Posts Tagged ‘inflation’
Better To Be Late, Amid Credit Crises: Thomas Barrack, Jr.
Thursday, October 30th, 2008
Thomas J. Barrack Jr., billionaire and Founder of Colony Capital, which controls $39-billion in real estate assets, in his recent newsletter, “Is the world going to an [Extinction Level Event?” provides his assessment of the state of the markets, and shares the following:
Why the Banks Have Most Likely Not Hit Bottom
• Corporate earnings from most sectors will be weak and capex programs will be slashed.
• Hedge funds will continue to be tortured by redemptions and their interplay with banks was
incestuous.
• The effect of hedge funds pulling out of the market will chill many sources of corporate
finance - Redemptions are massive.
• Counterparty risk in the CDS market will remain a bit of a mystery.
> CDS was equally as bad at the plate as equity and debt players
> The governments infusion of equity collapsed the CDS spreads
• CDS payments and failures at levels that are unfathomable - watch Lehman reconciliations on
Tuesday, Oct. 21st.
• The housing market will remain anemic.
• Insurance companies, automakers, airlines and shippers are all in trouble.
• State and municipalities are also Fed borrowers.
• Corporate refinancings at $150 billion a quarter with no one to refinance.
• Massive margin calls on the titans of America which will cause collapse in the corporate
equities they own.
• Forced liquidations.
• LBO restructurings and covenant violations.
• No DIP financing for bankruptcies, only liquidations.Long-term Consequences
The good news is that all we care about at the moment is SURVIVAL. We need to fight every day to monitor and steward the best deals we can find — the ones we own. However, eventually we will need to examine the long-term effects of our triage.
• Huge inflationary pressures. Inevitable higher interest rates and taxes.
• Massive national debt and budget deficits.
• Are we deferring the pain like Japan did?
• $11.3 trillion national debt is really $55 trillion due to OBL (off balance-sheet liabilities).
• Implications of investment losses for pension funds and endowments?Bottom Line
The game is afoot and not over. Don’t panic and don’t be euphoric. The discoveries will be constant and unsettling. Fortunately, the world powers have committed to win it. Now we all have to figure out what exactly that means. Based upon our past experience at implementing bank takeovers and “distressed asset” management and dispositions, we suggest that we all buckle our seatbelts for a longer ride with lots of ups and downs before we arrive to safety.
From Bloomberg, October 10, 2008:
“For once, it will be better to be late rather than early,” Barrack said in a four-page letter to investors on Oct. 8, a copy of which was obtained by Bloomberg News. “There is no bottom because no one believes the messenger.’
“As all markets come to the realization that we are now in a worldwide systemic recession — not just a credit crunch — things may get worse,” the Los Angeles-based Barrack, 61, wrote in the letter, titled “In God We Trust — But Not Counterparties.”
“The massive restructurings, refinancings and re-pricings that will now take place, cascading from the financial world to the industrial world, will be legend. The complexities, repercussions and consequences to all parties are indeterminate.”
From Donald Trump’s Blog, the Donald quotes his good friend’s (Thomas Barrack Jr.) newsletter:
Why Can’t Anybody Find the Bottom?
It all boils down to trust! The mantra of the country is “In God We Trust–but not counterparties.” No buyer trusts any seller, banker, insurer or intermediary. No investor trusts any depository, insurer, broker-dealer or advisor. No Main Street citizen trusts Wall Street, and neither Main Street or Wall Street trusts the government. No counterparty in any transaction has confidence in the other. Values at every level have been artificially adjusted and when the air comes out of the “speculative hope certificates” everyone is pointing fingers at each other for fault and retribution.
The Worst is in Front of Us
Counterparties are renegotiating, borrowers are violating covenants, banks are finding any excuse not to fund existing commitments, insurers are negating liability, and renegotiations of responsibility and liability are being conducted at every level of the capital structure across the spectrum of companies.
There is no bottom because no one believes the messenger. With trillions of dollars of re-pricing occurring in these markets there is no hurry to catch the falling knife. There will be ample time once that last “dead cat bounce” has bounced and the government launches a coherent and consistent program. For once it will be better to be late rather than early.
Bottom Line: This is Not the Bottom.
Thomas J. Barrack Jr., “Is the World Going To ELE?”, October 14, 2008
Source: NakedShorts.com, Colony Capital
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Tags: Banks, CDS, Credit, Dollar, energy, Fed, Housing Market, inflation, interest rates, Japan, Markets, Real Estate, Recession, spreads, Value
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Jeremy Grantham: Silver Linings and Lessons Learned
Wednesday, October 29th, 2008
Jeremy Grantham is the Chairman of the Board of Grantham Mayo Van Otterloo, who manage approximately $120-billion in assets, well known among institutional investors but relatively unknown to retail investors. Here are some highlights from both parts of Grantham’s October 2008 newsletter “Reaping the Whirlwind,” and ”Silver Linings and Lessons Learned.”
Part 1, “Reaping the Whirlwind,” published 2 weeks ago:
“At under 1,000 on the S&P 500, US stocks are very reasonable buys for brave value managers willing to be early. The same applies to EAFE and emerging equities at October 10 prices, but even more so. History warns, though, that new lows are more likely than not.
“Fixed income has wide areas of very attractive, aberrant pricing.
“The dollar and the yen look okay for now, but the pound does not.
“Don’t worry at all about inflation. We can all save up our worries there for a couple of years from now and then really worry!
“Commodities may have big rallies, but the fundamentals of the next 18 months should wear them down to new two-year lows.
“As for us in asset allocation, we have made our choice: hesitant and careful buying at these prices and lower. Good luck with your decisions.”
You can read ”Reaping the Whirlwind,” in its entirety by clicking here where Grantham has published his views on the fallout from the financial crisis and the investment opportunities he sees.
Part 2, ”Silver Linings and Lessons Learned”, published early this week:
“When asked by Barron’s on October 13 if we would learn anything from this ongoing crisis, I answered, ‘We will learn an enormous amount in a very short time, quite a bit in the medium term, and absolutely nothing in the long term. That would be the historical precedent.’
“That is unfortunately likely to be the case. But over the next several years at least, there are many silver linings and valuable lessons to be learned.
“Chief among the many benefits of this crisis are unprecedented opportunities for investing in some fixed income areas where some spreads are so wide as to reflect severe market dysfunctionality.
“As of October 18, we also have moderately cheap US and global equities for the first time in 20 years. Probably quite soon, global equities too will offer exceptional opportunities after the additional pain that is likely to occur in the next year.
“We are reconciled to buying too soon, but we recognize that our fair value estimate of 975 on the S&P 500 is, from historical precedent, likely to overrun on the downside by 20% to 40%, giving a range of 585 to 780 on the S&P as a probable low.
“The world faces unavoidable declines in economic activity and profit margins, so this overrun is unlikely to be much less painful than average, although you never know your luck.”
You can read ”Silver Linings and Lessons Learned,” in its entirety by clicking here where Grantham has published his comments on lessons learned from the credit crisis, as well as his proposed strategy.
Source: Jeremy Grantham, GMO, October 2008.
Courtesy: Prieur du Plessis, Investment Postcards
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Tags: Barron's, Commodities, Credit, Credit Crisis, Dollar, EFU, Fixed Income, inflation, Investment Postcards, S&P 500, Silver, spreads, US Stocks, Value
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Governments Keep Making Mistakes: Jim Rogers
Wednesday, October 22nd, 2008
Jim Rogers, CEO, Rogers Holdings, appeared on CNBC’s European Squawk Box this morning with Geoff Cutmore, to discuss the progress of markets and his outlook.
click image for video
Rogers stated that the economy is in for high inflation given the size and nature of the central bank interventions and injections in to the financial system, and pre-ambles this saying,
“The world is unfolding. The American government keeps making mistake after mistake after mistake. Other governments do too. Unfortunately this is going to be a mess,” Jim Rogers, CEO of Rogers Holdings said Wednesday.
“Bernanke, and Paulson and the guy at the NY Fed, Tim G-r-eithner [or whatever his name is: slips Rogers] have been wrong every week for the last two years. Why do you think they know what they’re doing?”
He has covered most of his “shorts,” and wishes that he had not yet covered them, as their has been more downside.
He is long short-term US government bonds and short and shorting long term government bonds as he believes that we are heading for inflation. He has been buying agricultural commodities, though he admits that his timing is bad, as they are down.
“I bought some more agriculture earlier this week and it promptly went down. The fundamentals for commodities and agriculture have not changed,” says Rogers. “What’s happening in the world right now means that there will be less supply of everything coming out of this, and nobody can get a loan for a new zinc mine or a loan to increase their crop production.”
Rogers adds that
“What’s happening now is that we are in a period of forced liquidation; we’ve had 8 or 10 of these in the last 100-150 years; 1929 in the US, 1974 in the UK…We’ve had these before. The things that come out on the other side have always been the things that are unimpaired. The US financial system is impaired. The investment banking system is impaired.”
“But, commodities and agriculture are totally unimpaired by all of this. If history’s any guide, the things to buy will be the things that are doing fine; water treatment in Asia [for example], agriculture’s gonna do fine; that’s what you should buy.” Rogers adds, “However, my timing’s not very good.”
Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke should resign for keeping alive “zombie banks” that should be allowed to fail, he said.
The Japanese government refused to let financial institutions fail in the 1990s, Rogers said.
“It’s 18 years later and their stock market is 75 or 80 percent below what it was 18 years ago,” he added.
Rogers also said that interest-rate cuts are coming.
“I know we are going to get aggressive rate cuts everywhere, that’s why I’m long short-term government bonds in the U.S., but shorting long-term government bonds because it’s not going to help, it’s going to add to inflation.”
Source: CNBC
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Tags: Agricultural commodities, Agriculture, Asia, Banks, Bernanke, Commodities, Economy, EFU, Euro, Fed, Federal Reserve, inflation, Japan, Jim Rogers, Markets, Paulson, UK, Video, Water
Posted in Commodities, Markets | No Comments »
Donald Coxe: Homeicide: The Crime of the Century
Monday, October 13th, 2008
Donald Coxe, Chief Investment Strategist, BMO Capital Markets, has published his latest issue (October 8) of Basic Points, titled “Homeicide: The Crime of the Century.” Given the release date of this issue, its interesting to see how timely his calls to action are.
Particularly, we would highlight Coxe’s call to reduce general equity exposure further, prior to what was one of the worst weeks ever (last week), and to not wait too long to buy agricultural stocks.
Columbus Day 2008 will go down in the history books as the single-biggest one day rally since 1933, the Dow rising 936 pts (its biggest one day point closing ever, and fifth largest %-age closing) . This rally followed the US government’s announcement that it would take an equity stake in the banking sector, by injecting $250-billion into the sector.
Its still early though, and as Coxe says, this is likely a “Mama Bear.” Question is, is this a Mini-Mama Bear (like late1980’s or late 1990’s) or a Big Mama (like 1930’s). In the full text of Basic Points, a must read, Mr. Coxe explains himself fully.
Here, we summarize his recommendations:
- Recommended exposure to equities is 46% depending on investor’s overall portfolio and risk tolerance, and close to absolute minimum equity exposure of 40%. Cash is currently at 20%, the maximum. (nice call considering the following week was one of the worst weeks ever in the market)
- Long term investors should not wait too long to choose among the heavily battered commodity stocks. Specifically, the best companies the world has to offer, relative to the world economy, competitiveness, management, cash flows, and balance sheets. Many may now be bought at a discount to their reserves in the ground, without taking into account balance sheet assets.
- Agricultural stocks have been savaged. All it would take is one “medium-sized crop failure” to mark the return of the global food crisis. A handful of very important companies have the means and ability to make the difference of assisting in the fulfillment of the protein demands of a billion people escaping the rice bowl and bread diet.
- For the time being, their lower stock prices prevents them from over-expanding or over-producing, which means their profits will end up being even higher in the super-cycle.
- Interest rates are sharply lower, thanks to short covering in the dollar, and collapse of stock prices, which has forced asset reallocation. This will soften the blow to the mortgagees facing potential foreclosure and not be so ghastly, as predicted by gloomy forecasters.
- Commodity prices fall during recession, but the real value of them does not. Small under-capitalized producers will be devastated in a recession, making them easy pickings for the larger ones when clarity returns in the market.
- Gold and Gold-mining shares remain an effective way to reduce “endogenous” risk in an equity portfolio. Although inflation will recede for a short while, the sheer size of the economic stimulus (so-called printed money) means gold could move to new highs.
- The downward movement of commodity prices has been far more severe than we expected. We should have warned clients to the rapid deterioration in the fundamentals in the last Basic Points. On Sep. 19 conference call, we advised a significant reduction in equity exposure to energy and base metals, in favour of the precious metals. These rebalancings should be of some consolation to investors in the volatile period ahead.
- The size and complexity of the credit market created in the final days of the bank mania, and the scale of deleveraging has made measuring overall risk unknowable. The Lehman failure means huge losses and years of litigation. Those assets were either sold or still overhang the market. Never before have so many colluded to behave so badly. Our doubts remain their malefactions have created a really big bear market, but we’ll probably know within weeks.
Thank you Mr. Coxe.
The complete report is available here.
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Tags: Basic Points, BMO, BMO Capital Markets, Credit, Credit Market, DOG, Dollar, Donald Coxe, Economy, energy, Gold, inflation, interest rates, Markets, Metals, Mining, Mortgage, precious metals, Recession, Value
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Global Long-Term Rates Signal Deflation
Thursday, October 9th, 2008
Its pretty clear that the last thing on investors minds these days is inflation when the 10-year yields around the world are back at last year’s lows. Falling long rates are a fairly reliable signal of deflation, and given how commodities, both hard and soft, as well as housing prices in the G7, investors have been making the flight to safety for most of this year.
10-year government debt securities have been among the best performing investments anywhere in the developed world.
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Tags: Australia, Commodities, inflation, interest rates, Japan
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Interest Rates Cut by 0.50% Around World
Wednesday, October 8th, 2008
Key Central Banks around the globe have announced a concerted cutting of interest rates, by 0.50%, this morning, in an historic moment of cooperation, to stem the tide of the global credit market’s woes.
The US Federal Reserve, the European Central Bank, the Bank of England, and the central banks of Canada, Sweden, and the United Arab Emirates have all cut key lending rates by 50 bps or 0.5 percent.
The Bank of England also announced that it would partially nationalize the country’s banking system by investing $90-billion in some of its banks.
In China, the People’s Bank has cut its key rate by a commensurate 27 basis points, and the Bank of Japan whose key rate is only 0.5% did not cut, but is lending “strong support” to the other central banks’ moves.
In identical statements, the Fed, ECB, and Bank of England, explained that inflationary concerns have moderated, and the worsening financial crisis had “augmented the downside risks to growth.”
Trichet, the ECB’s Chair, very modestly stated that “inflation is moderating.” Critics have argued that the ECB has been too slow and looking in the rear view mirror too long, to do anything meaningful for the European economy, and at the expense of the financial stability of European businesses. Others argued that while the move is very welcome, it may be too little, too late.
Euro and Sterling both gained on the announcement, while the price of gold fell.
Equity markets in Europe rebounded from intraday lows on the hope that this monetary action would help banks and consumer stocks.
Pre-Opening trading in index futures indicate a strong opening for US markets following the announcements.
Key Rates (post-cut)
- US - 1.50%
- Canada - 2.50%
- ECB - 3.75%
- UK - 4.5%
- Sweden - 4.25%
- China - 6.93%
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Tags: Banks, Canada, China, Credit, Credit Market, ECB, Economy, Euro, Fed, Federal Reserve, Gold, inflation, interest rates, Japan, Markets, Sweden, Trading, UK
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Credit Crisis Observations
Tuesday, September 23rd, 2008
Niels Jensen and Jan Wilhelmsen of Absolute Return Partners (www.arpllp.com) produced an informative analysis of the credit crisis and provide the following observations. Here is our summary:
Loans and Mortgages are getting much harder to come by on average, globally.
This has bold and negative implications for property prices everywhere.
Observation # 1
It all began with housing and it will end with housing.
The current overhang caused by the tightness of credit (mortgages) will take years not months to unwind and housing prices will not begin to rise again until this occurs.
Observation# 2
Don’t trust central banks to always do the right thing.
Evidence suggests that while their intent seems to be genuine, central banks around the world have not been very effective at taming inflation. For example, simply raising interest rates in the underlevered economies of the BRIC countries has been futile, since most consumers and companies do not employ credit to the extent that those of us in the west do.
In the case of the BRIC countries, it appears the problem does not consist of sustaining growth, but rather containing growth. China, for instance, has a record of under-reporting both real and nominal GDP growth, and may have only recently more accurately stated inflation owing to the fact that they could not hide from skyrocketing oil and food prices.
Observation # 3
Policy mistakes are likely to be repeated.
The US is currently at risk of making the same policy making mistakes Japan made 10-15 years ago. US residential property prices have risen more during 2000-2006 boom than did the Japanese during the late 80s boom.
Japan too, though more rapidly, reduced the cost of money dramatically to fend off its crisis.
Japan bailed out many of its institutions and used taxpayers money to fund the activity of fixing the ‘unfixable,’ and this could have profound implications for the US GDP growth in years to come.
Observation # 4
The golden era of investment banks is over.
The biggest independent investment banks have just become banks. The US investment banking business is becoming more like Canada’s where the business is dominated by the large schedule “A” chartered banks and America’s “free” market just became a little more socialist. How ironic…The folding of GS and MS into banks also has valuation considerations for the venerated firms as their revenues and earnings are sure to decline under the auspices of Fed regulation. Further de-levering also has negative implications for the market as it entails more liquidation. Hopefully this will be done in an orderly fashion now that the conversion is underway.
Observation # 5
The final shoe hasn’t dropped yet.
There is more to come. For instance, the financial system has yet to deal with $1-trillion in Alt-A securities and further degradation of the CDS market and counter-party risks.
Absolute Return Partners states that the commodity bull is just the final leg of the liquidity super-cycle: take a look the Economist’s VAR-VAR-Voom chart.
Observation # 6
Leverage is ‘dead’ but capital is not.
Global savings rates now exceed 20%, except in the US, and while this is a positive for global stability, the question remains about whether investors are willing to invest money where it is most needed, the shore up the world’s banks. Failing that, property prices will need to stabilize before we can expect better times.
Observation # 7
The end of the crisis looks further away than it did a year ago.
Its complicated, very complicated.
Commodity price induced inflation has made it hard for policy makers to reduce interest rates. Despite this, interest rate cuts may not be the magic bullet and in 20 of the 36 countries recently surveyed by Morgan Stanley, real short-term interest rates are currently negative.
At this point the $700-billion Treasury/Fed proposal appears to be a solid response, as does the stimulus injections of cash into markets around the world.
This problem remains possibly years away from being done with.
Observation # 8
Traditional risk management has lost its way.
Paul McCulley of Pimco touched on the subject in the July 2008 issue of Global Central Bank Focus:
“[...] every levered financial institution - banks and shadow banks alike - decided individually that it was time to delever their balance sheets. At the individual level, that made perfect sense. At the collective level, however, it has given us the paradox of deleveraging: when we all try to do it at the same time, we actually do less of it, because we collectively create deflation in the assets from which leverage is being removed.”
In fact, while it is known that PIMCO was regularly consulted by Secretary Paulson, it was Paul McCulley who rightly proposed in his newsletter during the summer, that the only real solution would consist of the formation of a new government agency to create a market to thaw frozen or cemented assets. This would be the only viable long term solution.
Conclusion
Where is the opportunity? According to Absolute Return Partners, real value is to be found in credit instruments. This is where the most damage has been inflicted and it is where the biggest bargains are to be found in today’s markets.
What would you rather own? Equities which trade at 15-20 times earnings or credit instruments trading at a fraction of that cost? Deutsche Bank estimates that senior secured loans are trading at an implied PE ratio of 5-less than a third of the cost of equities.
You may read the full original version, at Observations on a Crisis, Courtesy John Mauldin
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Tags: Banks, BRICs, Canada, CDS, Chart, China, Credit, Credit Crisis, EFU, energy, Fed, Focus, Food prices, GDP Growth, Gold, inflation, interest rates, Japan, liquidity, Markets, Mortgage, Paul McCulley, Paulson, PIMCO, Savings Rate, Trading, Value
Posted in Markets, inflation | 1 Comment »
Donald Coxe’s Investment Recommendations, September 2008
Saturday, September 13th, 2008
We are big fans of Donald Coxe, Chief Strategist, BMO Capital Markets, whose track record on calling the “macro” market conditions and opportunities has, more often than not, been reliable. In this period, where it appears the market has no direction, his views are especially welcome.
Here, we provide a summary of his recommendations from Basic Points, September 2008, for your review.
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The current commodity bear market will turnaround when financials rollover.
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The “Frannie” bailout is Act II in a play whose plot will thicken
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When financials roll over, gold and gold stocks will recover
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Inflation remains above central bank targets
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Oil will fall further. OPEC production cut not impressive enough to support prices.
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Any civil strife in Nigeria could put upward pressure on oil
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We expect oil to trade between $80 -130/bbl next year (though not a reliable forecast)
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We are more confident in predicting $150/bbl in three years
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The corn crop will be a “barn buster.” Corn in “modest” contango for next two years. Translation: Fertilizer, seed and equipment stocks are relatively cheaper now, than in the past four years.
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The sharp drop in oil prices and “dramatic” bank bailouts should have been a catalyst for market
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S&P needs to break 1310 to “take away the bearish condition of market.”
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Real yield on 10-yr Treasuries is -145 bps. Treasuries are overvalued
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Biggest near-term surprise could come from recovery in Natural Gas, barring sunspot activity, and/or historic correlations of oil/gas reassert themselves.
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C$ under pressure from falling commodity prices, but Canada’s fiscal health makes C$ a strong alternative to the greenback
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US election campaign could be a risky period geo-politically as “foreign adventurers” may try to take advantage of the distraction. Rogues should remember that Bush is still president for another 4 months
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We have no idea how long it will be until we can say, “Wow, I wish I’d loaded up then!” on commodity stocks. “We remain certain that day is coming.”
The complete text can be read here.
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Tags: Basic Points, BMO, BMO Capital Markets, Canada, contango, Correlation, Donald Coxe, energy, Financials, Gold, gold stocks, inflation, Markets, Natural Gas, Oil Prices, upw, Value
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China: The Post-Olympic Slowdown
Thursday, August 21st, 2008
August 20, 2008 - Here’s what BCA Research says about China - Growth moderation in the Chinese economy will continue. However, unlike many previous Olympic-hosting countries, the end of the game-related construction will have little tangible impact.
While the growth moderation in China will persist, it will be gradual with limited downside. Olympics-related capital spending (although estimated at a record US$43 billion) is only a fraction of China’s total capital spending and a relatively small portion of its US$3.6 trillion economy. In addition, the Chinese authorities are being proactive and have already shifted their focus to protecting growth, even though signs of the slowdown are still very preliminary and headline inflation remains above their target. So far, domestic demand is holding up well: retail sales volumes continue to accelerate and the softening in food inflation over the past several months is helping to alleviate a meaningful drag for lower-income households. Although it is still too early to expect a rebound in China’s export sector (the weakest link in the economy), the slowdown may already be well advanced. Moreover, the Chinese government has started to increase its tax rebates to exporters of some low-value-added industries, which should help stabilize their overseas sales. Additional fiscal support is expected if excessive weakness in these sectors persists. Bottom line: We expect a further moderation in China’s economic growth but maintain a positive outlook. The two primary risks that we are monitoring are the ongoing shortage of electricity and the rebound in the U.S. dollar.
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Tags: China, Dollar, Economy, Focus, inflation, Value
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US Inflation: Soon to Erode (BCA Research)
Friday, August 15th, 2008
The July headline and core inflation numbers were higher than expected. However, lower energy prices, if sustained, should begin to help cool inflation fears. In addition, core inflation will turn lower because the economy remains weak and companies are failing to pass through higher input costs.
We have highlighted several times before that core CPI is likely at a cyclical peak: inflation lags economic growth by several quarters and the economy continues to slow. We still assign a very low probability to rising inflation on a cyclical basis, because wage costs failed to rise during the economic boom and are already rolling over substantially. In addition, the gap between headline and core inflation is likely to close dramatically, via a sharp decline in the headline rate as both energy and food inflation cool. Bottom line: Hawkish Fed rhetoric is unlikely to translate into a change in policy rates for a long time because inflation fears should gradually recede. Further economic weakness remains the more immediate threat.
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Tags: CPI, Economy, energy, Fed, inflation
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Hendry: De-flation is Contrarian
Sunday, August 10th, 2008
Hugh Hendry, CIO, Partner, Eclectica
“Bonds! The credit crunch – you’ve got to go back to 1942 to last observe the contraction in lending in America to the corporate and industrial sector. You can’t go back far enough to find a period in the UK where mortgage loan growth has just stopped. There are queues outside banks to get mortgages. That is profoundly deflationary. This spike that caught everyone out in oil - when it went from 100 to 140 - got all the experts pointing the wrong way, and saying “inflation inflation”. When the banks are as insolvent as they are today, there is no dissemination. There is no ability to carry higher prices from the specific sector of commodities into the general and into general wages. You have to be willing to be contrarian at this point and own government bonds. And it’s hardly contrarian because — would you believe — if you had a portfolio that was solely comprised of 10-Year US treasury bonds then in the year to June this year you would have returned 15 percent. Ross, the market fell 20 percent, so you would be up 35 percent vis-à-vis the average stock. It’s ironic that we have this obsession with something, whereas the reality – the litmus test – is the Treasury bond, and it’s recording gains of 15 percent, and that’s telling you of the turmoil in the equity markets and the turmoil in the real economy.”
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Tags: Banks, Commodities, Credit, Economy, energy, Hugh Hendry, inflation, Markets, Mortgage, UK
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Hugh Hendry:10-year Treasury Signals Deflation
Wednesday, August 6th, 2008
We’ve recently become huge fans of anything that Hugh Hendry, the cutting and brash CIO, Eclectica Asset Management, has to say. On August 1, 2008, Hendry appears on CNBC’s powerlunch europe opposite Lloyd’s Nick Hodson. Each takes turns discussing the state of the market and opportunities, and if you watch at least half way through you’ll get to see what it looks like when someone gets harpooned for what seems to be sycophantic commentary.
Hendry is a regular on CNBC, known mostly for his incisive and blunt force commentary. Besides being entertaining, Hendry is enlightening and speaks to the heart of what is wrong in the market, and what to do in this confusing, tumultuous time.
Among other things said in this segment, Hendry points out that investors in 10-year treasuries would be up 15% YTD vs. -20% for stocks, and that the 10-year US treasury is signalling deflation while everyone else seems to still be hung up on inflation. On this front, he would rather own bonds than gold.
This is must see commentary:
Click on image to watch segment.
Source: CNBC, August 1, 2008 - Hugh Hendry, PowerLunch Europe
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Tags: Euro, Gold, Hugh Hendry, inflation, Video
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“Appalling” Market Fundamentals the Problem, Not Inflation
Monday, July 7th, 2008
Fascinating discussion a few weeks ago in welling@weeden with Albert Edwards and James Montier of Societe Generale, reprinted with permission:
“In the cacophony that is global investment strategy research, Albert Edwards (that’s him, below left) and James Montier (on the right) stand out as clearly distinctive voices. And not merely because of their British accents or because they’ve tended to the decidedly bearish side of the scale over the last decade or so. Despite long tenure in the rarified top echelons of the investment banking world, for many years with Dresdner Kleinwort and more recently at Societe Generale(where they are co-heads of global cross asset strategy) both have managed to retain a natural plain-spoken bluntness. Also large dollops of common sense and strong streaks of reflexive independence, which they employ in conveying their often invaluable insights on investment strategy. In Albert’s case, those spring mostly from his long experience in the dismal science of economics and in James’, from his explorations of the equally mysterious realms of behavioral neuroscience.
They are, in a word, skeptics, and at this juncture most deeply skeptical of any and all notions that “the worst is over.” The recession, which has barely begun, is more likely to be deep than shallow, market valuations are hideously expensive and the flation policymakers should be worried about starts with de-, not in-.
For their reasons, keep reading, if you dare.”
Source:
Inflation Not The Problem
Kate Welling
welling@weeden, May 30, 2008
Download 053008_Welling_Edwards-Montier_REPRINT.pdf
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Interview: Nick Barisheff, Bullion Management Group Inc.
Tuesday, June 17th, 2008
Exclusive Interview
Nick Barisheff,
President and CEO,
Bullion Management Group Inc.
This week we interview Mr. Nick Barisheff, President & CEO, Bullion Management Group, and discuss with him the importance of gold bullion. Mr. Barisheff founded Bullion Management Group Inc. in 1997, and is the portfolio manager of BMG BullionFund, Canada’s only open-ended fund investing purely in gold, silver, and platinum bullion.
For a PDF version, click here:[PDF] Interview with Nick Barisheff, BMG Inc. Here is the interview:
GreenLightAdvisor.com: What’s the most important thing people need to understand about gold?
Nick Barisheff: Many people think gold is a commodity like copper, zinc or pork bellies, but it has 3,000 years of history as money. It was money that no government created by edict. It was just adopted for usage by itself, and it was and still is the best form of money. Currently, we have a 37-year global experiment in paper money. All prior paper money experiments ended in hyperinflation, with the currencies becoming worthless. All previous hyperinflations were contained within a single country, but this time, because of the reserve status of the US dollar, it is likely to be global in nature.
Right now, the price of gold is rising while most currencies are losing purchasing power as well as their value against gold. Gold comes back into its monetary role when there’s a loss of confidence in the financial system or in paper money, and that’s when people are attracted to it.
Before 1971, the monetary system was governed by the Bretton Woods Agreement. Under that agreement, the US dollar was backed by gold, and other currencies were pegged to the dollar. Other countries could trade their US dollars for gold. Essentially, US gold indirectly backed all other currencies. Then things changed. As the US was getting into the Vietnam War and into President Johnson’s policy of guns and butter, US gold reserves started declining. Countries holding dollars were presenting their US dollars and asking for gold in return, and that led to US gold reserves dropping from a peak of 22,000 tonnes to 8,800 tonnes. On August 15, 1971, President Nixon “closed the gold window” and stopped the exchange of US dollars for gold. Closing the gold window was a euphemism, but basically the US declared bankruptcy. When you can’t meet your obligations when they are due, that’s what it is. So from that point in time, we’ve had 37 years where the entire world has been on a global fiat currency monetary system.
Since 1971, when the dollar was freed from the constraints imposed on a currency backed by gold, the US has experienced increasing federal government and current account deficits. The US is now borrowing $800 billion annually to fund its consumption of foreign-made goods and commodities, and the federal government is running a deficit of almost $350 billion. At some point, foreigners will become unwilling to continue funding US expenditures, forcing the Federal Reserve to expand the money supply at a faster pace. This will result in rising inflation, rising interest rates and a continuous decline in the US dollar.
GLA: We’ve had the fastest money supply growth in almost 40 years that’s resulting in increased inflation. Why would an investor want to go into T-bills, given that interest rates don’t even cover half of the stated inflation rate, which we know isn’t even the real inflation rate?
NB: For the first time in history, we have an unlimited ability, by all central banks, to print, however much money we want, so to speak. Apart from the US M3 money supply growing at about 20%, we also have India and China growing theirs at about the same rate. China is at 18%, India is at 20%, and Russia is at 45%. As China or India sell goods to the US, they take in US dollars and they print yuan or rupees against those US dollars. Japan’s a little different; there, individuals and corporations can take their US dollars and buy US assets themselves. In China you have to turn your US dollars in to the central bank.
In today’s inflationary environment, many who invest in fixed income investment do not appreciate that instead of being “safe” investments, they are in fact guaranteed losses of purchasing power when you take inflation and taxation into account. We have done some analysis into a systematic withdrawal from our Fund for those investors requiring income. Based on the fact that precious metals have a long track record of staying ahead of inflation, an investor would be far better off in precious metals in terms of maintaining principal after inflation and having more after-tax cash flow to spend.
GLA: What did you think of John Embry’s (Sprott Asset Management) recent article about the manipulation of the price of gold? His assertion was that the central banks are deliberately keeping gold below $1,000 per ounce.
NB: John and Eric Sprott have recently written an extensive report called Not Free, Not Fair. The report brings forth a great deal of evidence that the precious metals markets may be manipulated. While it may seem like there’s a conspiracy to suppress the gold price, I think it’s simpler than that. It’s a well know fact that it is the job of central banks to manage their country’s currency, that’s part of their mandate. Central banks understand that gold is a currency, but one that they can’t expand as easily as paper money. I don’t think there is any lack of understanding on the part of central bankers that gold is an alternative currency.
GLA: Isn’t gold considered to be just a commodity with no real monetary role anymore?
NB: I’d like to refer to an article by Tony Fell , and it’s particularly interesting, given that he was chairman of RBC Capital Markets at the time of writing. He talks about how gold has three attributes: it’s a commodity, a store of value and a currency. He says so many people now think of gold only as a commodity or jewellery, or as an archaic relic, that there’s a feeling of “who needs it anymore?” People don’t think of it as money.
However, the daily sales volume gives a conclusive indicator that gold is much more than an industrial commodity. The physical turnover of gold by members of the UK’s London Bullion Marketing Association is about *$25 billion per day. We’re talking about net turnover between the LBMA members. The volume is estimated at 7-10 times that amount.
It’s pretty clear that these are currency transactions. That’s why gold, silver and platinum trade on the currency desks of all the banks and brokerages, not the commodity desks.
What people need to know is that gold is a currency [like dollars or euros or yen]. Gold is not trading at these volumes as a commodity or as some archaic relic.
GLA: What are your thoughts on technical analysis, given that gold is a currency?
NB: Technical analysis works if you’re looking at widely distributed stocks like the S&P 500, for example, where there are many, many transactions that accurately reflect public sentiment. The price of gold, however, can be impacted by one country, or one very wealthy individual who wakes up one morning and decides to buy, and then you can throw the charts away. Or when a government decides to sell or a government intervenes. I’ve looked at technical analysis for gold in the past and tried to back-test with various techniques and found that they don’t work more often than they do. In the most recent case, there is no justification for the drop in gold price; it should have been rising because nothing has fundamentally changed. In fact, the fundamentals got worse and the gold price should have rallied. None of the problems went away; nothing was solved; the conditions are as bad as or worse than they were previously. So the drop in gold’s price has been a false decline.
GLA: So, it’s the value of paper currency that changes, not the value of gold [so to speak]?
NB: One of the attributes of gold as money is that you can’t simply create it at will, like paper money. It’s no one else’s promise of performance and it’s not someone else’s liability. It’s not going to zero, no matter what. And, whether we’re moving the measuring stick of inflation or deflation really doesn’t matter, because the way gold should be measured is in terms of purchasing power. It doesn’t matter if gold is priced at $1,000 in paper money per ounce or $2 in paper money per ounce, it will retain its purchasing power in either circumstance.
The first important step in the big picture of understanding gold is that it is a store of wealth with a 3,000 year history, and it’s money. Over the long term, it retains its purchasing power. That’s why they say that an ounce of gold will always buy a man’s suit.
Apart from that, the US dollar is down 85% in purchasing power since 1971. In 1971 you could buy a car with 100 ounces of gold; a car was about $3,500 and gold was $35 an ounce. With 1,000 ounces, or about $35,000, you could buy a house. Today, you could buy several cars or a luxury car with 100 ounces, and a mansion with 1,000 ounces. You could also buy more units of the Dow Jones Industrial Average with your ounce today than you could in 1971. So that ounce has preserved its purchasing power while currencies have lost over 80% of their value.
GLA: Apparently, in the last 40 or 50 years, there’s only been three years that there was net selling by gold investors, three years out of almost half a century. Is this true?
NB: People who hold bullion tend to hold it for a long time, as the core of their entire wealth. It’s not sold once you understand its basic characteristics, because you have to have a reason to sell it, you have to use it to buy something better. I tend to look at investment performance as to whether I end up with more gold ounces or less gold ounces rather than percentage returns; you get a different conclusion then. For example, if you had invested 44 ounces in the Dow in 2000, you would now get back only 14 ounces.
This current cycle is not a conventional bull market in precious metals; I think we’re in the midst of a change in the global monetary system. This is not going to be like a typical commodity cycle where we go up for four years and down for four years; I think we’re witnessing a transition into another monetary system, whatever form that may take. At the end of this period the US dollar will no longer be the world’s reserve currency.
GLA: What happens if the US dollar ceases to be the standard?
NB: What happened when the British pound ceased to be the standard? It just ceased to be the standard. Its decline in value is still ongoing. It’s happened to every empire throughout history: the British, the Roman, the Greek, the Spanish, the Persian, and the Chinese. Every single empire ended up debasing their currency in order to maintain the empire.
GLA: Is gold likely to increase further going forward or has it topped and investors have missed out?
Currently, we have a lot of noise in terms of the credit contraction, real estate bubble, record high debt at all levels, dangerous derivatives vulnerabilities and unsustainable US current account and trade deficits. These could still blow up into bigger problems at any time. However let’s hope they get resolved or at the very least postponed somehow.
But there are two factors that are not changeable in all of this.
First: The US has to print money on an accelerating basis. Has to – because of the underfunded Social Security and Medicare obligations – which at present are about $60 trillion. If you took all of the net earnings of US individuals and companies it would not be enough to pay that off. You can’t tax people enough and politically you cannot tell everybody, “Sorry, we can’t give you your Social Security – we don’t have the money. And no Medicare either.” So they have to keep printing money.
Second: The issue of Peak Oil – it used to be a debate as to when the production of oil would peak. Now it looks like that has already happened, in March 2006. As a result we have a situation where oil production is declining while demand is increasing, particularly from India and China. This will result in ever-increasing oil prices, and also increasing prices for almost every product and service.
As these two forces – increased money printing and peak oil – interact, the result is a declining dollar alongside constantly increasing oil prices. This leads to even greater oil price increases in an effort to offset the dollar decline. These two highly inflationary factors are working in tandem, and they can’t be changed.
Therefore, as oil rises and the dollar declines, commodities – and particularly precious metals – will continue to rise.
GLA: What’s the relationship between oil and gold?
NB: There’s not necessarily a great deal of correlation between the two in the short term. However, in the longer term, the correlation has been in the order of about 16 barrels of oil for every ounce of gold.
GLA: Has that been consistent long term and what is the outlook for precious metals?
NB: With only short-term fluctuations, this ratio has held up over the long term. At this point the price of gold is undervalued compared to the price of oil. Gold should be closer to $1,500 an ounce if you use this measure.
On top of this kind of inflationary issue eroding financial confidence, we’re at peak production in gold. When the price of gold was low, miners employed high-grading to get the most easily attainable gold out of the ground. As the price rises, miners resort to lower-grade mining, which has become worthwhile – but in some cases you have to sift through tonnes of ore for each ounce.
Platinum, for instance; it takes six months to get an ounce of platinum out of roughly 10,000 tonnes of ore. Right now, almost all the platinum produced originates in South Africa, and the mines are miles underground, and electricity intensive. Power shortages in South Africa are interfering with production and slowing things down. All these forces are coming together, slowing production and driving up prices.
With silver, most of the aboveground reserves have been depleted – most of the silver that is produced is consumed each and every year. Silver also has two demand drivers – monetary and industrial. The number of industrial applications are growing every year while the monetary demand has also been growing in the past few years. It is important to remember that “silver” means “money” in several languages.
GLA: Why is gold so important as an element of diversification for investors?
NB: Take a look at the cycle from 1968 to 1982 – during that time it took stocks the whole 14 years to break even. If you factor inflation into it, it actually took until 1995. So stocks didn’t look so good in the past cycle, and they are not looking very good now. The DJIA is well below its inflation-adjusted highs. Its performance is much worse when measured in gold ounces. The DJIA has declined from a high of 44 ounces of gold in 2000 to about 14 today, but if you look at a chart the Dow appears to be at new highs. It’s like taking the Zimbabwe stock market and saying, “Look how well Zimbabwean stocks have done; the market was up 8,000%.” But what if we adjust for the 100,000% inflation in that country? Not so good, is it?
BMG BullionFund is internally diversified. We buy physical gold, platinum, and silver in equal amounts. While some people like to focus on gold, they would miss out on the fact that silver and platinum have both outperformed gold since the beginning of this cycle in 2002.
GLA: What do you do about inflation?
NB: First, it is important to look at real inflation. What is real inflation? The real number is around 9%, not 3%. The calculations the government uses for the Consumer Price Index (CPI) are really meaningless as a true inflation indicator. The real definition of inflation is an increase in the money supply that leads to an increase in prices. Prices do not increase on their own unless you have a shortage; when you increase the money supply, what you’re really doing is debasing the currency, and as the purchasing power of the currency declines prices appear to be rising. So with the US money supply (M3) growing at 20%, Canada’s growing at 9%, and most other countries’ growing at around 15%, that’s going to result in rising prices and real inflation.
If you take real inflation into account, Wainwright Economics suggests that the appropriate bullion allocation for a bond investor’s portfolio is 18%, and for the equity investor’s portfolio 40%, and that’s just to break even with inflation. Although this may sound incredible, think of the 1970s. How much bullion was required just to break even in an equity portfolio? Bullion went up 2,300%, while equities were flat on a nominal basis. Inflation was 15%.
So without even getting wrapped up in a discussion about the complex subject of money, those two points are fairly straightforward. Ibbotson Associates confirmed that precious metals are the most negatively correlated asset class to the traditional financial assets, so it gives the biggest bang for the buck for the least amount of allocation. In the process you also achieve a more balanced, diversified portfolio. Advisors would do well to have an allocation to precious metals to protect their clients from under-diversification.
GLA: Do you think this pullback in gold is an opportunity to add to positions at this time?
NB: Yes as long as there hasn’t been a major change in the fundamentals that drive the price. When these pullbacks occur, you always get some technical interpretations, whether it’s conventional technical analysis or Elliot Wave, coming out with the idea that the bull market in precious metals is over and that it’s now going down forever and so on.
When these things happen, you have to ask if anything changed fundamentally to justify that decline. If nothing changed fundamentally, the only conclusion you can draw is that something’s wrong in the technical interpretations. In all likelihood the technical interpretation is wrong because there’s been an intervention by monetary authorities. Technical analysis only works when the markets are working freely.
GLA: Well, whatever it is they’re trying to do to knock the price down, once again, he who wins in the end is he who has the most ounces and the most shares. It’s got to have been a good year for you with gold prices up 10%, silver up close to 19% and platinum prices over 30%.
NB: Yes, it has. We have grown assets year-over-year by 80% this year alone, so it’s been a substantial increase, and performance-wise, we’re about 20% year-to-date.
GLA: Thank you very much for sharing your knowledge with us.
*All amounts expressed in US dollars, unless otherwise noted.
For a PDF version, click here: [PDF] Interview with Nick Barisheff, BMG Inc.
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