Wednesday, February 27th, 2008
Feb. 28, 2008 - In a February 21, 2008 article, the Globe’s Rob Carrick, provides an inside view of the workings of Canadian asset manager, Eric Sprott and his team at Sprott Asset Management. Carrick writes:
There’s a mix of suits and office casual attire, and a collegial flow of banter as Eric Sprott guides the session with questions and comments. But there’s also a feeling of tension, of wanting to say something that piques the interest of a boss who is good-natured and sociable, and yet intimidates with his obvious grip on market developments. The milk-as-gold idea is the sort of thing that might conceivably appeal to Sprott, manager of the amazingly successful Sprott Canadian Equity Fund and a keen prospector for investing themes with a future. Sprott was buying gold back in 2000, when it traded below $300 (U.S.) per ounce and few people envisioned the $800 prices we’ve seen recently. He took a shine to uranium in 2003, on the cusp of a gradual 10-fold price increase, with the expectation that nuclear power will have a big future in an era of high oil prices. Lately, his search for the next big score has led him to stocks in commodities like molybdenum, phosphates and silicon. “When looking at a stock, we ask, ‘What could happen that would make this thing triple or quadruple or quintuple?’ ” Sprott says, later, after the meeting. “We’re a sucker for big things. If someone says, ‘I have something big,’ that appeals to us.”
In the February 2008, Sprott Asset Management newsletter, Markets At A Glance, Eric Sprott shares his point of view that the market’s darkest days are not upon us yet, that there is in his estimation, more Unidentified Flying Objects from Mars to come. Sprott writes:
It’s been yet another awful month for the financial markets, even though the stock markets continue to be blissfully impervious to the carnage that is taking place in the rest of the financial world. This is not to say that the stock markets are by any definition bullish. But they certainly aren’t in the panic state that the credit markets are in at the moment. If they were then we’d be talking a full scale stock market crash, for that’s what invariably happens when bidders cease to show up. This is the state of the bond and credit markets right now. For all intents and purposes, save for government bonds, there is no functioning bond market. The stock market seems to be playing to a different tune. So, for now, the prognosis is for a long and drawn out bear market that could last for years to come, for the authorities are loath to allow a quick resolution to the bursting of the credit bubble. In our minds it is difficult to rationally reconcile current equity valuations with the washout that is occurring in the credit and bond markets and the US recession that we believe is now in full swing. But as bad as things are in the financial world, they seem to keep getting worse because problems heretofore unanticipated are coming at us from unforeseen quarters, like Unidentified Flying Objects from Mars. Things we already knew, about the credit bubble and the risks that were being taken, tell us that the problems in the financial system are bad. Things we don’t know, but that are only now coming to the fore, tell us that the situation could be unfathomably worse.
Which brings us to the point of the article:
Which brings us to the main topic of this article: UFO’s… the unanticipated surprises that are ravaging the financial system. With or without rate cuts, we already know that the banking system is in deep trouble. On top of the hundreds of billions lost in subprime, MBS’s, CDS’s, CDO’s, SIV’s and other toxic waste (the losses from which keep mounting by the day), what remains on bank balance sheets is also falling in value.
And Finally…
Have you ever heard of auction-rate securities? Neither have we. Before this month they were on no one’s radar screen. Out of the blue they’re suddenly a $360 billion problem.3 These are bonds that have been issued by municipalities, student-loan organizations, and others that seek long term financing with short term flexibility.
…What other incidents such as these have yet to be reported in the banking/insurance industries? We do not, and cannot, know. What we already know is worrisome enough… but what we don’t yet know can be downright frightening!
Make sure you read the whole newsletter. After all, it is coming from one of the brightest guys in asset management.
Tags: Markets
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Friday, February 22nd, 2008
February 22, 2008 - George Soros, the infamous hedge fund manager who broke the British Pound, penned an article for FT.com, in which he posits that this crisis, unlike many of its peers, which occur every 4-10 years, is actually the end of a 60 year period of credit expansion led by the once dominant greenback. Here are a few excerpts from The Worst Market Crisis in 60 Years, by George Soros:
…the current crisis marks the end of an era of credit expansion based on the dollar as the international reserve currency. The periodic crises were part of a larger boom-bust process. The current crisis is the culmination of a super-boom that has lasted for more than 60 years.
…Everything that could go wrong did. What started with subprime mortgages spread to all collateralised debt obligations, endangered municipal and mortgage insurance and reinsurance companies and threatened to unravel the multi-trillion-dollar credit default swap market. Investment banks’ commitments to leveraged buyouts became liabilities. Market-neutral hedge funds turned out not to be market-neutral and had to be unwound. The asset-backed commercial paper market came to a standstill and the special investment vehicles set up by banks to get mortgages off their balance sheets could no longer get outside financing. The final blow came when interbank lending, which is at the heart of the financial system, was disrupted because banks had to husband their resources and could not trust their counterparties. The central banks had to inject an unprecedented amount of money and extend credit on an unprecedented range of securities to a broader range of institutions than ever before. That made the crisis more severe than any since the second world war.
Credit expansion must now be followed by a period of contraction, because some of the new credit instruments and practices are unsound and unsustainable. The ability of the financial authorities to stimulate the economy is constrained by the unwillingness of the rest of the world to accumulate additional dollar reserves. Until recently, investors were hoping that the US Federal Reserve would do whatever it takes to avoid a recession, because that is what it did on previous occasions. Now they will have to realise that the Fed may no longer be in a position to do so. With oil, food and other commodities firm, and the renminbi appreciating somewhat faster, the Fed also has to worry about inflation. If federal funds were lowered beyond a certain point, the dollar would come under renewed pressure and long-term bonds would actually go up in yield. Where that point is, is impossible to determine. When it is reached, the ability of the Fed to stimulate the economy comes to an end.
And finally,
Although a recession in the developed world is now more or less inevitable, China, India and some of the oil-producing countries are in a very strong countertrend. So, the current financial crisis is less likely to cause a global recession than a radical realignment of the global economy, with a relative decline of the US and the rise of China and other countries in the developing world.
Soros concludes that there is a danger that US protectionism could disrupt the global economy and plunge the world into a recession or worse.
Source: The Worst Market Crisis in 60 Years, George Soros, FT.com
Tags: BRICs, China, credit market, Economy, Emerging Markets, India, Investment Wisdom, Markets
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Wednesday, February 20th, 2008
Feb. 20, 2008 - Stagflation is a threat that is best defended against with commodities and Treasury Inflation Protected Securities or TIPS as they are commonly referred to.
A recent article by John Wasik, Bloomberg describes a few ways that investors protect against stagflation:
Several investments come to mind: commodities and Treasury inflation-protected securities, or TIPS.
…One refuge in inflationary times has been gold. Held in huge quantities by large banks and the favorite commodity of inflation speculators, it has been in demand over the past year.
You are better off buffering the ravages of inflation on your portfolio.
That means finding investments that combine income and price appreciation, and rise with inflation expectations.
Two investments come to mind: commodities and Treasury inflation-protected securities, or TIPS. A deft combination of TIPS and commodities can be found in the PIMCO Commodity Real Return Strategy Fund. It returned 23 percent last year. This is my portfolio’s key inflation buffer.
Whatever stagflation strategy you adopt, remember that overconcentrating in any of the inflation-fighting vehicles will add unnecessary risk to your portfolio.
Inflation is an often-unpredictable ogre that creeps up slowly. You will need a number of weapons to do the job.
Canadian investors seeking to invest in inflation protected securities and commodities may look at any of a number of Real Return Bond and diversified commodity products. Some of these include:
ETFs
iShares Real Return Bond ETF (XRB)
Claymore Global Agriculture (COW)
Canadian Mutual Funds
TD Real Return Bond Fund A (TDB755)
Investors Real Return Bond Fund (IGI491)
Don Coxe’s January 2008 recommendations include this particular paragraph:
Bond investors face two risks: inflation and credit. Nominal Treasury bond yields are far too low, and quality corporates are too rare – with 71% of corporate debt junk-rated. Buy inflation-hedged sovereign bonds – preferably in major foreign currencies. Simplicity is good: avoid complex products that are subject to drastic rating writedowns.
George Soros discusses the circumstances under which the Fed might be rendered impotent at macroeconomic control:
Credit expansion must now be followed by a period of contraction, because some of the new credit instruments and practices are unsound and unsustainable. The ability of the financial authorities to stimulate the economy is constrained by the unwillingness of the rest of the world to accumulate additional dollar reserves. Until recently, investors were hoping that the US Federal Reserve would do whatever it takes to avoid a recession, because that is what it did on previous occasions. Now they will have to realise that the Fed may no longer be in a position to do so. With oil, food and other commodities firm, and the renminbi appreciating somewhat faster, the Fed also has to worry about inflation. If federal funds were lowered beyond a certain point, the dollar would come under renewed pressure and long-term bonds would actually go up in yield. Where that point is, is impossible to determine. When it is reached, the ability of the Fed to stimulate the economy comes to an end.
Caution: One thing to remember is that TIPS or Real Return Bonds in a mutual fund do not provide investors with the same degree of risk management where date-driven spending plans are concerned. The maturity date of any bond is a guarantee the face value will be paid at an exact time in the future. Bond mutual funds, unlike the underlying security, do not provide any fixed maturity date or guranteed sum. Ideally, if you can get your hands on the bonds, then do so.
…leaves you wondering just how far the Fed may or will have to go with rate cutting in order to get the economy going again, and in the process, provide enormous [inflationary] stimulus to the rest of the world. This is truly a mixed blessing.
Tags: Agriculture, Commodities, credit market, Investment Strategy, Markets
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Wednesday, February 13th, 2008
Feb. 13, 2008 - Warren Buffett, live on CNBC, proposed to buy the muni-bond portfolio from the monoline insurers, an offer, which if accepted would be very good for muni-bond holders (as it would protect the bond’s AAA ratings and their pricing) and Berkshire Hathaway, and would effectively leave the CDO portfolios right where they are. This could in no way be misconstrued as a bailout. This is Warren Buffett doing what he does best. Ahhhh…Capitalism at its finest.
Here is the excerpt of the transcript from CNBC.
Becky Quick: We know Warren that you’ve already put a plan out where you are, in fact, a bond insurer yourself. You have a new company that’s doing that. But beyond that, Ambac, FGIC and MBIA, they all have some significant problems. What do you think needs to be done?
Warren Buffett: Well, last Wednesday, as you know we have formed a new bond insurer. And last Wednesday, Berkshire Hathaway made a firm offer to the three largest bond insurers, who in aggregate I think, insure about 800 billion (dollars) of tax exempt bonds.
And what we said we would do is, and we gave a copy of this, of course, to the Superintendent of Insurance of New York. We said we would form, we would add to our company’s resources five billion dollars. That five billion dollars in the new insurance company, we would pledge that there would be no dividends or any kind of distributions or management fees taken out of that for ten years, so all the earnings of that company would be retained to build up the claims-paying ability.
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And we offered to take over the liabilities for the whole $800 billion of these three companies for a premium that would be equal to, essentially, one-and-a-half times the remaining premium left over the life of the bonds. They have what they call an ‘unearned premium reserve’ which reflects the original premium less the amount that’s been proportionately earned. And we said, for one-and-a-half times that amount, we would take away all of their liabilities so that the $800 billion in bonds would carry a real triple-A insurance, and would sell in the market as if it had real triple-A insurance. Whereas now the bonds sell at significant discounts.
And we provided additionally that if they felt that this premium was too high or that they could do better that for thirty days, they would have the backstop of our offer which would be totally firm, and if they came up with anything better for themselves and for the holders of their insured bonds, that for a break-up fee of one-and-a-half percent of the premium, that they could go and take the other deal. So that the world would know that, one way or the other, that that the municipal bond insurance problem was behind it. It would be either with our offer or some other offer that they went out and obtained.
So, we put that out there to the three largest insurers and if they should decide to take it, eight-hundred billion of bonds that are now selling as if they were uninsured, or even in some cases a little worse. They’re probably selling on balance maybe 5 percent below where would sell for if the insurance was regarded as good, which is 40 billion on 800 billion. We will see what happens.
Good Luck Mr. Buffett, and good luck muni-bond holders…
Tags: ABK, CDS, credit market
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Sunday, February 3rd, 2008
Feb. 3, 2008 - The nature of the economic strength and stability of the BRIC (Brazil, Russia, India, China) countries is a less well known or understood fact among investors. There remains a wide gap between perceptions and reality.
Remember 1997 and 1998? Many investors, excited about the growth of Asian and emerging countries in the late nineties and invested their money found out about credit related risk first when the 1997 ‘Asian Contagion’ occurred and was followed upon by the Long Term Capital Management bailout which unfolded in 1998. These events destabilized global markets and investors were taken by surprise as markets melted down.
For this reason, its important to go back to that time and re-examine Malaysia and Thailand, as examples, of where investors were excited by the rapid economic growth, but ignored the then inherent high credit risk, much to their expense. A decade ago (yes, a decade ago) when all of this was happening, only 3% of the grand total of emerging markets sovereign debt was rated as investment grade by any of the ratings agencies.
In 1997, only 10 out of 120 companies that form the MSCI Emerging Markets Index, had ADRs.
Excited by the G7 debt-financed growth, investors made bets that were inherently risky to their preservation of capital, not simply volatile. Circa 1997, emerging markets were in debt to the industrialized world by about $100-billion in the current account deficit column, and dependent on the kindness of their G7 financiers.
When the Malay and Thai governments were unable to meet current account obligations, and started printing money in order to meet them, the Fed blew the whistle upon discovering that sufficient reserves were not available to support the currency valuations. Hence the overnight slashing of Asian currencies.
At best, the general sentiment surrounding emerging markets has remained sceptical, and for this reason, as fundamentally sound as the BRIC countries economies are today, the market has been adopting the BRIC investment story very gradually. This time though, it is credit worthiness that is being overlooked.
Source: Merrill Lynch October 2006
Source: Merrill Lynch, October 2006
Today, emerging markets sit atop a current account surplus in excess of $700-billion, and it is the industrialized G7 who are in debt, by the same amount. Longer term surpluses in excess of $3-trillion are to be found on the balance sheets of mostly the BRIC countries today in the form of Foreign Exchange surpluses, and trade surpluses. China alone now nurses a trade and forex surplus nearing US$1.5-tillion. Russia, has managed to build up reserves of US$450-billion as well as Putin’s US$150-billion ‘contigency’ fund, set aside so that it may sidestep any kind of financial shock. India has amassed a forex surplus of around US$275-billion. Brazil’s forex reserves now stand at US$178-billion.
BRIC countries have been financing the debt, and driving the growth of G7 countries for the last 5-7 years. China has emerged as the worlds manufacturing hub, while India has come on very strong as its counterpart hub in services, both providing Western firms access to inexpensive educated and -or- highly-skilled labour. Russia, under Putin, has successfully emerged as a highly profitable energy and raw materials producer, second in oil and gas reserves to Saudi Arabia. Brazil has changed the regional balance in the Americas by turning itself into the winds of east-west trade in hard and soft commodities and using its strength to bolster its new economic clout in relation to North America.
China’s growth is less dependent on the health of the US economy, as is commonly perceived. A recent Economist article points out that China’s true exports-to-GDP ratio is actually below 10%, that China has been quite successful to date at rebalancing its economy in favour of domestic growth as a driver. As for India, 87% of its GDP is consumed domestically, making it quite independent from the risk of the US threatened consumer hegemony. Russians are enjoying three times the disposable income of 7 years ago and driving consumption growth, as are Brazilians.
North American and European companies are looking to these consumers to drive demand and growth to their top and bottom lines.
In a word, things have changed.
They have changed in a very meaningful, very important way. The relationship that now exists between emerging markets and G7 countries is ‘symbiotic.’ and interdependent.
Source: Merrill Lynch, October 2006
Today, around 60-70% of emerging markets sovereign debt is investment grade rated and all 120 companies that form the key MSCI Emerging Markets Index have ADR listings.
In 1997-1998, the world’s biggest western banks took advantage of bailout conditions to take ownership of Asian banks, once protected by thousand-year-old protectionist laws. Today, powerful and wealthy Sovereign Wealth Funds (SWFs) are bailing out the same banks, Citigroup, Merrill Lynch, and Morgan Stanley.
On Wall Street in the past few weeks, the sums have been bigger and the actions more benign—at least so far. This week Merrill Lynch and Citigroup became the latest to get the sovereign-wealth treatment, picking up a further $6.6 billion and $14.5 billion respectively, much of it from governments in Asia and the Middle East (see article). Sapped by the subprime crisis, rich-world financial-services groups have been administered nearly $69 billion-worth of infusions from the savings of the developing world in the past ten months, according to Morgan Stanley.
Commodities are not the only source of sovereign wealth. Many Asian emerging markets have been running current-account surpluses at the same time as they have been managing their exchange rates. As they have mopped up dollars, using government bonds, they have accumulated reserves. At first these went into safe, liquid assets like American Treasury bonds—the Asian financial crisis of 1997-98 was still a recent memory and many countries were keen to amass reserves. But economies like China, South Korea and Taiwan now have more reserves than they need to defend themselves against shocks. Their governments understandably want to earn a higher return than Treasury bonds will pay, so they create a fund to manage their assets. Source: The Economist, Jan. 17, 2008, Asset-Backed Insecurity
It has become such that neither Emerging Markets nor the G7 can allow each other to be destabilized, as evidenced by the large, noted, SWF investments, as they have each other’s economic ‘lives’ in the balance.
You might get the idea that emerging markets are correlated more to the US than they actually are, when you see that they have suffered like western stock markets, from a selloff. Their correlation is low, between .30 and .40, not zero or negative. There are those who would have us believe that the decoupling thesis is suffering from the same disease as the bull market. Those are probably the same folks, who last year began to re-write their theses from decoupling to recoupling to suit themselves this year, as the need to raise cash by selling the last two year’s profitable trades became an increasingly inevitable requirement, in order to shore up balance sheets.
Our expectation is that the credit squeeze ailing the market will come to a reversal point, at some point over the next 2-4 weeks as the banks round the corner on the cash call that has forced the wholesale liquidation of emerging markets and commodities related investing.
Emerging Markets are strong, and some of their [inflationary] growth pressures may get somewhat solved by a slowdown in the US, in the form of an imported soft landing. This is by no means advice, but if you subscribe to this thesis, then there is reason (for those of us on the buy-side) to believe that there will be a recovery in the decoupling thesis, and thus emerging markets equities throughout the second half of the year, from the current lows.
First, however, until the cash call is complete, and the future of the monoline insurers (MBIA, ABK) is resolved in the form of perhaps a bailout, we may continue to see more downside.
Now may prove to be a good time to nibble at emerging markets and commodities again and add or gain exposure as they are far more attractively priced. Here are a variety of ETFs and open ended funds (Canadian fund companies with offerings) that provide broad (diversified) and narrow exposure (country and regional funds) to BRIC and emerging markets.
On the AMEX
“Total” Emerging Markets ETFs
iShares MSCI Emerging Markets Index Fund (EEM)
PowerShares FTSE RAFI Emerging Markets Portfolio (PXH)
SPDR S&P Emerging Markets ETF (GMM)
Vanguard Emerging Markets ETF (VWO)
Dividend Emerging Markets ETFs
WisdomTree Emerging Markets High-Yielding Fund (DEM)
Multi-Region (but not Total) Emerging Markets ETFs
BLDRS Emerging MKTS 50 ADR Index Fund (ADRE)
Claymore/BNY BRIC (Brazil, Russia, India, China) ETF (EEB)
streetTRACKS SPDR S&P BRIC (Brazil, Russia, India, China) 40 ETF (BIK)
iShares MSCI BRIC Index Fund (BKF)
Latin America Regional ETFs
iShares S&P Latin America 40 Index Fund (ILF)
SPDR S&P Emerging Latin America ETF (GML)
European Emerging Markets Regional ETFs
SPDR S&P Emerging Europe ETF (GUR)
Middle East and Africa Regional ETFs
SPDR S&P Emerging Middle East & Africa ETF (GAF)
India - Barclays iPath India ETN (INP)
On the Toronto Stock Exchange
Claymore BRIC ETF (CBQ.T)
Open Ended Funds (Canadian)
Broad Mandate Emerging Markets
Tmpleton Emerging Markets
AGF Emerging Markets
Pro FTSE RAFI Emerging Markets Index
TD Emerging Markets
United-Emerging Markets Pool Cl A
CI Emerging Markets
United-Emerging Markets Pool Cl W
BMO Emerging Markets
Brandes Emerging Markets Equity
CIBC Emerging Markets Index
National Bank Emerging Markets
Region/Country Mandates
Excel India Fund
Excel China Fund
Excel Chindia Fund
Excel Emerging Europe Fund
Templeton BRIC Fund
Tags: Brazil, BRICs, Commodities, credit market, de-coupling, Emerging Markets, India, Latin America, Markets, Russia, SWFs
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