Dear CIGAs,
Developments in Europe have dominated the world’s economic headlines
in recent days and have obscured some good news from China. In this
week’s newsletter, we will cover the background of these important
events and their meaning to global investors.
Making Sense Of The European Chaos
We have long believed that the European currency union will not
survive in its current form and that some governments will never pay off
their huge bond debts. Recent news about the European sovereign debt
crisis has been negative and supports our bleak evaluation of the
situation. However, reporters and commentators alike tend to miss the
one critical point that is essential for the investing community: the
banking system will be bailed out.
The fear dominating the world markets today is “Made in Europe”. It
exists because European nations are trying to reach a political
compromise to solve crushing fiscal problems created by free spending,
social service-oriented governments. For years, political leaders have
nonchalantly exercised their power to tax, spend, and borrow without
considering more than how their actions will impact their own chances in
the next election. Such warped focus places a low priority on long-term
responsibility to bond holders and now the bond holders are revolting.
In this skewed scenario, the very same bond holders who provided the
politicians much of the capital with which to fund social service
largess, are now seen as the enemy because they have lost faith in the
politicians’ willingness to repay them. Bond holders have now voted with
their feet – “fleeing from bondage”, so to speak – by cashing out and
thus raising the cost to borrow. Spending-oriented politicians, of
course, are angry. In turn, they do not trust the bond holders. There
is now little mutual trust between traditional bedfellows.
As we look at Europe today, we see a stand-off situation. Many
investors globally fear that the enmity towards bond holders on the part
of European governments is so great that they may let the banks fail in
order to teach the bond holders a lesson. Keep in mind that banks are
among the biggest bond holders, and if bonds are not repaid, then banks
will fail unless some entity steps in with large infusions of rescue
capital. It is clear that European Sovereign debt will continue to be
downgraded by the credit agencies. We expect not one but several
European debt downgrades over the next few years.
Heard Only Here!
This is not the view you will see on TV, but this is what will
probably occur. Some small banks may fail. It may be that one big bank
will be allowed to fail, but the global banking system will be protected
at all costs.
Why The European And Global Banking System Will Not Be Allowed To Fail
Banks provide many services that people either do not know exist or fail to fully appreciate. Here are a few of them:
● Loans to companies to facilitate expansion and hiring.
● Underwriting of stocks so companies can sell shares and further expand operations.
● Handling the receipt and delivery of investments.
● Clearing of transactions in bond, stock, and commodity markets as
well as mutual funds and ETF industries, thus serving governments,
companies and investors everywhere.
● Holding assets in private banks that allow you to own gold, stocks,
bonds and other commodities. This service allows you to buy gold
without traveling to a mine in, say, Peru and then transporting the
precious metal to your home. It allows you to buy and hold stocks
without traveling to various company headquarters.
● In addition, banks provide vital behind-the-scenes functions
supporting credit cards, money transfers, dividend payments, interest
payments of stocks and bonds, and numerous other functions.
Having accentuated the banking positives, there is no denying the
negatives, namely the mortgage bond underwriting, sales, and in-house
trading departments of some banks that violated the spirit and letter of
fundamental banking principles. Their actions have resulted in terrible
losses over the last few years for investors, taxpayers, other banks
and overall global economic equilibrium. We strongly believe that banks
that broke the law should be punished and their ability to repeat those
wrongs should be removed. However, banks must continue to operate and
perform their vital functions unless we want to return to a barter
economy in the developed world.
Politicians want banks to survive. Without banks there is no
mechanism of easily raising money through bond sales. They need agents
to sell bonds. A strong banking sector is imperative for any country to
prosper. This fact of life is understood clearly by the business,
political, and investment community alike. For all these reasons, the
ruling class will not allow the banking sector to sink. The big banks
reeling with sovereign bond debt will be bailed out. We have no doubts
about that.
Assessing Europe From An Investor’s Perspective
Our long held opinion is that the Euro currency union will not
continue in its current form. The sovereign debts of many nations are in
such a pickle that there cannot be a happy ending for some of them.
We expect a deep recession for distressed countries such as Italy,
Spain, Greece, Ireland, and Portugal, and a lesser one for the rest of
Europe. We anticipate a decline in European real GDP of 1-2 percent in
2012. That not good, but it’s not terrible. The U.K. has wisely
continued to remain outside the Euro currency and the financial
monitoring mechanism currently being formed.
If implemented and fiercely enforced, this program has a chance to
work. The odds, however, favor politics trumping common sense and the
program failing. Failure or success aside, we expect a bailout for the
European banks.
What does all this mean to an investor not holding any European
sovereign debt and who does not own stocks that will be hurt by a big
recession in Europe? Let’s say you are an investor living in Australia,
Asia, North America, South America or a European not at all invested in
the European arena.
Expect to see temporary bond, stock, and commodity market volatility
and fear in the short run, but little else in the long run as long as
the European banking system is bailed out. European debt problems will
take years to work out, and they may never really work out. Countries
may renege on their debt and fall into deep, enduring recession.
However, the world banking system will be rescued.
China – The Positive News
We consider China the growth engine of the world. As goes China, so
goes the world. And we think things are going pretty good. Here’s our
current roundup:
● Export data is better than expected. Many had envisioned a steep
drop in exports, yet the growth rate is humming at about 13.8 percent.
We don’t expect this rate to continue. Eventually it will fall into
single digit growth, but the growth will stay solidly on the positive
side. Many argued that exports would collapse due to significant
increases in wages (some coastal manufacturing hubs have seen wages rise
30 percent in the last couple years) and the continuing rise in the
value of the Chinese currency, the renmimbi. This prediction has not
materialized.
● Imports remain strong and growing in the 15-20 percent range. Thus,
the Chinese trade surplus is falling. Consumers have more money to
purchase goods and services. Real estate prices have fallen in the last
six months, so the frantic rush to buy homes has abated. Chinese
citizens are saving cash that would normally go towards a 30 to 50
percent down payment, and are instead spending more on all kinds of
consumer goods, from apparel and household appliances to luxury items
and meals away from home.
● Inflation for November was well below expectations. Food prices
peaked a few months ago, but are now declining at both the wholesale and
retail levels.
● Interest rates have begun to fall. That’s because the government no
longer needs to keep rates high to discourage real estate speculation.
The decline in wholesale and retail inflation further permits cutting
interest rates. With a lower interest rate, and banks now permitted to
reduce their reserve requirement (as we reported last week), businesses
now have greater access to more attractively-priced lending from banks
rather than having to borrow from other companies or loan sharks. The
impact will be more available capital for business expansion at less
cost.
●We do not fear a meltdown in property prices in China. As expected,
nationally, home prices have stopped rising and are starting to retreat
to more reasonable levels. This is positive and normal. The big run up
in home prices was negative and has now been stopped. Homes are becoming
more affordable especially for those entering the new middle class.
Home prices remain stratospheric in Shanghai and Beijing, but most
cities see home prices becoming more rational.
Russia – Not So Positive News
Vladimir Putin runs Russia like a modern day Czar, wielding tight
control of the government through fear-based administration. Groups
rising up to confront him and his allies in power are quickly quashed.
The country is treated by him and his kleptocratic friends as their own
personal property. Outside of the big oligarchs, Russian citizens in
general continue to suffer.
For several years, we have warned investors about Russia. We are
aware that periodically trading opportunities arise, and money can be
made, but we are afraid to commit because of the corrupt courts system
and accounting profession, the lack of legal redress, the theft of the
businesses of companies critical of government activity, and the
heavy-handed bureaucracy. It is too difficult to effectively evaluate
reward and risk in Russia.
To those who do invest there, we wish you well. Your courage exceeds our own.
U.S. Federal Reserve 2008-2009 Crisis Actions Revealed
The U.S. Federal Reserve has made public its pattern of lending
against bond collateral in the 2008-2009 period. During that crisis
time, the U.S. supported global banks through loans, capital injections,
and deposit guarantees to the tune of $7.7 trillion (including
rollovers). On one day alone, $1.2 trillion was provided to banks in
need, many of them European banks.
Based on such mega-money manipulations of the U.S. Fed by itself,
imagine the massive potential of the European, Japanese, Canadian, U.K.,
and Swiss central banks. You will have plenty of buyers for the bad
bonds of weak countries held by European banks. The U.S. and others
have shown that they will lend at face value and a low rate of interest
on mortgage bonds in the U.S. in 2008. Why would the central banking
fraternity not lend on bad European debt today in a similar crisis? By
the way the above list does not include China, the oil-producing
nations, and hedge funds that would all love to buy cheap European
assets once a bailout begins. For example, hedge fund mogul George
Soros has invested $2 billion of family money in European government
debt bought (presumably at a bargain price) during the liquidation of MF
Global. Additional MF Global bond holdings were purchased by JP Morgan
and another major hedge fund.
On the Gold Front
Day-to-day fluctuations aside, we believe that declines in the gold
price provide buying opportunities. We have counseled buying gold on
many declines in the past 8 years. The current decline offers another
such opportunity.
*courtesy of Bloomberg
Summary
We are recommending using the gold market decline to add to gold positions, we continue to hold other long term positions.
|
Date |
Date |
Appreciation/Depreciation |
| Investment |
Recommended |
Closed |
in U.S. Dollars |
|
|
|
|
| Current Recommendations |
|
|
|
| Gold |
6/25/2002 |
Open |
+385.5 |
| Wheat |
10/24/2011 |
Open |
-7.0% |
| Long Canadian Dollar |
10/24/2011 |
Open |
-3.2% |
| Long Singapore Dollar |
10/24/2011 |
Open |
-2.9% |
| U.S. Equity Market |
11/30/2011 |
Open |
+1.4% |
|
|
|
|
| Closed Commodity Recommendations |
|
|
|
|
|
|
|
| Oil |
10/24/2011 |
11/17/2011 |
+16.4% |
| Corn |
4/20/2011 |
8/3/201 |
-6.3% |
| Oil |
2/11/2009 |
8/3/2011 |
+157.1% |
| Corn |
12/31/2008 |
3/3/2011 |
+81.0% |
| Soybeans |
12/31/2008 |
3/3/2011 |
+44.1% |
| Wheat |
12/31/2008 |
3/3/2011 |
+35.0% |
|
|
|
|
| Closed Currency Recommendations |
|
|
|
| Long Canadian Dollar |
9/13/2010 |
9/21/2011 |
+2.2% |
| Long Chinese Yuan |
9/13/2010 |
9/21/2011 |
+5.8% |
| Long Swiss Franc |
9/13/2010 |
9/21/2011 |
+12.1% |
| Long Brazilian Real |
9/13/2010 |
9/1/2011 |
+6.4% |
| Long Singapore Dollar |
9/13/2010 |
8/3/2011 |
+10.9% |
| Long Australian Dollar |
9/13/2010 |
6/29/2011 |
+14.1% |
| Long Thai Baht |
9/13/2010 |
6/22/2011 |
+6.5% |
| Short Japanese Yen |
4/6/2011 |
7/27/2011 |
-9.7% |
| Short Japanese Yen |
9/14/2010 |
10/20/2010 |
-3.3% |
|
|
|
|
| Closed Equity Market Recommendations |
|
|
|
| IShares MSCI Emerging Market Index |
10/24/2011 |
11/21/2011 |
-0.8% |
| U.S. |
10/24/2011 |
11/21/2011 |
-1.6% |
| U.S. |
9/14/2011 |
9/21/2011 |
-2.3% |
| India |
4/6/2011 |
9/21/2011 |
-21.6% |
| Malaysia |
6/29/2011 |
8/3/2011 |
+0.1% |
| U.S. |
6/29/2011 |
8/3/2011 |
-4.6% |
| Japan |
2/15/2011 |
8/3/2011 |
-9.5% |
| Australia |
2/15/2011 |
6/22/2011 |
-0.9% |
| Canada |
3/24/2011 |
6/22/2011 |
-7.1% |
| Colombia |
9/13/2010 |
6/22/2011 |
+2.6% |
| Malaysia |
4/6/2011 |
6/22/2011 |
+0.8% |
| Canada |
12/16/2010 |
3/11/2011 |
+7.9% |
| U.S. |
9/9/2010 |
3/11/2011 |
+18.1% |
| South Korea |
1/6/2011 |
3/3/2011 |
-2.9% |
| Colombia |
9/13/2010 |
2/2/2011 |
+3.9% |
| China |
9/13/2010 |
1/27/2011 |
+5.0% |
| India |
9/13/2010 |
1/6/2011 |
+7.9% |
| Chile |
9/13/2010 |
12/16/2010 |
+8.9% |
| Indonesia |
9/13/2010 |
12/16/2010 |
+9.5% |
| Malaysia |
9/13/2010 |
12/16/2010 |
+1.3% |
| Peru |
9/13/2010 |
12/16/2010 |
+32.2% |
| Singapore |
9/13/2010 |
12/16/2010 |
+4.8% |
| Thailand |
9/13/2010 |
12/16/2010 |
+11.9% |
|
|
|
|
| Closed Bond Market Recommendations |
|
|
|
| 30 YR Long Term |
|
|
|
| U.S. Treasury Bond |
8/27/2010 |
10/20/2010 |
0.0% |
More..
bottom
of every collapse (or death), a forensic analysis of the last minutes
of any transition from life to death has to be perormed. So far, we have
only had broad strokes of the key events in the last days of MF Global
as obviously many of them will implicate the management team in gross
criminal behavior. Until now, when courtesy of the CME we have
received a full breakdown of every key events in the chronology of MF
Global's last days on earth, starting with October 24, and the rating
agency downgrade of the futures broker (the same catalyst incidentally
that started the AIG death spiral waterfall... and yet clueless pundits will tell you the ratings are totally irrelevant), and ending with the firm's filing for bankruptcy protection. Anyone
who has any interest in the MF Global collapse, which incidentally
should be anyone who has capital in third party possession and thus has
counterparty risk, should read this narrative from first to last
bullet.
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