Gold Outlook 2010: Gold Resuming its Historical Monetary Role – as the Anti-Currency

Monday, January 11th, 2010

Keynote Speech Presented by Nick Barisheff at the Empire Club’s 16th Annual Investment Outlook Luncheon

Thursday January 7, 2010

To download the PDF version of this article, click here.

Good afternoon. As always, it is a privilege to speak at the Empire Club.

Each year for the past three years, I have returned to share perceptions about the precious metals industry and specifically about gold. Generally, this forces me to step back and assess the previous year’s events and then to speculate about what they may indicate for the coming year. Choosing the seminal events this year has been more difficult than usual. Lately the pace of gold-related news has accelerated exponentially with gold’s rising price. While 2009 was an exciting year for gold, setting a new average high of $1,088, 2010 promises to be even more exciting.

In 2009 gold resumed its historical monetary role - as the anti-currency. Therefore, the influences and events that affect its price are not simple commodity supply/demand fundamentals, but the more complex global monetary issues.

To summarize some of the important key events, I thought it would help to separate them into three categories.

First, there are the obvious events-those whose implications for gold are self-evident.

Second, there are the events that require some interpretation and, finally, there are the events that we might call “incipient”. These events and stories are in their early stages of development. They may amount to nothing, or they may develop into tectonic forces that completely disrupt the gold-related financial landscape.

It is more than a year since Wall Street made some very bad bets that resulted in unprecedented losses, losses that were passed on to the American taxpayer. For their incompetence and greed, most of the company heads responsible were rewarded with generous severance packages, or with new jobs commensurate in pay and status to the ones they left behind. Even more surprising, perhaps, is that one year later many of these people continue to advise the US government’s financial policy makers. My associate, trend analyst Richard Karn, likens this particular situation to a group of chickens getting together and consulting with the foxes about a problem that is plaguing their community-the rapidly decreasing chicken population. Since the same key figures remain firmly in charge of US fiscal policy, we can assume the status quo will continue until the ship finally hits the iceberg.

So let’s start with the obvious gold events of the past year.  It was the first time in 20 years that gold purchases for investment purposes outpaced gold purchases for jewellery demand.  However, in terms of significance, central bank buying of gold this past year upstaged all other events. For the first time in over 20 years, central banks became net buyers rather than net sellers of gold. This is a watershed event.

India’s central bank purchase of over 200 tonnes of IMF gold in the fall of 2009 demonstrated that large central banks were willing to pay the market price for gold. This removed the concern that official sector sales could cut short any meaningful rally.  Although the central banks have been selling less gold each year lately, the threat of IMF sales had continued to weigh on the market.  Russia and China further dispelled this fear with the disclosure that they too have added 130 and 454 tonnes respectively.  Several smaller central banks such as those in Sri Lanka and Maritius also added to their gold reserves. Therefore, central bank buying was clearly the significant gold event of 2009 and will likely continue to be in 2010.

The next level of news events had implications that might not have been so obvious at first glance. On October 6, Robert Fisk, a veteran Middle East correspondent writing for the UK’s Independent, published an article entitled “The Demise of the Dollar.” The article described how “Arab states have launched secret moves with China, Russia and France to stop using the US currency for oil trading.” Although the central banks immediately rejected these rumours, the market treated their denials as a clear admission of guilt and gold broke through year-long resistance at $1,020 an ounce into an entirely new trading range that day.

The Iranian oil bourse, which allows oil sales in several currencies except the US dollar, is another indication that this trend will continue.  In addition, the US’s greatest supporter of the petrodollar, Saudi Arabia, announced that it would no longer trade oil futures on the NYMEX. And on October 19 a related event occurred that received almost no mainstream press coverage; in fact, the only mention I could find of this story at first was at Al Jazeera Online. This was an agreement between ten member states in Central and South America and the Caribbean to use the sucre rather than the dollar for intra-regional trade. Venezuela, one of the West’s largest oil suppliers, is also a member of this new alliance.

This trend is significant to gold because, since 1973, the US has been able to accumulate huge deficits thanks to an agreement with OPEC to price oil in dollars exclusively. This system worked until the 2008 financial crisis, which many felt weakened the dollar’s inherent worth beyond repair. The petrodollar experiment, which started in 1971 with the removal of the dollar’s peg to gold and continued in 1973 when the dollar was essentially backed with oil, is coming to an end after only 36 years. However, given the weakness of other currencies and the fact that no other paper currency currently threatens to replace the US dollar, the process may take years to complete. The end of the petrodollar’s hegemony, which is inevitable in my opinion, will have significant implications for gold.

Another event whose implications may require some extrapolation was the move by the Chinese government to encourage and facilitate gold buying by the Chinese public. China watchers know the Chinese have a long-term love for gold. In fact, on December 9, Reuters announced that China had surpassed India as the world’s largest gold buyer, for the first time in recorded history.  The Chinese have also demonstrated a strong propensity for saving. With their government making no secret of its displeasure with the US dollar, and with few other safe investment options available, the Chinese public could provide the fuel to move the gold price to new highs. One ounce purchased by each of the 80 million middle-class Chinese would equate to 2,500 tonnes of gold.  It is important to remember that during the last gold bull, the Chinese public was unable to participate. This is a story that definitely bears watching.

Finally, in the third category, is the news we might compare to the first spark of a match that either extinguishes uneventfully or ignites a raging, out-of-control forest fire. Most of us in the gold industry have discovered that we ignore these flickers at our own peril. Many of the stories that started as hints or rumours a few years ago are now accepted as fact. The first of these issues we are watching is the imbalance between gold derivatives and paper proxies and the amount of physical gold in existence. This is important because despite its best efforts, Wall Street still cannot print gold.

Since almost all the gold ever mined remains in existence and gold reserves and production estimates are monitored meticulously, such discrepancies will show up faster in the relatively small gold market than they might with other commodities. As Wall Street churns out new gold investment vehicles, people are starting to do the math. If it becomes apparent that financial institutions have sold more paper gold than actually exists in physical form, then the price of paper gold and physical gold could diverge.

This year, many analysts began to apply increased scrutiny to the gold and silver ETFs. In mid-July, hedge fund giant Greenlight Capital announced they were moving assets out of the world’s largest gold ETF - SPDR Gold Shares - and into physical gold. Greenlight is an industry leader whose movements are carefully studied and often emulated. Although Greenlight’s manager, David Einhorn, claimed it was cheaper to own and store physical gold than it was to pay the ETF fees, the fact that a major, industry-leading fund would move to physical bullion set off many alarm bells.

Since ETFs do not actually purchase their assets, there is nothing prohibiting Authorized Participants from contributing baskets of borrowed gold. The amount of borrowed gold held by ETFs is a matter of speculation.  With multiple claims on the bullion, ETF investors may suffer unexpected losses under stress conditions when they need their gold the most.

So with these events of 2009 in mind, I am often asked, “How high might the price of gold go?”

Let’s look at some figures.

We know that the US must refinance at least two trillion dollars of debt in 2010. They can raise this money in one of three ways:  through the sale of bonds, through increased taxation, or through monetization by the Federal Reserve. Foreign investors showed decreasing appetite for US treasuries in 2009. Rising unemployment along with an aging population makes increased taxation a poor option. Therefore, the US Fed will be forced to monetize the ballooning debt, further eroding  confidence in the dollar as the world’s reserve currency.

This will encourage central bankers, especially those of the developing countries, to accelerate their accumulation of gold. Stephen Jen, a managing director at hedge fund BlueGold Capital and an expert on sovereign wealth funds from his days at Morgan Stanley, estimates that the percentage of gold held by the Chinese, Indian and Russian central banks is just 2.2 percent. This compares with 38 percent held by Western central banks. According to Jen, they would have to buy $115 billion dollars worth of gold at current prices to raise their bullion to just 5 percent of total reserves, and $700 billions’ worth to reach just half of Western levels.

Along with many others in the gold industry, we have noticed that fund managers are starting to buy gold as long-term insurance, which they intend to hold for several years. By one estimate, if the world’s pension funds and hedge funds moved only five percent of their assets into gold, which these days seems quite conservative, gold would trade above $5,000.  With leading wealth managers such as David Einhorn, John Paulson and Paul Tudor Jones allocating significant amounts of their portfolios to gold, the process may have already begun.

In conclusion, the events of the past year bode well for the price of gold in 2010. At the recent highs of $1,200 many thought that gold was overbought. For those who feel this way, I would like to close with some recent words from investment legend Richard Russell who said, “If gold is going parabolic, then there’s no such thing as ‘overbought’,” Almost any of the events of 2009 I have highlighted could trigger such a parabolic rise. Right now the Chinese and Indian public, the non-Western central banks, the sovereign wealth funds, the pension funds and the hedge funds of the world are all looking for ways to increase their long-term gold holdings. The pull-back from the recent highs of $1,200 seems to be over, providing an attractive entry point for investors. In 2010 we will likely see prices rise to at least $1,300 to $1,500.

It is important to understand that this isn’t a typical bull market. Unless governments around the world stop creating massive amounts of new money, the price of gold will continue to rise.

There is a famous investment axiom that states, “Now is always the most difficult time to invest.”  To that I would add, “But now is also the best time to insure the wealth we have accumulated is protected through the ownership of gold.”

Thank you.

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Canada’s Universal Appeal and Advantage

Thursday, September 17th, 2009

The Lehman Bros. bust, one year ago this week, was a watershed moment and event that many would like to erase from memory, given that the consequences were disastrous, wiping out trillions of dollars in wealth and destroying the financial plans of so many in the Western World. But, there is a silver lining, in particular, for Canadians. While we were not spared the pain, Canada is now uniquely positioned against the rest of the struggling western world, and it is Canadians who should grab the advantage.

First, we have no inflation - interest rates will remain low for some time - perhaps one to two years.

Canada has experienced the steepest fall in consumer prices in more than 50 years. That is remarkable.

Canada prices fall, recovery signals brighten, Reuters, September 17, 2009

Consumer prices overall fell by 0.8 percent in August from a year earlier, the second-largest 12-month drop since 1953, Statscan said. In July, consumer prices slid 0.9 percent at an annual rate, which was the sharpest drop since 1953 when the CPI fell 1.4 percent.

…

Statistics Canada also said on Thursday that the composite leading indicator rose by a sharper-than-expected 1.1 percent in August, the latest sign the economy is pulling out of deep recession.

…

“We haven’t seen the end to the downsides on core consumer prices going forward,” said Derek Holt, vice-president at Scotia Capital Economics.

“If we are right and the Canadian dollar goes to parity (with the U.S. dollar) then inflation is going to be parked as a side issue for a good couple of years,” he said.

Yesterday we wrote that the US dollar had fallen to its lowest levels in a year, this due to investors ditching risk-free assets such as cash and cash instruments in favour of higher yielding assets and … gold. Hence, the price of gold doubly has been fueled by the exit from cash and the bidding up of gold itself.

Price deflation, however, in Canada has been due to the rising value of the loonie. Thankfully, Canadian consumers’, banks’ and the country’s balance sheets are not overlevered. And that has placed Canada in an advantageous position, vis-a-vis our neighbours to the south.

Second, Canadian banks are strong and in an enviable financial position

Canadian banks are eyeing opportunties to expand south further into the US banking sector - prices are depressed and the Canadian dollar is strong …

Canadian Banks See Takeover ‘Opportunities’ in U.S., Bloomberg, September 16, 2009

Canadian banks may step up acquisitions and investments in the U.S. as troubled lenders falter amid the economic slump.

“Significant opportunities” exist outside Canada in the next two to five years as banks restructure, Royal Bank of Canada President and Chief Executive Officer Gordon Nixon said today during a conference in Toronto sponsored by Scotia Capital. Other Canadian bank executives agreed, and Bank of Montreal President and CEO William Downe called this a “once in decades growth opportunity”.

It’s reminiscent of the days when Canadian moguls snapped up cheap Manhattan real estate in the mid 70s crisis. This period of opportunity for Canadian banks rhymes with those partaken by firms like historic components of Brookfield Asset Management (Edper, Brascan, Trizec) and the once great Olympia and York, in the period following economic crises in 1973-74 and during the 90s. Brookfield is today the largest single landlord in Manhattan.

In Canada: There’s No Place Like Home we discussed the idea that Canada was in a uniquely advantageous position on three fronts - fiscal soundness, healthy and strong banking sector, and a resilient consumer. Let’s discuss investing in Canada - its time Canadian investors realize the grass is greener on our side of the fence, and if so, to act on that belief and position ahead of interested foreign acquirers of our key resource and commodities companies. I say this, because although many Canadians would say “duh!,” how do we explain that for years we have been letting our companies be acquired by dragons in return for adequate levels of capital funding for our expansions. Why aren’t we sponsoring our own businesses to the degree that they can remain in Canadian hands.

We are taking our advantage for granted - Foreign investors see greater value in our key assets than we do.

“If you’ve been in the [poker] game for 30 minutes and you don’t know who the patsy is,” said Warren Buffett, “you’re the patsy”.

Why, for instance, was Research in Motion denied the opportunity to acquire some Nortel’s key telecom patents and assets, and in essence, keep them Canadian. Instead, they were awarded to Ericsson, and a subsequent sale of additional key intellectual properties and technologies were sold to Avaya. Why? It’s madness that one of our own homegrown, and financially willing and able corporate darlings lost this chance, and subsequently, that Siemens bid to re-invigorate Nortel into Canadian-headquartered $5-billion-a-year tech giant failed because of a lack of support for it from Ottawa.

How a Made-in-Canada Nortel solution died, Andrew Willis, The Globe and Mail, Sept. 17, 2009

A year-long drive by a German company to create a Canadian-headquartered, $5-billion-a-year telecom equipment maker from the remnants of Nortel Networks Corp. ended in failure because of a lack of support from Ottawa, according to people close to the situation.

…

But the landscape in Ottawa changed in late July, after RIM co-CEO Jim Balsillie publicly attacked the planned sale of Nortel’s wireless unit, claiming RIM had been shut out of the process. EDC arranged a $300-million loan to one of the bidders, Nokia Siemens Networks, and the business was eventually bought by Sweden’s Ericsson.

While RIM did not take part in the auction, Mr. Balsillie framed the issue as one of foreigners being favoured over a home-grown tech play.

Now it also appears Chinese interests are visiting Canada in order to investigate Canadian financing options for what would be the acquisition of Canadian companies in the resource sector. The Chinese want to secure as much of their future natural resource requirements as they can - but they want to see if we can help them to finance their acquisition of Canadian companies. If we are selling our companies to the Chinese and other foreign investors now, in return for making sure our projects are adequately funded and viable in the long run, like the oil sands, then how do we justify this when some parties are willing to discuss funding the acquisitions for them, as in the example of Macquarie. Is this an extension of our risk aversion - we would rather fund the obligations and collect the interest, than take the developmental risks ourselves on resource projects and maintain Canadian interests?

Sinopec, China Firms Seek Canadian Financing, Resource, Bloomberg, September 15, 2009

China Petroleum & Chemical Corp.’s finance subsidiary said it held talks with Macquarie Group Ltd.’s Canadian unit as part of efforts to raise funds for the refiner’s operations.

“We’ve had discussions over what kind of cooperation we can have in the area of financial services,” said Song Guoming, a Sinopec Finance Co. Ltd. manager who held talks with Australia’s biggest investment bank yesterday in Toronto. “We’re studying their methods of raising funds.”

Canada has universal appeal as an investment destination, finally

As Canadians we should take a larger interest in maintaining and making financially viable what we already have, rather than helping foreigners help themselves to it. This is quite possibly the time to do it, given that Canada now has what appears to be real global and universal appeal as a destination for investment.

“In our opinion, Canadian assets (bonds and equities) punch well above their weight and, as we believe Canadian equities remain underweight in global portfolios, global investors should heighten their focus north of the U.S. border,” he said. “We would also point out that Canadian domestic investors should temper their international endeavours and stick to a higher domestic bias in their portfolios.”  - Vincent Delisle, Scotia Capital

Sources: Reuters | Bloomberg | Globe and Mail | Scotia Capital (via G&M Market Blog)

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Higher bond yields raise caution

Friday, May 29th, 2009

While investors’ attention was focused on global government bond yields marching higher, the holiday-shortened week produced a surprisingly small number of video clips.

Some quality footage was nevertheless produced, featuring the likes of David Rosenberg, now in his new role as chief economist and strategist of Gluskin Sheff, Mohamed El-Erian, Barry Ritholtz, Puru Saxena and Mario Gabelli.

And then there is “out of the box” analyst Marc Faber arguing that the US economy will enter “hyperinflation” approaching the levels in Zimbabwe. “I am 100% sure that the US will go into hyperinflation,” Faber said in an interview with Bloomberg. “The problem with government debt growing so much is that when the time comes and the Fed should increase interest rates, they will be very reluctant to do so and so inflation will start to accelerate.”

The selection kicks off with a humorous take by Emmy Award winner Hoofy and Boo on “How not to save Detroit”, and concludes with a clip featuring Twitter co-founders Biz Stone and Evan Williams explaining how they plan to attain their goal of generating revenue by the end of the year. (By the way, you can follow me on Twitter by clicking here.)

Hoofy & Boo (Minyanville): How not to save Detroit
“Chrysler is in dire straits and hoping that Fiat will save the company. Join Hoofy and Boo as they watch two turkeys combine in an ill-conceived effort to make an eagle.”

Source: Hoofy & Boo, Minyanville, May 2009.

Financial Times: GM’s future
“Spencer Jakab says once General Motors emerges from almost certain bankruptcy, it may be in surprisingly good shape.”

Source: Spencer Jakab, Financial Times, May 26, 2009.

Fox Business: End of recession? Not so fast
“David Rosenberg, chief economist at Gluskin Sheff & Associates, gives his take on the end of the market downturn.”

Source:Fox Business, May 26, 2009.

CNBC: Outlook from the Bond King - Mohamed El-Erian
“Current perspectives on the future of the economy, with Mohamed El-Erian, Pimco CEO/co-CIO.”

Source: CNBC, May 27, 2009.

Bloomberg: Wachovia’s Vitner says consumers seeing better economy
“Mark Vitner, managing director at Wachovia Corp., talks with Bloomberg’s Erik Schatzker about data showing that confidence among US consumers jumped this month to the highest level since September. The Conference Board’s sentiment index surged to 54.9, higher than forecast and the biggest gain since April 2003, the New York-based research group said today.”

Source: Bloomberg, May 26, 2009.

CNBC: Blitzer on S&P/Case-Shiller home price declines
“The data shows home prices fell at the fastest rate ever in the first quarter. Insight with David Blitzer, Standard & Poor’s managing director/chairman.”

Source: CNBC, May 26, 2009.

CNBC: Ritholtz - how far from the housing bottom?
“Searching for the housing bottom, with Barry Ritholtz, FusionIQ CEO and the Fast Money traders.”

Source: CNBC, May 26, 2009.

John Authers (Financial Times): House prices key to consumer confidence
“John Authers, FT’s investment editor, says that until US house prices recover we will not see consumer confidence return in earnest.”

Click here for the article.

Source: John Authers, Financial Times, May 26, 2009.

The Wall Street Journal: The rise of a financial stability regulator
“Just as the Great Depression led to the creation of new institutions and financial practices, the Obama administration is on track to impact financial regulations. One of the new concepts involves a financial stability regulator, David Wessel explains.”

Source: The Wall Street Journal, May 27, 2009.

The Washington Post: Geithner dismisses GOP socialism charge as “ridiculous”
“Treasury Secretary Timothy Geithner admits private investors are worried about investing in new government-backed commercial mortgage securities and dismisses as ‘ridiculous’ a recent Republican National Committee resolution stating that Democratic policies bordered on socialism.”

Source: The Washington Post, May 24, 2009.

The Wall Street Journal: Mythology of bulls and bears
‘As the bulls gain force, investors must avoid getting trampled in a stampede. Barron’s Steven Sears comments.”

Source: David Ranson, The Wall Street Journal, May 21, 2009.

CNBC: Puru Saxena - expect a mild correction
“As markets have run ahead of themselves, expect a mild correction or consolidation soon, predicts Puru Saxena, money manager and CEO, Puru Saxena Wealth Management. He tells CNBC’s Chloe Cho why this will be positive for the US dollar.”

Source: CNBC, May 27, 2009.

Bloomberg: Gabelli says stock market finding “place of equilibrium”
“Mario Gabelli, chairman and chief executive officer of Gamco Investors Inc., talks with Bloomberg’s Betty Liu about the outlook for the US economy and stocks.”

Source: Bloomberg, May 28, 2009.

CNBC: Faber - market correction will unfold
“Marc Faber, editor and publisher of The Gloom, Boom & Doom Report, says the overbought market will correct but he is uncertain about the magnitude of the correction. He speaks to Sean Callow of Westpac Bank, CNBC’s Martin Soong & Sri Jegarajah.”

Source: CNBC, May 25, 2009.

CNBC: Dr Gloom - paper money will become worthless
“Hold onto gold as paper money will become worthless in the future, warns Marc Faber, editor & publisher of The Gloom, Boom and Doom Report. CNBC’s Martin Soong & Sri Jegarajah asked Faber how he was gaining exposure to the precious metal.”

Source: CNBC, May 25, 2009.

The Street: Gold can hit $1 000
“Is a perfect storm of a weak dollar, weak markets, options expirations and physical demand going to push gold higher? Carlos Sanchez, Associate Director of Research for CPM Group offers his take at TheStreet.com.”

Source: The Street, May 28, 2009.

CNBC: OPEC secretary general - oil should be above $70
“OPEC is looking for a ‘reasonable’ oil price, which is not below $70 a barrel, OPEC secretary general Abdalla Salem El-Badri told CNBC after the organization left output unchanged Thursday.”

Source: CNBC, May 28, 2009.

MarketWatch: Twitter founders aim for revenue by year end
“Twitter co-founders Biz Stone and Evan Williams tell MarketWatch columnist Therese Poletti how they plan to attain their goal of generating revenue by the end of the year.”

Source: MarketWatch, May 27, 2009.

Tags: Barry Ritholtz, Biz Stone, Bond Yields, Chief Economist, Cnbc, David Rosenberg, Financial Times, Global Government, Gluskin Sheff, Good Shape, Government Bond, Hyperinflation, King Mohamed, Marc Faber, Mario Gabelli, Market Downturn, Mohamed El Erian, Puru Saxena, Quality Footage, Shape Source
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Corporate Bonds or Equities? Deflation or Inflation?

Monday, March 30th, 2009

The debate rages on, and it is between whether to invest in corporate bonds or equities, or if economic conditions are deflationary or inflationary? FT Alphaville, Fortune.com and Capital Spectator have covered this quite well. Here are all the pieces:

Of Bonds and Stocks and the Weimar Republic
(FT.com/Alphaville, March 30, 2009)
by Tracy Alloway

You’d have to be living under a bailout-sized rock not to be aware of the current debate surrounding equities vs corporate bonds.

HSBC has now thrown its hat in the ring, in a 24-page research note entitled “The triumph of the pessimists”, which looks at the behaviour of corporate bonds and equities over the past 140 years or so. Here’s the summary.

Lots of studies have looked at government bond and equity valuations, few at the relationship between corporate debt and equities. We’ve filled the gap, going back to the middle of the 19th century.

The results don’t look pretty for equities, which are likely to suffer a multi-year downgrading compared with corporate debt… Historically, there have been three multi-decade periods. Relative prices in the first two were very different to those in the third. Before the beginning of the last century, yields on corporate equity were sometimes lower than those on corporate debt and sometimes higher.

Over the following 50 years — from about 1907 until 1951 — they were almost always higher, sometimes a great deal higher. But for the 50 years starting in the early 1950s, dividend yields on equities fell sharply relative to yields on corporate bonds. By 2000, the peak of the cult of the equity, the relative yield of equities compared with government and corporate bonds had reached its lowest level ever.

In fact, the only significant period in which dividend yields weren’t higher than corporate bond yields was in the early 1930s (chart, using railway bond yields as a proxy for corporates, below), when dividend yields collapsed and corporate bond yields surged because of the cascade of Depression-related defaults, according to HSBC. Investors’ enthusiasm for equities was dulled, and, in a parallel with our current financial crisis, their appetite for corporate debt sharpened. Even as the economy improved and profits rose, investors attached an increasingly low valuation to dividend payments, resulting in increased dividend yields.

Fearing another depression, then, investors demanded more of their returns upfront. That’s why dividend yields went up and corporate spreads went down. Although stocks went up and down, the shift continued until 1950, by which time the trailing PE for the S&P had fallen to 6x, its dividend yield had reached 7.5%, yields on Baa bonds had fallen to 3.2% and spreads to less than 80bps. In the early 1930s, Baa yields reached 11% and spreads touched 725bps.

That was the cheapest that equities have ever been against corporate bonds. Over the next 50 years, not all at once and with big, sometimes huge setbacks, valuations of stocks compared with corporate bonds moved from their cheapest ever to their most expensive. Which … is the situation in which we find ourselves now.

Which leads us to today, when, according to HSBC, we’re facing two scenarios for corporate bonds and equities.

Over the past 18 months, the implosion of the global financial system has led to huge risk aversion and acute deflationary concerns, both of which have driven government bond yields lower still. Now, it could be that quantitative easing by central banks will lead to a pick up in inflationary concerns and worries about how governments will repay the huge numbers of bonds that they have issued and will continue to issue. That’s certainly not an argument that one should dismiss out of hand. That wouldn’t augur well for government bonds in the long term.

Alternatively, the situation we’re in now might echo the 1930s, when risk appetite was shot to pieces and, regardless of whether inflation fell through the floor or picked up somewhat, government-bond yields fell and then fell further. For their part, having spiked up hugely, corporate spreads declined for the rest of the decade. But as we saw earlier, if investors lapped up bonds, particularly corporate bonds, they shunned equities; earnings yields and dividend yields rose dramatically. In that environment, investors, in other words, were expressing a strong preference for safety and income over risk and capital gains.

Although we strongly suspect that the present world looks more like the second of these scenarios than the first, we really don’t know for sure. Perhaps it doesn’t much matter, as long as governments don’t unleash another huge inflation. For what is certainly true is that central bankers have now told us explicitly that they will not allow government bond yields to rise for the foreseeable future. Their aim is simple: to make risk-free assets so unattractive that investors wade into riskier markets, thus restoring confidence to the financial system and the economy as a whole. For now, it’s clear, equity markets have taken the hint, but corporate credit markets haven’t. That situation will, we think, be reversed.

This is a sentiment echoed in The Aleph Blog and Crossing Wall Street. The spread between corporate bonds and equities is getting big - corporates were sitting out of the recent rally. They are, as per HSBC’s research title, the pessimists.

However, as HSBC also notes, this is essentially a deflationary vs inflationary debate. In a deflationary environment, as in the Great Depression, corporate bonds, with their stable returns, make sense. In an inflationary environment those fixed returns are eroded. Equities, with their ability to raise prices in tandem with inflation (or as close as they can get) could be more attractive.

A slightly random example here - but the German stock market of the 1920s increased by a staggering amount as inflation shot through the roof. We’re far from hyper-inflation, but throwbacks to that era, like the below 1921 clipping from the New York Times, should give us pause for thought.

Related links:
Sunday links: Stocks vs bonds - Abnormal Returns
Is it back to the Fifties? - FT
Equity lives! - FT Alphaville
The death of equity - FT Alphaville

This entry was posted by Tracy Alloway on Monday, March 30th, 2009 at 16:32.

WHAT ARE MONEY MANAGERS THINKING? (Capital Spectator)

What are professional money managers thinking these days? A new poll by Russell Investments offers an answer. Among the highlights:

• 67% of managers are now bullish on corporate bonds
• 61% are bullish on high-yield bonds

In both cases, the percentages are a bit higher compared with the previous poll from last December. “In this environment of caution and realism, managers are finding opportunity in spreads between high-quality corporate bonds and Treasuries that are at historic levels,” Erik Ristuben, Russell’s chief investment officer, says in the accompanying press release. Expectations for junk bonds are also higher from late last year.

U.S. equities, on the other hand, have fallen in the eyes of managers. Value and small-cap equities suffer the most in terms of the current outlook, according to the Russell survey. Here’s an overview of how the changes in expectations for the various asset classes stack up:

Source: Capital Spectator

High-yield bonds: Appetite for risk

If you’ve got the stomach for it, industry watchers say now is the time to hit the bargain buffet.

By Beth Kowitt, reporter

Last Updated: March 30, 2009: 12:02 PM ET

NEW YORK (Fortune) — Like most investments with higher credit risk, the high-yield bond market took a huge hit in 2008 as investors fled to quality. But with the sector recently seeing its deepest discount ever - and even rallying a bit - some say it’s time to test the waters again.

“The values are just extraordinary,” says Martin Fridson, CEO of Fridson Investment Advisors and a high-yield bond specialist. “I think it’s an opportunity you’re not going to see very often in your lifetime.”

Fridson says the spread between high-yield bonds and treasuries over the last few months has been far beyond anything seen before. The option adjusted spread, which measures the difference, is about 17.6 points, according to Merrill Lynch data. A year ago, the spread was 8.2 points.

Lower valuations mean more upside, Fridson says, but they’re also the reason for investors’ hesitations. Default rates will likely run higher than during past recessions, he notes, partly because the quality of the sector has deteriorated since the last low cycle.

Lawrence Jones, associate director of fund analysis at Morningstar, said some experts he’s spoken with expect default rates, which have run between 2% and 3% the last few years, to reach between 10% and 15%.

“I see the opportunity,” Jones says, “but almost everyone who’s being straight with you will say there’s a lot of risk.”

You may know them as “junk”

High-yield bonds, or “junk” bonds, are defined by the industry as a bond with below a Standard and Poor’s BBB- rating. They have a higher risk of default (failure to make a scheduled interest or principal payment), and are subject to greater price swings than more highly rated bonds. But on the upside they also have a higher rate of interest.

Jones suggests making high-yield bonds a small part of your portfolio through bond funds run by experienced managers and research teams investing in better-quality high-yield securities. A fund provides the advantage of a manager’s expertise and also the diversification that’s needed to limit the risk of default in any single investment. And high-yield bonds can be highly illiquid, i.e., hard to unload if they’re thinly traded, but a fund gives you the security of getting in and out when you want.

Read the entire piece here.

Source: Fortune.com

Tags: 1930s, 1950s, Alphaville, Bailout, Capital Spectator, Cascade, Corporate Bond Yields, Corporate Bonds, Corporate Debt, Corporate Equity, Corporates, Debate Rages, Deflation, Dividend Yields, Economic Conditions, ETF, Ft Alphaville, Gap, Government Bond, Government Bonds, Pessimists, Relative Prices, Valuations, Weimar Republic
Posted in Bonds, Canadian Stocks, Credit Markets, ETFs, Markets, Outlook, US Stocks | No Comments »

Prem Watsa: 2008 Letter to Shareholders

Tuesday, March 10th, 2009

Prem Watsa, Chairman and CEO, Fairfax Financial, one of Canada’s most successful investors, and often compared to Warren Buffett, has been vindicated with blockbuster returns arising from the company’s investments in 2008. Below are excerpts from his letter to shareholders for 2008, where Mr. Watsa discusses his observations of the year that has past and his outlook.

The letter opens with Watsa describing the results of the vindicating year:

Since we began 23 years ago, book value has compounded by 25% while our common stock price has followed at 23% per year. The last two years have made up significantly for the biblical seven lean years that you have suffered. In the seven lean years (1999-2005),we made no money on a cumulative basis. In the three years since (2006-2008), we have earned $2.8 billion after tax and book value per share has more than doubled. While we are pleased that our forecast of “the seven lean years are over” did come true, we much prefer the Noah principle, “Forecasting doesn’t count, building an ark does”!

On Page 5, the company’s moves in the market are described in some detail:

In November of 2008, after the stock markets had dropped 50% from their highs, we decided to remove the equity hedges on our portfolio investments. Also, as the yield on long (30-year) U.S. Treasuries began to drop below 3%, we sold almost all our U.S. Treasuries (at year-end we had only $985 million left, compared to $6.4 billion on December 31, 2007), having realized net gains of $583 million in 2008 on sales of U.S. Treasuries. Both the equity hedges and the U.S. Treasuries have done an outstanding job in protecting our capital. Our U.S. Treasury bond position was to a large extent replaced by $4.1 billion in U.S. state, municipal and other  tax-exempt bonds (of which $3.6 billion carry a Berkshire Hathaway guarantee) with an average yield (at purchase) of approximately 5.79% per annum. During the fourth quarter of 2008, we also increased our cash and short term investments by $752 million and invested an additional $2.3 billion in common stocks. The annualized pre-tax equivalent interest and dividend income has increased significantly for our company by virtue of our significant holdings of tax-exempt bonds and as we have taken advantage of the significant widening in corporate and non-Federal Government spreads.

In previous annual reports, we have discussed the holding of some common stock positions for the very long term. Last year we identified Johnson & Johnson as one name and said that Mr. Market may give us more opportunities in the future. As shown in the table below, at the end of 2008 we had taken advantage of the major decline in stock prices to purchase additional positions in outstanding companies with excellent long term track records which we contemplate holding for the long term.

On Page 10, Watsa describes the year that was in terms of Hamblin Watsa’s triumph in the market:

2008 was another very good year for Hamblin Watsa’s investment results, even excluding our CDS position which is not included in the results shown above. These results are due to Hamblin Watsa’s outstanding investment team, led by Roger Lace, Brian Bradstreet, Chandran Ratnaswami, Sam Mitchell, Paul Rivett, Frances Burke and Enza La Selva.

As I said earlier, the return that our investment team produced in 2008 was the best since we began in 1985 - 23 years ago! All of the investment risks that we worried about and have written to you about for at least the past five years simultaneously reared their ugly head as the 1 in 50 or 1 in 100 year storm in the financial markets landed in the fall of 2008. All the major stock markets worldwide were down about 50% and all corporate and non-Federal Government bond spreads widened to historically high levels. Risk was back with a vengeance and, as Grant’s Interest Rate Observer wrote back in 1996, “the return of one’s money, the humblest investment attribute in good times, is always prized in bad times”.

Long U.S. Treasury yields declined to 2.5% - a low not seen since 1954 - and 3-month T-Bills were yielding close to 0% for much of the fourth quarter of 2008. All parts of the U.S. economy and financial markets began to deleverage at the same time, led by financial institutions, hedge funds, businesses and individuals. Mutual fund redemptions began worldwide and the risk in common stock investing was exposed as stock markets declined viciously in the fourth quarter of 2008 and have continued to decline in 2009. Comparing levels at the end of 2008 and the end of 1998, most U.S. and worldwide stock market indices had not provided any return for the past 10 years. For example, the S&P 500 had a compound annual return of minus 3.0% (excluding dividend reinvestment) over the past 10 years. Of course, for the investor in late 2008, the returns in the future may be very different from the past.

Watsa writes of the various points of vindication, discussing where in past years he quoted Hyman Minsky, and Ben Graham admonishing investors to remain patient:

Last year, I quoted Hyman Minsky who said that history shows that “stability causes instability”. He said that prolonged periods of prosperity lead to leveraged financial structures that cause instability – and did we see that in spades in 2008!! With SIVs, CDOs, CDOs squared, among any other structures, leverage on leverage was exposed in 2008. Private equity firms that could do no wrong in 2005/2006 were down 90% from their IPO price in 2007. While Madoff may be the  biggest Ponzi scheme yet unearthed, what Mr. Minsky calls Ponzi financial structures, where interest and principal cannot be financed by internal operations, are being unmasked daily in the financial markets.

Structured investments based upon consumer debt that we warned you about for some time took a real beating in 2008, as 47% of the original AAA ratings on U.S. residential mortgage-backed and various other asset-backed securities issued between 2005 and 2007 were downgraded.

In fact, as of January 9, 2009, over 13% of those securities which had originally been rated as AAA had been downgraded to CCC+ or lower!

Last year, we quoted Ben Graham who said that only 1 in 100 of the investors who were invested in the stock market in 1925 survived the crash of 1929-32. Our experience has been the same.

On his outlook and investments:

We had to endure years of pain before harvesting the gains in 2007 and 2008.

We think this recession is going to be long and deep and the only comparable data points are the debt deflation that the U.S. experienced in the 1930s and Japan experienced from 1989 to the present time. While the U.S. government has initiated a massive stimulus program and is providing up to $2 trillion for its Financial Stability Program, the effect of these programs will be diminished by the enormous deleveraging going on by businesses and individuals: government in the U.S. only accounts for less than 20% of GNP while the private sector accounts for more than 80%. The situation will have to be monitored carefully over the next few years. Of course, many of these negatives are being discounted in the stock market and credit markets as stock prices are down more than 50% and credit spreads are at record levels. We have not had as many opportunities in both markets in our investing career and we are busy!

For the first time in more than a decade, we are very excited about the long term prospects of our common stock investments and believe that these investments have been purchased at prices well below their intrinsic values. This, of course, does not mean stock prices cannot go lower! Mark-to-market gains or losses on these investments will make our book value more volatile, but in the next five years, these investments should be a major reason for our success.

And if you happen to be in Toronto on April 15, 2009, that is when the company’s AGM will take place:

9:30 a.m. on Wednesday, April 15, 2009 in the John W.H. Bassett Theatre, Room 102, Metro Toronto Convention Centre, 255 Front Street West.

Our Presidents, the Fairfax officers and the Hamblin Watsa principals will all be there to answer any and all of your questions.

Download the letter here.

Tags: 23 Years, Berkshire Hathaway, Blockbuster, Canada, Common Stock, Cumulative Basis, December 31, Fourth Quarter, Hedges, Lean Years, Letter To Shareholders, Noah, Portfolio Investments, Stock Markets, Stock Price, Tax Exempt Bonds, Treasuries, Treasury Bond, U S Treasury, Warren Buffett, Year End
Posted in Bonds, Canadian Stocks, Credit Markets, Economy, Markets, Outlook | No Comments »

Jim Rogers: Buying Farmland in Brazil and Canada (and farming!)

Wednesday, March 4th, 2009

Jim Rogers, the legendary co-founder of Quantum Fund, is buying greenfields for farming in Brazil and farmland in Canada to get into the farming business, on the basis that farming is going to be one of the great businesses over the next 20 years, and also on the conviction that global shortages of food are coming, coupled with farmers’ inability to get supplies and credit for expansion, will make for very profitable conditions in the long term for investors in Agricultural stocks and commodities.

Here he is in an interview with Martin Soong, on CNBC Asia’s Last Word. To watch this here, click play:

Commodities are still the best play for the long term, legendary investor Jim Rogers told CNBC, confessing that he has been buying farmland himself.

“We’re still going to eat, probably; we’re still going to wear clothes, probably. Farmers cannot get loans for fertilizers right now. So the supplies of everything are going to continue to be under pressure,” Rogers said.

He is the director of two funds which are buying greenfield land in Brazil and existing farms in Canada and starting to farm it. The funds are clearing the land, fertilizing it, irrigating it and hiring farmers and, Rogers said, some day will probably sell the land but that is a remote prospect.

“If I’m right, agriculture is going to be one of the greatest industries in the next 20 years, 30 years.”

Food inventories are at their lowest in 50 years, Rogers said, while the oil and mining sectors are also good bets.

“Even if demand goes flat or down, as it did in the 30s, as it did in the 70s, you can still have a nice market,” he told CNBC.

Despite the recent rally, gold is still a good opportunity if investors choose the right time and way to get in, according to Rogers.

“I own some gold, of course I own some gold. If gold goes down, I’ll buy more,” he said. “The IMF is trying to sell their gold and if they do then they’ll drive the price of gold down a lot. If they do … that’ll be the last opportunity to buy gold in a long, long time.”

“You can buy coins, you can buy the real stuff, you can buy ETFs and ETNs on the exchanges, you can buy mining companies if you know what you’re doing…,” he added.

Earlier this year, Rogers said he liked the Swiss franc and the yen but gave up the Swiss currency. “I stopped buying the Swiss franc when the Swiss (central) bank bailed out UBS. I still hold the yen.”

Asked whether the current collapse in commodities prices worries him, he said: “You’re supposed to buy when they’re collapsing. I expect to own commodities for years, for a long time.”

Source: CNBC

Tags: Bets, Brazil, Canada, Cnbc, Cnbc Asia, Co Founder, Conviction, ETF, Farmers, Farming Business, Farmland, Fertilizers, Greenfield Land, Imf, Inventories, Investors, Jim Rogers, Last Word, Martin Soong, Price Of Gold, Quantum Fund, Right Time, Rogers Canada, Sectors, Stocks And Commodities
Posted in Canadian Stocks, Commodities, Credit Markets, Gold, Markets, Oil and Gas | 3 Comments »

Donald Coxe: Have Commodities Started to Outperform?

Wednesday, February 11th, 2009

Although we have anxiously awaited a new issue of Basic Points from Donald Coxe, since he announced his departure from BMO in December, he has continued to make himself available via conference calls. Among other things, Mr. Coxe did mention that there would be an issue this month. Here, however, is the full transcript of the February 6, 2009 conference call, that we have produced for your review:

Donald Coxe, February 6, 2009, 10:00 a.m. - Conference Call Transcript

The chart we sent out is the relative strength of the Reuters Jefferies CRB Index to the SP500.
The tagline was, “Have commodities started to outperform?”

There’s a lot in this chart and I want to take you through the story, where we’ve got just horrendous economic news. We’ve gone from the bad, to the terrible, to the scary, to the absolutely horrendous with both Canada and the US, announcing the worst job, losses either on record, or back to the middle of the 70s. And yet, we’ve got the stock market up, the TED spread narrowing, the VIX narrowing, and the BKX is strongly outperforming the S&P today.

So we’ve got very mixed numbers. if you’re looking at it from an economist’s standpoint, the world is just spiralling downward to disaster. But the commodity story is gradually changing, and remember as you can see from the chart, the relative strength off the CRB futures to the S&P was a terrific forecaster of what economic news was coming.

Commodities collapsed really before we had the collapse in the S&P, and one very brief spike, and then going down to a new low which was reached at the beginning of December. We’ve been just gradually working a little bit higher. Now you may say, well this is really struggling to find something good out there but theres much more than just this.

As you know, I’ve always put great strength on looking at Investors Business Daily Reports on their 197 stock groups that are traded in the US market. Now Remember, these aren’t just US stocks, these are stocks that trade on US stock exchanges, and over the years, I have found this to be one the most helpful tools in getting an idea of the way in which the market is dealing with its views of the future, as opposed to the economic numbers which basically reflect what is happening right now. When there’s a divergence between the two, quite often it turns out that the performance of the equity groups in the IBD was a better forecaster than any of the economic forecasts that were out there.

Now this isn’t a one hundred percenter, but its a very good indication and over the last few weeks, ie. since this new year began, there’s been a huge change in the makeup of the IBD list of 197 groups. As we look at it this morning, I recommend that you all use this: page B2 of the IBD, andif we look at it this morning, this is the relative ranks over the last 6 months, so therefore you don’t get an instant change. This is not an extremely short-term index; this shows you that over the last 6 months which stock groups have done best, and what’s really crucial is to see how they’ve changed their ranking because they show them, right now, three weeks ago, 6 weeks ago, and then way back; and what we see here is the number 1 ranked group in the whole group is metal ores, gold and silver, and they’ve got several stories in today’s IBD about various gold mining stocks and how well they’re doing.

That’s the number one group. Now, in the top twenty, and they always have a box around the top twenty group, we’ve had a big, big change in the last few weeks. We now have a total of 5 groups, which are commodity related which are ranked in the top twenty for performance over the last 6 months. #13; I’ve just come back from speaking to big group of grocery and wholesale conference in Nevada, and the #13 group is retail and wholesale food. #17 is oil and gas transports and pipelines; #18 is oil and gas refining and marketing; #21, just off the bottom of that, food, flour and grain; #23, food preparation; #26, oil and gas, international exploration and production; and, not doing as well, but not off the bottom of the chart, are Banks, North East, at #47; Banks, Southeast at #52, Finance, Savings and Loan #56, and moving up in just 3 weeks, from 165th rank to #66 is the fertilizer stocks. And, once again today, fertilizer stocks are strong, in fact, the agriculturals are very very strong today.

The importance from our standpoint of this is that the view out there within the commodity industries about the outlook is changing even while the economic numbers just get worse and worse and worse. And I’ve got to take you back to what happened back in the 70s, because this is almost eery as to how much this is the way things were in ‘74, ‘75, One of the statistics published about the unemployment numbers was that these were the worst unemployment numbers since 1975 in the US and Canada, they’re the worst on record. And Canada, of course, has great commodity orientation in its economy. The unemployment numbers tend to be coincident to lagging numbers, and the unemployment numbers will continue to get bad and worse.

Why is the stock market overall so strong? Well, this virtually guarantees that the stimulus package will get passed. Now I’m deeply disappointed in how the stimulus package has turned out. its turned out to be a grab bag of a whole bunch of liberal wishlist programs they figured they could never get passed through Congress under ordinary circumstances but by labelling them as stimulus ther’re going to be able to get them through.

Rahm Emanuel, who’s the head honcho, next to Obama, in the White House said, “It would be a shame to waste the worst financial crisis since the Great Depression.”

So, what we’ve got here is a wolf in sheep’s clothing, but at least we’ve got activity. And, the evidence on the financial side is that the massive re-liquifications that are being done by the Fed, and then the various bailout programs are having their effect, because the TED spread is way down at 92.50, and the VIX index is also way down. Either the stock market is dealing with a total unreality, or there’s already a change out there.

One of the surprises has been the strong performance of the base metals recently, and that’s because both China and Korea have announce that they’re going to be buying base metals to build into their national reserves. Korea is very frank about it because they want to protect margins of their industries against what they see is stronger demand later in the year.

Now this is a sort of a Sovereign Wealth Fund type deal, when commodity importing countries use their reserves to buy in cheap raw materials to protect their goods producing industries, but its interesting that it came on the same day this week. And this is a sign in the key Asian economies, that as bad as things are for them, their export numbers are terrible and all these things that we know about, and the Baltic Dry Index has doubled since being down 99%. Dennis Gartman remarks today in his great letter.

Does this just mean that we’re going down along with the economic numbers, or is the world changing? Its been out thesis that the commodities stocks would start to outperform before the stock market really had reached a recognizable bottom. And that was on the basis that they were the strongest groups going into the downturn, they were the group that led the downturn, and therefore what you want is to see whether that was that the whole story had changed, the whole story of commodities as an asset class, and that that was over. Or whether this was, as it was back in 1974 and 1975, a great pause in a much bigger trend. We, of course, are of the second view.

This is a pause, a dramatic pause, in a much bigger trend, and as you can also see from the chart, what happened with the commodities, was the real collapse occured as the banking crisis really got out of control, and we went to the low, where the CRB futures at the 1st of December, when the whole picture of the banking industry was really grim. This was a low on relative strength for them after the stock market had already reached its November low, so again, its a relative strength reading.

The fact that all commodity stock groups have been strong lately is in itself a really impressive sign of either, total un-reality out there, or that the market is sensing a big change in the wind. As I look at my screen here of all the commodity stocks, every single agricultural stock isi up except one. The oil stocks are somewhat mixed, although oil prices are down. The group is about flat. And of course the precious metals stocks notwithstanding that gold is pausing in here as a group are up, but the base metals stocks are all up, all up substantial amounts.

This again is like 1975, and I beleive that what we’re seeing here is a recognition that financial assets are going to have trouble doing as well as hard assets, because the sheer scale of the reflation, is so dramatic, far beyond anything that was done. Back in the 70s we had inflationary monetary policies which made things worse, but we didn’s have the derivatives there back then driving things. It was actually monetary growth which signalled to people that monetary growth was too much, and that we’re going to have more inflation. And Gold is giving the signal, coming off $38 on what was going to be its eventual run up to $825-850, much later.

For investors, this dramatic outperformance, a one-month date, its just been amazing to these stocks, the last month, I mean we’re talking of double digit returns for a great number of commodity stocks no matter which group you’re looking at. That’s why, of course, the IBD Stock Index shift. Because this is after all, you know, the stock market has been a really bad place to be, the worst January on record. The worst for the S&P on record and so the conventional strategists have gone back to the forecasting ability of the S&P in January and predicting that this could be a year as bad or worst than last year. I’m not going to make an overall stock market forecast here; that will come later. But when you look that while the stock market was going down, that all of a sudden the most beaten up group is starting to perform very strongly, what it is is a fundamental change, I believe, in direction, and therefore, our favourite group is going to continue to give good relative strength.

Now of course, relative strength can still be a negative if the stock market breaks through to new lows. I can’t talk right now about the alpha that you’ve got, but I can point out that despite all the problems we’ve had, we still have a gigantic contango in oil. Now this is being treated by most observers as a sign of weakness. Again, I go back to the 70s. What happened was oil swung into contango, and stayed there year after year. It hasn’t been in contango on a sustained basis, except during the period which ran for about 18 months earlier in this decade, when oil demand kept running ahead of supply, and gradually, people saw this happening, and bought out the futures curve farther, but we swung back into backwardation, and now we’re in this sustained contango. At meetings with clients in Las Vegas, the oil contango was for them, and this is the grocery industry, this is a big part of their costs, they kept saying, ” What does this mean? Why is it that oil prices even a few months out are way ahead, let alone, years out?”

My view is that this is an expression of the relative willingness of producers to sell forward, as against the willingness of consumers to lock in prices that they feel they can live with. And so we’ve got a gigantic rebalancing and hedging game going on here, and I don’t think much of this is speculative activity. I think the speculative activity got excreted from the system by the collapse of the hedge funds, and particularly after the collapse of Lehman, which locked in $65-billion of hedge fund assets, so that the big debate that we were having last spring was that oil breaking through a $100 was purely a speculative thing, and not reflecting reality. It turned out there was more speculation than even I understood. But, we certainly knocked that out because the big players have been decimated. This of course also spreads out into the valuations of the private equity companies which have been sort of the worst area of the financial market recently, apart from the Wall Street banks.

There’s these currents around here which indicate that there’s gradually a belief system that although China and India and Korea and these economies which were the drivers of the commodity bull market, are slowing down, and are having troubles. At the conference, the first speaker in the panel in the morning, who is a guy loaded with data; he’s from First Data. He was just back from China; he said that unemployment rate is skyrocketing over there, the government is desperate and they’re pulling out all the stops. What we know is this is a very responsive command and controlled economy and therefore they still have the liquid assets. Remember, they got a 40% savings rate in China, so those savings can be moved out into the economy. Where as opposed to the US, our savings rate has just finally crept above the zero rate.

If in fact then, these big economies are not going to collapse along with the OECD, then its a very clear cut case as to which asset class is going to do better than the other. That’s the hard asset class. Bbut what’s also fascinating is the change in the prices of the grains relative to other commodities. And, thats at a time when the USDA keeps increasing its estimates of the reserves on hand of the grains. i.e. we’re getting bearish news on the grains from the USDA, very disconcertingly bad news, in fact, as they’ve calculated that particularly in the case of corn, how much isi on hand, and it turns out to be more, and the reason for that is the bankruptcy of these ethanol companies, the Verasun’s of the world. So. of course, ethanol based consumption of corn has collapsed. But when you look out further out on the futures curve, what you see is strength, and then you come down on to the statistic that nobody wants to talk about, which is the sun spots and the weather.

Well, the weather data, you can pick your stories as you want. As I was flying out there, to Las Vegas, sitting watching CNN in the terminal, they had a great scene in Trafalgar Square, which was totally buried in snow, and they had kids rolling in the snow. The only other active people in the square other than the kids playing in the snow, were a group of war protesters. it was explained to us that they’re paid for being there. Once again another snow storm has hit England. Now this isn’t January, or December, its February.

The sunspots have still not come back. Right up to date, we’re still getting very low sunspot acivity. In another 6 weeks, my back of the envelope calculation works it out, if they don’t come back, we will have the longest sustained low sunspot activity, in about 2 centuries. At some point, this is going to start attracting attention from the people out there who are telling us that the only we have to fear is global warming and of course, naturally, in this collection of liberal wishlists that are going to get voted through the senate. There’s huge amounts of money to deal with Global Warming. And, this will another case I believe where the liberals’ agenda will be based on theories that are being exploded before our very eyes about the reality. If the correlations of past history work, then we’ve got a very late planting season coming up at the very least and so we start to count the time because if the sunspots haven’t returned by May, then based on correlations dating back to 1804 when the astronomer Royal, William Herschel, one of the greatest astronomers of all time, saw the correlation of sunspots and the price of wheat, then we’re going to have a shock to the global system, and I believe that that much history should be respected.

While I was on vacation, I read a History of Scotland, and one of the small stories was explaining why Scotland got taken over by Britain at the end of the 17th century. The biggest reason was 6 straight years of crop failure. Now this was the years of the ‘Maunder Minimum,’ in terms of sunspots, the lowest sunspot activity for which we have proven records, because they only, started keeping the sunspot data with the time of Galileo; and of course, Scotland is very far north, and the effect of cooling naturally is felt the further far north you are from the equator you are, because the tropical zones are such a huge percentage of the actual face of the Earth, because of the width of the Earth, the zones, that as you move further north, you get cooler temperatures, then the effect of any reduction of solar energy is felt much more powerfully. In other words the further north you are, the more damage is done from cooling on crop production.

That’s why it is that Brazil can continue to have terrific production of soybeans because they’re so close to the equator, in their main production zones. But what happened in Scotland, was that although crops were erratic, poor to marginally good at times in England, they were much better than in Scotland, because there, they had late Springs, and devastating frosts.

Now will all this repeat itself? The scientific community says ‘no.’ There’s a correlation that you can show, but they can’t show how it works. But as an historian, I have to tell you that I still believe this could prove to be one of the biggest stories of the year, but nobody’s talking about it.

Therefore, if you’re buying into the agricultural stocks, you don’t need to feel that you’re taking a bet on this, because the market is already taking a big bet on it; Not so. There’s just nobody out there except the Farmer’s Almanac, by the way, that said it was going to be a bad planting spring, because of sunspots. You may say, “Come on, you can’t cite the Farmer’s Almanac.” Well, the Farmer’s Almanac has managed to stay in business as long as it has by using the climatalogical data and they were quite candid about it, that it was because of sunspots, or the lack thereof. So that’s the only support there is at the moment that I’m aware of for our thesis.

So what you should do now, in terms of your overall equity exposure, the fact remains that the big stock indices are still weighted to the economy stocks and the financial stocks. The financials have a much lower weight than they had before, but within the financials, and that’s why I talked about these regional banks, I believe that what we’re going to see is continued great relative strength of the bank banks; the regional banks, those who actually know their customers, and do traditional banking, as opposed to the investment banks, and the glamorous Wall Street types who dissipated their stockholders’ equity by levering up with the colateralized debt obligations and all those other monstrous products that they didn’t understand. They ceased to be bankers, and became packagers of toxic waste which was re-labelled as great food.

So if we separate out from this the highly publicized banks which are on life support systems supplied by Washington, then I believe that there’s still enough relative strength being shown there that the economy is suffering, but just because Citibank and these other banks are down 80% or 90%, you shouldn’t say that that means the banking industry is down 80% or 90%.

So the economy is going to be a series of stories here and there, and I don’t believe we’re going to get economic numbers for some time, which are going to be the kind of things that are going to be stock market friendly, so I can’t make out at the moment a case for increased equity exposure. I can simply reiterate that within the equity group the signals that we’re getting are that the commodities selloff on relative strength is over, and that the fundamentals are that people are going to be starting to look further out. The stock market is supposed to be a forecasting tool. What they’re saying is that these reflations are eventually going to work enough so that the world will not go down the tubes, and there will be demand for hard assets. That’s the story of the 70s, and its going to come back in somewhat different form, its going to be a shock to the stock market, its going to be a shock, certainly to the intellectuals and the others in control of the media, but I do believe that this implies that the TSE will once again outperform the S&P this year and therefore, that the worst is over, that you pick your spots.

Now as far as weightings, we are coming out with an issue of Basic Points this month, and we will be publishing revised recommended weightings in the commodity groups. I’m at a bit of a disdavantage here, because I’ve got to; I know that the number of people on the call is a fraction of the number of people who read Basic Points, but I can simply tell you that I believe that we’re getting the signals already from what stock groups are doing as to where your emphasis should be. So I recommend that you check those out and that that be part of your guide as you’re figuring out you’re going to be allocating your capital or for those who are thinking of things like RRSP season in Canada, and haven’t given up the faith on stocks, which stocks it is you want to buy now to put in your RRSP. Not that you’re planning to go back and look at it 90 days from now to see how its done.

The fact remains that the billion people that we’ve added to the world’s consumption side, haven’t all turned poor, just because of all the unemployment in the US. So its still going to be a tough winter and a tough spring, but I think that the world of the future is starting to show itself and our job is to try to predict the future rather than getting to mired down in the gloom right now.

Remember the same economists were telling us things can only get worse. As recently as last June were predicting 2-3% economic growth. Now they’re saying there’s no hope, and I’m not ridiculing the economists, because there are a few of them like Nouriel Roubini, who correctly called it. David Rosenberg did a great job. But the economic consensus just suddenly changed and that’s why we had this V-shaped collapse which came as fast as the collapse came the last time in 1974. And at the worst in 1974, the multiple on the Dow got down to 6 (times). I don’t think that we’re going to see that this time, but it means that you’ve got to be cautious about having said that there’s definitely been a bottom in the S&P and the Dow. But I do believe we’ve seen the bottom for the commodity stocks as a group. That’s it.

Tags: Bkx, BMO, Canada, Collapse, Commodities, Conference Call, Crb Index, Donald Coxe, Economic News, Economist, Emerging Markets, Forecaster, Full Transcript, India, Investors Business Daily, Jefferies, Relative Strength, Reuters, S&P500, Standpoint, Stock Groups, Stock Market, Tagline
Posted in Canadian Stocks, Commodities, Economy, Emerging Markets, Gold, India, Markets, Oil and Gas, Outlook | 2 Comments »

What are the Gurus Buying Now?

Sunday, February 1st, 2009

Where are the investing world’s gliterati investing in today’s financial climate. WSJ.com’s Eleanor Laise, has written a timely article. Here is an organized run-down of all the participants’ investments:

Robert Arnott, Research Affiliates
“I think this is a marvelous time to be investing,” says Rob Arnott, the 54-year-old chairman of Research Affiliates LLC, an investment-management firm in Newport Beach, Calif. “There are more interesting opportunities out there now than any of today’s investors have ever seen.”

“Certain parts of the bond market are priced for a scenario that’s worse than the Great Depression.”

One favored area is Treasury Inflation-Protected Securities, or TIPS, (Real Return Bonds in Canada) a type of Treasury bond whose principal is adjusted based on changes in the inflation rate. Ten-year Treasurys currently yield only about 0.9 percentage point more than 10-year TIPS, indicating that investors believe inflation will remain quite low in the coming years. Mr. Arnott says he boosted his TIPS allocation “in a very big way” in his personal taxable account toward the end of last year because he expects a substantial increase in inflation in the next three to five years.

Mr. Arnott boosted his allocation to investment-grade corporate bonds in his personal taxable account late last year because the market had reached “irrationally high yields,” he says.

Other experts say that emerging-markets stocks, which were hit especially hard last year, are starting to look tempting. If these shares take another dip, they could become “extremely interesting,” Mr. Arnott says.

John Bogle, Vanguard Funds - Tax Exempt Municipal Bonds
“I earn my money and spend my money in dollars, and I don’t need to take currency risk.”
Municipal bonds also look attractive to many longtime investors. Munis are typically exempt from federal and, in many cases, state and local income taxes. Many are now yielding substantially more than comparable Treasury bonds. In his taxable account, Mr. Bogle holds two muni-bond funds: Vanguard Limited-Term Tax-Exempt and Vanguard Intermediate-Term Tax-Exempt.

Burton Malkiel, Princeton University, author of bestseller, Random Walk Down Wall Street.
He has boosted his allocation to highly rated tax-exempt bonds in his taxable account late last year, since yields available on some of these bonds were “unheard of.”

Jeremy Siegel, Wharton School of Finance, and senior advisor to Wisdomtree ETFs
“Emerging-markets stocks have ‘gotten cheap enough to really give value now.’”
He has recently raised his allocation for junk bonds.
“Stocks and high-yield bonds will move together as the crisis passes,” rebounding from their depressed levels, the 63-year-old Mr. Siegel says.
Mr. Siegel keeps one-quarter to one-third of his foreign-stock allocation in emerging markets, and “they’ve gotten cheap enough to really give value now,” he says. He has bought some more of these shares as they’ve declined in recent months.
Mr. Siegel recently added some U.S. real estate investment trusts to his portfolio, which got “very cheap” after declining sharply last year, he says.

Muriel Siebert, Muriel Siebert & Co.
She has recently been buying shares of companies like Pfizer Inc., Altria Group Inc., and General Electric Co. “I don’t mind buying a stock on the bottom and waiting,” says the 76-year-old Ms. Siebert. “But I do think when you get a market like this, you should be paid while you wait.” Pfizer and Altria yield roughly 8%, while GE yields over 9%.

David Dreman, Dreman Value Management LLC
The 72-year-old chairman and chief investment officer of Dreman Value Management LLC, says he has a roughly 70% stock allocation.
Some battered stocks in the energy sector also look like bargains, Mr. Dreman says. He likes oil and gas exploration and production companies like Anadarko Petroleum Corp., Apache Corp., and Devon Energy Corp. If we don’t have a long world-wide recession — a scenario that Mr. Dreman thinks oil prices currently reflect — “we’ll see much higher prices for oil again,” he says.

Don Phillips, Managing Director, Morningstar
Invests his entire individual retirement account in the Clipper Fund, a large-cap stock fund that lost about 50% last year. Early this year, he made the maximum IRA contribution to that fund, just as he has for the last 20 years. “It’s long-term money, and you have to look at it that way,” he says.

Jim Rogers, Rogers
Jim Rogers, a 66-year-old veteran commodities investor, is putting new money into Chinese shares. He’s focusing on sectors of the economy that the Chinese are pushing to develop, such as agriculture, water, infrastructure and tourism.

Mr. Rogers is putting some new money into commodities, particularly agricultural commodities. “We’re burning a lot of our food in fuel tanks right now,” he says.

Source:
January 29, 2009, Where the Financial Gurus Are Putting Their Own Money, WSJ.com, Eleanor Laise http://online.wsj.com/article/SB123319078518226995.html#printMode

Tags: Burton Malkiel, Canada, Corporate Bonds, Currency Risk, Eleanor Laise, ETF, Exempt Municipal Bonds, Financial Climate, Inflation Protected Securities, Inflation Rate, Investment Management Firm, John Bogle, Marvelous Time, Muni Bond, Newport Beach, Princeton University, Real Return Bonds, Research Affiliates, Rob Arnott, Robert Arnott, Timely Article, Treasury Bond, Treasury Bonds, Treasury Inflation Protected Securities, Vanguard Funds
Posted in Bonds, Canadian Stocks, Commodities, Economy, Emerging Markets, Markets, Oil and Gas | No Comments »

World Markets Performance 2009 YTD

Monday, January 26th, 2009

Year-to-date equity market performance has been bleak, considering that out of 84 countries, 19 are up and the remainder are down. 17 countries are down more than -10%. China is the second best performing equity market so far, up 9.3%, and Brazil is the only other of the BRIC that is up, with a smaller gain of 2.49%.

Canada is the best performing G7 country with a smaller than the rest YTD loss of -3.50%.

Chart: Bespoke Investment Group

Tags: Brazil, BRIC, Canada, China, Equity Market, G7 Country, Investment Group, Market Performance, Remainder, World Markets, Year To Date, Ytd
Posted in Canadian Stocks, Markets | No Comments »

World Markets Performance (January 7, 2009)

Friday, January 9th, 2009

Below are charts from the Economist detailing the overall comparative performance of world markets in World equity markets for all of 2008, followed by YTD, the first week of 2009. Overall, the first week of the new year to January 7, was a decent week.

Saudi Arabia turned in the biggest gain on the week with a gain of 10.8%, most likely on hopes that oil prices would recover. Since then, that has not materialized. Denmark turned in a respectable 9.4%, South Korea gained 9.2%, and Brazil was up 8.7%.

Canada turned in a modest gain of 1.5%, while US results were mixed, with the Nasdaq up 1.4%, the S&P 500 up 0.4%, and the Dow a slight loser with a tiny loss of -0.1%.

The week’s losers turned out to be Mexico with a loss of -1.2% and the World Bond Index, losing -2.0%.

Tags: Brazil, Canada, Comparative Performance, Denmark, Dow, Economist, Loser, Losers, Mexico, Nasdaq, New Year, Oil Prices, Saudi Arabia, South Korea, World Bond Index, World Equity Markets, World Markets
Posted in Bonds, Canadian Stocks, Markets, Oil and Gas | No Comments »

Tom Stanley’s Investment Philosophy

Thursday, December 18th, 2008

Tom Stanley, founder of Resolute Funds, has earned a stellar reputation as one of North America’s greatest investors. This year has not been kind to investors in Canada and as of the end of November, it certainly was not kind to Tom Stanley either. But then, its been no one’s equity market, except if you’ve been short. For value investors and contrarians, the problem has been that stocks that were deemed to be cheap during last summer, have become cheaper, and much quicker too than anticipated, as equity market liquidation continued and as economic fundamentals deteriorated both in Canada and globally. It is discipline, however, that sets the best asset managers apart from the crowd, and Tom Stanley is perhaps one of the best there is.

We would like to share his investment philosophy with you. We have gratuitously taken the following information from the Resolute Funds website.

About Tom Stanley: After earning his undergraduate degree in Psychology at the University of Western Ontario, Tom Stanley completed his Master of Business Administration at York University. Tom entered the investment industry in 1980 and served as an Investment Advisor for “regular people”. He put a strong emphasis on educating the public on good investing practices. To this end, he taught investing at Ryerson University, Seneca College and at neighborhood YMCAs. He was also producer, host and moderator of the TV show “Your Business”.

In 1989, Tom became a Portfolio Manager and subsequently founded the Resolute Growth Fund in 1993. He continued serving as an Investment Advisor until 2004 when he retired from this position to focus solely on fund management. His twelve and a half years of managing the Resolute Growth Fund came to an end in 2006, when Tom made the difficult decision to terminate the Fund. At its last month end, Resolute Growth Fund enjoyed the best ten-year performance track record in North America for all funds tracked by Globefund & Morningstar. Tom currently oversees the Resolute Performance Fund, a private mutual fund sold by offering memorandum founded in 2005.

Here as published by Tom Stanley, are Tom Stanley’s ideals about investing:

There are many ways to be a successful investor. I have no claim that what has worked for me in the past will continue to work in the future, but I would like to share with you some of the principles I have learned over the past 25 years that have helped me become a better investor.

1. Be a Long Term Investor
Too much emphasis is placed on short-term fluctuations. It is easier to anticipate long-term trends.

2. Have a Flexible Approach
Change is the only certainty and as markets change, one should change as well.

3. Actively Look for Ideas
I find many of my best ideas; they don’t find me.

4. Be Skeptical
Check facts directly. Strive to understand the bias and potential conflicts of interest among the sources that provide them.

5. I Eat my Own Cooking
My only stock market investment is the Resolute Performance Fund. This aligns my interests with the rest of the unitholders.

6. I Buy my Best Ideas
I prefer to buy only my best ideas.

7. Filter out the Noise
One of the greatest challenges is to filter out the noise and use only what is relevant.

8. Be Thrifty
Moderate costs facilitate moderate fees. Moderate fees facilitate performance.

9. Outperform by Being Different
To have a chance of outperforming the market, invest differently than the market.

10. Know Your Limits
It is just as important for me to know what I don’t know as it is to know what I know.

11. Stay Humble
Stay humble or the market will make you humble.

12. Being Small is an Advantage
It is easier to outperform being small.

13. Apply Spiritual Principles
An important measure of one’s success is how much he benefited his fellow man.

14. Investing is Not a Team Sport
The best decisions are rarely made by committee.

15. A Good Card Player Does Not Show His Hand
Confidentiality is essential for successful small cap investing.

16. Too Much Emphasis is Placed on Precision
I don’t need exact numbers to make decisions.

17. Be a Contrarian
Being a contrarian is harder in practice than in theory.

18. Strive for Effective Rationality
Do the homework; know the facts; and make decisions based on the facts.

Here are some more of Tom Stanley’s thoughts on investment management:

Tags: Asset Managers, Canada, Degree In Psychology, Difficult Decision, Economic Fundamentals, Flexible Approach, Investment Advisor, Investment Industry, Investment Philosophy, Master Of Business, Master Of Business Administration, Morningstar, Offering Memorandum, Performance Track, Portfolio Manager, Resolute Funds, Resolute Growth Fund, Resolute Performance Fund, Ryerson University, Seneca College, Stellar Reputation, Term Fluctuations, Term Investor, Tom Stanley, University Of Western Ontario, Value Investors, Value Stocks
Posted in Canadian Stocks, Markets | 1 Comment »

The Yield Curve is Flattening?

Wednesday, December 17th, 2008

Long-term government bond yields are dropping everywhere. Is anybody going this way?

Here is what some of the folks in the bond market are saying:

Eric Lascelles, Chief Economic and Rates Strategist,  TD Securities Inc.: “It is remarkable, the speed at which this is happening,” said Eric Lascelles, chief economics and rates strategist for TD Securities Inc.

Stewart Hall, currency and fixed-income strategist with HSBC Securities (Canada) Inc.: “I think one of the overarching themes today is global recession.” On a positive note, “You have the Fed and other government agencies operating in an imaginative and innovative fashion to throw as much as necessary [at the problem] to get the economy back in track.”

Mark Chandler, fixed-income strategist with RBC Dominion Securities Inc.: “Long-term rates are playing catch-up in terms of the decline in yields we have seen in short-term bonds.  There is limited downside in short-term yields.”The relatively greater drop in yields on long-term bonds compared with short-term bonds is a theme that could continue into the first half of 2009, Mr. Chandler said. In the parlance of bond traders, this is known as a yield curve flattener, as the difference in yield between short-term and long-term bonds narrows.

The decision by the Fed last week to buy $500-billion (U.S.) of agency guaranteed mortgage-backed securities, along with $100-billion of other agency (government-sponsored enterprises) debt, is a force acting to push yields down.

On an increasing basis, the Fed has been taking steps to manage through the U.S. housing crisis. The plan injects liquidity into the system, and frees up cash available for mortgage lending, as well as serving to lower U.S. mortgage rates. The rate of 30-year mortgages has fallen to 6 per cent last week from 6.5 per cent.

Less than two weeks ago, Federal Reserve Board chairman Ben Bernanke indicated that the Fed could also decide to buy longer-term U.S. Treasuries, which would reduce bond supplies, resulting in higher prices and a decline in yields.

From Bloomberg:

The 10-year note’s yield fell as much as 14 basis points, or 0.14 percentage point, to 3.37 percent. It traded at 3.40 percent at 3:04 p.m. in Toronto. The price of the 4.25 percent security maturing in June 2018 advanced 84 cents to C$106.86.

The yield on the two-year government bond dropped six basis points to 1.77 percent. The price of the 2.75 percent security due in December 2010 rose 12 cents to C$101.95.

The 10-year bond yielded 163 basis points more than the two- year security, down from 168 basis points yesterday. The so- called yield curve reached 184 basis points on Nov. 6, the steepest since May 2004.

Our thoughts are that Government of Canada bond yields which are still higher than those of comparable US treasuries will also come down over the next year, as investors seek the refuge of government securities (and Canada’s higher yields), on the Canadian as well as global recession trend. The current blows to the Canadian economy come as the Auto industry copes with the difficulties of the Big Three automakers, and in the commodities sector, with the decline in commodities prices that has led producers to consider shutting in mining and exploration projects, and laying off employees. On this basis, it seems far more likely that Canada’s yield curve could continue to flatten along with the US treasury yield curve, leading to higher bond prices and lower yields.

Levente Mady, a fixed-income strategist at MF Global Canada Co.: “Inflation doesn’t matter any more. It’s deflationary concern that’s underpinning the bid in the long end of the market. Yields are literally gravitating towards zero. It’s almost like it doesn’t matter if the news is good, bad or indifferent.”

Sources: Globe and Mail, Bloomberg

Tags: Array, Ben Bernanke, Bond Traders, Bond Yields, Canada, Canada Inc, Federal Reserve Board, Federal Reserve Board Chairman, Global Recession, Government Bond, Government Sponsored Enterprises, Hsbc Securities, Lascelles, Mark Chandler, Mortgage Backed Securities, Other Government Agencies, Rbc Dominion Securities, Rbc Dominion Securities Inc, Td Securities Inc, Term Bonds, Term Yields, Yield Curve
Posted in Bonds, Canadian Stocks, Commodities, Economy, Markets | No Comments »