about in coming weeks and months. And that's a large part of why I'm remaining so cautious about the near term.

Indeed, I began reloading my index puts this morning. I'm using very liquid ETF puts, such as the Nasdaq 100 Unit Trust (QQQQ) and the Russell 2000 iShares (IWM) , mostly using out-of-the-money puts dated in October.

I don't like that I have to pay a bit more premium because of all the recent volatility out there, but I am not the world's best short-seller. By using puts, I define my total potential loss (the whole price of the put could go to zero).

Robert Marcin argues that it's not my lack of shorting skills that's the reason I've never made much money on the short side and have little confidence in my skills. Rather, I launched a tech-centric hedge fund in October 2002, and the market's been in a remarkably steady uptrend in the years since. So of course my longs have worked better than my shorts.

At some point, a bear market is sure to return to the U.S. equity markets. And even though James Altucher rightly points out that most shorts failed to make money even when the Nasdaq dropped 50% in the year 2000, I tend to think that it's gotta be easier to make money on the short side in a bear market than in a bullish one.

I've been asking for months: Is it too late to short the mortgage guys and the homebuilders? And everybody usually answers that yes, it is. So then I ask, "How about going long them, then?" You can imagine that everybody thinks that's a stupid idea right now.

Makes me wonder if the mortgage guys and homebuilders are good longs for a trade. Don't kid yourself into thinking they're good investments right now, though.

I keep using the telecom bubble as a rough playbook for the housing bubble. JDSU (JDSU) , Nortel (NT) and the highest-flying telecom companies dropped 99% by the time the bubble was done unwinding (many are still down that much, by the way).

That means you could have shorted Bookham or JDSU or Lucent or Level 3 when they were down 90% -- and you still would have made a 90% return on your short before they bottomed. Certainly a lot of these homebuilders share a similar fate.

I bought some more SanDisk (SNDK) this week, as I wrote Tuesday. I also bought some more Kansas City Southern (KSU) . Remember, that latter one is a five-year, 10-year or even lifetime investment -- so long as it delivers on these new ports and railroads to bring in goods to the U.S. from Mexico. I'll do a complete write-up on this one in the next couple weeks.

And with that, I thank you for reading and head out to one of these beautiful Hampton beaches to start the weekend early. See you Tuesday.