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
Sunday, 20 June 2010
Investment Note: 16/06/2010 - Offshore Bonds-The New Pensions
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.
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
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.
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
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.
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
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.
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
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
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
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.
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
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.
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
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
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
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.
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
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.
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.
Sunday, 7 March 2010
Don't Care By Bill Gross of PIMCO
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
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
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.
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.
Monday, 30 November 2009
The Crisis: Goodbye To Dubai? By Gareth Milliams
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'.
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