The Constant Broker

Apologies...

2010-06-20T22:47:00.004+09:00

This year I have been very busy and a little inefficient with my time. Whilst I have been sending regular investment notes to my clients, I have not been posting them on to this blog. Now this has been rectified and all of the notes are published here.

Best,

Gareth

Investment Note: 16/06/2010 - Offshore Bonds-The New Pensions

2010-06-20T22:44:00.001+09:00

There was a time when ‘offshore’ investments were frowned upon in the British press, but it seems that times have changed.

Below is a recent article from thetimesonline.com that recommends offshore investments as preferable even against a qualifying British pension.

The Times recommends the portfolio bond even if you never live outside the UK. Yet for those of us that do, every year of investment whilst expat is repaid as tax free income.

It doesn’t even mention that monthly savings plans are just as tax efficient, but offer greater liquidity.

What a great opportunity...

Click the link below for the original article.

http://www.timesonline.co.uk/tol/money/investment/article7144532.ece

Offshore bonds: the new pensions
Wealthy are looking for alternatives as reliefs vanish.
Elizabeth Colman
Aadvisers report a surge of interest in offshore bonds from high earners looking for an alternative to pensions for their retirement savings.

From next April, those earning more than £130,000 a year will gradually lose their higher-rate tax relief under changes designed by Labour and, so far, maintained by the coalition.

Offshore bonds provide significant tax savings for investors because you can withdraw up to 5% of your capital while deferring higher-rate tax.

Danny Cox of Hargreaves Lansdown, the adviser said: “The argument for an offshore bond has become a lot more compelling for high earners facing the loss of higher-rate relief on pension contributions. Clients are reluctant to tie up money in pensions in return for comparatively little tax relief.”

The schemes are also becoming a popular way to meet the cost of private school fees. According to SG Hambros, the wealth manager, parents facing the 50p top tax rate — those earning more than £150,000 a year — could save as much as £51,000 using offshore bonds to save for school fees. Those in the 40p higher-rate tax bracket could save £42,000, SG Hambros said.

How do offshore bonds work?

Offshore bonds are an insurance “wrapper” round a portfolio of investments, which receive tax advantages by allowing you to defer the tax on the growth of the investments.

Capital growth in an onshore bond is taxed at 20%, whereas offshore bond capital grows tax free.

While basic-rate taxpayers have no more tax to pay when they cash in an onshore investment bond, higher-rate taxpayers must pay a further 20% and top-rate taxpayers must pay 30%.

With offshore bonds, there is no tax to pay until you encash the bond, when higher-rate taxpayers will pay the entire 40% and top-rate payers will be liable for 50%.

If you invested £100,000 in an onshore bond, you would have a lump sum of £155,000 after 10 years with growth of 6% a year, according to Barclays Wealth. If you invested the same in an offshore bond, a higher-rate taxpayer would have £196,000 at the end of the term — an extra £41,000 as gains would have rolled up gross. Also, bonds allow withdrawals of up to 5% a year for up to 20 years with no immediate tax to pay. In effect, you are “rolling up” the tax, which could mean big savings for those who expect to move to a lower tax rate later in life.

Assuming a higher-rate taxpayer cashed in the £196,000 bond while still in Britain, they would pay £48,000 at 50%. However, if they encashed the bond in Italy they would pay just 12.5% or £12,000, assuming they had been resident for a year. In Spain, they would pay 18% or £17,000, according to figures from Barclays Wealth.

What about the fees?

Charges are high, typically 0.3% to 1% upfront plus £400 to 0.25% a year, depending on how much you invest. Adviser commission on top means the bonds are generally best for investments greater than £100,000 held for more than five years.

How do they compare with pensions?

If you invested £80,000 in the offshore bond, it would have a value of £231,086 in 20 years assuming a 5.5% return and charges of 1% a year.

After basic-rate tax it would be worth £200,869, or £170,652 for a higher-rate taxpayer. You could withdraw an income of £16,242, or £13,180, by taking advantage of the 5% rule. This income would last 20 years.

By comparison, a top-rate taxpayer who made an £80,000 pension investment grossed up to £100,000 (if eligible for basic-rate tax relief only), would have a £320,714 retirement pot. After taking 25% tax-free cash at £80,178, there would be an annuity of £9,381 for a higher-rate taxpayer or £12,508 for a basic-rate taxpayer.

Cox said: “If the investor were to die at the age of 77 after taking an annuity each year for 12 years, the tax savings would be identical when using an offshore bond or a pension. However, the plus point for the offshore bond is that you will have been able to make the 5% withdrawal at any time.

“We are increasingly recommending these schemes for retirement saving for higher-rate taxpayers who use their Isa and capital gains allowance, and no longer benefit from high rate tax relief.

Investment Note: 27/05/2010 - Euro, Gold and Oil By Gareth Milliams

2010-06-20T22:42:00.001+09:00

One of those perverse but interesting facts of this recession is that a share of Citibank is now worth less than a McDonalds Happy Meal costs. But do you get a plastic Shrek with Citibank stock? I think not...

Euro

On the ‘up’ days on the NYSE there appears to be a pattern forming. Europe comes out with news of further potential default in its banking system and credit markets and New York opens down accordingly. The Euro crisis is a disease that cuts to the heart of the European economic system and threatens to spread to the rest of the world. This appears not to bother the US which can take a 250 point drop due to looming sovereign default and turn it into a 50 point gain on the day due to a better than expected loss at Alcoa or John Deere. Call me cynical but if the band is playing whilst the ship is sinking, I ain’t gonna dance!

The European Monetary System needs to be overhauled and restructured. It must protect the conservative from the profligate and have the flexibility to suspend membership or expel those who would do others harm. What is wrong with a Franco-German currency system that is less tolerant of those who break the rules in order to create a currency that is less volatile and more stable? Why not have a ‘Chapter 11’ trigger for countries that are in breach of the Maastricht Accord? It will give them time to sort their problems without bringing down the entire system.

If Greece has the chance to go back to the Drachma, it will be able to cut interest rates in order to boost exports and pay its way out of this crisis. It is the absolutism of Maastricht that kept the British and Scandinavians out of the common currency. This lack of flexibility for once sovereign nations is what is threatening the Euro now and will do so again into the future.

As a former federalist and believer in the Euro I stand corrected. The legislated inability of nations to act on behalf of their own economic national interests is wrong. Moreover, the inability of the EU Premier League to prevent nations from behaving badly is even more worrisome. Who trusts Estonia or Bulgaria or Rumania to act as soberly as the Germans? I don’t, but if my country was in the Eurozone, I would expect them to.

We are still shorting Euro and will continue to do so whilst appropriate.

Gold

Gold has recently been trading with significant volatility. Whilst buying gold is considered to be a ‘flight to safety’, large waves tend to lift and lower all boats. The Lehman crash in 2008 saw a 20% drop in the price of the Gold ETF, GLD. Ironically, gold was dumped for dollars which retrospectively was probably exactly the wrong move to make. Gold does well because it is an asset with an intrinsic value, whereas dollars are backed up by promises from a government that is effectively bankrupt.

So worry not, about exaggerated price movements and volatility within the gold price. It is part of its normal cycle, along with finding strong resistance and range trading when on an upswing.

Long term, gold is a hold, however we may buy some more on dips as the volatility continues.

Oil

Despite ( or maybe because of) the fall in prices, the oil contango is massive. Anybody buying oil today at $72.12 can immediately sell it on a December contract for $91.60. All they have to do is store it for a December 18 delivery. This is despite increases in inventory that are pushing the price down. The question that has to be asked however, is, will oil reach $100 per barrel again? The answer is obviously yes, but you may need patience and a weaker dollar. $100 per barrel is an almost 40% return. The 800 pound gorilla however, could be China. Should Chinese demand for oil reduce, then that could have a further huge effect upon prices.

Oil is fast becoming an underweight recommendation.

Investment Note: 18/05/2010 - The Euro By Gareth Milliams

2010-06-20T22:40:00.000+09:00

The Euro

In October 2008, we were hit by the biggest black swan since 1929. The entire banking system had failed and the resulting tsunami sank all boats. Clients who have been with me since the September crash know how bullish I was then about bear funds. . We were long gold and yen in October 2008 and these proved to be profitable calls. That November, I shorted the Russell 2000 and the Materials Index and we did pretty well. In fact we stopped shorting on the 23rd February 2009, not long before the March 9th bull market.

This time, (until now) I’ve resisted doing the same. In 2008, the reasons for the crash were purely commercial. The Banks had made bad bets and paid a heavy price for investments that even they didn’t understand. This correction is different. Sure, there are fundamental economic reasons for the Euro to fall (Greece, Portugal etc) but this crisis is essentially political. Politicians are notoriously bad economic indicators and are not too be trusted. So I’ve waited. I’ve waited for the economic fundamentals to rise above political expediency and that appears to be happening.

The Germans are leery of the bailout and Chancellor Merkel is fully aware that more than 50% of Germans are clamouring for the return of the Deutsche Mark. Last Friday stories emerged of threats by Sarkozy to withdraw France from the Euro unless Germany and other Euroland nations supported the bailout for Greece. Presently this rescue plan is held together with duct tape and politicians promises, nothing more.

As of today, I think we are more likely to get closer to dollar parity than $1.50 to the Euro this year.
On the back of euro weakness and a fear that Europe’s contagion could spread to the US, the oil price dipped briefly below $70. This is despite the onset of the American driving season. The weak demand in Europe must also be pared with a stronger dollar, penalising petroleum buying nations who have weaker currencies, stifling demand.

The big worry is China. Should their demand for oil reduce, then the price could fall further toward $60. But even now (for the patient investor) the price is attractive, offering a 40% return @ $100 per barrel and it will get back to $100 per barrel.

As you know, I am bearish on China. 60% of Chinese GDP being due to construction is frightening. Things that are built need to be bought and that is an awful lot of property to sell. However, the Chinese government needed to find quick jobs in order to prevent potential unrest amongst its retrenched factory workers. My fear is that they have overspent too early on this stimulus and have underestimated the weakness of the western economies. For the stimulus to work, they have to continue injecting cash into the system beyond the recovery for it to become part of the recovery. If the recovery is at least a year away (highly possible) then China may be in trouble.

The Euro rears its ugly head again when talking of China. Europe is China’s biggest market. If the Euro continues to fall in value, Chinese imports will become more expensive exacerbating China’s problems. Some say that the Shanghai Index offers real value, trading at levels not seen since 2006 (2688) but still (I believe) it has yet to bottom. We will be buyers but at the right price.

The Euro is still the focus of concern around the world and today Greece receives its first payment from its EU partners. Will it be enough? Will the contagion spread? We shall have to wait and see.

Investment Note: 13/05/2010 - The Return Of The DMark By Gareth Milliams

2010-06-20T22:34:00.003+09:00

No. Surely not. A part finished web page on Kitco yesterday, showed gold valued in Deutsche Marks. This then spread market rumour and conjecture and the gold price spiked again. I cannot believe that the German government is about to scrap the Euro and effectively tear up scores of EU treaties, because of the PIIGS. There would have to be a renegotiation to unwind the dollar and the ECB would have to upsticks from Frankfurt. The whole thing would be a total calamity and an unprecedented disaster.

More worrying is that people actually believe this. My view is that gold has deviated from its normal trading pattern and that this unquestioning spike cannot be trusted. Traditionally, the gold price will increase due to a weaker dollar or impending inflation. Gold is presently going up as the dollar strengthens and inflation is not a factor. This deviation will not be long term. In the short/medium term, there will be a correction followed by a strengthening based upon traditional reasoning and not punting.

A web page of precious metals prices provider Kitco.com has sparked rumors that Germany will leave the Eurozone and reintroduce German Marks, sending gold to a new record of $1,244 and silver to a multi-year high of $19.64. 

And there is still more material feeding the rumour. German leftist politician Gregor Gysi announced on TV that there may be an important announcement to be made on Friday. The video below is in German.

In a literal translation Gysi did not say that Germany will reintroduce the Mark but made a curiosity-inspiring statement, saying that there may be some very important news that will be announced on Friday.

A poster claiming to be an employee of Deutsche Bank wrote that the bank received a container full with new German Marks banknotes and coins. He wrote he will publish a picture of the new Marks on Thursday morning. He also said the currency change would happen this weekend with German chancellor Angela Merkel scheduled to give a speech to the nation on Friday evening.

As we see the rapid destruction of the next fiat currency - all of them have failed in the past 3 centuries - rocketing precious metals prices prove once more there is no other safe haven when the going gets really tough.

Investment Note: 06/05/2010 - Oil and China By Gareth Milliams

2010-06-20T22:31:00.001+09:00

Oil
The massive oil spill off the coast of Louisiana will not directly affect the short term oil price. It is only a single rig and individually will have a limited impact. However, seasonal increases in productivity, the summer driving season and a possible ban on offshore drilling could push crude prices higher as demand increases.

The most immediate danger is that the 30-mile oil slick starts to disrupt tanker traffic in the Gulf of Mexico, slowing shipment of imported crude oil to two refineries in Mississippi and Alabama. Shipments of crude could be slowed on the Mississippi River between New Orleans and Baton Rouge, home to 11% of the US’s crude oil refineries.

Downside for oil is limited due to this correlation of circumstances. However, the underlying dynamic is that demand is rising, due to increases in US industrial growth. If true then this is fundamental growth and $100 per barrel becomes a stronger possibility.

I recommend consideration of the ETF USO.

China

Although it is unfashionable to say and goes against conventional wisdom, I believe that there is a possibility that China is a massive bubble of diminishing viscosity.

China has been implementing the largest economic stimulus in history as a percentage of GDP (14%). This is because China has no social safety net and construction is the easiest way to keep people employed during a global recession.

Fact: According to Credit Suisse, the average mass market home in Beijing costs 12 years of annual household income. The nearest equivalent is 7.5 years in New Zealand.

60% of China’s GDP is construction. There's currently 30 billion square feet of Chinese real estate in the works, which would work out to a 5x5x5 cubicle for every man, woman, and child in the country. Beijing alone has more empty commercial real estate than all of the property that exists (occupied or unoccupied) in Manhattan.

Their stimulus is underwritten by the government but what is the quality of those loans? Has China created a sub-prime credit class within its own business community? The problem is, is that as with bank profits, whilst speculators and construction companies are making massive profits (from government hand outs), it is impossible to see the real picture.

Therefore the two questions to be asked are:

1. Can China deflate the bubble by growing into its property development?

Entire ghost towns are appearing all over China. These will decay and fall to ruin. But as they disintegrate, the debts on the books of China’s banks will grow creating a potentially massive credit crunch.

2. Has China overdone its stimulus package by handing out too much money too early?

You can only stop financial stimuli when the recovery is a reality. If the capital flow is cut off too early then the problems that they were originally trying to avoid may manifest themselves.

Part of the problem is that China has a centralised government. Centralised governments with absolute power have absolutist mindsets. There is little room for flexibility. Conversely, in a democratic free market, financial power is fragmented between corporations of various sizes trading and vying within a legislative framework. There is intervention from government but only so as to maintain order.

The Chinese government may be able to plan its own economy but it cannot control events beyond its own borders. China is an export economy. The stimulus package is very dependent upon the countries that import Chinese goods actually doing so. Should there be a double dip, China could face its own crisis.

The crisis that we face will be a crash in industrial commodity prices and shipping. Commodity currencies such as the Aussie dollar that are dependent upon business with China will fall dramatically.

I recommend China as a component of a savings plan portfolio. No matter how far it falls it will jump back twice as high. But the profit will be made via the volatility.

Have a profitable week

Gareth

Investment Note: 28/04/2010 - Beware Of Gifts Given To Greeks By Gareth Milliams

2010-06-20T22:25:00.003+09:00

From Standard and Poors:

27/04/10
Standard & Poor's Ratings Services has updated its assessment of the political, economic, and budgetary challenges that the Greek government faces in its efforts to place Greece's public debt burden onto a sustained downward trajectory.

We are lowering our ratings on Greece to 'BB+/B' from 'BBB+/A-2' and assigning a negative outlook.

The negative outlook reflects the possibility of a further downgrade if the Greek government's ability to implement its fiscal and structural reform program materially weakens in our view, undermined by domestic political opposition at home or by even weaker economic conditions than we currently assume.

The Greek economic model was unsustainable. No country can maintain a public sector that employs 18% of its total adult workforce. The inevitable austerity measures will need to be harsh and implemented swiftly. The danger is contagion. The question to be asked is whether Greece is the new Bear Stearns?

The note below was written two months ago. It looks at Greece and the PIIGS and beyond. I thought it worth resending.

Beware of Gifts Given To Greeks

There are cracks appearing in the Eurozone. The Greek economy is in full tragedy mode and could collapse without an immediate financial injection. The rest of the PIIGS could easily follow, including G8 member Italy. The pressure on France and Germany to finance these bailouts is enormous. Therefore the question is this: “If they had to, could France and Germany continue to rescue other basket case economies within the Eurozone?”

The answer is, of course no. The problem is, is that within the Eurozone, there are only two tier one economies and the tier two nations such as Spain, Ireland and Italy look like being the next to topple.

In addition to Greece and Spain, we have smaller EU countries such as Rumania, Czech Republic and Bulgaria who also have debt issues. These countries benefit from the largesse of the leading economies. Can this continue if the PIIGS gobble up all the spare financial resources and if they are no longer recipients of EU grants and aid, what will happen to their economies?

For all the benefits of uniting Europe with one currency, the birth of the euro came with an original sin: countries like Italy and Greece entered the monetary union with bigger deficits than the ones permitted under the treaty that created the currency. The disadvantages now seem enormous. Previously, Greece could have devalued the Drachma, relatively reducing its labour costs and restructured its debt. Now it cannot. Its economy is subject to dictat from Berlin and Paris.

Instead, the Greek people face a period of vicious cuts in public services as they enter an enforced depression. The nightmare scenario is if the Papendreou government does not do enough and are forced to default. The issue then becomes one of contagion and Spain with its 20% unemployment is too big to fail and too big for Germany to refinance.

Tim Bond of Barclays Capital expands further:

‘The broad picture is that many, if not most, G20 economies are in a fiscal mess. This is not a problem merely confined to southern European nations. The aggregate of G20 government debt/GDP ration is projected (by the IMF) to reach 118% of GDP by 2014.’

Bond also points out demographics are a big issue. ‘The long-run fiscal outlook, due to aging, is extremely poor. In this respect, IMF projections point to advanced G20 government debt/GDP ratios rising by 50 percentage points of GDP over the next two decades due to aging”.

‘The broad picture is that many, if not most, G20 economies are in a fiscal mess. This is not a problem merely confined to southern European nations. The aggregate of G20 government debt/GDP ration is projected (by the IMF) to reach 118% of GDP by 2014.’

Bond also points out that demographics are a big issue. ‘The long-run fiscal outlook, due to aging, is extremely poor. In this respect, IMF projections point to advanced G20 government debt/GDP ratios rising by 50 percentage points of GDP over the next two decades due to aging”.

This is massive. As a financial adviser, my job is to ensure that my clients achieve the retirement that they aspire to. More than ever, it appears that there will be a massive disparity between planned and unplanned retirements.

I cannot emphasise enough that those who under invest into their pensions and lump sum portfolio bonds face the igmony of a disappointing retirement income backed up by a welfare system that will provide nothing of value.

The global economy can no longer sustain return based upon a mere promise of repayment. We are facing a future of massive deficits and low growth, of high taxes and low interest rates.

More than ever, we need to provide independent advice that considers the political and economic as well as the market dynamic.

I am beginning to believe that the days of early retirement for the wealthy pensioner are gone. With medical advances, my generation will live into their 90’s. Retirement at 60 will obviously require 30 years of income. Those unprepared and who depend upon the state will face penury, whilst even those who create a financial foundation will require steady and consistent management.

Investment Note: 19/04/2010 - Another Black Swan By Gareth Milliams

2010-06-20T22:22:00.000+09:00

Another Black Swan has crashed into Wall Street, this time hitting the HQ of Goldman Sachs. This wasn’t happenstance. This was a precisely aimed ballistic missile fired by the Obama administration via the SEC in order to force through a banking reform bill and (just maybe) curb the power and influence of Goldman Sachs.

At this point, one cannot underestimate the potential effect of this action. Goldman Sachs is the worlds’ most powerful merchant bank. It is more influential than most countries with an alumni list that includes three US Treasury Secretaries, two national bank governors and a Prime Minister.

The SEC announced that it was to charge Goldman Sachs with fraud only hours after holdout Senator Susan Collins (R-Maine) chose to change her mind & join her 40 other fellow senators in signing a letter to the Democratic Majority Leader asking for further negotiation in order to weaken the legislation. It meant that a filibuster proof 60-40 majority was not going to happen.

However, this note is not concerned with Washington infighting but with the potential financial fallout from the SEC charges.

To understand the possible implications for investors, we must look at the specific charges;

The Commission brings this securities fraud action against Goldman, Sachs & Co. and a GS&Co employee, Fabrice Tourre ("Tourre"), for making materially misleading statements and omissions in connection with a synthetic collateralized debt obligation ("CDO") GS&Co structured and marketed to investors. This synthetic CDO, ABACUS 2007AC1, was tied to the performance of subprime residential mortgage-backed securities ("RMBS") and was structured and marketed by GS&Co in early 2007 when the United States housing market and related securities were beginning to show signs of distress. Synthetic CDOs like ABACUS 2007-AC1 contributed to the recent financial crisis by magnifying losses associated with the downturn in the United States housing market.

Basically, it is alleged that a GS client, ACA Management was courted and encouraged by GS to invest in a synthetic CDO, ABACUS 2007-AC1. It is also alleged that unbeknownst to ACA that hedge fund Paulson & Co Inc. was a significant participant in the construction of the RMBS portfolio. The indictment continues:

After participating in the selection of the reference portfolio, Paulson effectively shorted the RMBS portfolio it helped select by entering into credit default swaps ("CDS") with GS&Co to buy protection on specific layers of the ABACUS 2007-AC1 capital structure. Given its financial short interest, Paulson had an economic incentive to choose RMBS that it expected to experience credit events in the near future. GS&Co did not disclose Paulson's adverse economic interests or its role in the portfolio selection process in the term sheet, flip book, offering memorandum or other marketing materials provided to investors.

In sum, GS&Co arranged a transaction at Paulson's request in which Paulson heavily influenced the selection of the portfolio to suit its economic interests, but failed to disclose to investors, as part of the description of the portfolio selection process contained in the marketing materials used to promote the transaction, Paulson's role in the portfolio selection process or its adverse economic interests.

Tourre was principally responsible for ABACUS 2007-AC1. Tourre devised the transaction, prepared the marketing materials and communicated directly with investors. Tourre knew of Paulson's undisclosed short interest and its role in the collateral selection process. Tourre also misled ACA into believing that Paulson invested approximately $200 million in the equity of ABACUS 2007-AC1 (a long position) and, accordingly, that Paulson's interests in the collateral section process were aligned with ACA's when in reality Paulson's interests were sharply conflicting.

A good definition of a conspiracy is two or more people acting in an illegal manner in order to achieve a legal outcome. If the SEC allegations are proven correct, then GS could be in a world of hurt.

Fabien Tourre is probably just the first Goldman Sachs executive to be named. There could be others, after all, the well heeled do tend to crack under questioning!

So how serious could this be? The implications could be massive. Firstly, should Goldman’s be found guilty in the civil SEC case, it is more than possible that criminal prosecutions could ensue. Remember that back in 1986, Rudi Guiliani used a RICO indictment against Drexel Burnham Lambert on the basis that they were involved in an organised criminal conspiracy. Drexel was also potentially liable under the doctrine of respondeat superior, which holds that companies are responsible for an employee's crimes.

Ultimately, this may not be just about the SEC complaint.

From the Huffington Post: “The Welt am Sonntag newspaper quoted Chancellor Angela Merkel's spokesman, UIrich Wilhelm, as saying that German regulator BaFin will ask the U.S. Securities and Exchange Commission for information.

"After a careful evaluation of the documents, we will examine legal steps," he said, according to the report”.

Gordon Brown ordered a special investigation into Goldman, accusing the bank of "moral bankruptcy". He threatened to block multimillion-pound bonus payouts if the firm is found guilty of wrongdoing.

This potential case against GS may redefine counterparty risk, particularly if other governments (such as Greece) join the feeding frenzy. Additionally, what of the other banks around the world that have also lost vast amounts of money with Goldmans? Will they be observing this case and exploring their legal options? I think so.

Could this also be the end for Goldman Sachs? Probably not. But if they are ultimately found guilty of the SEC charges, then what is to stop even ordinary householders from threatening class action law suits?

John Paulson’s problems are potentially even more dire in the short term. Paulson & Co are the largest institutional investor in SPDR Gold Trust (GLD), the world's largest physically backed gold exchange-traded fund--with 31.5 million shares valued at $3.38 billion. After the announcement on Friday of the GS indictment, gold dropped 2%. Goldman’s are also one of the biggest brokers and traders of raw materials in the world.

From BusinessWeek.com

“This is not good for commodities,” said Michael Pento, the chief economist at Delta Global Advisors. He correctly predicted the 2008 price collapse in raw materials. “It could be the case that traders stop making trades with Goldman.”

John Paulson’s much vaunted Paulson Gold Fund has woefully underperformed the market. But if you are presently an investor in the $10bn Paulson Advantage hedge fund what would you do? After all, Paulson & Co have not been named on the indictment as a co-conspirator. They did not market CDO’s to ACA. But are Paulson possibly vulnerable to future legal action should Goldman be found guilty? The answer has to be yes. The assets of Paulson & Co could be seized in a civil/criminal action. If that is so, then some people may be tempted to redeem their investments. That scenario is fatal for any fund manager.

However, we need to look beyond the indictments and see the bigger picture. The most Keynesian of all Presidents is taking on the most powerful financial institution in the world in a battle for survival.

Investment Note: 0-4/04/2010 - When Sugar Tastes Sour By Gareth Milliams

2010-06-20T22:20:00.000+09:00

When Sugar Tastes Sour

Probably one of the best decisions I made last year was not the decision to
buy the ETFS Sugar Fund at $19.60 (SUGA.L) but to sell at $19.36. Yes I made
a slight loss but my reasoning was sound. The volatility was madness. One
day it could be up by 5%, the next down by 7%. It had no stability. What it
did have was a traditionally low volume market with stable pricing that had
been 'invaded' by hedge funds and ETF's.

At a seminar last year, I even asked Jim Rogers face to face, "How can
small, traditionally stable markets, protect themselves from bubbles created
by massive inflows of capital?" His answer was that there had always been
bubbles in commodity markets. My response to him was that previous bubbles
were usually created by internal market events, not by external actors who
had short term profit targets to hit. He ignored me and went on to the next
question.

Whilst I really believe in ETF's, I also realise their ability to distort a
market. ETF's (and hedge funds) can be disastrous for small illiquid indices
unused to hot money.

The problem is, is that the sugar price is down not because of hot money but
because of fundamentals. However, the hot money will eventually exacerbate
the situation by selling in a collapsing market.

White sugar prices have sunk 36.9 per cent since reaching a record $767 a
tonne in January. Raw sugar prices have also dropped nearly 50% per cent since
reaching a 29-year high of 30.40 cents a pound in February.

So what are these fundamentals? Brazilian yields are beating forecasts as a
waning El Nino brings dry weather, boosting prospects for a record harvest.
Mills began crushing cane early after two years of heavy rains pared output,
said Maurilio Biagi Filho, the world's second- largest grower.

"I had never seen a single mill operating in January before," Biagi said in
an interview with BusinessWeek on March 24. "This January, we had 90 of them
working at full capacity."

Conversely in India,in 2009, sugar soared partly because two straight years
of drought damaged the Indian crop. A weakening El Nino is a "positive sign"
for the monsoon, India's main source of irrigation, Ajit Tyagi, a director
general at the India Meteorological Department, said on March 18. "A repeat
of last year (drought) is positively not going to happen." In fact, it now
appears that last year, the Indian harvest was nowhere near as bad as first
thought.

The sharp decline in prices has encouraged some hedge funds to re-enter the
market with fresh long positions - bets on a recovery in prices - which were
more than double the increase in short positions, according to weekly data
from the Commodity Futures Trading Commission. But if production continues
to grow, demand will drop and the price will continue to fall. In fact,
considering the futures positions taken, I'd say that the price of sugar is
already inflated and sugar itself, overbought, despite the near 50% price
fall.

Sugar will find a bottom. There will be a time (whether in the short or long
term) when demand will outstrip supply. But it seems that with production capacity approaching
full tilt that that time is not now.

As I said, sometimes it can feel good to sell in order to preserve capital.

Have a profitable week.

Gareth

Investment Note: 16/03/2010 - Loonies, Titanium and a Rant By Gareth Milliams

2010-06-20T22:17:00.001+09:00

This note looks at loonies, titanium and finally I have a rant.

Canadian Dollar

The only G8 country that has appeared to have completely avoided the banking crisis is Canada. Their financial system was protected by strong, enforceable legislation and their housing market by prudent lending. Now that commodity prices are firming, the Canadian dollar is doing likewise. In fact, it is today at its highest level since July 2008.

Are the Canucks overly concerned? No. Finance Minister Jim Flaherty said on Friday that whilst he is always worried about volatility in the currency, that for a second time in a week, he also noted that a stronger currency did have advantages, in that it helped Canadian manufacturers acquire foreign technology and thereby become more competitive. That is a far cry from last summer when Flaherty raised the possibility that "some steps" could be taken to slow the rise of the Canadian dollar that seemed to be partially spurred by speculative buyers.

However, we can expect the Canadian central bank to raise rates well before the US Federal Reserve, particularly if their economy and housing market continues to grow at a rapid pace.

Kenmare Resources

I had never heard of this company until I read an article in (of all places) the Daily Mail and was then called by a client who had also read the article. Midas' column noted that Kenmare Resources, presently in the process of raising new funds presents an 'opportunity to pick up shares on the cheap'. Midas commented that demand for titanium is good for Kenmare Resources and thinks that whilst the price is at the current level that the shares are a buy.
Basically, Kenmare Resources intends to raise almost €200 million to boost production at its African titanium mine in anticipation of growing demand for the mineral in emerging economies.

“The issue price of 12 pence per new ordinary share represents a 41.8 per cent discount to the closing mid-market price of 20.625 pence per ordinary share on the London Stock Exchange on March 4th and a 45.7 per cent discount to the closing mid-market price of 24.3 cents per ordinary share on the Irish Stock Exchange on March 4th,” the company said yesterday.

It’s an interesting long term opportunity, particularly as the discount is 41.8% to fair value.

A Rant

There are many things that I like about the offshore investment business. I like that I can set my own level of regulation whilst being able to invest via numerous jurisdictions. I like that should I do my job well that my clients will reward me with even greater fidelity and in turn will achieve financial security.

What I hate (other than outright dishonesty) is unthinking stupidity. The first duty of a financial adviser is to protect his client’s assets. In the last week, I have been sitting down with people who were sold products from LM and Brandeaux. Both offered funds that traditionally offered returns in excess of 9%. Both have funds in their range that (for various reasons) have been suspended. Brandeaux now has a six month redemption period, but also has the option to extend the redemption for a further six months thereafter, ad infinitum. LM have to sell their assets to reduce debt, in a difficult market. None of you reading this mail has ever been sold these funds by me. Everything that you have had bought for you is intraday traded. In a credit crunch, liquidity is king.

That’s the end of the rant. That is the end of this note. I feel better now.

Investment Note: 01/02/2010 The Myth Of China By Gareth Milliams

2010-06-20T22:11:00.003+09:00

The Myth of China

When historians look back at the first decade of the 21st century, they will say that its single most important event was not 911 and ‘The War On Terror’, but the rise of China.

In the last 10 years we have seen the beginning of a change in the political and economic world order. China has been flexing its muscles and asserting its influence around the globe. It is both admired and feared. The total dominance of the West is now under much doubt, as its’ financial engine ceases up, polluted by the credit crunch and damaged by erroneous investment engineering.

China has benefitted from the collapse of the Anglo American hegemony. Its economy is not dominated by a free market financial sector and its people save rather than rely upon credit. But this is true of most developing nations. The difference is, is that the free market exists to a much greater extent in the other BRIC’s and emerging nations.

China is different. India has Tata and Reliance Industries. Russia can boast Lukoil, Gazprom and Sibneft. Brazil can include Vale do Rio Doce, Telebras and Petrobras. Conversely, it is really hard to name three great (and independent) Chinese companies, yet 70% of its economy is private.

China operates a system of one party dictatorship with a market economy (“Market Leninism”). Therefore, when Chinese companies invest overseas, they have to have the support and permission of the government.

This can be highly beneficial. China sees the private sector as an individualistic extension of itself and the rewards for the compliant business can be tremendous.
Western economies rely on a structure of laws, regulation and open competition to ensure that companies fall in line. Companies in China, on the other hand, operate within a government-led, relationship-based structure.

As such, when evaluating a Chinese company, investors should not just look at the governance and accounting indicators. Rather, they should also assess the firm’s ownership type, corporate structure and equally important, the political environment within which it operates.

A lack of independent institutional leadership is an additional problem. A stock choice is an opinion acted upon. But where do you find published independent opinion on equities, when there is no freedom of expression or corporate transparency? There is no CNBC or Bloomberg studio transmitting from Shanghai. The tough questions asked of Chinese banks and fund managers live on TV emanate from Hong Kong and Singapore.

Investor stock choices in China are usually a direct reaction of stated government proclamation and policy. The biggest Chinese red chips are government owned and political influence is all encompassing. Thus the ordinary investor reacts to official statements accordingly.

At this point, I have to add a clarification. I believe in the future of the Chinese Economy. Without a doubt, the rise of China would not have happened anywhere near as fast or as surely without the policies of the Chinese government. I also believe that there are some tremendous opportunities for all investors who commit to the long term. However, the myth of China is that it is the worlds leading emerging market for investors. It patently is not. Amongst the BRIC’s, over the last two years, it has been the laggard. Below, is the one-year chart, comparing 2823.HK, the Shanghai A Share ETF with RSX of Russia, INP of India and Brazil’s EWZ. Its results are at best, poor in comparison, this despite a stellar start in January 2009. Take a look at the chart below, which illustrates the growth within the aforementioned ETF over a one year period:

From Newsweek, January 14th 2010
Why Colombia's Stock Market Beat China's
Rana Foroohar

If you had any doubt about what Fareed Zakaria calls "the rise of the rest," consider a new Bank of America Merrill Lynch report on the performance of emerging markets over the past decade. If you had invested $100 in -emerging-market stocks on Dec. 31, 1999, you'd have $262 today, while $100 invested in the S&P would be worth $91.

The most surprising thing about the study: tiny Colombia tops the list of performers, with a 1,529 percent return over the past decade. That's basically a commodities story (the South American nation is rich in coal, copper, and gold), and indeed, the huge global demand for everything from oil to minerals to agricultural crops (due itself in large part of the rise of developing nations) has made numerous poor nations richer in recent years.

An even bigger surprise is that BRIC darling China actually underperformed its peers, rising only 150 percent compared with energy-rich Brazil (520 percent) and Russia (326 percent) or well-regulated India (274 percent), which some investors see as a safer and more diverse bet compared with the Chinese equity market, which is dominated by bank stocks.

The final Myth of China, is that it should be an automatic selection in any portfolio. This is at once absurd and misguided. It’s equity markets are highly volatile performers that rollercoaster without the stability provided by major institutions.

Under its present structure, it is vulnerable to the whims of government policy and a population who invest as if the Shenzhen A was a roulette wheel. For these reasons it will always form part of my savings plan portfolio but not necessarily within my lump sum structures, at least not until I can see some long term value.

Don't Care By Bill Gross of PIMCO

2010-03-07T21:03:00.006+09:00

For the original article from PIMCO, click here.

I haven’t gone to a cocktail party in over 10 years. Granted, perpetually watching Seinfeld reruns on Friday and Saturday nights makes for a dull boy, but the alternative is excruciating. Uh, which would I prefer – solitary confinement or water boarding? I lean strongly in the direction of a warm bed and peace as opposed to a glass full of tinkling ice cubes and a room resonating with high-decibel blather. I suppose the parties wouldn’t be so bad if there was something original to be said, or if “you” had a genuine interest in “me” as opposed to “you,” but let’s face it folks, no one does. The only reason any of us really cares about cocktail conversations is to quickly redirect someone else’s stories into autobiographies that we assume to be instant bestsellers if only in print. If not, if the doe-eyed listener seems simply fascinated by what you’re saying, you can bet there’s a requested personal favor coming when you finally shut up. “Say Bill, I was wondering if you knew somebody at…that could…” Yeah right! But, as my chart shows, 90 seconds into a typical conversation, no one gives a damn about you and your problems – maybe those shoes and that dreadful eye shadow you’re wearing, but not anything audible coming out of your mouth.

During that unbearable minute-and-a-half, however, you’re likely to have covered some of the following topics:

Where are you from? (If it’s not a place where I’ve been or have a distant second cousin – don’t care.)

How’s the family? (If Johnnie is in advanced placement courses and my kids aren’t – don’t care. Don’t care about your kids’ soccer games either or that upcoming wedding.)

Medical problems. (Unless you’re dying from cancer – don’t care. Your artificial hip and kidney stone stories are important only to let me tell you about mine.)

How’s work? (Forgot where you work, but it’s a good lead in. Don’t really care though unless you can direct some business my way.)

Can you believe Tiger? (Now there’s something I care about, but the wife is only five feet away.)
Actually, the “afterparty” is the best party of all – driving home with your partner and dissing all of the guests. Still, give me a home where Seinfeld roams, I suppose. Boring is better – cocktail parties are so 1990s.

In contrast to those cocktail parties, I‘ve got so much to say in this Investment Outlook that I don’t know where to start. Don’t be lookin’ around for something more important though, like you do at a cocktail party; I need your undivided attention for the full 90 seconds allotted me.

To begin with, let’s get reacquainted with the fundamental economic problem of our age – lack of global aggregate demand – and how we got to where we are today: (1) Twenty years of accelerated globalization incrementally undermined the real incomes of most developed countries’ workers/citizens, forcing governments to promote leverage and asset price appreciation in order to fill in what is known as an “aggregate demand” gap – making sure that consumers keep buying things. When the private sector assumed too much debt and asset prices bubbled (think subprimes and houses, or dotcoms/NASDAQ 5000), American-style capitalism with its leverage, deregulation, and religious belief in lower and lower taxes reached a dead end. There was a willingness to keep on consuming, there just wasn’t the wallet. Vigilantes – bond market or otherwise – took away the credit card like parents do with a mall-crazed teenager. (2) The cancellation of credit cards led to the Great Recession and private sector deleveraging, the beginning of government policy reregulation, and gradual deglobalization – a reversal of over 20 years of trade policies and free market orthodoxy. In order to get us out of the sinkhole and avoid another Great Depression, the visible fist of government stepped in to replace the invisible hand of Adam Smith. Short-term interest rates headed to 0% and monetary policies of central banks incorporated new measures labeled “quantitative easing,” which essentially involved the writing of trillions of dollars of checks to replace the trillions of dollars of credit that disappeared after Lehman Brothers. In addition, government fiscal policies, in combination with declining revenues, led to double-digit deficits as a percentage of GDP in many countries, a condition unheard of since the Great Depression. (3) For awhile it seemed that all was well, that the government’s checkbook could replace the private market’s wallet and credit cards. Risk markets returned to normal P/Es as did interest rate spreads, and GDP growth resumed; it was only a matter of time before job growth would assure the world that we could believe in the tooth fairy again. Capitalism based on asset price appreciation was back. It would only be a matter of time before home prices followed stock prices higher and those refis and second mortgages would stuff our wallets once again. (4) Ah, but Dubai, Iceland, Ireland and recently Greece pointed to a potential flaw in the model. Shaking hands with the government was a brilliant strategy in 2009 when it was assumed that governments had an infinite capacity to leverage themselves.

But what if they didn’t? What if, as Carmen Reinhart and Kenneth Rogoff have pointed out in their book, “This Time is Different,” our modern era was similar to history over the past several centuries when financial crises led to sovereign defaults or at least uncomfortable economic growth environments where real GDP was subpar based on onerous debt levels – sovereign and private market alike. What if – to put it simply – you couldn’t get out of a debt crisis by creating more debt?

You are now up-to-date and I’ve used up all of my 90 seconds, but bear with me, patient reader. I may not be able to get your kid a job at PIMCO, but maybe I could give you an idea or two as to what lies ahead. Let’s explore the last line in the previous paragraph first – can you get out of a debt crisis by piling on another layer of debt? The answer, of course, is that “it depends.” Replacing corporate and mortgage debt with a government checkbook is initially beneficial because the sovereign is assumed to be more creditworthy than its private market serfs. It taxes, it prints, it confiscates wealth if need be and so this substitution is medicinal in the early stages of a financial crisis aftermath – especially if debt/GDP levels are low to begin with. That is the case currently at most G7 countries, with the exception of Japan, although the balance sheets of Germany/France are obviously contaminated by its weaker EU members, and that of the U.S. by its Agencies and other off-balance-sheet liabilities. But based on existing deficit trends and the expectation that not much progress will be made in reducing them, markets are raising interest rates on sovereign debt issuance either in anticipation of higher future inflation, increased levels of credit risk, or both. This places a potential “cap” on the “debt” that supposedly can be created to get out of the “debt crisis.”

The threat of credit deterioration is clearly evidenced in the CDS or credit default market for sovereign countries. Greece has taken the headlines with its 350–400 basis point cost of “protection,” but even Japan and the U.K. approach 100 and the U.S. is nearly half of that. Markets, in fact, are demanding 20–30 basis points of higher insurance premiums for the best of credits relative to levels prior to Dubai and Greece. The inflation component of sovereign issuance is obvious as well. Potential serial reflators such as the U.K. and U.S. both show an increase of 50 basis points in their 10-year notes since the Dubai crisis in late November. While a portion of that 50 may in fact be credit related as pointed out above, the combination of credit and inflationary protection demanded by the market suggests, as Reinhart and Rogoff point out in their book, that government securities following a financial crisis are subject to huge increases in supply and accordingly, significant increases in risk and real yield levels.

It is interesting to observe that over the past few months when investors have begun to question the ability of governments to exit the debt crisis by “creating more debt,” that increases in bond market yields have been confined almost exclusively to Treasury/Gilt-type securities, and long maturities at that. There has even been a developing debate in the press (and here at PIMCO) as to whether a highly-rated corporation could ever consistently trade at lower yields compared to its home country’s debt. I suspect not, but the narrowing in spreads since late November solicits an interesting proposition: Government bailouts and guarantees such as those evidenced and envisioned in Dubai and Greece, as well as those for the last 18 months with banks and large industrial corporations across the globe, suggest a more homogeneous “unicredit” type of bond market. If core sovereigns such as the U.S., Germany, U.K., and Japan “absorb” more and more credit risk, then the credit spreads and yields of these sovereigns should look more and more like the markets that they guarantee. The Kings, in other words, in the process of increasingly shedding their clothes, begin to look more and more like their subjects. Kings and serfs begin to share the same castle.

This metaphor doesn’t really answer the critical question of whether a debt crisis can be cured by issuing more debt. The answer remains: It depends – on initial debt levels and whether or not private economies can be reinvigorated. But it does suggest the likely direction of sovereign yields IF global policymakers are successful with their rescue efforts: Sovereign yields will narrow in spreads compared to other high-quality alternatives. In other words, sovereign yields will become more credit like. When sovereign issues become more credit-like, as evidenced in Greece, Spain, Portugal, and a host of others, they move closer in yield to the corporate and Agency debt that supposedly rank lower in the hierarchy. That process of course can be accomplished in two ways: high-quality non-sovereigns move down to lower levels or governments move up. The answer to which one depends significantly on future inflation, the aftermath of quantitative easing programs, and the vigor of the private economy going forward. But the contamination of sovereign credit space with past and future bailouts is a leveler, a homogenizer, a negative for those sovereigns that fail to exert necessary discipline. Only if global economies stumble and revisit the recessionary depths of a year ago should the process reverse direction and place Treasuries, Gilts, et al. back in the driver’s seat.

Investors should obviously focus on those sovereigns where fundamentals promise lower credit or inflationary risk. Germany and Canada are amongst those at the top of our list while a rogues’ gallery of the obvious, including Greece, Euroland lookalikes, and the U.K. gather near the bottom. PIMCO’s “Ring of Fire” remains white hot and action, as opposed to cocktail blather, is required to maintain or regain trust in sovereign credits approaching the rocks. Just last week Bank of England Governor Mervyn King said that it would be difficult to cut government spending quickly, but that there needs to be a clear plan for doing so. Not good enough, Mr. King. Don’t care. Show investors the money, not vice-versa. An investor’s motto should be, “Don’t trust any government and verify before you invest.” The careful discrimination between sovereign credits is becoming more than casual cocktail conversation. A deficiency of global aggregate demand and the potential impotency of policymakers to close the gap are evolving into a life or death outcome for the weakest sovereigns, with consequences for credit and asset markets worldwide.

William H. Gross
Managing Director

Investment: Thoughts From My Watch List By Gareth Milliams

2010-03-07T17:21:00.002+09:00

Below are some random thoughts on some markets that have been in the news
and on my watch list. These are all long term buys but at the moment some
may have temporarily stalled.

China

The central government is looking to slow down the economy. Lending has
become more restrictive and banks have been told to increase their reserves.
There is a fear that the Chinese economy is overheating, but it still
appears to be quite a distance from an actual correction.

A strong indication of potential contraction could be a significant decline
in domestic demand coinciding with an increase in supply. However it may be
simply that the Chinese government has underestimated the weakness of the
western economies and the return of demand for material goods. The stimulus
is economic bridging designed to keep the economy strong until the rest of
the world recovers. The inability of the western economies to return to
sustainable growth fast enough could prove to be significant.

Gold

Whilst happy that we sold gold at a peak four weeks ago, my belief that it
would test $1,000 per ounce has not materialised yet. The Greek crisis led
initially to Euro weakness but in the last three days as Germany announced
it would buy Greece's bonds, the dollar declined against Euro, supporting
the gold price. Additionally, unsubstantiated rumours from a Russian website
called Rough & Polished have spread that China has purchased 191 tons of
gold. The market reacted by pushing the price up by $10 per ounce. However,
the dynamic with the dollar is further strengthening, which will lead to
lower commodity prices and particularly with gold.

The sale of my clients gold was a strategy designed to protect client
capital values against a potentially serious drop in value. However, I still
believe that gold @ $2,000 per ounce is almost inevitable. Gold is a hedge
against inflation and dollar weakness. It is entirely possible that the Fed
will continue to keep monetary policy loose until consumer inflation becomes
an issue. Gold works under both circumstances. We will buy again.

Silver

Silver has underperformed gold thus far YTD. However, it is traditionally
more volatile than the yellow metal. My belief is that (long term) silver
can enjoy a more sustained rally than gold because of its industrial usage.
Clients who know me well, also know of my admiration for Silver Wheaton
(SLW). Silver Wheaton is a company that finances mining companies who mine
silver as a byproduct in order to buy the silver from the mines at a fixed
price of $3.90.

Therefore as the price of silver rises and SLW buys it at $3.90, it is
almost as if buying with leverage.

Russia

This is the only European economy completely dependent upon commodities. It
is in the words of President Medvedev, "a primitive economy based on raw
materials and endemic corruption." Unfortunately, Medvedev is a President
who does not preside. That honour, is claimed by Vladimir Putin. Russia is
lawless and a producer of manufactured goods of almost inevitable low
quality.

However, the Russian economy is expected to grow by 6.2% this year according
to Citibank. Russia's GDP shrank by an annual 2.2% during the last quarter
according to ING Bank NV, compared to an 8.9% decline in the third quarter
and a record-breaking 10.9% decline during the second quarter. Therefore an
increase of 6.2% is massive.

Citibank said that "Loose fiscal and monetary policies will, in our view,
stoke domestic demand and inflation, forcing the central bank to allow
rouble appreciation" during the second half of the year. The report also
predicted that the Russian rouble will strengthen to about 34 against the
euro-dollar basket.

Turkey

Turkey was the recipient of upgrades in its credit rating. However the
recent increase in its islamification and the trial of the General of the
1st Army and the head of the Special Forces has some potential investors
preferring to sit on the sidelines. Citi has downgraded Turkey from
overweight to neutral accordingly.

Verdict: Still a great opportunity, but not for the moment. Dissatisfaction
in the traditionally secular officer class could lead to unrest in the
military. Additionally, Prime Minister Tayyip Erdogan's ruling AK Party is
also embroiled in a clash with the secularist judiciary and is becoming
increasingly vocal in its calls for constitutional reform -- a move which
could fuel discord.

The Crisis: Goodbye To Dubai? By Gareth Milliams

2009-11-30T14:01:00.005+09:00

It has been a while since I last posted on my blog. I’m not good at writing just for the sake of it. For me, there has to be a reason for doing it and context to write about. November was also comparatively uneventful and I was busy, so nothing got done. The last three days have seen that dynamic turned upon its head.

The attempt to become the Singapore of the Middle East has failed. The ultimate city of bling and excess, Dubai, is going broke. Unable to service its massive loans, it has asked for a six month moratorium on debt repayment and an extension in order to arrange a restructure.

On Friday morning , as Dubai languished in potential bankruptcy, its head of state, Sheikh Mohammed spent £335,000 on three foals at the Tattersall’s sales. This as his city state draws nearer to being reclaimed by the desert from whence it came.

The effect of the collapse of Dubai World is not yet fully known. That will unfold within the next few weeks. The immediate danger could be for highly exposed British Banks such as RBS and HSBC.

Banks across the globe are researching the extent of their relationship with Dubai this weekend, and more information should emerge on Monday. As it does, markets will surely respond – as global markets sunk on Thursday and Friday, bad information could put banks further into a tailspin and risk widespread panic.

Meanwhile, question marks hang over the fate of thousands of Britons employed by companies under Dubai's control. The emirate's investment vehicles hold interests in Alton Towers, the London Eye, P&O, Travelodge and the London Stock Exchange.

There are fears that Dubai will have to launch a fire-sale of assets as it struggles with restructuring its debts.

Abu Dhabi has already said that it is unwilling to provide a blanket bailout of Dubai, preferring to be selective with its largesse. The reason for this is simple: It is not the Dubai debt per se, but the ‘Dubai Effect’ cascading into governments, companies and institutions associated directly or indirectly with them.

So what could the ‘Dubai Effect’ be? Just how black is this black swan?

From The Wall Street Journal:

“The price of a $3.5 billion sukuk, or Islamic bond, issued by a subsidiary of Dubai World, plunged to 57 cents on the dollar Friday from 110 cents on Wednesday, according to two investors.

Dubai's troubles resonate far beyond the desert fantasyland that its borrowing created, fueling concerns that financially stretched nations like Greece and Hungary may struggle to pay off debts.

Investors and analysts say they're worried about the health of Greece's heavily indebted economy and banks, which could suffer as the European Central Bank moves to pull away some of its financial-support measures. These measures have included ultra-cheap bank funding.

The gap between the yield on a Greek government bond and relatively-safe German debt -- a key gauge of market fear -- jumped to a peak of 2.2% Friday, before falling slightly. When the pan-European Stoxx 600 index fell 3.3% on Thursday, Greece's market fell twice that amount, over 6%.

Dubai's debt restructuring drove up the cost of insuring against default in other countries as well

Another window into the growing concern about government creditworthiness is the credit-derivatives market. Investors are now paying much higher prices to insure themselves against bond defaults in countries like Turkey and Bulgaria.

When Dubai announced its debt standstill on Wednesday, the cost of insuring against a Dubai debt default more than doubled. The cost of debt-default insurance also rose for a range of countries, including Hungary, Brazil, Mexico and Russia.

While the cost of debt insurance for stressed countries hasn't hit levels seen at the height of the financial crisis, "the recent rises are altogether more sinister in our view, as they reflect genuine concerns about default within the euro-zone," said Steven Barrow, a currency analyst at Standard Bank in London, in a note Friday.

Dubai itself demonstrates how quickly countries can veer off the road to recovery and into trouble”.

So could Greece or Hungary default upon their loans? Is sovereign debt the new sub-prime? It all depends upon what happens this week. The markets have now had three days to absorb the bad news and will react accordingly.

On Sunday, the UAE Central Bank and Abu Dhabi intervened to underwrite all banks, whether domestic and foreign in the Emirates. The crisis for the moment has been averted. However, the larger questions regarding emerging debt are still unresolved. Not every nation can call upon it’s cousins in Abu Dhabi, Qatar and Bahrain to bail it out. Who would Turkey or Bulgaria turn to?

This is the point. It doesn't matter a jot that Dubai was rescued by an intervention of various Emirates from around the gulf. Dubai just got lucky. What matters is that it happened. What matters is that we have yet again been exposed to the fragility of the system. Should this happen again, I doubt whether that beleaguered nation will have easy access to 'family money'.

I think that there could be an opportunity to bottom fish. Should any of the South East European nations default, there could be a fire sale on decent quality debt. If that’s the case then we should consider purchasing a nominal amount.

Markets: Investment Outlook From Bill Gross Managing Director of PIMCO

2009-11-10T00:31:00.006+09:00

Original article to be found by clicking here.

Investment Outlook

Bill Gross | November 2009

Midnight Candles

A cold wind from the future blows into my nighttime bedroom, more often than not during those midnight hours when fear dominates and hope retreats to a netherworld. This wind is a spectre, an oracle of darkness and eventual death, not easily dismissed. Once merely a whisper, its decibels intensify with the advancing years. It will be heard, this reaper – this grim reaper, yet in the nights when it howls the loudest I fight back, silently screaming for it to get out, to leave me alone, to let it all be a bad dream. It never is. Shakespeare’s Macbeth expressed it more subtly: “Out, out, brief candle!” Yet the finer words provide no solace; the final act is always the same.

Those of you in your sixties and older know of what I speak; even during daylight hours you read the obits and notice that contemporaries have passed into the beyond. Those of you much younger must wonder what has come over me, yet I was young once too. I remember as a teenager camping out under the stars with friends wondering aloud at the mystery of it all, knowing the reaper was far off in the distance, so far away that death was more a philosophical discussion point than an impending reality. In my thirties, I recall standing in front of a mirror in my physical prime and instructing my image that I would never grow old, that I somehow would live forever, that I, the me, the ego, would be eternal. Now when I face the glass my eyes avoid the unmistakable conclusion: I am everyman – everyone that ever was and ever will be. This world will outlast me.

What to do? Enjoy these senior years and take advantage of the gifts I have been given – a healthy 65-year-old body, an amazing job where I can still make a vital contribution, a wonderful wife who shines brightly and muffles the sound of my nighttime intruder. Still there is no acceptance of Macbeth’s or any of our “dusty deaths.” At midnight there is only fear and rage – rage against this night whose wind will one day take us all.

An investment segue is a tough one this month: markets whistling past the graveyard? A vampire economy? A ghostly correction ahead? Pretty lame, so I’ll jump straight into a discussion of why in a New Normal economy (1) almost all assets appear to be overvalued on a long-term basis, and, therefore, (2) policymakers need to maintain artificially low interest rates and supportive easing measures in order to keep economies on the “right side of the grass.”

Let me start out by summarizing a long-standing PIMCO thesis: The U.S. and most other G-7 economies have been significantly and artificially influenced by asset price appreciation for decades. Stock and home prices went up – then consumers liquefied and spent the capital gains either by borrowing against them or selling outright. Growth, in other words, was influenced on the upside by leverage, securitization, and the belief that wealth creation was a function of asset appreciation as opposed to the production of goods and services. American and other similarly addicted global citizens long ago learned to focus on markets as opposed to the economic foundation behind them. How many TV shots have you seen of people on the Times Square Jumbotron applauding the announcement of the latest GDP growth numbers or job creation? None, of course, but we see daily opening and closing market crescendos of jubilant capitalists on the NYSE and NASDAQ cheering the movement of markets – either up or down. My point: Asset prices are embedded not only in our psyche, but the actual growth rate of our economy. If they don’t go up – economies don’t do well, and when they go down, the economy can be horrid.

To some this might seem like a chicken and egg conundrum because they naturally move together. For the most part they do – and should. As pointed out in a recent New York Times article titled “Dow Bubble?,” stocks and nominal GDP growth should be correlated because profits and nominal GDP are correlated as well. Witness the PIMCO Chart 1, researched by Saumil Parikh, which covers a time period of 50 years. Granted the R² correlation is only .305, but that is to be expected – profits are also a function of the respective entities that feed at the GDP growth trough – corporations, labor, government and other countries – and when corporations and their profits are ascendant they do well; when not, they fall below the best fit line appearing in the chart. Notice as well that in a normally functioning economy growing at 6-7% nominal GDP, that profits grow at the same rate. (At growth distribution tails there are substantial distortions.) And if long term profits match nominal GDP growth then theoretically stock prices should too.

Not so. What has happened is that our “paper asset” economy has driven not only stock prices, but all asset prices higher than the economic growth required to justify them. Granted, one must be careful of beginning and ending data points in any theoretical “proof.” Such is the fallacy of Jeremy Siegel’s Stocks for the Long Run approach which begins at very low PEs and ends most long-term time periods with much higher ones, justifying a 6.5% “Siegel constant” real rate of return for U.S. equities over the past 75 years or so. It may also be a weakness of the New York Times “Dow Bubble” article where the authors claim that since the Dow Jones average was at 4,000 in 1995, that a 100% step-for-step correlation with nominal GDP growth since then would produce a reasonable valuation of 7,800 – not the current 10,000.

Having said that, let me introduce Chart 2 a PIMCO long-term (half-century) chart comparing the annual percentage growth rate of a much broader category of assets than stocks alone relative to nominal GDP. Let’s not just make this a stock market roast, let’s extend it to bonds, commercial real estate, and anything that has a price tag on it to see if those price stickers are justified by historical growth in the economy.

This comparison uses a different format with a smoothing five-year trailing valuation growth rate for all U.S. assets since 1956 vs. corresponding economic growth. Several interesting points. First of all, assets didn’talways appreciate faster than GDP. For the first several decades of this history, economic growth, not paper wealth, was king. We were getting richer by making things, not paper. Beginning in the 1980s, however, the cult of the markets, which included the development of financial derivatives and the increasing use of leverage, began to dominate. A long history marred only by negative givebacks during recessions in the early 1990s, 2001–2002, and 2008–2009, produced a persistent increase in asset prices vs. nominal GDP that led to an average overall 50-year appreciation advantage of 1.3% annually. That’s another way of saying you would have been far better off investing in paper than factories or machinery or the requisite components of an educated workforce. We, in effect, were hollowing out our productive future at the expense of worthless paper such as subprimes, dotcoms, or in part, blue chip stocks and investment grade/government bonds. Putting a compounding computer to this 1.3% annual outperformance for 50 years, produces a double, and leads to the conclusion that the return from all assets was 100% (or 15 trillion – one year’s GDP) higher than what it theoretically should have been. Financial leverage, in other words, drove the prices of stocks, bonds, homes, and shopping malls to extraordinary valuation levels – at least compared to 1956 – and there could be payback ahead as the leveraging turns into delevering and nominal GDP growth regains the winner’s platform.

This 100% overvaluation from recent price peaks of course is crude, simplistic, and unrealistically pessimistic. It implies that stocks should be at – gasp – Dow 7,000 – and that home prices – gasp – should be cut in half from 2007 levels, and that commercial real estate (Las Vegas hotels, big city office buildings that are 20% empty) should likewise face the delevering guillotine. Some of these price adjustments have already taken place, and to be fair, corporate and high yield bonds as well, should be thrown into this overpriced vortex more resemblant of a black hole than American-style paper wealth capitalism. This is where it gets tricky, however, because policymakers, (The Fed, the Treasury, the FDIC) recognize the predicament, maybe not with the same model or in the same magnitude, but they recognize that asset prices must be supported in order to generate positive future nominal GDP growth somewhere close to historical norms. The virus has infected far too many parts of the economy’s body, for far too long, to go cold turkey. The Japanese example over the past 15 years is an excellent historical reference point. Their quantitative easing and near-0% short-term interest rates eventually arrested equity and property market deflation but at much greater percentage losses, which produced an economy barely above the grass as opposed to buried six feet under. The current objective of global policymakers is to do likewise – keep the capitalistic patient alive through asset price support, but at an “old normal” pace if possible, six feet or 6% in U.S. nominal GDP terms above the grass.

That support, of course, comes in numerous ways. Financial system guarantees, TARP recapitalization of banks, TAFs, TALFs, PPIFs – and in Europe and the UK, low interest rate term financing, semi-bank nationalizations, and asset purchase programs similar to the United States. In the case of the U.S., the amount of the implicit and explicit financial support given by policymakers totals perhaps as much as $5 trillion, which goes part way to support the $15 trillion overvaluation of assets theoretically calculated in the PIMCO model (100% of nominal GDP). China, interestingly, is taking another approach, throwing equivalent trillions into their real economy to make things as opposed to support paper, if only because exports are at the heart of their economic growth and they haven’t caught the American virus or suffered, I suppose, a “paper cut.”

At the center of U.S. policy support, however, rests the “extraordinarily low” or 0% policy rate. How long the Fed remains there is dependent on the pace of the recovery of nominal GDP as well as the mix of that nominal rate between real growth and inflation. My sense is that nominal GDP must show realistic signs of stabilizing near 4% before the Fed would be willing to risk raising rates. The current embedded cost of U.S. debt markets is close to 6% and nominal GDP must grow within reach of that level if policymakers are to avoid continuing debt deflation in corporate and household balance sheets. While the U.S. economy will likely approach 4% nominal growth in 2009’s second half, the ability to sustain those levels once inventory rebalancing and fiscal pump-priming effects wear off is debatable. The Fed will likely require 12–18 months of 4%+ nominal growth before abandoning the 0% benchmark.

Here is another way to analyze it. It seems commonsensical that because of asset market value losses over the past 18 months, the Fed must keep future real and nominal interest rates extremely low. Because
401(k)s have migrated to 201(k)s, and now 301(k)s, the negative wealth effect must be stabilized in order to reintegrate the private sector into the current economy. Renormalizing risk spreads – stock, investment grade, and high yield bonds among them – is another way to describe this hoped for foundation for future growth. PIMCO estimates that this process is perhaps 80–85% complete, which provides the potential for a sunny-side, right-side of the grass outcome, although still with New Normal implications. Still, investors must admit that without the policy guarantees of the Fed, Treasury, and FDIC, as well as the continuation of punitive 0% short-term rates that force investors to buy something, anything, with their cash, that risk spreads may widen again, not stabilize.

This somewhat detailed analysis on Fed funds policy rates should return us to my beginning thesis as to why they need to stay low: Asset appreciation in U.S. and other G-7 economies has been artificially elevated for years. In order to prevent prices sinking even lower than recent downtrends averaging 30% for stocks, homes, commercial real estate, and certain high yield bonds, central banks must keep policy rates historically low for an extended period of time. If policy rates are artificially low then bond investors should recognize that artificial buyers of notes and bonds (quantitative easing programs and Chinese currency fixing) have compressed almost all interest rates. But while this may support asset prices – including Treasury paper across the front end and belly of the curve, at the same time it provides little reward in terms of future income. Investors, of course, notice this inevitable conclusion by referencing Treasury Bills at .15%, two-year Notes at less than 1%, and 10-year maturities at a paltry 3.40%. Absent deflationary momentum, this is all a Treasury investor can expect. What you see in the bond market is often what you get. Broadening the concept to the U.S. bond market as a whole (mortgages + investment grade corporates), the total bond market yields only 3.5%. To get more than that, high yield, distressed mortgages, and stocks beckon the investor increasingly beguiled by hopes of a V-shaped recovery and “old normal” market standards. Not likely, and the risks outweigh the rewards at this point. Investors must recognize that if assets appreciate with nominal GDP, a 4–5% return is about all they can expect even with abnormally low policy rates. Rage, rage, against this conclusion if you wish, but the six-month rally in risk assets – while still continuously supported by Fed and Treasury policymakers – is likely at its pinnacle. Out, out, brief candle.William H. Gross

William H. Gross

Managing Director

The Markets: Popping The Echo Bubble By Gareth Milliams

2009-11-07T14:24:00.009+09:00

There are only two questions that an investment adviser should ask himself when recommending an investment to a client. They are "why this particular fund/stock/bond?" & "what will happen if I buy it?"

Every time that we make changes to a portfolio it has a direct effect upon our clients wealth. An investment recommendation is a serious intellectual challenge and one which should be embraced. This is why the aforementioned pair of questions always need to be asked and answered.

It is also why I get frustrated when I see portfolios put together by incompetent advisers who then leave them unmanaged. All too often I see 'European Managed' and 'UK Performance' funds that are destined too fail but put into client portfolios only because the name sounds positive.

Everything in life has to have context, particularly investments. Investing in anything because historically it has performed is naive. Continuing to do so, despite evidence to the contrary is negligent and stupid. Once a decision has been made to invest, it has to be reassessed, continually with context. We are, after all subject to the principles of cause and effect.

Presently, we are in the midst of a gold bull market. Gold's growth is partly a result of investor uncertainty in the financial markets but mainly due to the debasement of the US dollar.

Gold is a traditional hedge against dollar weakness but also a bastion against inflation. Yet we are presently still suffering deflation in the UK and US general economies. However, the weak dollar is creating a small island of inflation in the commodity markets. But the dollar cannot keep falling forever and it's reversal could (and probably will) herald a crash in asset prices.

It is a new bubble. How else can you explain declining oil consumption, yet a 132% increase in its price per barrel?

Nouriel Roubini said on CNBC last week, "There is a wall of liquidity…chasing assets,""Now we are in the mother of all carry trades. "It seems to me that this rally in oil prices is way ahead of the economy."

So what kind of Bubble is this? . According to Newsweek, it's an 'echo bubble'.

"It's a term economists use to describe the smaller bubbles that follow on the heels of major ones, usually after the authorities helicopter in loads of cash to patch up the first round of damage, setting the stage for a second round of easy-money-driven speculation. The phenomenon has been observed throughout history, from the British railway bubble of 1830 to the Saudi stock bubble of 2005. Edward Chancellor, author of Devil Take the Hindmost: A History of Financial Speculation, says, "Echo bubbles tend to be smaller and fade away faster than the first bubble." On average, they reach about 30 to 40 percent of the size of the original before bursting and sending market values back down to where they should have been all along, wiping out the gains of the echo, but generally not dipping back to the previous low. That implies a Dow falling to 7000 or 8000.

While new bubbles tend to build on entirely new market fads, echo bubbles generally retrace old territory. It's no accident that today's biggest price spikes are in assets like commodities (which peaked in 2008) and emerging markets (late-2007 peak). "The story of endless global growth, now driven by China and other key emerging markets, is a dream that dies hard," notes Ruchir Sharma, head of emerging markets for Morgan Stanley Investment Management".

Bad investment decisions are liable to be victims of the "law of unintended consequences" After all, nobody makes mistakes on purpose, but mistakes are made. It is the job of an investment adviser to reduce the probability of a mistake. For that reason alone, no investment strategy can be written in stone.

If this is an echo bubble and less face it, how can these markets justify their growth when unemployment is still rising, states as large as California are bankrupt and credit is almost impossible to get? The US and UK are in deflation yet gold which has a negative relationship with it, rises?

So we keep a vigil. We watch the markets.

Closely.

The Crisis: Rolling Stones Matt Taibi Says J'accuse.

2009-10-22T00:13:00.004+09:00

If any journalist covering the behaviour of the banks leading up to the crisis deserves a Pullitzer Prize, it is Matt Taibbi of Rolling Stone. This latest article focuses upon a conspiracy to defraud.

Wall Street's Naked Swindle

A scheme to flood the market with counterfeit stocks helped kill Bear Stearns and Lehman Brothers — and the feds have yet to bust the culprits

MATT TAIBBI

Posted Oct 14, 2009 9:30 AM

Watch Matt Taibbi break down short-selling vs. naked short-selling on his blog, Taibblog.

On Tuesday, March 11th, 2008, somebody — nobody knows who — made one of the craziest bets Wall Street has ever seen. The mystery figure spent $1.7 million on a series of options, gambling that shares in the venerable investment bank Bear Stearns would lose more than half their value in nine days or less. It was madness — "like buying 1.7 million lottery tickets," according to one financial analyst.

But what's even crazier is that the bet paid.

At the close of business that afternoon, Bear Stearns was trading at $62.97. At that point, whoever made the gamble owned the right to sell huge bundles of Bear stock, at $30 and $25, on or before March 20th. In order for the bet to pay, Bear would have to fall harder and faster than any Wall Street brokerage in history.

The very next day, March 12th, Bear went into free fall. By the end of the week, the firm had lost virtually all of its cash and was clinging to promises of state aid; by the weekend, it was being knocked to its knees by the Fed and the Treasury, and forced at the barrel of a shotgun to sell itself to JPMorgan Chase (which had been given $29 billion in public money to marry its hunchbacked new bride) at the humiliating price of … $2 a share. Whoever bought those options on March 11th woke up on the morning of March 17th having made 159 times his money, or roughly $270 million. This trader was either the luckiest guy in the world, the smartest son of a bitch ever or…

Or what? That this was a brazen case of insider manipulation was so obvious that even Sen. Chris Dodd, chairman of the pillow-soft-touch Senate Banking Committee, couldn't help but remark on it a few weeks later, when questioning Christopher Cox, the then-chief of the Securities and Exchange Commission. "I would hope that you're looking at this," Dodd said. "This kind of spike must have triggered some sort of bells and whistles at the SEC. This goes beyond rumors."

Cox nodded sternly and promised, yes, he would look into it. What actually happened is another matter. Although the SEC issued more than 50 subpoenas to Wall Street firms, it has yet to identify the mysterious trader who somehow seemed to know in advance that one of the five largest investment banks in America was going to completely tank in a matter of days. "I've seen the SEC send agents overseas in a simple insider-trading case to investigate profits of maybe $2,000," says Brent Baker, a former senior counsel for the commission. "But they did nothing to stop this."

The SEC's halfhearted oversight didn't go unnoticed by the market. Six months after Bear was eaten by predators, virtually the same scenario repeated itself in the case of Lehman Brothers — another top-five investment bank that in September 2008 was vaporized in an obvious case of market manipulation. From there, the financial crisis was on, and the global economy went into full-blown crater mode.

Like all the great merchants of the bubble economy, Bear and Lehman were leveraged to the hilt and vulnerable to collapse. Many of the methods that outsiders used to knock them over were mostly legal: Credit markers were pulled, rumors were spread through the media, and legitimate short-sellers pressured the stock price down. But when Bear and Lehman made their final leap off the cliff of history, both undeniably got a push — especially in the form of a flat-out counterfeiting scheme called naked short-selling.

That this particular scam played such a prominent role in the demise of the two firms was supremely ironic. After all, the boom that had ballooned both companies to fantastic heights was basically a counterfeit economy, a mountain of paste that Wall Street had built to replace the legitimate business it no longer had. By the middle of the Bush years, the great investment banks like Bear and Lehman no longer made their money financing real businesses and creating jobs. Instead, Wall Street now serves, in the words of one former investment executive, as "Lucy to America's Charlie Brown," endlessly creating new products to lure the great herd of unwitting investors into whatever tawdry greed-bubble is being spun at the moment: Come kick the football again, only this time we'll call it the Internet, real estate, oil futures. Wall Street has turned the economy into a giant asset-stripping scheme, one whose purpose is to suck the last bits of meat from the carcass of the middle class.

What really happened to Bear and Lehman is that an economic drought temporarily left the hyenas without any more middle-class victims — and so they started eating each other, using the exact same schemes they had been using for years to fleece the rest of the country. And in the forensic footprint left by those kills, we can see for the first time exactly how the scam worked — and how completely even the government regulators who are supposed to protect us have given up trying to stop it.

This was a brokered bloodletting, one in which the power of the state was used to help effect a monstrous consolidation of financial and political power. Heading into 2008, there were five major investment banks in the United States: Bear, Lehman, Merrill Lynch, Morgan Stanley and Goldman Sachs. Today only Morgan Stanley and Goldman survive as independent firms, perched atop a restructured Wall Street hierarchy. And while the rest of the civilized world responded to last year's catastrophes with sweeping measures to rein in the corruption in their financial sectors, the United States invited the wolves into the government, with the popular new president, Barack Obama — elected amid promises to clean up the mess — filling his administration with Bear's and Lehman's conquerors, bestowing his papal blessing on a new era of robbery.

To the rest of the world, the brazenness of the theft — coupled with the conspicuousness of the government's inaction — clearly demonstrates that the American capital markets are a crime in progress. To those of us who actually live here, however, the news is even worse. We're in a place we haven't been since the Depression: Our economy is so completely fucked, the rich are running out of things to steal.

If you squint hard enough, you can see that the derivative-driven economy of the past decade has always, in a way, been about counterfeiting. At their most basic level, innovations like the ones that triggered the global collapse — credit-default swaps and collateralized debt obligations — were employed for the primary purpose of synthesizing out of thin air those revenue flows that our dying industrial economy was no longer pumping into the financial bloodstream. The basic concept in almost every case was the same: replacing hard assets with complex formulas that, once unwound, would prove to be backed by promises and IOUs instead of real stuff. Credit-default swaps enabled banks to lend more money without having the cash to cover potential defaults; one type of CDO let Wall Street issue mortgage-backed bonds that were backed not by actual monthly mortgage payments made by real human beings, but by the wild promises of other irresponsible lenders. They even called the thing a synthetic CDO — a derivative contract filled with derivative contracts — and nobody laughed. The whole economy was a fake.

For most of this decade, nobody rocked that fake economy — especially the faux housing market — better than Bear Stearns. In 2004, Bear had been one of five investment banks to ask the SEC for a relaxation of lending restrictions that required it to possess $1 for every $12 it lent out; as a result, Bear's debt-to-equity ratio soared to a staggering 33-1. The bank used much of that leverage to issue mountains of mortgage-backed securities, essentially borrowing its way to a booming mortgage business that helped drive its share price to a high of $172 in early 2007.

But that summer, Bear started to crater. Two of its hedge funds that were heavily invested in mortgage-backed deals imploded in June and July, forcing the credit-raters at Standard & Poor's to cut its outlook on Bear from stable to negative. The company survived through the winter — in part by jettisoning its dipshit CEO, Jimmy Cayne, a dithering, weed-smoking septuagenarian who was spotted at a bridge tournament during the crisis — but by March 2008, it was almost wholly dependent on a network of creditors who supplied it with billions in rolling daily loans to keep its doors open. If ever there was a major company ripe to be assassinated by market manipulators, it was Bear Stearns in 2008.

Then, on March 11th — around the same time that mystery Nostradamus was betting $1.7 million that Bear was about to collapse — a curious thing happened that attracted virtually no notice on Wall Street. On that day, a meeting was held at the Federal Reserve Bank of New York that was brokered by Fed chief Ben Bernanke and then-New York Fed president Timothy Geithner. The luncheon included virtually everyone who was anyone on Wall Street — except for Bear Stearns.

Bear, in fact, was the only major investment bank notrepresented at the meeting, whose list of participants reads like a Barzini-Tattaglia meeting of the Five Families. In attendance were Jamie Dimon from JPMorgan Chase, Lloyd Blankfein from Goldman Sachs, James Gorman from Morgan Stanley, Richard Fuld from Lehman Brothers and John Thain, the big-spending office redecorator still heading the not-yet-fully-destroyed Merrill Lynch. Also present were old Clinton hand Robert Rubin, who represented Citigroup; Stephen Schwarzman of the Blackstone Group; and several hedge-fund chiefs, including Kenneth Griffin of Citadel Investment Group.

The meeting was never announced publicly. In fact, it was discovered only by accident, when a reporter from Bloomberg filed a request under the Freedom of Information Act and came across a mention of it in Bernanke's schedule. Rolling Stone has since contacted every major attendee, and all declined to comment on what was discussed at the meeting. "The ground rules of the lunch were of confidentiality," says a spokesman for Morgan Stanley. "Blackstone has no comment," says a spokesman for Schwarzman. Rubin declined a request for an interview, Fuld's people didn't return calls, and Goldman refused to talk about the closed-door session. The New York Fed said the meeting, which had been scheduled weeks earlier, was simply business as usual: "Such informal, small group sessions can provide a valuable means to learn about market functioning from people with firsthand knowledge."

So what did happen at that meeting? There's no evidence that Bernanke and Geithner called the confidential session to discuss Bear's troubles, let alone how to carve up the bank's spoils. It's possible that one of them made an impolitic comment about Bear during a meeting held for other reasons, inadvertently fueling a run on the bank. What's impossible to believe is the bullshit version that Geithner and Bernanke later told Congress. The month after Bear's collapse, both men testified before the Senate that they only learned how dire the firm's liquidity problems were on Thursday, March 13th — despite the fact that rumors of Bear's troubles had begun as early as that Monday and both men had met in person with every key player on Wall Street that Tuesday. This is a little like saying you spent the afternoon of September 12th, 2001, in the Oval Office, but didn't hear about the Twin Towers falling until September 14th.

Given the Fed's cloak of confidentiality, we simply don't know what happened at the meeting. But what we do know is that from the moment it ended, the run on Bear was on, and every major player on Wall Street with ties to Bear started pulling IV tubes out of the patient's arm. Banks, brokers and hedge funds that held cash in Bear's accounts yanked it out in mass quantities (making it harder for the firm to meet its credit payments) and took out credit- default swaps against Bear (making public bets that the firm was going to tank). At the same time, Bear was blindsided by an avalanche of "novation requests" — efforts by worried creditors to sell off the debts that Bear owed them to other Wall Street firms, who would then be responsible for collecting the money. By the afternoon of March 11th, two rival investment firms — Credit Suisse and Goldman Sachs — were so swamped by novation requests for Bear's debt that they temporarily stopped accepting them, signaling the market that they had grave doubts about Bear.

All of these tactics were elements that had often been seen in a kind of scam known as a "bear raid" that small-scale stock manipulators had been using against smaller companies for years. But the most damning thing the attack on Bear had in common with these earlier manipulations was the employment of a type of counterfeiting scheme called naked short-selling. From the moment the confidential meeting at the Fed ended on March 11th, Bear became the target of this ostensibly illegal practice — and the companies widely rumored to be behind the assault were in that room. Given that the SEC has failed to identify who was behind the raid, Wall Street insiders were left with nothing to trade but gossip. According to the former head of Bear's mortgage business, Tom Marano, the rumors within Bear itself that week centered around Citadel and Goldman. Both firms were later subpoenaed by the SEC as part of its investigation into market manipulation — and the CEOs of both Bear and Lehman were so suspicious that they reportedly contacted Blankfein to ask whether his firm was involved in the scam. (A Goldman spokesman denied any wrongdoing, telling reporters it was "rigorous about conducting business as usual.")

The roots of short-selling date back to 1973, when Wall Street went to a virtually paperless system for trading stocks. Before then, if you wanted to sell shares you owned in Awesome Company X, you and the buyer would verbally agree to the deal through a broker. The buyer would take legal ownership of the shares, but only later would the broker deliver the actual, physical shares to the buyer, using an absurd, Brazil-style network of runners who carried paper shares from one place to another — a preposterous system that threatened to cripple trading altogether.

To deal with the problem, Wall Street established a kind of giant financial septic tank called the Depository Trust Company. Privately owned by a consortium of brokers and banks, the DTC centralizes and maintains all records of stock transactions. Now, instead of being schlepped back and forth across Manhattan by messengers on bikes, almost all physical shares of stock remain permanently at the DTC. When one broker sells shares to another, the trust company "delivers" the shares simply by making a change in its records.

Watch Matt Taibbi break down short-selling vs. naked short-selling on his blog, Taibblog.

This new electronic system spurred an explosion of financial innovation. One practice that had been little used before but now began to be employed with great popularity was short- selling, a perfectly legal type of transaction that allows investors to bet against a stock. The basic premise of a normal short sale is easy to follow. Say you're a hedge-fund manager, and you want to bet against the stock of a company — let's call it Wounded Gazelle International (WGI). What you do is go out on the market and find someone — often a brokerage house like Goldman Sachs — who has shares in that stock and is willing to lend you some. So you go to Goldman on a Monday morning, and you borrow 1,000 shares in Wounded Gazelle, which that day happens to be trading at $10.

Now you take those 1,000 borrowed shares, and you sell them on the open market at $10, which leaves you with $10,000 in cash. You then take that $10,000, and you wait. A week later, surveillance tapes of Wounded's CEO having sex with a woodchuck in a Burger King bathroom appear on CNBC. Awash in scandal, the firm's share price tumbles to 3½. So you go out on the market and buy back those 1,000 shares of WGI — only now it costs you only $3,500 to do so. You then return the shares to Goldman Sachs, at which point your interest in WGI ends. By betting against or "shorting" the company, you've made a profit of $6,500.

It's important to point out that not only is normal short-selling completely legal, it can also be socially beneficial. By incentivizing Wall Street players to sniff out inefficient or corrupt companies and bet against them, short-selling acts as a sort of policing system; legal short- sellers have been instrumental in helping expose firms like Enron and WorldCom. The problem is, the new paperless system instituted by the DTC opened up a giant loophole for those eager to game the market. Under the old system, would-be short-sellers had to physically borrow actual paper shares before they could execute a short sale. In other words, you had to actually have stock before you could sell it. But under the new system, a short-seller only had to make a good-faith effort to "locate" the stock he wanted to borrow, which usually amounts to little more than a conversation with a broker:

Evil Hedge Fund: I want to short IBM. Do you have a million shares I can borrow?

Corrupt Broker [not checking, playing Tetris]: Uh, yeah, whatever. Go ahead and sell.

There was nothing to prevent that broker — let's say he has only a million shares of IBM total — from making the same promise to five different hedge funds. And not only could brokers lend stocks they never had, another loophole in the system allowed hedge funds to sell those stocks and deliver a kind of IOU instead of the actual share to the buyer. When a share of stock is sold but never delivered, it's called a "fail" or a "fail to deliver" — and there was no law or regulation in place that prevented it. It's exactly what it sounds like: a loophole legalizing the counterfeiting of stock. In place of real stock, the system could become infected with "fails" — phantom IOU shares — instead of real assets.

If you own stock that pays a dividend, you can even look at your dividend check to see if your shares are real. If you see a line that says "PIL" — meaning "Payment in Lieu" of dividends — your shares were never actually delivered to you when you bought the stock. The mere fact that you're even getting this money is evidence of the crime: This counterfeiting scheme is so profitable for the hedge funds, banks and brokers involved that they are willing to pay "dividends" for shares that do not exist. "They're making the payments without complaint," says Susanne Trimbath, an economist who worked at the Depository Trust Company. "So they're making the money somewhere else."

Trimbath was one of the first people to notice the problem. In 1993, she was approached by a group of corporate transfer agents who had a complaint. Transfer agents are the people who keep track of who owns shares in corporations, for the purposes of voting in corporate elections. "What the transfer agents saw, when corporate votes came up, was that they were getting more votes than there were shares," says Trimbath. In other words, transfer agents representing a corporation that had, say, 1 million shares outstanding would report a vote on new board members in which 1.3 million votes were cast — a seeming impossibility.

Analyzing the problem, Trimbath came to an ugly conclusion: The fact that short-sellers do not have to deliver their shares made it possible for two people at once to think they own a stock. Evil Hedge Fund X borrows 100 shares from Unwitting Schmuck A, and sells them to Unwitting Schmuck B, who never actually receives that stock: In this scenario, both Schmucks will appear to have full voting rights. "There's no accounting for share ownership around short sales," Trimbath says. "And because of that, there are multiple owners assigned to one share."

Trimbath's observation would prove prophetic. In 2005, a trade group called the Securities Transfer Association analyzed 341 shareholder votes taken that year — and found evidence of over-voting in every single one. Experts in the field complain that the system makes corporate-election fraud a comically simple thing to achieve: In a process known as "empty voting," anyone can influence any corporate election simply by borrowing great masses of shares shortly before an important merger or board election, exercising their voting rights, then returning the shares right after the vote is over. Hilariously, because you're only borrowing the shares and not buying them, you can effectively "buy" a corporate election for free.

Back in 1993, over-voting might have seemed a mere curiosity, the result not of fraud but of innocent bookkeeping errors. But Trimbath realized the broader implication: Just as the lack of hard rules forcing short-sellers to deliver shares makes it possible for unscrupulous traders to manipulate a corporate vote, it could also enable them to manipulate the price of a stock by selling large quantities of shares they didn't possess. She warned her bosses that this crack in the system made the specter of organized counterfeiting a real possibility.

"I personally went to senior management at DTC in 1993 and presented them with this issue," she recalls. "And their attitude was, 'We spill more than that.'" In other words, the problem represented such a small percentage of the assets handled annually by the DTC — as much as $1.8 quadrillion in any given year, roughly 30 times the GDP of the entire planet — that it wasn't worth worrying about.

It wasn't until 10 years later, when Trimbath had a chance meeting with a lawyer representing a company that had been battered by short-sellers, that she realized someone outside the DTC had seized control of a financial weapon of mass destruction. "It was like someone figured out how to aim and fire the Death Star in Star Wars," she says. What they "figured out," Trimbath realized, was an early version of the naked-shorting scam that would help take down Bear and Lehman.

Here's how naked short-selling works: Imagine you travel to a small foreign island on vacation. Instead of going to an exchange office in your hotel to turn your dollars into Island Rubles, the country instead gives you a small printing press and makes you a deal: Print as many Island Rubles as you like, then on the way out of the country you can settle your account. So you take your printing press, print out gigantic quantities of Rubles and start buying goods and services. Before long, the cash you've churned out floods the market, and the currency's value plummets. Do this long enough and you'll crack the currency entirely; the loaf of bread that cost the equivalent of one American dollar the day you arrived now costs less than a cent.

With prices completely depressed, you keep printing money and buy everything of value — homes, cars, priceless works of art. You then load it all into a cargo ship and head home. On the way out of the country, you have to settle your account with the currency office. But the Island Rubles you printed are now worthless, so it takes just a handful of U.S. dollars to settle your debt. Arriving home with your cargo ship, you sell all the island riches you bought at a discount and make a fortune.

This is the basic outline for how to seize the assets of a publicly traded company using counterfeit stock. What naked short-sellers do is sell large quantities of stock they don't actually have, flooding the market with "phantom" shares that, just like those Island Rubles, depress a company's share price by making the shares less scarce and therefore less valuable.

The first documented cases of this scam involved small-time boiler-room grifters. In the late 1990s, not long after Trimbath warned her bosses about the problem, a trader named John Fiero executed a series of "bear raids" on small companies. First he sold shares he didn't possess in huge quantities and fomented negative rumors about a company; then, in a classic shakedown, he approached the firm with offers to desist — if they'd sell him stock at a discount. "He would press a button and enter a trade for half a million shares," says Brent Baker, the SEC official who busted Fiero. "He didn't have the stock to cover that — but the price of the stock would drop to a penny."

In 2005, complaints from investors about naked short-selling finally prompted the SEC to try to curb the scam. A new rule called Regulation SHO, known as "Reg SHO" for short, established a series of guidelines designed, in theory, to prevent traders from selling stock and then failing to deliver it to the buyer. "Intentionally failing to deliver stock," then-SEC chief Christopher Cox noted, "is market manipulation that is clearly violative of the federal securities laws." But thanks to lobbying by hedge funds and brokers, the new rule included no financial penalties for violators and no real enforcement mechanism. Instead, it merely created a thing called the "threshold list," requiring short-sellers to close out their positions in any company where the amount of "fails to deliver" exceeded 10,000 shares for more than 13 days. In other words, if counterfeiters got caught selling a chunk of phantom shares in a firm for two straight weeks, they were no longer allowed to counterfeit the stock.

A nice, if timid idea — except that it's completely meaningless. Not only has there been virtually no enforcement of the rule, but the SEC doesn't even bother to track who is targeting companies with failed trades. As a result, many stocks attacked by naked short-sellers spent years on the threshold list, including Krispy Kreme, Martha Stewart and Overstock.com.

"We were actually on it for 668 consecutive days," says Patrick Byrne, the CEO of Overstock, who became a much-ridiculed pariah on Wall Street for his lobbying against naked short-selling. At one point, investors claimed ownership of nearly 42 million shares in Overstock — even though fewer than 24 million shares in the company had actually been issued.

Byrne is not an easy person for anyone with any kind of achievement neuroses to like. He is young, good-looking, has shitloads of money, speaks fluent Chinese, holds a doctorate in philosophy and spent his youth playing hooky from high school and getting business tips from the likes of Warren Buffett. But because of his fight against naked short-selling, he has been turbofragged by the mainstream media as a tinfoil-hat lunatic; one story in the New York Post featured a picture of Byrne with a flying saucer coming out of his head.

Nonetheless, Byrne's howlings about naked short-selling look extremely prescient in light of what happened to Bear and Lehman. Over the past four years, Byrne has outlined the parameters of a naked-shorting scam that always includes some combination of the following elements: negative rumors planted in the financial press, the flooding of the market with enormous quantities of undelivered shares, absurdly high trading volumes and the prolonged appearance of the targeted company on the Reg SHO list.

In January 2005 — at the exact moment Reg SHO was launched — Byrne's own company was trading above $65 a share, and the number of failed trades in circulation was virtually nil. By March 2006, however, Overstock was down to $28 a share, and Reg SHO data indicated an explosion of failed trades — nearly 4 million undelivered shares on some days. At those moments, in other words, nearly a fifth of all Overstock shares were fake.

"This really isn't about my company," Byrne says. "I mean, I've made my money. My initial concern, of course, was with Overstock. But the more I learned about this, the more my real worry became 'Jesus, what are the implications for the system?' And given what happened to Bear and Lehman last year, I think we ended up seeing what some of those implications are."

Watch Matt Taibbi break down short-selling vs. naked short-selling on his blog, Taibblog.

Bear Stearns wasn't the kind of company that had a problem with naked short-selling. Before March 11th, 2008, there had never been a period in which significant quantities of Bear stock had been sold and then not delivered, and the company had never shown up on the Reg SHO list. But beginning on March 12th — the day after the Fed meeting that failed to include Bear, and the mysterious purchase of the options betting on the firm's imminent collapse — the number of counterfeit shares in Bear skyrocketed.

The best way to grasp what happened is to look at the data: On Tuesday, March 11th, there were 201,768 shares of Bear that had failed to deliver. The very next day, the number of phantom shares leaped to 1.2 million. By the close of trading that Friday, the number passed 2 million — and when the market reopened the following Monday, it soared to 13.7 million. In less than a week, the number of counterfeit shares in Bear had jumped nearly seventyfold.

The giant numbers of undelivered shares over the course of that week amounted to one of the most blatant cases of stock manipulation in Wall Street history. "There is not a doubt in my mind, not a single doubt" that naked short-selling helped destroy Bear, says Sen. Ted Kaufman, a Democrat from Delaware who has introduced legislation to curb such financial fraud. Asked to rate how obvious a case of naked short-selling Bear is, on a scale of one to 10, former SEC counsel Brent Baker doesn't hesitate. "Easily a 10," he says.

At the same time that naked short- sellers were counterfeiting Bear's stock, the firm was being hit by another classic tactic of bear raids: negative rumors in the media. Tipped off by a source, CNBC reporter David Faber reported on March 12th that Goldman Sachs had held up a trade with Bear because it was worried about the firm's creditworthiness. Faber noted that the hold was temporary — the deal had gone through that morning. But the damage was done; inside Bear, Faber's report was blamed for much of the subsequent panic.

"I like Faber, he's a good guy," a Bear executive later said. "But I wonder if he ever asked himself, 'Why is someone telling me this?' There was a reason this was leaked, and the reason is simple: Someone wanted us to go down, and go down hard."

At first, the full-blown speculative attack on Bear seemed to be working. Thanks to the media-fueled rumors and the mounting anxiety over the company's ability to make its payments, Bear's share price plummeted seven percent on March 13th, to $57. It still had a ways to go for the mysterious short-seller to make a profit on his bet against the firm, but it was headed in the right direction. But then, early on the morning of Friday, March 14th, Bear's CEO, Alan Schwartz, struck a deal with the Fed and JPMorgan to provide an emergency loan to keep the company's doors open. When the news hit the street that morning, Bear's stock rallied, gaining more than nine percent and climbing back to $62.

The sudden and unexpected rally prompted celebrations inside Bear's offices. "We're alive!" someone on the company's trading floor reportedly shouted, and employees greeted the news by high-fiving each other. Many gleefully believed that the short-sellers targeting the firm would get "squeezed" — in other words, if the share price kept going up, the bets against Bear would blow up in the attackers' faces.

The rally proved short-lived — Bear ended the day at $30 — but it suggested that all was not lost. Then a strange thing happened. As Bear understood it, the emergency credit line that the Fed had arranged was originally supposed to last for 28 days. But that Friday, despite the rally, Geithner and then-Treasury secretary Hank Paulson — the former head of Goldman Sachs, one of the firms rumored to be shorting Bear — had a sudden change of heart. When the market closed for the weekend, Paulson called Schwartz and told him that the rescue timeline had to be accelerated. Paulson wouldn't stay up another night worrying about Bear Stearns, he reportedly told Schwartz. Bear had until Sunday night to find a buyer or it could go fuck itself.

Bear was out of options. Over the course of that weekend, the firm opened its books to JPMorgan, the only realistic potential buyer. But upon seeing all the "shit" on Bear's books, as one source privy to the negotiations put it — including great gobs of toxic investments in the subprime markets — JPMorgan hedged. It wouldn't do the deal, it announced, unless it got two things: a huge bargain on the sale price, and a lot of public money to wipe out the "shit.

So the Fed — on whose New York board sits JPMorgan chief Jamie Dimon — immediately agreed to accommodatethe new buyers, forking over $29 billion in public funds to buy up the yucky parts of Bear. Paulson, meanwhile, took care of the bargain issue, putting the government's gun to Schwartz's head and telling him he had to sell low. Really low.

On Saturday night, March 15th, Schwartz and Dimon had discussed a deal for JPMorgan to buy Bear at $8 to $12 a share. By Sunday afternoon, however, Geithner reported that the price had plunged even further. "Shareholders are going to get between $3 and $5 a share," he told Paulson.

But Paulson pissed on even that price from a great height. "I can't see why they're getting anything," he told Dimon that afternoon from Washington, via speakerphone. "I could see something nominal, like $1 or $2 per share."

Just like that, with a slight nod of Paulson's big shiny head, Bear was vaporized. This, remember, all took place while Bear's stock was still selling at $30. By knocking the share price down 28 bucks, Paulson ensured that the manipulators who were illegally counterfeiting Bear's shares would make an awesome fortune.

Although we don't know who was behind the naked short-selling that targeted Bear — short-traders aren't required to reveal their stake in a company — the scam wasn't just a fetish crime for small-time financial swindlers. On the contrary, the widespread selling of shares without delivering them translated into an enormously profitable business for the biggest companies on Wall Street, fueling the growth of a booming sector in the financial-services industry called Prime Brokerage.

As with other Wall Street abuses, the lucrative business in counterfeiting stock got its start with a semisecret surrender of regulatory authority by the government. In 1989, a group of prominent Wall Street broker-dealers — led, ironically, by Bear Stearns — asked the SEC for permission to manage the accounts of hedge funds engaged in short-selling, assuming responsibility for locating, lending and transferring shares of stock. In 1994, federal regulators agreed, allowing the nation's biggest investment banks to serve as Prime Brokers. Think of them as the house in a casino: They provide a gambler with markers to play and to manage his winnings.

Under the original concept, a hedge fund that wanted to short a stock like Bear Stearns would first "locate" the stock with his Prime Broker, then would do the trade with a so-called Executing Broker. But as time passed, Prime Brokers increasingly allowed their hedge-fund customers to use automated systems and "locate" the stock themselves. Now the conversation went something like this:

Evil Hedge Fund: I just sold a million shares of Bear Stearns. Here, hold this shitload of money for me.

Prime Broker: Awesome! Where did you borrow the shares from?

Evil Hedge Fund: Oh, from Corrupt Broker. You know, Vinnie.

Prime Broker: Oh, OK. Is he sure he can find those shares? Because, you know, there are rules.

Evil Hedge Fund: Oh, yeah. You know Vinnie. He's good for it.

Prime Broker: Sweet!

Following the SEC's approval of this cozy relationship, Prime Brokers boomed. Indeed, with the rise of discount brokers online and the collapse of IPOs and corporate mergers, Prime Brokerage — in essence, the service end of the short- selling business — is now one of the most profitable sectors that big Wall Street firms have left. Last year, Goldman Sachs netted $3.4 billion providing "securities services" — the lion's share of it from Prime Brokerage.

When one considers how easy it is for short-sellers to sell stock without delivering, it's not hard to see how this can be such a profitable business for Prime Brokers. It's really a license to print money, almost in the literal sense. As such, Prime Brokers have tended to be lax about making sure that their customers actually possess, or can even realistically find, the stock they've sold. That point is made abundantly clear by tapes obtained by Rolling Stone of recent meetings held by the compliance officers for big Prime Brokers like Goldman Sachs, Morgan Stanley and Deutsche Bank. Compliance officers are supposed to make sure that traders at their firms follow the rules — but in the tapes, they talk about how they routinely greenlight transactions they know are dicey.

In a conference held at the JW Marriott Desert Ridge Resort in Phoenix in May 2008 — just over a month after Bear collapsed — a compliance officer for Goldman Sachs named Jonathan Breckenridge talks with his colleagues about how the firm's customers use an automated program to report where they borrowed their stock from. The problem, he says, is the system allows short-sellers to enter anything they want in the text field, no matter how nonsensical — or even leave the field blank. "You can enter ABC, you can enter Go, you can enter Locate Goldman, you can enter whatever you want," he says. "Three dots — I've actually seen that."

The room erupts with laughter.

After making this admission, Breckenridge asks officials from the Securities Industry and Financial Markets Association, the trade group representing Wall Street broker-dealers, for guidance in how to make this appear less blatantly improper. "How do you have in place a process," he wonders, "and make sure that it looks legit?"

The funny thing is that Prime Brokers didn't even need to fudge the rules. They could counterfeit stocks legally, thanks to yet another loophole — this one involving key players known as "market makers." When a customer wants to buy options and no one is lining up to sell them, the market maker steps in and sells those options out of his own portfolio. In market terms, he "provides liquidity," making sure you can always buy or sell the options you want.

Under what became known as the "options market maker exception," the SEC permitted a market maker to sell shares whether or not he had them or could find them right away. In theory, this made sense, since delaying the market maker from selling to offset a big buy order could dry up liquidity and slow down trading. But it also created a loophole for naked short-sellers to kill stocks easily — and legally. Take Bear Stearns, for example. Say the stock is trading at $62, as it was on March 11th, and someone buys put options from the market maker to sell $1.7 million in Bear stock nine days later at $30. To offset that big trade, the market maker might try to keep his own portfolio balanced by selling off shares in the company, whether or not he can locate them.

But here's the catch: The market maker often sells those phantom shares to the same person who bought the put options. That buyer, after all, would love to snap up a bunch of counterfeit Bear stock, since he can drive the company's price down by reselling those fake shares. In fact, the shares you buy from a market maker via the SEC-sanctioned loophole are sometimes called "bullets," because when you pump these counterfeit IOUs into the market, it's like firing bullets into the company — it kills the price, just like printing more Island Rubles kills a currency.

Which, it appears, is exactly what happened to Bear Stearns. Someone bought a shitload of puts in Bear, and then someone sold a shitload of Bear shares that never got delivered. Bear then staggered forward, bleeding from every internal organ, and fell on its face. "It looks to me like Bear Stearns got riddled with bullets," John Welborn, an economist with an investment firm called the Haverford Group, later observed.

So who conducted the naked short- selling against Bear? We don't know — but we do know that, thanks to the free pass the SEC gave them, Prime Brokers stood to profit from the transactions. And the confidential meeting at the Fed on March 11th included all the major Prime Brokers on Wall Street — as well as many of the biggest hedge funds, who also happen to be some of the biggest short-sellers on Wall Street.The economy's financial woes might have ended there — leaving behind an unsolved murder in which many of the prime suspects profited handsomely. But three months later, the killers struck again. On June 27th, 2008, an avalanche of undelivered shares in Lehman Brothers started piling up in the market. June 27th: 705,103 fails. June 30th: 814,870 fails. July 1st: 1,556,301 fails.

Then the rumors started. A story circulated on June 30th about Barclays buying Lehman for 25 percent less than the share price. The tale was quickly debunked, but the attacks continued, with hundreds of thousands of failed trades every day for more than a week — during which time Lehman lost 44 percent of its share price. The major players on Wall Street, who for years had confined this unseemly sort of insider rape to smaller companies, had begun to eat each other alive.

It made great capitalist sense to attack these giant firms — they were easy targets, after all, hideously mismanaged and engorged with debt — but an all-out shooting war of this magnitude posed a risk to everyone. And so a cease-fire was declared. In a remarkable order issued on July 15th, Cox dictated that short-sellers must actually pre-borrow shares before they sell them. But in a hilarious catch, the order only covered shares of the 19 biggest firms on Wall Street, including Morgan Stanley and Goldman Sachs, and would last only a month.

This was one of the most amazing regulatory actions ever: It essentially told Wall Street that it was enjoined from counterfeiting stock — but only temporarily, and only the stock of the 19 of the richest companies on Wall Street. Not surprisingly, the share price for Lehman and some of the other lucky robber barons surged on the news.

But the relief was short-lived. On August 12th, 2008, the Cox order expired — and fails in Lehman stock quickly started mounting. The attack spiked on September 9th, when there were over 1 million undelivered shares in Lehman. On September 10th, there were 5,877,649 failed trades. The day after, there were an astonishing 22,625,385 fails. The next day: 32,877,794. Then, on September 15th, the price of Lehman Brothers stock fell to 21 cents, and the company declared bankruptcy.

That naked shorting was the tool used to kill the company — which was, like Bear, a giant bursting sausage of deadly subprime deals that didn't need much of a push off the cliff — was obvious to everyone. Lehman CEO Richard Fuld, admittedly one of the biggest assholes of the 21st century, said as much a month later. "The naked shorts and rumormongers succeeded in bringing down Bear Stearns," Fuld told Congress. "And I believe that unsubstantiated rumors in the marketplace caused significant harm to Lehman Brothers."

The methods used to destroy these companies pointed to widespread and extravagant market manipulation, and the death of Lehman should have instigated a full-bore investigation. "This isn't a trail of bread crumbs," former SEC enforcement director Irving Pollack has pointed out. "This audit trail is lit up like an airport runway. You can see it a mile off. Subpoena e-mails. Find out who spread false rumors and also shorted the stock, and you've got your manipulators."

It would be an easy matter for the SEC to determine who killed Bear and Lehman, if it wanted to — all it has to do is look at the trading data maintained by the stock exchanges. But 18 months after the widespread market manipulation, the federal government's cop on the financial beat has barely lifted a finger to solve the two biggest murders in Wall Street history. The SEC refuses to comment on what, if anything, it is doing to identify the wrongdoers, saying only that "investigations related to the financial crisis are a priority."

Watch Matt Taibbi break down short-selling vs. naked short-selling on his blog, Taibblog.

The commission did repeal the preposterous "market maker" loophole on September 18th, 2008, forbidding market makers from selling phantom shares. But that same day, the SEC also introduced a comical agreement called "Rule 10b-21," which makes it illegal for an Evil Hedge Fund to lie to a Prime Broker about where he borrowed his stock. Basically, this new rule formally exempted Wall Street's biggest players from any blame for naked short-selling, putting it all on the backs of their short-seller clients. Which was good news for firms like Goldman Sachs, which only a year earlier had been fined $2 million for repeatedly turning a blind eye to clients engaged in illegal short-selling. Instead of tracking down the murderers of Bear and Lehman, the SEC simply eliminated the law against aiding and abetting murder. "The new rule just exempted the Prime Brokers from legal responsibility," says a financial player who attended closed-door discussions about the regulation. "It's a joke."

But the SEC didn't stop there — it also went out of its way to protect the survivors from the normal functioning of the marketplace. On September 15th, the same day that Lehman declared bankruptcy, the share price of Goldman and Morgan Stanley began to plummet sharply. There was little evidence of phantom shares being sold — in Goldman's case, fewer than .02 percent of all trades failed. Whoever was attacking Goldman and Morgan Stanley — if anyone was — was for the most part doing it legally, through legitimate short-selling. As a result, when the SEC imposed yet another order on September 17th curbing naked short-selling, it did nothing to help either firm, whose share prices failed to recover.

Then something extraordinary happened. Morgan Stanley lobbied the SEC for a ban on legitimate short-selling of financial stocks — a thing not even the most ardent crusaders against naked short- selling, not even tinfoil-hat-wearing Patrick Byrne, had ever favored. "I spent years just trying to get the SEC to listen to a request that they stop people from rampant illegal counterfeiting of my company's stock," says Byrne. "But when Morgan Stanley asks for a ban on legal short-selling, they get it literally overnight."

Indeed, on September 19th, Cox imposed a temporary ban on legitimate short- selling of all financial stocks. The stock price of both Goldman and Morgan Stanley quickly rebounded. The companies were also bailed out by an instant designation as bank holding companies, which made them eligible for a boatload of emergency federal aid. The law required a five-day wait for such a conversion, but Geithner and the Fed granted Goldman and Morgan Stanley their new status overnight.

So who killed Bear Stearns and Lehman Brothers? Without a bust by the SEC, all that's left is means and motive. Everyone in Washington and on Wall Street understood what it meant when Lehman, for years the hated rival of Goldman Sachs, was chosen by Treasury Secretary Hank Paulson — the former Goldman CEO — to be the one firm thatdidn't get a federal bailout. "When Paulson, a former Goldman guy, chose to sacrifice Lehman, that's when you knew the whole fucking thing was dirty," says one Democratic Party operative. "That's like the Yankees not bailing out the Mets. It was just obvious."

The day of Lehman's collapse, Paulson also bullied Bank of America into buying Merrill Lynch — which left Goldman Sachs and Morgan Stanley as the only broker-teens left unaxed in the Camp Crystal Lake known as the American economy. Before they were hacked to bits, Merrill, Bear and Lehman all nurtured booming businesses as Prime Brokers. All that lucrative work had to go somewhere. So guess which firms made the most money in Prime Brokerage this year? According to a leading industry source, the top three were Goldman, JPMorgan and Morgan Stanley.

We may never know who killed Bear and Lehman. But it sure isn't hard to figure out who's left.

While naked short-selling was the weapon used to bring down both Bear and Lehman, it would be preposterous to argue that the practice caused the financial crisis. The most serious problems in this economy were the result of other, broader classes of financial misdeed: corruption of the ratings agencies, the use of smoke-and-mirrors like derivatives, an epidemic tulipomania called the housing boom and the overall decline of American industry, which pushed Wall Street to synthesize growth where none existed.

But the "phantom" shares produced by naked short-sellers are symptomatic of a problem that goes far beyond the stock market. "The only reason people talk about naked shorting so much is that stock is sexy and so much attention is paid to the stock market," says a former investment executive. "This goes on in all the markets."

Take the commodities markets, where most of those betting on the prices of things like oil, wheat and soybeans have no product to actually deliver. "All speculative selling of commodity futures is 'naked' short selling," says Adam White, director of research at White Knight Research and Trading. While buying things that don't actually exist isn't always harmful, it can help fuel speculative manias, like the oil bubble of last summer. "The world consumes 85 million barrels of oil per day, but it's not uncommon to trade 1 billion barrels per day on the various commodities exchanges," says White. "So you've got 12 paper barrels trading for every physical barrel."

The same is true for mortgages. When lenders couldn't find enough dope addicts to lend mansions to, some simply went ahead and started selling the same mortgages over and over to different investors. There are now a growing number of cases of such double-selling of mortgages: "It makes Bernie Madoff seem like chump change," says April Charney, a legal-aid attorney based in Florida. Just like in the stock market, where short-sellers delivered IOUs instead of real shares, traders of mortgage-backed securities sometimes conclude deals by transferring "lost-note affidavits" — basically a "my dog ate the mortgage" note — instead of the actual mortgage. A paper presented at the American Bankruptcy Institute earlier this year reports that up to a third of all notes for mortgage-backed securities may have been "misplaced or lost" — meaning they're backed by IOUs instead of actual mortgages.

How about bonds? "Naked short-selling of stocks is nothing compared to what goes on in the bond market," says Trimbath, the former DTC staffer. Indeed, the practice of selling bonds without delivering them is so rampant it has even infected the market for U.S. Treasury notes. That's right — Wall Street has actually been brazen enough to counterfeit the debt of the United States government right under the eyes of regulators, in the middle of a historic series of government bailouts! In fact, the amount of failed trades in Treasury bonds — the equivalent of "phantom" stocks — has doubled since 2007. In a single week last July, some $250 billion worth of U.S. Treasury bonds were sold and not delivered.

The counterfeit nature of our economy is troubling enough, given that financial power is concentrated in the hands of a few key players — "300 white guys in Manhattan," as a former high-placed executive puts it. But over the course of the past year, that group of insiders has also proved itself brilliantly capable of enlisting the power of the state to help along the process of concentrating economic might — making it less and less likely that the financial markets will ever be policed, since the state is increasingly the captive of these interests.

The new president for whom we all had such high hopes went and hired Michael Froman, a Citigroup executive who accepted a $2.2 million bonus after he joined the White House, to serve on his economic transition team — at the same time the government was giving Citigroup a massive bailout. Then, after promising to curb the influence of lobbyists, Obama hired a former Goldman Sachs lobbyist, Mark Patterson, as chief of staff at the Treasury. He hired another Goldmanite, Gary Gensler, to police the commodities markets. He handed control of the Treasury and Federal Reserve over to Geithner and Bernanke, a pair of stooges who spent their whole careers being bellhops for New York bankers. And on the first anniversary of the collapse of Lehman Brothers, when he finally came to Wall Street to promote "serious financial reform," his plan proved to be so completely absent of balls that the share prices of the major banks soared at the news.

The nation's largest financial players are able to write the rules for own their businesses and brazenly steal billions under the noses of regulators, and nothing is done about it. A thing so fundamental to civilized society as the integrity of a stock, or a mortgage note, or even a U.S. Treasury bond, can no longer be protected, not even in a crisis, and a crime as vulgar and conspicuous as counterfeiting can take place on a systematic level for years without being stopped, even after it begins to affect the modern-day equivalents of the Rockefellers and the Carnegies. What 10 years ago was a cheap stock-fraud scheme for second-rate grifters in Brooklyn has become a major profit center for Wall Street. Our burglar class now rules the national economy. And no one is trying to stop them.

[From Issue 1089 — October 15, 2009]

The Markets: How Goldman Sachs Did It By Dylan Rattigan

2009-10-18T11:07:00.013+09:00

Goldman Sachs reported breathtaking figures this week. But how did they do it? This article from Dylan Rattigan of MSNBC explains:

How did Goldman, Sachs & Co. -- saved a year ago by the US taxpayer -- magically make $3 billion in 3 months a year later?

This as the US dollar collapses, unemployment soars and foreclosures hit a record?

Here is the Goldman, Sachs & Co. revenue break down for the past 3 months:

Financial Advisory-M/A: 325 million.

Equity Underwriting: 363 million.

Debt Underwriting: 211 million.

Trading-Principal Investments: 10 billion.

Notice that 10 billion is much bigger than two or three hundred million made from the traditional Wall Street businesses.

That $10 billion is evidence of their magic trick. For we the taxpayer gave Goldman Sachs the following:

10 Billion in TARP
11 Billion from the Fed
30 Billion from the FDIC
13 Billion from AIG

For a grand total of almost $70 Billion (Goldman along with every other bank and AIG would have been defunct without this money).

Goldman at the apex of the crisis is delivered this money -- which they then use to borrow against at $20 or $30 for every $1. Which at 30x equals $2.1 trillion in available capital.

As one of the only banks in the world with money at the time, Goldman Sachs was able to buy billions in distressed assets around the world at record low prices -- only to watch $23.7 trillion in US taxpayer money be deployed during the past year to re-inflate the asset's values that Goldman had purchased with our tax money.

The question is not why did we bail out the banks.

The question is why did we give the banks billions of our money so they could then buy assets by the trillions with our money and they keep the profits?

The answer is Henry Paulson, former Goldman Sachs CEO who ran the US Treasury, and Tim Geithner, current Treasury Secretary who at the time ran the New York Federal Reserve, willingly delivered Goldman Sachs the $70 Billion -- with no strings attached.

So what can we do?

We must demand the return of those investment gains made with America's money - it was stolen from us and we can get it back.
Demand Claw Backs - and not from the future but from the past-That is where our money is.

We must have an exchange for all credit derivatives -- the current version is riddled with loopholes that let banks avoid transparency by mobbing offshore and prohibiting government regulators from being able to force the use of the exchange by the banks.

So how do you do it?

Heed the Call!!!!

Investment: The Story So Far... By Gareth Milliams

2009-10-15T09:19:00.004+09:00

I thought that I'd take a look at the advice I've given via this blog over the last 17 months. Accountability and transparency are key to a successful investment practice as is advice based upon fundamental and reason. This is not an environment for short term 'punting' but for thoughtful strategies designed to firstly, preserve capital and secondly, encourage growth.

With each quote is a date appertaining to when the quote was made, so that you can check context.

I am proud of the work that we have done since the crisis began but more than anything I'd like to thank my clients who have been immensely supportive.

Before The Crash

Hopefully, you have already rigged for the financial typhoon the RBS and Morgan Stanley are now joining us in predicting. Don’t forget to warn your friends - Monday 23rd June 2008

Twin the sharp drop in housing (prices) with high inflation, low demand and a weak dollar and what we are left with is a perfect storm of bad economic conditions - Wednesday 25th June 2008

Lehman Brothers stock is falling through the floor on reports that it will be sold on to Barclays.

We've just been through a bear rally in equities without the expected retracing and the credit markets have just had the worst quarter in six years.

Be scared. Be very scared.... - Tuesday 1st July 2008

"So what has all of this to do with gold?", I hear you whine (whilst losing the will to live). The general stockmarket is very sensitive to the plight of the financials. If they continue to tumble, the equity market as a whole will fall with them, including mining stocks. Physical gold will become more attractive and may even head north of $950 per ounce again - Tuesday 8th July 2008

New plans and new money from existing investments should look to take advantage of the market volatility by dollar cost averaging with emerging funds from the BRIC nations and South East Asian Tigers. These economies whilst hit hard by the downturn in western markets do not have the structural issues that beset the 'developed' world. Buying them now on a regular basis with a 3 year view will prove highly profitable - Sunday 21st September 2008

Post Crash

I have nothing but sympathy for people who have lost money through mismanagement of their portfolio. But I can't help but breathe a sigh of relief and internally smile for my personalised portfolio clients.

It ain't easy being in cash and mistakes were made in December last year. But today we were proven right.

Unlike many, we can sleep easy at night... - Tuesday 30th September 2008

Gold or as Spandau Ballet once sang "GOLD!", is looking very attractive at present levels. Presently trading at $729 per ounce with the GLD ETF priced at $72.18, now is a great time to buy, even if gold drops further. Please remember that GLD buys physical gold held in New York by HSBC. It is not a paper investment. Please see a previous posting below which reports that even though the gold price is dropping, gold sales are rapidly increasing -

Monday 10th November 2008

$75 per barrel also bodes well for gold. There is a strong correlation between gold and oil and a 50% rise in the oil price could be positive for bullion and encourage weakness in the US$. It is also entirely possible that the price per barrel could rise without OPEC having to close the spigot. Dollar weakness due to the Fed's printing of US$ to reflate the US economy could also push the price of oil up, as it becomes more expensive to buy. In conclusion, oil at these levels may be presenting an investment opportunity unseen for a number of years - Monday 1st December 2008

We know that gold purchases are at record levels and that gold is a finite commodity. We know that the Federal Reserve and Congress have been injecting liquidity into the system like drunken sailors. We also know that massive increases in the money supply will always lead to currency weakness and inflation. These are the twin catalysts that drive the precious metals markets. Additionally, America needs a much weakened dollar to help manufacture its way out of recession. So fear not that gold will revisit $1000 per troy ounce. Its destiny is to go much further north.

Our 2008 strategies generally worked very well. Those of you who bought the gold ETF after my 10^th November recommendation on my blog have garnered a 15% return as have those who bought Yen in October - Tuesday 30th December 2008

2009

I do not believe that the reemergence from retirement of Sakakibara-san, the eponymous 'Mr Yen' was anything other than planned. A dedicated civil servant, he would not make a declaration to the press without the permission of his bosses in Kasumigaseki.

So when he declared that the Yen will probably trade between 70-100 against the dollar, it was significant. It also appears that the Yen is weakening without additional selling from the government - 14th March 2009

Gold Is This The Tipping Point? - Sunday 6th September 2009

Investment: The Myth Of The Gold Bubble By Gareth Milliams

2009-10-08T19:23:00.011+09:00

There is a widespread fear that gold is in a bubble and that the price could crash at anytime. This could not be more wrong. Gold's rise in value has not been due to "irrational exuberance" but because the US government has chosen (rightly or wrongly) to print money to buy their way out of recession.

The Federal Reserve is printing paper backed by politician's promises. People have recognised this and in order to prepare for 'the great inflation' have bought gold in physical and paper form in order to protect their capital.

Gold is just a yellow metal. It has little industrial use. It's value is based upon it's comparative rarity and investor perception. However, to many, gold is currency. This is made evident by renewed purchasing from the the Chinese and Russian Reserve Banks. In fact more than 20% of the worlds 'above ground' gold is owned by governments.

These governments are worried. The United States is their biggest trading partner and the US government owes them trillions of dollars. Unfortunately, it is also bankrupt.

So whilst the US prints more money and coordinates its stimuli with its global governmental partners, they buy gold, as a hedge against their dollar holdings and a potential debt default.

The relative weakness of the dollar and demand from BRIC nations have kept commodity prices high. This is dangerous. When the recovery comes, there will be a global craving for oil, copper and coal etc.

So now we have a scenario where the US government is flooding the market with money in order to lubricate the cogs and gears of its economy but cheapens its currency internationally, with every note printed pushing up the dollar price of materials. Add to this an eventual commodity bull market which will have been force fed on the steroids of recovery and we have an inflationary nightmare.

This is why people buy gold.

Below is a great chart from Barry Ritholtz of 'The Big Picture' busting the myth that gold is at a high. As he correctly points out, the high is merely nominal and not inflation adjusted.

As the chart shows, the actual gold price high in real terms is over $2,300. However, that high whilst magnificent was brief. This time, I believe that gold is in a long term secular bull market that has only just begun.

Are we irrationally exuberant about the price of gold? I don't think so. A good example are Apple shares. They are up over 120% since the start of the year whereas the ETF GLD has barely made a return of 20% since January 1.

In fact since March 2008, gold can barely scratch a 2% gain!

Exuberant? No.

Confident? Yes.

Inflation will come and we'll be vested in order to benefit and profit from it.

Markets: Q4 Earnings Season - The Marshmallow Test And Why You Should Never Overmix Metaphors....By Gareth Milliams

2009-10-04T14:20:00.010+09:00

It's been a miserable year if you are a logical thinking, market fundamentalist. This bear market rally, based not upon return or results but upon exceeding extremely low expectations has broken all records.

It's like rewarding a kid who got an 'E' rather than an 'F' in his economics exam.

My portfolios have stayed away. This rally was always like trying to ride a rattlesnake. Logic told us that it could have reared up and bitten us at any time and my job is to protect my clients assets.

You've heard this all before. No doubt, you are sick of hearing how this is not a real rally and that the sky will fall in.

It hasn't.

But it will.

Probably.

Marc Faber says that "the longer a trend has been in place, the more cautious an investor should become". He is right. If this market had been in the midst of a bull rally, people would be screaming for a correction. But it isn't. Instead we are in the middle of the worst financial crisis in 75 years and people are desperate for this rally to continue onward and upward in order to make back their losses from 2008.

I have a tip for them.

Get out.

Get out now.

Before it is too late and this market corrects radically.

To my clients I say, "good things come to those who wait".

It's a bit like the marshmallow test. A child is left alone in a room with a marshmallow and told that he can eat it. However, if he waits, he can have two. The smart kids wait. The dumb kids eat the marshmallow. The dull kids then have to watch the shiny ones eat two.

We are waiting.

We shall have two marshmallows and the stupid kids can watch us eat!

Markets: Jim Rogers Talks Inflation

2009-10-01T23:20:00.001+09:00

Investment: I Hate To Say I Told You So, But.....By Gareth Milliams

2009-10-01T16:14:00.003+09:00

We bought a heavily discounted high yield euro denominated bond in July. We paid a premium on the price which was at approx. 45 per cent of the face value. The yield though was paid at face value and so garnered us a 17% return. The bond price is up 10% thus my clients now received a handsome 27% return. Not bad for an investment since July.

For those of you whom I have called already, my apologies for overdoing the lap of honour.

For those of you who declined...reconsider. There is tremendous value in the high yield bond market still.

Economics: French Schadenfreude, Jim Callaghan, A Large Vault In Hong Kong, The Credit Crunch And Why Gold Looks So Shiny! By Gareth Milliams

2009-09-22T22:43:00.010+09:00

I hear so many reports of unemployment being a lagging indicator. This historically is true. However those who were rendered unemployed in previous recessions tended to be unskilled or semi skilled workers. This recession is different. It has affected every strata of society. It does not discriminate.

This recession was built upon our collective avarice and debt. Sure, the banks are guilty of bundling up mortgages and slicing and dicing and reselling them over and over again. But blaming the banks is like blaming a drug pusher for our addiction.

We live in a society which allows excess without taking responsibility. We can get fat on MacDonalds and sue them for our obesity. We can get drunk on cheap alcohol and take the brewer to court. If our lives are not happy, we blame our parents. We have become a society of grasping needy children wanting whatever shiny thing it is that takes our eye without considering the consequences.

We want fame without having talent, beauty without having the looks. We wanted homes without the wherewithal to buy them and the lifestyle without the hard work or means to finance it. Now that it has all gone wrong, we are looking to apportion blame. We take no responsibility. Yet "The truth", as the poet Browning said, "lies within us".

In Asia, people look askance at Europe and the US, wondering how these massive economies could have created such chaos. How entire nations could have allowed their economies to crash head first into the hardened concrete of financial reality. It almost became a right to own a million dollar home or to have a brand new car every year and take holidays in exotic climes. As aforementioned, we are grasping, needy children who have no regard for the consequences of our actions.

This recession is different. This one matters. This is not about overvalued stocks. It is about our financial values.

A good model of a sensible western economy is France. France was comparatively unaffected by the downturn and is now officially out of recession. In France, very few people own a credit card and proportionately less own their home. Lending criteria is much tighter than in the UK or US and therefore personal debt levels are markedly lower. Additionally, the state plays a massive role, in what is a Keynesian economy. This is not to say that France (or Germany) won't go back into recession, but it does highlight how a society more sensitive to personal debt can weather the credit crunch better.

From The Economist of May 7th 2009:

The French are great savers and most have not taken out unaffordable mortgages or spent heavily on credit. Household debt as a share of GDP is less than half that in Britain or America. The prospect of nationalising banks may give Americans nightmares about turning French. In fact the French government has not yet had to rescue any big French bank from collapse, let alone nationalise one. Though there is outrage at bonus payments in firms laying off workers, bosses’ pay in France is not that extravagant, and the income gap between the top 10% and the bottom 10% is far smaller than in Britain or America.

Please excuse the awful pun, but I think for the smirking Germans and French, schadenfreude has now become de riguer.

Surely the prerogative of government is to regulate. I cannot walk down the street shooting people because it is dangerous. We legislate and create severe penalties to stop me from doing that. I understand the letter of the law and the morality behind its spirit and so I choose not to kill. However, should a group of people decide to risk the financial security of others and enrich themselves doing it, then that is OK. Should they do so and bankrupt entire nations in the act, then they may do so with impunity. It seems that sheer greed has its own moral code.

So where are we now and where are going?

What worries many in the UK and US is the level of individual debt built up by people even on minimal wages. Many lower income workers have a large mortgage on their home and substantial debt via credit cards. It is the always the unskilled and semi skilled workers who are more likely to be laid off.

Once unemployed they are more likely to be unable to pay their mortgages thus could lose their homes increasing inventory reducing the value of all property. Even those that keep their houses and their jobs are likely to be underwater and so cannot move to an area with better employment prospects. Workforce mobility is key to long term economic growth.

Below is a graph highlighting state by state as to when US properties are likely to reach their previous highs. It is from an excellent article by Barry Ritholtz of The Big Picture (click provided links accordingly).

If you are wondering what CSI stands for; it is the Case-Shiller Index which calculates data based on repeat sales of single homes.

The findings are quite shocking with some states having to wait more than 14 years to regain peak value.

The devastating effects of this crisis are multifarious. For example, those who are younger may find themselves frozen out of jobs as senior staff are forced to take later retirement because of the decimation of their pensions. Employment is a trickle down system where older workers retire creating room upstairs for the next generation of senior staff. This continues down to the very lowest trainee levels.

Thus we have high unemployment with no relief from worker retirement and less worker mobility due to mortgage indebtedness. More dangerously, we may also have a generation of unemployed youngsters with nothing to do and no prospects.

On the matter of the unemployment figure; it did drop during the summer, but now we face the prospect of winter and an official figure somewhere north of 10%. Yet all we hear from the fund managers on CNBC is talk of green shoots and confidence. It is pure propaganda. They need you to spend your hard earned savings on equities. The fact that they know that the equity indices are overbought is irrelevant. So long as you believe that the recovery is here; all is right with the world.

However, where there is a lie, truth can also be found. To create this false environment of growth and stability, trillions of dollars, pounds sterling and euros have been spent by governments around the world in order to prop up their failing economies. This 'quantative easing' (QE) is where central banks inject into the banking system massive amounts of cash to lubricate the rusting teeth of the cogs of lending. Its immediate effect is beneficial. Used well and in overwhelming tranches, it will defeat deflation. But it comes at a price. When the printing of money is out of control, a time will come when it is supported by nothing other than a politicians promise.

It used to be that money was supported by gold and that government could not spend money like a drunken sailor unless there was enough gold or taxes to support it. No longer. Federal deficits rose under Reagan, fell under Clinton and exploded under George W Bush. Unfortunately, the Republicans lacked the courage of their outspoken convictions by refusing to cut services whilst slashing taxes and fighting two major wars. Preferring to talk of freedom from big government whilst indebting themselves to China and Japan.

So here we are faced with the massive levels of personal debt that caused the credit crunch and enormous governmental debt designed to fight it. The outcome will be inflation. If a government prints more money than the value of the assets that back it, then inflation will ensue.

From the Independent 22nd July 2009:

In the UK, debt as a proportion of national income is expected to surge above the level it reached when Jim Callaghan was forced to go cap in hand to the International Monetary Fund in 1976. And as a proportion of GDP, it is shooting up to levels not seen since Britain was paying off the borrowing it incurred to fund the Second World War.

So as an investor how do you make money with a large lump sum of cash? How can your portfolio grow in 2009/10?

The interesting thing about a market like this is that your choices are so limited. Therefore you work on what you know and what is systemic. The time for imaginative portfolio management has gone for the time being. Now it is about discipline and patience.

We know that inflation is coming. We know that gold reacts well to an inflationary environment. We know that gold is up despite it presently being in a deflationary environment, an adverse condition. Therefore we can assume that if gold is up in a negative climate, that its rise will logically be greater when inflation arrives.

We also know that the Chinese government is selling the concept of buying gold to its people via TV and radio advertising. Therefore, we can ultimately expect a massive increase in the purchase of physical gold making it more scarce, thus pushing up the price. This is in conjunction with Hong Kong withdrawing its gold reserves from London to be deposited in its own vault near Chep Lap Kok airport. This weakens the London gold market and establishes Hong Kong as a regional gold hub. The Chinese government knows the value of having access to available gold reserves at a time of financial crisis.

Lets assume that the inflation comes. It will not only be gold that rises but other commodities too. These we will select according to their particular market environment at the time. However, we like CAD and AUD. These are two great commodity currencies that offer a fair amount of hedging against a falling USD.

Mining has been on a tear for the last 6 months. It (possibly more than any other sector) was traumatised by the collapse in equity prices in October/November 08. When the hedge funds began to receive record redemption requests from worried clients last year, they dissipated their positions in mining. The effect was catastrophic. Anybody who held mining stock then, experienced a massive loss.

This time may be different. Mining stock is comparatively cheap compared to a year ago. In fact year to date the gold ETF, GLD has outperformed the worlds two largest gold miners, Barrick and Freeport McMoran by 10%.

This is key because during a bull market in gold, the physical metal prices will go higher, but the gold mining shares are leveraged to the physical price. In other words, as the price of gold rises, profits from mining stocks rise more in percentage terms. Generally, over the longer term, the share prices of the major gold producers rise by a factor of two to three times more than the price of gold. Successful junior mining companies can rise by a factor of 5 to 10 times more than the price of gold. The reason for this leverage is that a rising gold price does not lead to a rising cost of production. Therefore, for companies that are already profitable, incremental revenues received from selling gold at a higher price flow straight to the bottom line. For mining companies that are not profitable, a rise in the gold price can suddenly lift them into profitability and a much higher share price.

Effectively, I am recommending a three tier approach. Tier 1 is cash and physical gold. Tier 2 is large miners and tier 3, junior miners. As aforementioned, we are also looking at other industrial metals but the worlds largest gold miners tend also to be amongst the worlds largest silver and copper miners too.

So whether by lump sum via a portfolio bond or as a fund in a savings plan the future looks very shiny for those who love gold..

Investment: A Slight Change In Tactics By Gareth Milliams

2009-09-16T00:03:00.003+09:00

Short Yen

Long Dollar

Hold Gold

The dollar looks oversold and the Yen seems to have hit a wall. We bought at ¥98.8 we'll sell now at the lower ¥91's.

It won't be too long before we are long JPY again.

Happy days.

Gold will naturally weaken as it looks for a reason to make a sustained bid to get back over $1000. That context may not be available just yet. But no mistake it shall come.

So we shall hold.

Gold: Why Would The Chinese Government Become A Gold Broker?

2009-09-07T23:42:00.003+09:00

Why is it encouraging its citizens to buy gold and silver?

Why?

It is a specific investment.

The Chinese government is recommending a particular investment.

It is acting as if they were 'The Peoples Investment Broker'.

Could it be that they are confident that gold will go up, because they are about to dump the US dollar?

The effect on commodities will be cataclysmic.

A cheaper US dollar is inflationary. Oil, gas, corn (everything!) will rise in value at a rate of knots.

Whilst American manufacturing will benefit from being able to export their products at a cheaper price, the average American will find it harder to afford them because their dollar will be worth less.

Or even worthless.

Surely China won't do this.

Or would they?

Gold: Is This The Eureka Moment?

2009-09-06T11:27:00.004+09:00

There are moments in history that are tipping points. These events, whilst initially appearing inconsequential can act as the catalyst for major change.

Below is an article posted on Thursday 3rd September on www.mineweb.com. The report says that the Chinese government is advertising on TV in order to encourage its people to buy gold.

This is potentially huge. The Chinese are presently not avid buyers of gold, but could you imagine the effect on the gold price if they were?

China pushes silver and gold investment to the masses

A report suggests that the Chinese government is pushing the general public into buying gold and silver bullion, which could have a dramatic effect on the markets.

Author: Lawrence Williams
Posted: Thursday , 03 Sep 2009

LONDON -

We are indebted again to Paul Mylchreest's Thunder Road Report for news that will bring big smiles to gold and silver investors everywhere. Apparently China is pushing the idea of buying gold and silver for investment purposes to the general population in the way that Western television sells soap powder. If 1.3 billion Chinese citizens start buying gold and silver, even in tiny quantities, imagine what that will do to the market!

The report notes that China's Central Television, the main state-owned television company, has run a news programme letting the public know how easy it is to buy precious metals as an investment. On silver investment the announcer is quoted as saying " China has introduced its first ever investment opportunity for silver bullion. The bars are available in 500g, 1kg, 2kg and 5kg with a purity of 99.9%. Figures show that gold was fifty times more expensive than silver in 2007, but now that figure has reached over seventy times. Analysts say that silver has been undervalued in recent years. They add that the metal is the right investment for individual investors and could be a good way to cash in."

What appears to have happened in China is a total relaxation of strictures on holding precious metals by the individual with the government pushing gold and silver as an investment option, seemingly at every opportunity. This is a far cry from the situation only a few years ago where the distribution of gold and silver was strictly controlled. Now, the Thunder Road Report notes that every bank will sell gold and silver bullion bars in four different sizes to individuals and gold related investments are said to be soaring in popularity.

Around a year ago, Leyshon Resources managing director, Paul Atherley, in an investor presentation in London - and no doubt delivered elsewhere in the world too - commented that some employees at the company's gold mining project in northern China would, on pay day, go to the local bank and buy a small gold bar as an investment and wealth protector. To an extent we put this down at the time to mining company hype - but this seems to be exactly the same phenomenon noted by Thunder Road. The Chinese are being converted from being the lowest per capita gold consumers in the world to a nation of small precious metals investors. Now, by next year, Chinese consumption of gold is likely to exceed that of India, which has been for years the world's biggest gold market. And one suspects that the potential for gold purchasing by individuals is only in its earliest stages. As more and more Chinese move into the cities and individual wealth grows, this trend is only likely to accelerate.

Paul ends the piece on Chinese gold and silver potential with the following comment: "Simply put, the Chinese government is trying to trigger a national gold craze...and it's working. The Chinese public now has gold trading platforms on steroids.... ...Also, for the first time in history, Chinese investors can even trade gold abroad (in London) with the swipe of a ‘Lucky Gold' card. I can't even get Bank of America to open a foreign currency account."

This may be an overstatement of the case from a precious metals bull - or it may not! Certainly if China is indeed pushing the public to buy gold then there may well be a hidden agenda here. It's unlikely they are doing it and will suddenly pull the rug out from under millions of investors. A cynic (or a raging gold bull) would suggest that this will precede a move to switch a good proportion of the country's reserves into gold which would have a huge effect on the global gold price and could prove disastrous for the dollar. Maybe it's not in China's interests to drive the dollar down too much until it has managed to divest itself of the huge dollar overhang (see the article on Chinese Sovereign Wealth Funds we published yesterday - Chinese sovereign wealth fund dumping dollars for strategic investments like gold ). The country may well already be, of course, surreptitiously building its gold reserves without reporting the build-up.

If the Chinese are indeed beginning to buy gold and silver as the quoted report suggests then this has to be a strong signal that prices are going to rise, and perhaps rise dramatically, in the relatively near future. We await comment from other China watchers for confirmation of the gold and silver buying spree, but with global gold production at best flat and probably in decline, even a small increase in Chinese buying could have a substantial impact on gold and silver prices.

The Markets: Investment Outlook By Bill Gross of PIMCO

2009-09-04T19:17:00.009+09:00

Arguably, the worlds most powerful fund manager, when Bill Gross of PIMCO (click to link to their site) talks people listen. This month he looks at future market growth using golf as an allegory.

Investment Outlook

Bill Gross | September 2009

On the “Course” to a New Normal

Analyzing why people play golf is like exploring the intricacies of string theory – there are so many permutations lacking scientific observation that physicists or golfers can pretty darn well say anything they like and the explanation might stick. When it comes to whacking that little white ball, the possibilities are nearly endless: People play to relax, to be with friends, to get close to Mother Nature, to enhance business connections, to compete and excel. Gosh, I don’t know, the Zen explanation for why we play golf could even resemble the old saw about climbing a mountain: People golf because it’s there. Whatever the reason, it is the most frustrating, damnable game ever conceived – alternately elevating and depressing you within the span of mere minutes. I love golf. No, I hate it.

Personally, the reason that golf draws me to its intricate web of psychological entrapment is epitomized by a simple six-inch trophy: a chartreuse ball resting on top of its ebony base, preening on a bookshelf in the family room at our desert home. Its inscription reads, “Hole in one, March 15^th, 1990, 14^th hole Desert Course, 155 yards.” Well and good, I suppose – the ace of my life – except it wasn’t. It was the ace of my wife. Above the inscription rests the name Sue – not Bill – Gross. It was a great shot but it wasn’t my shot, and I guess therein lies the explanation for why I continue to tee it up.

Actually, two years ago I did tee it up in the sweltering 105° June heat of the Palm Springs desert. No one, of course, was crazy enough to be with me including my “ace” role model wife who was sipping a cool lemonade in the comfort of our air-conditioned home. Now, there is an “unwritten” rule in golf that in order to be official, a hole-in-one has to be witnessed, and that you have to play a full 18 holes. Otherwise, I suppose, you could stand on the tee with a bucket of balls and hit hundreds or thousands until one of the little guys went in – whatever. The fact is, on this particular day, I was playing only one ball, but I was alone, and – good God! – it went in! The trophy with ebony base and spanking white Titleist ball would read: “Hole in one, June 7^th, 2007, 17^th hole, Mountain Course, 139 yards.” Or was it? Does a falling tree make a sound in the middle of a forest if no one’s there? Is a hole-in-one a hole-in-one if no one else saw it? I say emphatically – yes! That damn ball went in and later that day Sue agreed with me (although she had a funny look in her eye – especially since she didn’t know a thing about the rules of golf). No one else though. No one else agrees with me. Not a soul. I suspect they’re jealous and, in fact, I’ve seen a few of them hitting buckets of balls at dusk from that very same tee when they think nobody’s looking. I’m watching, though, which brings up a funny question. If they sunk one, would theirs be a hole-in-one because I was a witness? Like I said – a damnable game.

“Is a hole-in-one a hole-in-one” may not strike you as the most critical question of the hour, and I would readily agree. “Will we have a New Normal global economy (and investment market)?” would probably usurp it on even Tiger Woods’s top ten list. This “new” vs. “old” normal dichotomy was perhaps best contrasted by Barton Biggs, as I heard him on Bloomberg Radio in early 2009, when he said he was a “child of the bull market.” I thought that was a brilliant phrase, and Barton is a brilliant phrase-maker. He went on to say though, that his point was that for as long as he’s been in the business – and that’s a long time – it has paid to buy the dips, because markets, economies, profits, and assets always rebounded and went to higher levels. That is not only the way that he learned it, but that is the way, basically, that capitalism is supposed to work. Economies grow, profits grow, just like children do. I think that’s why he said he was a child of the bull market, not just because he had experienced it for so long, but also because economic growth and higher asset prices are almost invariably a natural evolution, much like the maturation of a person. That’s how people grow, and so I think Barton was saying that capitalism just grows that way too.

Well, the surprise is that there’s been a significant break in that growth pattern, because of delevering, deglobalization, and reregulation. All of those three in combination, to us at PIMCO, means that if you are a child of the bull market, it’s time to grow up and become a chastened adult; it’s time to recognize that things have changed and that they will continue to change for the next – yes, the next 10 years and maybe even the next 20 years. We are heading into what we call the New Normal, which is a period of time in which economies grow very slowly as opposed to growing like weeds, the way children do; in which profits are relatively static; in which the government plays a significant role in terms of deficits and reregulation and control of the economy; in which the consumer stops shopping until he drops and begins, as they do in Japan (to be a little ghoulish), starts saving to the grave.

This focus on the DDRs – delevering, deglobalization, and reregulation – may be conceptually understandable, but nevertheless still a little hard to get one’s arms around. Why would they necessarily lead to a new, slower growth normal? A little easier to grasp might be the following approach, which feeds off the same concept, but which extends it a little further by suggesting that DD and R lead to a number of broken business or economic models that may forever change the world we once knew and make even Barton Biggs a chastened adult. They are as follows:

American-style capitalism and the making of paper instead of things. Inherent in the “great moderation” of the past 25 years was the acceptance of a sort of reverse mercantilism. America would consume, then print paper assets and debt in order to pay for it. Developing (and many developed) countries would make things, and accept America’s securities in return. This game is over, and unless developing countries (China, Brazil) step up and generate a consumer ethic of their own, the world will grow at a slower pace.
Private vs. public-driven growth. The invisible hand of free enterprise is being replaced by the visible fist of government, a temporarily necessary, but (if permanent) damnable condition itself in terms of future growth and profits. The once successful “shadow banking system” is being regulated and delevered. Perhaps a fabled “110-pound weakling” may be an exaggeration of where our financial system is headed, but rest assured it will not be looking like Charles Atlas anytime soon. Prepare to have sand kicked in your face, if you believe you are a “child of the bull market!”
Global economic leadership. It’s premature to award the 21st century to the Chinese as opposed to the United States, but if the last six months have been any example, China is sort of lookin’ like Muhammad Ali standing over Sonny Liston in 1964 yelling, “Get up, you big ugly bear!” Not only has China spent three times the amount of money (relative to GDP) to revive its economy, but it has managed to grow at a “near normal” 8% pace vs. our “big R” recessionary numbers. Its equity market, while volatile and lightly regulated, has almost doubled in twelve months, making ours look like that ugly bear instead of a raging bull.
United States housing and employment. Old normal housing models in the U.S. encouraged home ownership, eventually peaking at 69% of households as shown in Chart 1. Subsidized and tax-deductible mortgage interest rates as well as a “see no evil – speak no evil” regulatory response to government Agencies FNMA and FHLMC promoted a long-term housing boom and now a significant housing bust. Housing cannot lead us out of this big R recession no matter what the recent Case-Shiller home price numbers may suggest. The model has been broken if only because homeownership is declining, not rising, sinking to perhaps a New Normal level of 65% as opposed to 69% of American households.

Similarly, the financialization of assets via the shadow banking system led to an American era of consumerism because debt was available, interest rates were low, and the livin’ became easy. Savings rates plunged from 10% to -1%, as many (if not most) assumed there was no reason to save – the second mortgage would pay for everything. Now things have perhaps irreversibly changed. Savings rates are headed up, consumer spending growth rates moving down. Get ready for the New Normal.

I could go on, reintroducing the negatives of an aging boomer society not just in the U.S., but worldwide. Increased health care may be GDP positive, but it’s only a plus from a “broken window” point of view. Far better to have a younger, healthier society than to spend trillions fixing up an aging, increasingly overweight and diabetic one. Same thing goes for energy. Far easier and more profitable to pump oil out of the Yates Field in Texas or even Prudhoe Bay than to spend trillions on a new “green” society. Our world, and the world’s world, is changing significantly, leading to slower growth accompanied by a redefined public/private partnership.

The investment implications of this New Normal evolution cannot easily be modeled econometrically, quantitatively, or statistically. The applicable word in New Normal is, of course, “new.” The successful investor during this transition will be one with common sense and importantly the powers of intuition, observation, and the willingness to accept uncertain outcomes. As of now, PIMCO observes that the highest probabilities favor the following strategic conclusions:

Global policy rates will remain low for extended periods of time.
The extent and duration of quantitative easing, term financing and fiscal stimulation efforts are keys to future investment returns across a multitude of asset categories, both domestically and globally.
Investors should continue to anticipate and, if necessary, shake hands with government policies, utilizing leverage and/or guarantees to their benefit.
Asia and Asian-connected economies (Australia, Brazil) will dominate future global growth.
The dollar is vulnerable on a long-term basis.

Like playing in an Open Championship, future golfers/investors need to play conservatively and avoid critical mistakes. An “even par” scorecard (plus some hard earned alpha) may be enough to hoist the trophy in a New Normal world. Holes-in-one? Maybe if you’re lucky. But make sure someone’s watching, and that their eyes are focused on the New Normal. As for golf, even Sue, my only supporter, has asked me to move my ball, on its own ebony base, away from her more authentic and perhaps the still solitary ace made by Gross family golfers. What a damnable condition.

William H. Gross
Managing Director

Investment: Mutual Funds vs ETF's By Gareth Milliams

2009-08-30T23:04:00.006+09:00

It is the question that I get asked the most: “What is the better investment, the ETF or the mutual fund?” There is no easy answer, so lets look at the differences.

Mutual funds begin with buckets of cash and a (hopefully) top-notch investment team. The fund is then marketed by salesmen to the public. The fund manager is more often than not, a stock picker with a particular brief. The quality of the fund manager determines the success or otherwise of the mutual fund.

ETFs work almost in reverse. They begin with an idea -- tracking an index -- and are born of stocks instead of money.

What does that mean? Major investing institutions like Barclays or the Deutsche Bank control billions of shares. To create an ETF, they simply transfer a few million of them, putting together a basket of stocks to represent the appropriate index, say, the Nasdaq composite or the Shanghai Stock Exchange.

They deposit the shares with a holder and receive a number of creation units in return. Creation units are the building blocks of an ETF. One creative share represents each individual stock within that ETF. Dependent upon the ETF and the weighting of the index, there could be 50,000 shares within a creative unit. The creation units are then split into individual shares for public consumption.

So, then what are the differences?

There are many, but rather than being fundamental, they tend to be nuanced.

For example, a mutual fund often has a minimum subscription of $50,000 or more. This is not the case with ETF’s, which have no minimum whatsoever.

As a mutual fund becomes more successful, more shares are purchased. In an open-ended mutual fund, additional shares do not dilute the net asset value (NAV) nor should they radically affect the value of the underlying assets.

A disadvantage of an ETF in an illiquid index (such as some soft commodity markets) is that the ETF can fundamentally change the price of the asset rather than reflect it. This has led to price fluctuations in markets such as corn and even oil. Many hedge fund managers favour the ETF because of its inherent flexibility.

But no investment is perfectly structured. Imagine, that you own a lump sum portfolio and it’s 10am in New York and the markets are tanking. The S&P 500 is 3% down and looking as if it has further to fall. You call me and ask me to sell immediately. I then immediately fax a sell instruction to the portfolio bond provider and the ETF is sold within the next few minutes. I can also take advantage of the declining market by buying short ETF’s.

Another client with another Tokyo brokerage owns mutual funds. He too, is spooked by a market down 3% and calls his broker who accordingly, faxes the provider who places the sell order. If the client is lucky (very lucky), the mutual fund will be sold at the end of the working day. Far more likely, it’ll be the end of the week or month or quarter with potentially horrendous damage to repair.

The ETF has also been bought and sold at a very low cost (less than 0.15%) whereas some mutual funds from boutique managers (usually fund of funds) can have redemption penalties of 5% or even more.

However, the story is not completely one sided. Whilst there are benefits to ETF’s with lump sums, there are also benefits to mutual funds with savings plans, particularly with regard to dollar cost averaging.

Dollar cost averaging demands that comparatively small amounts of money are invested on a regular basis into an investment. Here the mutual fund has an advantage. Because we are averaging, we are not going to sell should the NAV of the fund drop. In fact we initially encourage losses in order to build up additional units bought at discount. Additionally, because the mutual fund also holds cash, its position is slightly more defensive.

The ETF however, has a zero cash position and much higher expenses (brokerage fees etc) particularly if you buy very small amounts on a regular basis. Conversely, the costs of investing in a managed mutual fund based within a monthly contribution offshore savings plan with a major institution are comparatively low. Offshore mutual funds within a formal savings plan often have no bid/offer spread and they have unlimited switching.

So the answer to the question of “what is the better investment, ETF’s or managed funds?” is not simple. I generally prefer ETF’s for lump sum portfolios unless I come across something very special from a fund manager. However, within a monthly savings plan the managed mutual fund concept works very well indeed.

In my opinion, both of these popular investment vehicles have a viable future. The ETF industry will continue to grow at leaps and bounds, but there will always be a place for investments managed by people.

The Crisis: Is it over....or is it astroturf? By Gareth Milliams

2009-08-24T22:42:00.004+09:00

I heard a nice phrase the other day.

There are no green shoots, the recovery is artificial. It' s only astroturf...

Apocalypse When? Or What Will Happen To Your Money When The Correction Comes? By Gareth Milliams

2009-08-23T14:41:00.009+09:00

The chart above which takes into account inflation in order to plot 'real' returns is quite shocking. It seems that this financial crisis has been retracing the 1929-1949 bear market very closely indeed.

The run up from March 9th until now is almost unprecedented & the gains have been astronomic. Unfortunately, the rally has been built upon low expectations and cheap prices. But those expectations are now higher and the stocks are no longer cheap. These markets now have to justify their values and thats proving harder to do.

The rally is becoming unsustainable and is fast running out of breath. Volumes have been dropping gradually since March and rallies need to be fed.

The correction is coming and for my portfolio clients it will be an opportunity. They are cash rich and equity poor.

We expect all bond prices and commodity ETF's to drop in lockstep with equities and these will be our focus.

All savings plans less than a year old will dollar cost average, those with a considerable capital sum attached will be moved to a dominant cash position with possibly a small percentage switched to the CAAM Volatility World Equity Fund .

The question is this:

For those of you who are not my clients, I ask what are you doing to protect yourself from the gathering storm? More importantly, what is your financial adviser doing to preserve your wealth?

The next few weeks could be key. For many advisers who missed last years crash to your cost, it is a second chance. Should they miss the opportunity again, then you must surely reconsider your options.

The Markets: Plus ça change, plus c'est la même chose

2009-08-21T11:43:00.002+09:00

The more things change, the more they stay the same. Below is a daily summary of the Wall Street Journal from 1930. They talk of a bull market and a summer rally as well as credit expansion by the Fed. It is shocking to read in light of what is happening now. The past truly is prologue.

Thanks to newsfrom1930 for the content and James In Japan for the tip off.

Market commentary:

Bulls encouraged by resistance to repeated bear efforts Saturday and Monday following explosive rise Friday; buying movement spread broadly across the market early. Major industrials strong including US Steel, GE, Westinghouse, as were major utilities and rails (Consol. Gas, New York Central). Steel news caused some irregularity, but good buying appeared on setbacks. Bond market firm; corp. and preferreds up; govts. steady; Dow 40 bond average at new yearly high of 96.61.

E. Johnson, former Pres. Victor Co. (merged with RCA), returns from trip to survey conditions in Europe; feels general US business recovery under way, will be comparatively rapid up to a certain point; thinks stock prices somewhere near bottom.

Conservative observers even more cautious than usual; believe recent rally due to oversold condition, and decline will resume when short-covering ends.

Some market students encouraged by repeated support above June lows, advise buying leading stocks if they again approach these levels.

J.H. Oliphant & Co. finds Dow action this summer technically interesting; 6 times since June, market has found strong support after declining to 215-218 level.

Bears reportedly less confident after last week's action, though short interest remains large. Public participation still seen small.

Increase in credit outstanding in first half was interpreted bullishly, but has stopped since mid-June. “This may mean that stimulus to business in the form of credit expansion induced by Federal Reserve policy has reached its effective limits ... ”

Economic news and individual company reports:

US rail freight loadings for week ended Aug. 9 were 904,157 cars, down 14,178 from previous week and 187,966 from 1929; worst decline yet vs. 1929.

Steel production industry-wide was at 54.5% last week vs. 56% previous week and 58% two weeks ago; US Steel at 62% vs. about 62.75% previous week and 64% two weeks ago. Decline was unexpected; some improvement had been rumored.

Oil curtailment still working: Gasoline in storage at refineries Aug. 16 was 41.252M barrels, down 1.477M in past week; refineries operated at 72.6%, up from 69.1%; crude oil production was 2.464M barrels/day, down 16,800 from previous week and 478,000 from 1929.

Public utility earnings generally higher year over year in each month, though declining month by month this year. June net earnings of 95 utilities were $83M vs. $79M in 1929, but lowest of year so far and down from high of $92M in Jan.

NY City budget for 1931 expected over $600M vs. $569.8M this year.

Investment:Volatility Is Your Friend By Gareth Milliams

2009-08-11T11:52:00.013+09:00

The stock and equity fund investor is always going to be vulnerable to losses during recessions. There are so many factors that can make a single stock or an entire market fall; whether it be disappointing earnings, declining profits, increasing losses or more general financial unhealthiness such as a fall in national GDP or even a perception of weakness.

Investing into a single stock or equity fund is a declaration of faith. It is an affirmation of a belief that the share or unit will be worth more when sold than when bought. To achieve that aim, all the positive financial ducks need to be in a row. Perception has to be ready to strengthen and that sentiment has to be translated into the physical purchase of goods and services. Moreover, those goods and services need to be sold at a healthy margin.

Only then can our equity funds show profit.

Unfortunately we are having to constantly battle a 7 year cycle of boom bust. For example:

2008: Global Financial Crisis

2001: Global Recession

1994: Mexican Peso Crisis

1987: Black Monday

1980: Global Recession

1973: Oil Crisis

1966: Global Recession

Investment can be hazardous (to say the least) for the average punter. However, those of you who invested with me were out of the equity markets in August 2008. We preserved capital and kept our powder dry.

The issue that we face now, is what to do with that saved money? We have bought some high yield bonds and will look (when appropriate) to buy more (probably tier 2+) in the future. We will buy these assets because they offer real value at discounted prices.

Last week I met with two senior executives of Friends Provident International. They told me of a new fund that they are launching with Credit Agricole which invests in the volatility created within the S&P 500, DJ Eurostoxx 50 and the Nikkei. Weightings are 50%, 30% and 20% respectively.

The basic principle is simple:

When volatility is high, they are short and when volatility is low, they go long. The results have been stunning. In 2008, the CAAM Volatility World Equities fund returned 26.84%. 2009 has also been positive YTD.

It is daily traded and marked to market with daily pricing and redemption and has an institutional class. It is available via the Reserve portfolio bond and as a mirror fund in Premier and Premier Ultra.

This fund is not designed to be a core profit driver but as a satellite holding with a 10% position.

Below is its chart since actual inception (please click to enlarge to full size):

I think that we can all agree that the recovery will be volatile. Happy days are not quite here again and it will be a bumpy road until we get there. This fund is designed to smooth those bumps and ensure that you get there wealthier and in comfort.

Investment: The End Of A Year Of Living Less Dangerously By Gareth Milliams

2009-08-10T14:45:00.004+09:00

For a year I held back, not believing the propaganda and kept it simple, just gold and yen/dollar. However, in the last week, after consultation with clients and much research, we bought back in.

Bought back in, but not into the equity market, nor into commodities. Instead, we bought high yield corporate bonds from banks. The bond that we bought had an interest rate in excess of 7% but a price less than half of its original minimum. The yield is based upon the original minimum, therefore because the price has dropped below half we will receive a return in excess of 16%pa. No matter how far down the price drops, the yield always assumes that the bond price is at EUR1.00.

With the bond price below EUR0.50, we can look forward to further growth with a price of at least EUR1.00 on maturity. That is way beyond double.

Obviously there is risk with the bond price. It has already fallen more than 50%. With that in mind we bought the minimum subscription. This reduces risk but more importantly will allow us to buy further tranches if the market falls.

This blog post is in no way a solicitation to buy and we assume all investments have risk attached.

The Markets: When Sticking To Your Guns Feels Like A Futile Gesture By Gareth Milliams

2009-08-10T10:47:00.005+09:00

Apologies Father for I have sinned, it has been nearly a month since my last post.

It has been a while. I feel a bit like the man who built a nuclear shelter. And waited. And waited. Only for the Berlin Wall to collapse along with the Soviet empire.

A year ago, I sold my clients equity assets and held just physical gold and currencies. Until last week, this was still my strategy. Maybe I'm a bitter-ender, the last man standing, but I cannot believe that all is well, when the worlds financial architecture crumbled less than a year ago.

There has been no reform, unless massive quantitative easing constitutes reformation. But chucking money at a bankrupt financial system is like putting out an oil fire with water. There will be an explosion and people shall be burned.

So, I'll stick to my guns until I know I'm wrong and I will not risk my clients money buying equities in a market as brittle as this.

Investment: The Long Slow Bleed By Gareth Milliams

2009-07-13T14:56:00.017+09:00

You would have thought that people would have learned their lesson. You would have thought that since the great crash of 2008 that people would be more wary of the markets.

There has been much talk of a 'V' shaped recovery. It is foolish. In my lifetime I have never witnessed such a phenomenon and probably never will. I've seen a few 'U's and a Japanese 'L' as well as a "head and shoulders' and many square roots. But a perfect 'V', never.

1929 Crash and the Current Bear | Shift the Overlay by 10.6 Months

For comprehensive retirement planning advice, dshort.com recommends Rule Your Retirement.

data sources

Market volumes have dropped. A lot. If institutions are on the sidelines, there is good reason.

Insider selling is at a high for 2009. If senior executives at S&P corporations are dumping shares, there is also good reason.

If President Obama, VP Biden and Larry Summers, the Director of the White House's National Economic Council say that the worst is not over, then I tend to believe them.

There is no certainty that the markets will fall, but there is uncertainty in the markets.

People have been waiting for the cataclysmic event. The big crash that creates history. But thats over. Thats 2008. There will probably be no more nuclear explosions in the markets but the fallout will be radioactive. This market is in slow bleed mode.

Unemployment will be a drag on growth. According to super-analyst Meredith Whitney, unemployment could be going as high as 13-15% in the US. How many of those workers were to be retirees that have now chosen not to retire thus clogging up the job market?

How many of the 13-15% are property owners with prime loans in danger of foreclosure? What will the effect be of lower contribution levels from 401k's and IRA's?

Too often we look at the equity markets as an indicator of financial well being. They are not. They respond to drivers such as earnings expectations and perception. Perception can bring markets down. It is perception that makes markets fall in lockstep, despite minimal correlation. It is also perception behind the low trading volume that we are experiencing.

This chart is called "Diversification Works Until It Doesn't!" and it illustrates the fact that perception can make markets drop in harmony with minimal deviation.

I am searching (in vain?) to find the catalyst that will continue to push this market up or for reasons that will help it maintain this level for the next few months.

Instead, I am glad that I am holding US$, JPY and some gold bullion rather than equities in my lump sum portfolios.

My monthly savings plans are generally in cash with new contributions invested in the hard hit, still deleveraging mining and oil sectors. Energy and commodities offer terrific long term value for monthly savers by dollar cost averaging with heavily discounted units. With only monthly contributions going in, the risk is negligible with a massive upside.

There is a phrase that has become rather fashionable in investment circles recently. It is "Ignorant Capital". It is used to describe investment into some fund of fund hedge funds. I believe that it can also be used to characterise investments left to the whims and caprice of an uncertain August by investors and advisers who do not take heed.

Economics: Bill Gross Of Pimco On The 'New Normal'

2009-07-09T23:14:00.009+09:00

Investment Outlook

Bill Gross | June 2009

Staying Rich in the New Normal

“Behind every great fortune lies a great crime.”
Balzac

Balzac was on to something 200 years ago, but to be fair to modern day multi-millionaires, the only real way to accumulate wealth prior to the 18th century was to steal it, or tax it, I suppose, as was the case with kings and their royal courts. It was only with the advent of capitalism and annual productivity gains that entrepreneurs, investors, and risk-takers with luck or pinpoint-timing could jump to the head of the pack and accumulate what came to be recognized as a fortune. Still, the negative connotations persist. I remember a cocktail party in the early 80s where a somewhat inebriated guest engaged me in a debate about the merits of capitalism. “You’re filthy rich,” he said, which struck me as most unfair from a number of angles. First of all, he hadn’t seen anything yet, I thought, and second, I wasn’t quite sure where the “filthy” came from. Resentment that he’d missed out on my presumed good deal, I suppose, and in the process using a hackneyed phrase that was bitter and biting, yet had some context of historical sociological relativity. Still, he might have been on to something there – not about me, hopefully, because I’ve always felt that while PIMCO has prospered, it’s only because its clients have benefitted even more so – but about the developing sense of one-sided, perhaps off-sided wealth generation that was to dominate the next several decades. Granted, we had Bill Gates and Steve Jobs and other true capitalistic dynamos who benefitted society immeasurably. But growing percentages of fortunes were being made by those who could borrow or aggregate other people’s money. Because our economy was still in a relatively early stage of leveraging, those who borrowed money and used it to invest in higher-risk yet higher-return financial or real assets didn’t require a lot of skill, they just needed to be able to convince a bank or an insurance company to lend them some money. After that, the secular wave of leverage would be enough to multiply their meager equity many times over and carry them to a beach where a fortune awaited them much like a pirate’s buried treasure.

I remember as a child my parents telling me, perhaps resentfully, that only a doctor, airline pilot, or a car dealer could afford to join a country club. My how things have changed. Now, as I write this overlooking the 16th hole on the Vintage Club near Palm Springs, the only golfers who shank seven irons into the lake are real estate developers, investment bankers, or heads of investment management companies. The rich aredifferent, not only in the manner intoned by F. Scott Fitzgerald, but also in who they are and what they do for a living. Whether some or all of them are filthy is a judgment for society and history to make. Of one thing you can be sure however: over the next several decades, the ability to make a fortune by using other people’s money will be a lot harder. Deleveraging, reregulation, increased taxation, and compensation limits will allow only the most skillful – or the shadiest – into the Balzac or Forbes 400.

Readers who are interested in such things as the Forbes annual list of hoity-toities will have noticed that more and more of them are global, not U.S. citizens. The U.S., in other words, is not producing as much wealth in proportion to the rest of the world. Its fortune-producing capabilities seem to be declining, which might suggest that its relative standard of living is doing so as well. If so, the implications are serious, not just for Donald Trump but for wage earners and ordinary citizens, as reflected in their income levels and unemployment rates. Stockholders, 401(k) investors, and yes, bond managers will be affected too. Last week’s furor over the possibility of an eventual downgrade of America’s AAA rating demonstrates that only too clearly. On the night of May 20, Standard & Poor’s announced a downgrade watch for the United Kingdom and since the U.S. and U.K. are Siamese-connected, financially-levered twins, the implications were obvious: the U.S. might be next. In the space of 48 hours, the dollar declined 2%, and U.S. stocks and long-term bonds were down by similar amounts. Such a trifecta rarely occurs but in retrospect it all made sense: a downgrade would cast a negative light on the world’s reserve currency, and since stocks and bonds are only present values of a forward stream of dollar-denominated receipts, they went down as well.

The potential downgrade, while still far off in the future in PIMCO’s opinion, seemed dubious at first blush.While country ratings factor in numerous subjective qualifications such as contract rights, military might, and advanced secondary education, the primary focus has always been on the objective measurement of debt levels, in this case sovereign debt, as a percentage of GDP. Yet, as shown in Table 1, both the U.S. and the U.K. entered the Great Recession with attractive ratios compared to such grievous offenders (and AA rated) as Japan.

Yet as the markets recognized rather abruptly last week, both countries seem to be closing the gap in record time. To zero in on the U.S. of A., its annual deficit of nearly $1.5 trillion is 10% of GDP alone, a number never approached since the 1930s Depression. While policymakers, including the President and Treasury Secretary Geithner, assure voters and financial markets alike that such a path is unsustainable and that a return to fiscal conservatism is just around the recovery’s corner, it is hard to comprehend exactly how that more balanced rabbit can be pulled out of Washington’s hat. Private sector deleveraging, reregulation and reduced consumption all argue for a real growth rate in the U.S. that requires a government checkbook for years to come just to keep its head above the 1% required to stabilize unemployment. Five more years of those 10% of GDP deficits will quickly raise America’s debt to GDP level to over 100%, a level that the rating services – and more importantly the markets – recognize as a point of no return. At 100% debt to GDP, the interest on the debt might amount to 5% or 6% of annual output alone, and it quickly compounds as the interest upon interest becomes as heavy as those “sixteen tons” in Tennessee Ernie Ford’s famous song of a West Virginia coal miner. “You load sixteen tons and whattaya get? Another day older and deeper in debt.” Pretty soon you need 17, 18, 19 tons just to stay even and that describes the potential fate of the United States as the deficits string out into the Obama and other future Administrations. The fact is that supply-side economics was a partial con job from the get-go. Granted, from the 80% marginal tax rate that existed in the U.S. and the U.K. into the late 60s and 70s, lower taxes do incentivize productive investment and entrepreneurial risk-taking. But below 40% or so, it just pads the pockets of the rich and destabilizes the country’s financial balance sheet. Bill Clinton’s magical surpluses were really due to ephemeral taxes on leverage-based capital gains that in turn were due to the secular decline of inflation and interest rates that at some point had to bottom. We are reaping the consequences of that long period of overconsumption and undersavings encouraged by the belief that lower and lower taxes would cure all.

The current annual deficit of $1.5 trillion does not even address the “pig in the python,” baby boomer, demographic squeeze on resources that looms straight ahead. Private think tanks such as The Blackstone Group and even studies by government agencies, such as the Congressional Budget Office, promise that Federal spending for Social Security, Medicare, and Medicaid will collectively increase by 6% of GDP over the next 20 years, leading to even larger deficits unless taxes are increased proportionately. Collectively these three programs represent an approximate $40 trillion liability that will have to be paid. If not, you can add that present value figure to the current $10 trillion deficit and reach a 300% of GDP figure – a number that resembles Latin American economies such as Argentina and Brazil over the past century.

So the rather conservative U.S. government debt ratio shown in Table 1 will likely be anything but in less than a decade’s time. The immediate question is who is going to buy all of this debt? Estimates suggest gross Treasury issuance of up to $3 trillion this calendar year and net offerings close to $2 trillion – almost four times last year’s supply. Prior to 2009, it was enough to count on the recycling of the U.S. trade/current account deficit to fund Treasury borrowing requirements. Now, however, with that amount approximating only $500 billion, it is obvious that the Chinese and other surplus nations cannot fund the deficit even if they were fully on board – which they are not. Someone else has got to write checks for up to $1.5 trillion additional Treasury notes and bonds. Well, you’ve got the banks and even individual investors to sponge up some of the excess, but a huge, difficult to estimate marginal supply will have to be bought. The concern is that this can be accomplished in only two ways – both of which have serious consequences for U.S. and global financial markets. The first and most recent development is the steepening of the U.S. Treasury yield curve and the rise of intermediate and long-term bond yields. While the Treasury can easily afford the higher interest expense in the short term, the pressure it puts on mortgage and corporate rates represents a serious threat to the fragile “greenshoots” recovery now underway. Secondly, the buyer of last resort in recent months has become the Federal Reserve, with its publically announced and near daily purchases of Treasuries and Agencies at a $400 billion annual rate. That in combination with a buy ticket for over $1 trillion of Agency mortgages has been the primary reason why capital markets – both corporate bonds and stocks – are behaving so well. But the Fed must tread carefully here. These purchases result in an expansion of the Fed’s balance sheet, which ultimately could have inflationary implications. In turn, nervous holders of dollar obligations are beginning to look for diversification in other currencies, selling Treasury bonds in the process.

The obvious solution to both dollar weakness and higher yields is to move quickly towards a more balanced budget once a sustained recovery is assured, but don’t count on the former or the latter. It is probable that trillion-dollar deficits are here to stay because any recovery is likely to reflect “new normal” GDP growth rates of 1%-2% not 3%+ as we used to have. Staying rich in this future world will require strategies that reflect this altered vision of global economic growth and delevered financial markets. Bond investors should therefore confine maturities to the front end of yield curves where continuing low yields and downside price protection is more probable. Holders of dollars should diversify their own baskets before central banks and sovereign wealth funds ultimately do the same. All investors should expect considerably lower rates of return than what they grew accustomed to only a few years ago. Staying rich in the “new normal” may not require investors to resemble Balzac as much as Will Rogers, who opined in the early 30s that he wasn’t as much concerned about the return on his money as the return of his money.

William H. Gross
Managing Director

Economics: Where We Stand - Market Data From The Wall Street Journal - Click Charts For Full Details

2009-07-09T10:54:00.006+09:00

Consumer Activity

Q1: -5.5% Full report	June: 9.5% Full report



May: -1.1% Full report	June: 44.8 Full report


May: $340.0 billion Full report	May: +1.4% Full report


June: 49.3 Full report


Inflation

May: -1.3% Full report	May: -5.0% Full report

Housing Construction and Sales

May: 532,000 Full report	April: 4.68 million Full report

International Trade

April: $29.16 billion Full report

Investment: A Report On The Year Thus Far By Gareth Milliams

2009-07-08T13:01:00.007+09:00

We have just finished the first half of 2009 and it has been to say the least, interesting. If I was going to mark my own performance, I'd give myself a 'B'. Not an 'A'. An 'A' would require me to have invested my clients lump sum portfolio's into China, the S&P, Goldman Sachs and oil from March 9th. But I wasn't prepared to do that. I still believe that this is a bear market rally and that the first principle of investment is to preserve capital (particularly when its not your own).

The 'A' would have also required selling out at the end of June. I worry about investors who are still committed with large sums to equity markets that are presently struggling to maintain growth with thin volume and that were originally led upward by the financial sector. So I didn't participate. Instead we held gold and Yen. It was smart. It made sense. But jeez, it was tough watching the stock markets head north from the sidelines.

As Gladys Knight once asked "If we had the chance to do it over again, would we?" Yes Glad, we would.

The regular monthly plans also did well. Existing clients of mine were switched from equity funds to US$ cash deposits in August last year. From September 2008 we invested new monthly contributions aggressively in Emerging Markets. This strategy worked like a dream and so in May this year, we took those profits and again reverted to cash deposit with the monthly contributions heavily weighted in commodities and oil from June.

The challenge now is to maintain the B. If I can do this in the second half of 2009, I'll be a very happy man.

Investment: A Hat Tip To Cap & Trade By Gareth Milliams

2009-07-03T10:42:00.015+09:00

Ethical investment has been popular with investors for more than a decade. The notion of making a good profit whilst making the planet a cleaner place is very appealing. But the reality is that very few ethical funds have made money. Part of the problem is that the technology for most green initiatives is not that green.

Solar energy is fashionable at the moment. The worlds largest solar power 'park' in the Mojave desert will become operational in 2011. Taking up 24 square miles of land, the park will generate some of the power for 400,000 homes. It will also destroy vast swathes of pristine desert and a delicate ecological system.

Wind power turbines are a common site all over the world. The problem is that for them to be truly effective you need to cluster hundreds of them together. Unfortunately, this leads to a change in the weather on the ground.

Ethanol as a commercial proposition is unsustainable without its massive subsidies, additionally there is evidence that towns where ethanol plants are situated suffer from massive air pollution problems because of noxious fumes.

My point is that as a long term sustainable investment, ethical funds and stocks have disappointed and that in their present level of sophistication have not proved themselves viable.

However, there is an eco-investment solution on the horizon that does not involve any technology whatsoever. It could prove to be highly lucrative and go a long way to cleaning the air that we breathe. So what is it?

This week, the US House of Representatives passed legislation on a Cap and Trade emission policy that limits the amount of pollution that a company can emit. If that corporation exceeds its set emissions, it may then buy credits from companies that have reduced their carbon footprint. These credits are traded to the highest bidder via either the Chicago Climate Exchange or the European Climate Exchange in London. Both are owned by Climate Exchange PLC. The main investors in the Climate Exchange are Goldman Sachs, HSBC, JP Morgan and Barclays Capital (GS holds a 10% stake in The Climate Exchange).

The beauty of the Cap and Trade legislation is that not only will there be competition for extra credits but that the threshold for emissions levels will be cut every year. Overall emissions will reduce by 17% by 2020 and by 83% by 2050, effectively increasing prices of carbon credits every year as the threshold drops and credits become more expensive. The market will dictate the price of the credits by auction. But surely, as the threshold drops, the cost of the credits will dramatically rise.

Below is a clickable chart that highlights the growth in this stock since the legislation passed the House of Representatives.

We'll have to see how the legislation fares through the Senatorial process, but should it remain more or less intact, it could be a terrific opportunity.