Bill Gross: Investment Outlook (March 2010) “Don’t Care”

Monday, March 1st, 2010

Bill Gross has released his newly penned investment outlook letter, titled “Don’t Care.” The intro is aptly hilarious, a must read, and of course the body of this month’s investment outlook makes for interesting reading.

You can also listen to it by pressing the play button below:
Bill Gross, Don’t Care, March 2010

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“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:

1. Where are you from? (If it’s not a place where I’ve been or have a distant second cousin – don’t care.)
2. 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.)
3. 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.)
4. 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.)
5. 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.”

Read the whole letter here.

PDF VERSION

Tags: Advanced Placement Courses, Autobiographies, Bill Gross Pimco, Cocktail Party, Decibel, Dull Boy, Eye Shadow, Genuine Interest, Gross Investment, Ice Cubes, Investment Outlook, Investment Recommendations, Listener, Personal Favor, Play Button, Saturday Nights, Second Cousin, Seinfeld Reruns, Solitary Confinement, Those Shoes, Typical Conversation
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Investing for 2010: Ideas from Gross, MacAllaster & Witmer

Monday, February 1st, 2010

Three members of Barron’s roundtable, Bill Gross, Archie MacAllaster and Meryl Witmer shared their views on market outlook and investment ideas with Wall Street Journal.

The following is a recap with video links of the interviews.

Gross’ Three Market Drivers for 2010

Bill Gross, founder and co-chief investment officer at Pimco, believes the direction of short-term interest rates, inflation and quantitative easing will be the driving market forces in 2010.

Inflation: Contained & moving lower

Short-term Interest Rate is Central banks response to inflation.  He expects them to maintain the current near zero policy amid low inflation.

Quantitative Easing - Central banks withdrawal from buying mortgages and treasuries will have great impact on stocks, bonds and other riskier assets.

Note:  Bill Gross’ February 2010 Investment Outlook: The Ring of Fire is available at Pimco.com here.

MacAllaster Sees A “Good Size” Correction Coming

Archie MacAllaster, chairman of MacAllaster Pitfield MacKay, believes there will be a “good size” market correction in 2010 before rebounding later in the year with a possible 15% upside. He expects financials, particularly life insurance stocks to rise.

(MacAllaster interview video link here)

Witmer Expects Compass Mineral to Outperform

Meryl Witmer, general partner at Eagle Capital Partners, likes Compass Minerals (CMP), a salt and specialty potash maker. She expects its shares to have above trend growth over the next several years as it has one of the few expandable salt mines in the country.

Witmer sees Compass making $8-9 a share in 2011 or 2012, and should trade north of $100 in a year or so.

(Witmer video interview link here)

Video Source: WSJ.com

Tags: Archie Macallaster, Bill Gross, Central Banks, Chief Investment Officer, Compass Mineral, Compass Minerals, Eagle Capital, General Partner, Insurance Stocks, Interview Link, Investment Ideas, Investment Outlook, Market Drivers, Meryl Witmer, PIMCO, Salt Mines, Stocks Bonds, Video Link, Video Source, Wall Street Journal, Wsj
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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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Bill Gross: Investment Outlook (January 2010)

Thursday, January 7th, 2010

Bill Gross, co-Chief, PIMCO, has just released his latest instalment of his newsletter, titled, “Let’s Get Fisical.”

In it, Gross discusses the theme, that 2010 will be a year of “exit strategies,” of breaking free of government assistance. As usual, Gross’ outlook is captivating, and like others requires some interpretation as well as look-through.

Here is an excerpt:

“If 2008 was the year of financial crisis and 2009 the year of healing via monetary and fiscal stimulus packages, then 2010 appears likely to be the year of “exit strategies,” during which investors should consider economic fundamentals and asset markets that will soon be priced in a world less dominated by the government sector. If, in 2009, PIMCO recommended shaking hands with the government, we now ponder “which” government, and caution that the days of carefree check writing leading to debt issuance without limit or interest rate consequences may be numbered for all countries.”

and,

Additionally, if exit strategies proceed as planned, all U.S. and U.K. asset markets may suffer from the absence of the near $2 trillion of government checks written in 2009. It seems no coincidence that stocks, high yield bonds, and other risk assets have thrived since early March, just as this “juice” was being squeezed into financial markets. If so, then most “carry” trades in credit, duration, and currency space may be at risk in the first half of 2010 as the markets readjust to the absence of their “sugar daddy.” There’s no tellin’ where the money went? Not exactly, but it’s left a suspicious trail. Market returns may not be “so fine” in 2010.

I find it unusual that the discussion of carry trades is seldom discussed in depth, especially when it is such an integral, and functional, moving part of both the credit and equity markets. There has been a noticeable amount of press on the dollar carry trade ending, and the threat that poses, but very little on the subsequent presence and resumption in the yen carry trade, our Japanese “sugar-daddy.” As Hosein Askari recently asked, “Whose paying for the beer?”

Gross doesn’t mention it. There has been a reversal of the inverse relationship between the U.S. dollar and equity markets, emerging markets, commodities,  and the Canadian dollar, et al., since the U.S. dollar recovered off its late November lows. Where is the mysterious support coming from? Perhaps its too early to tell, OR, those who do know about it, are exploiting the opportunity, and keeping their lips tightly sealed.

Read the whole newsletter here.

Tags: Asset Markets, Bill Gross, Canada, Check Writing, China, Commodities, Debt Issuance, Economic Fundamentals, Emerging Markets, Exit Strategies, Financial Crisis, Financial Markets, Fiscal Stimulus, Government Assistance, Government Checks, Government Sector, Gross Co, Gross Investment, High Yield Bonds, Instalment, Investment Outlook, PIMCO, Shaking Hands, Sugar Daddy
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Bill Gross: Investment Outlook (December 2009)

Friday, November 20th, 2009

Bill Gross, Co-Chief at PIMCO has just released his latest investment outlook, titled Anything but 0.1%. Gross reveals that he is worried that bubbles are forming as a result of zero interest rate policy. This is a must read issue.

Listen to the newsletter, read by Bill Gross:

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On one hand Gross says it is prohibitive to stay for too long in money market instruments yielding next to nothing. On the other hand Gross says that zero interest rates are forcing investors back out on to the risk spectrum.

Ah, but this is not a vindictive diatribe, although to me, money changers resemble Mammon more than archangels, and they all make too much money, including PIMCO. My point is to recognize, and to hope that you recognize, that an effective zero percent interest rate, as a price for hiding in a foxhole, is prohibitive. Like the American doughboys near France’s future Maginot line in WWI – slumping day after day in a muddy, rat-infested pit – when the battalion commander finally blew his whistle to charge the enemy lines, it probably was accompanied by some sense of relief; anything, anything but this! Anything but .01%!

Recently, approximately $20 billion a week has been exiting those payless, seemingly godless funds in search of a higher-yielding Nirvana. Yet, as Will Rogers knew, and Lehman Brothers demonstrated to another generation, the pain of the foxhole can immediately transition to the dodging of real bullets on the investment battlefield. Moving out on the risk asset spectrum has worked wonders since March of this year, but it comes with the risk of principal loss – failing to receive the return of your money. When viewed from 30,000 feet, there is even a systemic risk that new asset bubbles are in the formative stages – perhaps because of the .01%. Gold at $1,130 an ounce, global equity markets up 60-70% from their 2009 lows, a cascading dollar now 15% lower against a basket of global currencies just 12 months ago, oil at 80 bucks, mortgage rates at 4% thanks to a $1 trillion dollar credit card from the Fed; the list goes on. The legitimate question of the day is, “Is a 0% funds rate creating the next financial bubble, and if so, will the Fed and other central banks raise rates proactively – even in the face of double-digit unemployment?” As Chicago Fed President Charles Evans said in a recent speech, “This notion is often described as an imperative to ‘lean against a bubble,’ meaning that a central bank should act to lower asset prices that by historical standards seem unusually high.”

Gross makes the interesting point, that in the “New Normal,” of lower growth, with companies transforming into low-growth utilities-like businesses, rather than looking like Boardwalk and Park Place, why not simply opt for the utilities? Buffett, for example, has taken down all of Burlington Northern.

In a low growth environment, it seems to me that a company’s stock should yield more than its less risky debt, and many utilities provide just that opportunity. Utilities and even quasi-utility telecommunication companies now yield between 5 and 6%, whereas their 10- and 30-year bond yield less and at a higher tax rate to you the investor.

Read the whole letter here, download the PDF here.

Tags: Archangels, Battalion Commander, Bill Gross, Doughboys, Formative Stages, Foxhole, Global Currencies, Global Equity Markets, Gold, Gross Co, Gross Investment, Interest Rate Policy, Investment Outlook, Lehman Brothers, Maginot Line, Money Market Instruments, oil, PIMCO, Risk Spectrum, Systemic Risk, Will Rogers, Zero Percent
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Hugh Hendry: Investment Outlook (November 2009)

Thursday, November 19th, 2009

As usual, Hugh Hendry provides a profoundly insightful view of the global economy and markets, and this month’s letter is a must read:

Eclectica Asset Management -Letter to Investors - November 2009

by Hugh Hendry
Portfolio Manager, Eclectica Fund

“The power to become habituated to his surroundings is a marked characteristic of mankind.”

John Maynard Keynes
The Economic Consequences of the Peace, 1921

This month I will attempt to answer the entrance examination for the Chinese civil service. That is to say, I will attempt to tell you everything that I know. In doing so, I will argue that this year’s rally in inflationary assets, from emerging stock markets to industrial commodities to the fall in the US dollar, could be a FAKE. Let me explain why.

But first, I am indebted to Scott Sumner, professor of economics at the University of Bentley, and his essay on the economic lessons that can be drawn from timelessness in art (see http://blogsandwikis.bentley.edu/themoneyillusion/?p=2542). It is a theme that I will constantly revisit in my arguments below.

Sumner is able to take us from the Flemish forger, Van Meegeren, and his horrendous reproductions of the Dutch painter, Vermeer, to the notion that every recession seems unique and special to its protagonists. So just how did Van Meegeren fool the Nazis with paintings that today look so awful, so un-Vermeer? Jonathan Lopez, the noted art historian, argues that a FAKE succeeds owing to its power to sway the contemporary mind. Or in other words, the best forgeries tend to pay homage to the tastes and prejudices of their time. The present is so seductive.

However, forget the art world. Controlling the psyche of this generation of investor is the indelible mark of the falling dollar and the associated fear of inflation. Monetary inflation has been the distinguishing feature of the last ten years, and it is now firmly embedded in the contemporary mind. I am sure I need not remind you that gold, along with just about every other commodity, has at least quadrupled in price since 1999. You already know my explanation for why this has happened.

The spectacular rise in the Chinese trade surplus, predominantly with America, to $320bn per annum at its peak in 2007, and the mercantilist desire to prevent currency appreciation drove the Asians and the sheiks to buy Treasuries and print their own currencies. The ability of fractional reserve banking to leverage this liquidity many times over provided the monetary mo-jo to instigate ever higher commodity prices. In other words, quantitative easing, masquerading as a cheap but fixed currency regime, has succeeded where Japan’s orthodox version has failed. The QE succeeded because, amongst other features, it raised the velocity of monetary circulation.

However, it was not always like this. As an example, ten years ago it was unthinkable that the dollar would prove so fragile. Recall that back then, when the euro was first launched in 1999, it promptly lost 31% of its value against the greenback. The subsequent reconstruction of modern China, though, intervened. In order to finance the emergence of a new economic superpower, an abundance of dollars was needed. Have no doubt that had we not had the dollar as a reserve currency, the rise of China would not have been as swift nor as decisive.

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The Yellow Brick Road
Consider another economy needing to be rebuilt: that of the United States in 1865, the post Civil War era. The rebirth of the American economy was funded from the monetary rectitude of the gold standard, not from the generosity of a foreign and infinitely expandable paper currency. However, all of this occurred before the discovery of cyanide for heap-leaching and the opening up of the huge South African gold fields. In other words, hard money was in tight supply and the recovery was neither swift nor decisive. Indeed, 30 years later, during the presidential election campaign of 1896, Williams Jennings Bryan was still hotly contesting its merits. He railed against the persistent price deflation and argued that the economy was burdened by a “cross of gold” (see The Eclectica Fund Report, December 2005).
Perhaps I Should Stick to the Twenty-First Century?
My previous investment letter attempted to explain the subtleties of the Triffen dilemma and the dollar’s pre-eminent role in regenerating modern day economies. Let me repeat once more: lots of dollars were required, and duly delivered, to build modern China. They did not have to wait on the vagaries of a gold discovery to promote and sustain their economic engine. Instead, they required the willingness of their trade partners to run trade deficits. The US delivered and, partly as a consequence, the Fed’s broader trade weighted dollar index has now fallen 20% since its peak in 2002 (the narrower DXY index compiled by the Intercontinental Exchange has fallen more, but excludes the renminbi and overstates the role of the euro). In return, the world has a new $4trn trading partner: China.

Heady stuff, but not without precedent: recall the Marshall Plan, a watershed American aid program that assisted the reconstruction of the Western European economy during the 1950s and 60s. This was further augmented by America’s willingness to run trade deficits, the modern day equivalent to a gold discovery, which became necessary to sustain the emergence of the new economic trading bloc. This resulted in the dollar’s huge devaluation versus gold in the 1970s. However, back then, the broad trade weighted index kept rising. This time it has fallen sharply.
What an Ungrateful Lot We Are?
The dollar’s role as the world’s sole reserve currency has both assisted and accelerated the development of world trade. America’s trading partners have come to rely upon the bounty of dollars necessary to recycle their trade surpluses and thus finance their growing prosperity. This was done even at the expense of domestic American job losses. Replace the dollar with IMF special drawing rights; I hear your retort. Sure, but have you ever bought a cup of coffee with an accounting identity? And, fundamentally that argument still suffers from the dearth of any other major economy showing any willingness to sacrifice its short term economic standing for the longer-term mutual benefit of having enriched trading partners.

Do not forget that the Chinese could replicate equivalent currency baskets to SDRs at any moment. Instead, they continue to recycle almost three quarters of their trade surplus back into dollars. This is not coercion but simple commercial pragmatism. They know full well that neither Europe nor Japan nor Britain nor Switzerland nor the rest of Asia are willing to sacrifice the implicit loss of manufacturing jobs. They understand that it is only the US that is willing to embrace the benefits of comparative advantage that arise from international trade. Have you ever asked yourself why car prices in America are so low compared with those in Europe? This is my point.

I keep hearing that a dollar devaluation would help matters. I agree; it has. Let me say it again; we have already had the devaluation. That is what the last five years were all about. Now with China rebuilt, and the trade deficit in full retreat (note the -47% contribution from net exports to China’s GDP growth in the first 9 months of this year), there are less dollar bills being exported overseas to ungrateful recipients. Is it not time we drop our fascination with the present and consider the future? Is it really inconceivable that the dollar could now strengthen?
Women in Love, Investors in Love. What’s the Difference?
Of course this is a minority view. Investors have reacted to last year’s deflationary traumas by insisting that it is business as usual. They behave like D.H. Lawrence’s coal miner Gerald from the novel Women in Love, who, just days after his father’s funeral, steals into his former lover’s bedroom and, “…into her he poured all his pent-up darkness and corrosive heat, and he was whole again.” Or was he? The trouble is that we are so anchored to the recent past. Investors are fearful of what now seems so familiar and recognisable; at what they perceive as the reckless behaviour of our monetary authorities. “Inflation is a monetary phenomenon” is their Friedmanite dogma. Their salvation can only be found in the safe sanctuary of gold and the embrace of risky assets, but are they truly safe?

This is my home. Don’t be so sure about anything, Big Horace. Not about anything in this world.

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The Orphan’s Home Cycle
Horton Foote

And so, just as the Church of England commissioners became convinced by the cult of equity way back in the whimsical days of 1999 and went 100% long the stock market, investors today recant a new mantra of, “anything but the dollar (A-B-D)”. Inflation bets are all the rage. Some would insist that it is their fiduciary duty to protect their clients’ capital; I say tell that to the Church of England pension fund, whose assets today are just £461m against liabilities of £813m. Austerity beckons for the clergymen; heaven will have to pay their stipend.

But the spell cast by a contemporary cult is hard to resist. Take another august body, the Harvard Endowment Fund. Not typically renowned as a hotbed of reactionary fervour, the fund is nevertheless radical in its construction and has come to typify the A-B-D stance.

Harvard’s position could well be construed as a one-way bet. Almost half of the fund is invested in emerging market equities, commodities, real-estate, private equity and junk bonds. It is as though the rap artist 50 Cent has taken over the advisory board. The fund is going to, “get rich or die tryin’”.

We, on the other hand, approach risk by considering the worst possible outcome. For a current pension scheme the greatest torment would be a repeat of last year’s final quarter when 30 year Treasuries yielded just 2.5%. This would require a CAGR of 20% or more from the fund’s riskier assets at precisely the time that their future returns would seem most questionable; insolvency would beckon. And yet, they blithely run the risk of ruination.

Of course, they are not alone. Another popular argument is that the emerging economies have to urgently diversify their immense dollar reserves. And so the Chinese are colonising the African continent in the pursuit of commodities and the Indian government has just agreed to buy 200 tons of the IMF’s gold hoard.

Is this not a reincarnation of the 1980 trade of the brothers Hunt? It is hardly an exaggeration to suggest that China, for all intents and purposes, is already the commodity market. For despite providing less than 8% of global GDP, China accounts for more than half of the world’s steel production and more than half of global seaborne iron ore freight. Indeed, this peculiarity is circular in nature. Consider that a modern aluminium plant requires 25% of the project’s cost to be spent on buying aluminium in the first place. And remember that investments in fi xed capital formation (think new aluminium plants et al.) have made up 95% of Chinese GDP growth this year. China Inc. is Commodities Inc.

Accordingly, China shares the same risk as the world’s largest pension schemes. An over- leveraged American consumer does not return to his/her manic buying of old. As William White, former chief economist of the BIS, has argued:

Many countries that relied heavily on exports as a growth strategy are now geared up to provide goods and services to heavily indebted countries that no longer have the will or the means to buy them.

Surely, the Chinese stash of Treasuries is a prudent elimination of the fat tail risk that private sector deleveraging in the west ends up killing the golden goose of the trade surplus. But instead, in exercising good ol’ Texan tradition, they have opted, like the Hunt brothers did, to double up. It is the old dice game, Mort Subite, played by the employees of the National Bank of Belgium in the busy lunch time cafes of Brussels in 1910. If the players didn’t have time to complete their business, they played a final round with a sudden ending where the loser would be pronounced dead.

Much is made of the comparison between today’s balance sheet recession and Japan’s demise back in 1989. Despite their bubble never coming close to matching China’s prominence in industrial commodities, the loss of Japanese economic growth in the 1990s was nevertheless a major factor in the waterfall crash in commodities. This plunge ultimately saw oil trade for as little as $10 per barrel in the next decade. Just consider how much more devastating the experience would have been had they gone very long the commodity market in 1989 rather than golf courses and Rockefeller Centre. At least the Harvard endowment scheme did not share their enthusiasm for golf. But, this time around, I fear a Mort Subite beckons for the losers in Asia and the pension market.
Last Orders: Inflation or Deflation?
If a poet knows more about a horse than he does about heaven,
he might better stick to the horse… the horse might carry him to heaven.

Charles Ives

I am now going to return to the torturous and binary debate concerning inflation. As you know, I am in the deflation camp for now, and we own a modest amount of government bonds and a series of asymmetric bets which would receive a boost from a return to some form of risk aversion. You could say that I am sticking to my horse.

My intellectual foes, on the other hand, are adamant that long duration government bonds are a short. I even hear that some Wall Street legends are so convinced of the argument made by the likes of Niall Ferguson that they personally own Treasury put options and are actively counselling others to do the same. The argument can be condensed into just two fears.

First, they will suggest that 4.5% is not an adequate return for lending your money to the profligate United States for 30 years. I agree wholeheartedly. Again, I fear it is my accent, but let me stress once more that I do not propose that anyone adopt a buy-and-hold policy for the next thirty years in bonds. However, a nominal rate of 4.5% might prove very profitable over the coming year should breakeven inflation expectations head south again.

Second, the bears contend, a lower Chinese trade surplus will eliminate a very large source of Treasury buyers at a time of burgeoning supply. Again, we find ourselves agreeing vigorously. However, it is our contention that US savings are heading north over the months and years to come. And an America that saves is an America that does not run a current account deficit. It is an American that can finance its own spending domestically. The US produced a small surplus back in the 1990-91 recession, so why not again?

As a consequence the Chinese surplus is set to fall further and, with fewer dollars needing to be recycled to maintain the currency peg, their demand for Treasuries will continue to shrink. Now this is potentially a huge headache owing to the massive projected American budget deficits for this year and next, and the Treasury’s desire to extend the maturity of the existing stock of government bonds which is becoming perilously short dated. Some estimate new issuance of around $2.5trn for the upcoming year. Perhaps, it is better that we buy those Treasury put options after all?
American Gothic
Or is it? I have quoted Don Coxe’s definition of a bull market before and I intend to do so again. “The most exciting returns are to be had from an asset class where those who know it best, love it least.” On this point, America has fallen out of love with its own currency and bond market. Foreigners own over half of the outstanding Treasury stock. But, like I said, I think events could reignite some of the natives’ old amour.

It is almost like declaring an enthusiasm for Say’s Law. Think of it this way, a greater supply of Treasuries would be a very obvious by-product of weaker than anticipated economic growth. And in this environment risk aversion stimulates the investment desire for risk free assets. So, in a round about way, there are circumstances when supply and demand can match in the bond market. But weaker economic growth? Surely the governments’ interventions this year have remedied the economy?

The surprise might concern the role that rising leverage has played in boosting GDP and in anchoring investors’ expectations to an unrealistic level of nominal GDP. Over the last decade, each marginal dollar of debt has generated less and less marginal income. We knew that there would be a “zero-hour” for the economy when the creation of new debt would not contribute to GDP growth. The government’s reaction to last year’s demand shock has been to increase its own leverage. But, with the economy operating at its zero-hour, we believe this incremental leverage will actually have a negative impact. That is to say, the public sector will fail in its attempt to bring the economy back to its previous level of nominal GDP. In this scenario, the outcome will disappoint the market’s expectations, which are rampantly bullish as evidenced by this year’s dramatic re-pricing of risk assets.

This zero-hour for America has perhaps arrived sooner than many had anticipated. It was heralded by the Japanese experience. Japan is the bogeyman that confronts all academic thinkers, regardless of creed, from Krugman to Ferguson, as well as all who would choose to intervene in the workings of the economy. In a debate I had with Mr. Ferguson in London last month, he claimed that Japan was an extreme outlier and could be ignored. Really?

No sex, no drugs, no wine, no woman, no fun, no sin, no wonder it’s dark
Everyone around me is a total stranger.
Everyone avoids me like a psyched loan-ranger
That’s why I’m turning Japanese,
I think I’m turning Japanese,
I really think so

The Vapors, 1980

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Japan has championed both Friedman and Keynes. They have built bridges to nowhere and dropped Yen notes from helicopters for twenty years and still they have nothing to show for it. Clearly the additional return from Yen debt in Japan is close to zero and it exposes the nightmare of interventionists everywhere: it may just be that there are no policy remedies for a debt deflation. So to elaborate further, our chances of financial success are greatest under conditions where investors believe government spending will succeed but in reality it fails.

However, where will the demand for all of this additional government debt come from? Let us review the Fed’s Z1 numbers. The US has household wealth of some $67trn. Of that, $20trn is accounted for by real estate and is perhaps out of bounds for our purposes. But $8trn is held in the form of private pensions and insurance funds. And yet, remarkably, these institutions presently allocate just $630bn to Treasuries et al. Households have a further $22trn in time deposits and other financial assets. But again they own just $500bn of Treasuries, and commercial banks own a tiny $130bn or, 1% of their total asset base of $12trn.

Consider that in 1952, at the very end of the supernova bond bull market formed from the ashes of the Great Depression and the Liberty Bonds that financed the Second World War, US banks held 40% of their gross assets in Treasuries. That is a potential $5trn of demand from this one source alone, albeit spread out over a number of years. And again, the Japan experience lends support. Japanese financial institutions have quadrupled the percentage of their assets held in JGBs. Furthermore, their households have lifted their government bond weightings five-fold over the last ten years. Should the same pattern repeat itself stateside, American households would need to buy another $2.5trn, but again, over ten years.

And let us not forget that a trend of rising prices allied to the most basic human emotion of avarice encouraged commercial banks and other financial institutions to buy $3.2trn of questionable mortgage backed securities in 2004, $1.9trn in 2005, $2.2trn in 2006 and $2.1trn in 2007. So it is not inconceivable, at least in my mind, that financial institutions, and notable amongst them the nation’s pension and endowment schemes, could be motivated by another basic human emotion, namely fear for their own survival, to snap up all these new government bonds. Perhaps in the end supply will create its own demand.

Again, it all really comes down to your take on the ratio of total debt-to-GDP. If you believe, like I do, that it peaked in 2007 then the repercussions are enormous. The leverage does not necessarily have to come down (after peaking in 1932 at 300% it troughed 20 years later at 150%). Rather, it may well be that low interest rates allow the mountain of debt to continue to be serviced. This has been the Japanese experience to date. However, everything in our economic life exists at the margin, and the consequences of just maintaining the leverage constant would be a very low delta in nominal GDP growth. Consider that the Japanese, under these very circumstances, have managed to grow nominal GDP at just 1% compound since 1990.
In Bernie We Trust?
This is why China’s mad dash for commodities and its investment splurge this year is so worrying. In my marketing presentations I show a picture of Madoff superimposed on a dollar bill and ask, “…in Bernie we trust?” My point is that if the hedge fund fraudster had been given the responsibility for US GDP accounting, he would surely have overstated the figure. And in a similar way, the rise in leverage has probably misrepresented the truly recurring nature of nominal GDP. Now, if we repeat the Japanese experience then it is possible that nominal US G DP will rise from $14trn today to perhaps just $16trn in ten years time. Along similar lines, the German government does not anticipate its economy exceeding its previous GDP high until 2014. And yet it is as though the other surplus countries are behaving like Bernie’s former investors who, believing in the stated NAV and its promise of more of the same (i.e., predictable and attractive compound growth rates), were happy to spend lavishly. The Chinese are building capacity to meet a world where US nominal GDP is $25trn in ten years time. I fear they could be in for a nasty shock.

What Do I Mean?
Consider the steel market. The homogeneous nature of steel, as well as other factors such as its price-to-density, allows for the export of the finished good across trade boundaries. Now with China having been on such an expansionary tear, it may not surprise you to hear that finished Chinese steel prices today trade below their production cost. Furthermore, import license applications to sell steel in the US, the world’s largest export market, rose 24% last month. Now, mostly this comes from Mexican and Korean producers, but clearly there is the implicit threat that their Chinese competitors might also be tempted.
But the Economy is Growing?
Clearly it would be inappropriate to annualise the production of the US steel industry in the fourth quarter of last year when capacity utilisation plummeted to just 32%. So consider, instead, the annual run rate this year from January to August. This was a period of stabilisation in tandem with the cash-for-clunkers program, which boosted the industry’s largest customer, the car sector. It is quite chilling to note that steel production in America is on a par with output back in 1938, when GDP was a mere 7% of its current size. The industry’s run rate dropped to a paltry 13% during the Great Depression. However, output only troughed at its 1908 level; a twenty year retracement that is a far cry from our 70 year retracement. So the physical developments in the western steel markets should raise some concern. However, with an active steel futures market in China turning over $15bn a day (consult the Bloomberg page <RBTA CMDY CT>), speculative fears concerning the dollar have overcome the paucity of industrial demand in the west.

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Of course, it is not just steel. Consider the aluminium market. We recently had a very bearish meeting with the Norwegian company Norsk Hydro. Admittedly, their strong petro-currency does not help and you have to discount the solace I seek in finding people even more miserable than myself. Even so, the aluminium situation mimics that of steel, but with an even mightier inventory overhang. Four and a half million tons reside at the London Metal Exchange, perhaps 20% of world ex-China annual capacity. It is probable that 75% of this surplus stock is accounted for by financial players exploiting a contango.

Does Life Imitate Art?
The advocates of Prechter’s socio-economics would not be surprised to hear that the Romanian writer Herta Mueller has been awarded this year’s Nobel Prize for literature for her work depicting “the landscape of the dispossessed”. In a Los Angeles Times review of her book, The Appointment, they noted,

“…it is sometimes difficult to tell whether we are reading about people driven mad by a mad regime or people who may not have had all their marbles in the first place.”

My partner, Mr. Lee, reflected on this as he sat in the chilly offices of Norsk Hydro last week watching the snow fall outside. The Norwegians continued with their tale of woe: a couple of million tonnes of inventory remains unaccounted for on the world stage and are believed to be hidden in cheaper warehouses in Russia. The rationale behind this is the same as the rationale used by LME speculators. Furthermore, the big Russian players like Rusal are under intense pressure from Putin not to cut capacity (check out ‘Putin bitch slaps Deripaska’ on http://www.youtube.com/watch?v=PprlM5R3Hbg), and are rumoured to be surviving only by not paying their electricity bills.

To make matters even worse, the Chinese have stopped importing and are eager to ramp up domestic aluminium production. They havethe capacity to produce another 13mt annually, which is equivalent to 52% of global production. Lastly, there is the fact that Rio Tinto bought Alcan right at the very top of the cycle, though they dare not admit it is a terrible business.
Poor Old Norsk Hydro?
Who would want to share a stage with so many mad villains? The Norwegians noted that construction demand had just taken another leg down as buildings started pre-crisis are now finished whilst no further pipeline exists outside of China. Even Ryanair are talking about suspending their aggressive growth plans and may delay the purchase of more planes.

The Norwegians suffer the most pain at present, but if the dollar were to strengthen Alcoa could conceivably go bust. Their dollar cost is the company’s only competitive advantage. Let us not forget Alcoa has the most exposure to aircraft construction and still has $10bn of gross debt lording over an almost equivalent market cap. Imagine that we have not even considered their pension liabilities. Yet the Alcoa CDS trades at 200 basis points, down from its high of 1200 earlier this year. Why?!

“May sorrow break these chains of my sufferings, for pity’s sake”

Lascia ch’io pianga
Handel

Now remember I have been describing a positive macro scenario: a world in which low interest rates make the debt load manageable and that we muddle through with lower growth rates in nominal GDP. But clearly the consequences for corporate profitability are very poor. The alarming thing is that my opponents (see Ferguson et al.) believe that government bond yields are going much higher. Effectively, the world’s bond vigilantes are going to punish the Fed and tighten monetary policy. It is almost as if the world’s greatest speculators are agitating for their own demise. It is my contention that the leverage of the economy is only tenable if interest rates stay low and yet, whilst I believe some of them agree, they still fervently expect a rise.

Je consens, ou plutôt j’aspire à ma ruine.

Pierre Corneille
Polyeucte, 1642

Do not forget that the US does not share the distinction of the British or Australian housing markets. According to FSA data, 55% of UK mortgages are fixed rate and 45% are floating. The latter have, of course, collapsed and have proven a boon for disposable income. We must remember, however, that British fixed rates are determined by two and three year swap rates; so effectively the entire stock of UK mortgages are determined by the central bank and could be thought of as floating. In the US, however, things are very different. Total single-family mortgages outstanding are $11trn but $9trn is fixed to the prevailing 30 year Treasury yield. Banks just do not offer variable rate or teaser mortgages anymore. You might say that the American housing market hangs by the tender threads of the bond market’s generosity. Lose it, and let us say that the markets demand 6% yields on 30 year durations and mortgage rates would then shoot back up to 7%. And, I would argue, the econo my would come to a crashing halt. Do speculators really want this to happen?

Perhaps I am describing a pressure cooker. The private sector’s debt may be sustained by maintaining low nominal interest rates.But the pressure from so much issuance at a time of great reluctance from financial institutions to purchase bonds could break the stalemate. And with it the ominous precedent of 1931, outlined in our February report, when a back up in ten year Treasury yields from 3.1% to 4.4% undoubtedly accelerated the rate of deflation in the US economy.

Conclusion and Investment Review: The Augustus Gloop Song

Oompa loompa doompety doo I’ve got a perfect puzzle for you Oompa loompa doompety dee If you are wise you’ll listen to me What do you get when you guzzle down sweets Eating as much as an elephant eats What are you at, getting terribly fat What do you think will come of that…

Oompa loompa doompety da If you’re not greedy, you will go far Charlie and the Chocolate Factory Roald Dahl, 1964

I now return to Japan. Sometimes I find myself sounding like an apologist for Bernanke and big government. In my debate with Mr. Ferguson it was expected that I would represent Paul Krugman (yuck!) so let me attempt to clear any misapprehensions. I think our present lot of politicians and government officials are “filthy”. There are no limits as to how far they are willing to go in order to prevent a market inspired liquidation of all the economy’s rotten apples. After all, that is what deflation is all about. The government insists it understands the policy gaffes of the 1930s and has assured everyone that these will not happen again.

I want to punish them for this monstrous nonsense and their intellectual arrogance as much as you do. I want nothing to do with them. I want to watch them squeal as higher and higher gold prices rebuke their interventionist ways. But I also want to make money; lots of money. I simply do not want to do this in a manner in which my errors could cost the Fund a great deal of money and heartbreak. So I fall back on my old argument. It is perhaps too subtle, but at its core lies today’s most pertinent question. What if Bernanke, the Chinese, Putin, Obama, his Congress, and all the other interventionists, are simply impotent? What if they do not matter? Perhaps it is the debt, stupid. Perhaps the incremental GDP from all of this additional stimulus spending is zero. And, as Japan has foretold, perhaps all of this year’s interventions will be unable to lift the global economy from its funk. If this is so, you will not require all those inflation hedges; you have been sold a FAKE.

But first, it may require the spectacle of seeing Japan implode and so we have been actively positioning the Fund to profit from such a scenario. As many of you know, the fiscal situation in Japan is rapidly rising out of control. Government tax receipts are down 14% over the last 12 months; government spending is twice the receipts and the trade surplus appears structurally impaired. We have to go back to 1991 to find the last time they ran a primary surplus sufficient to meet their national debt’s interest payments. Today they would need the equivalent of 4.4% of GDP. Failing this, and assuming they do not shorten the debt maturity of the JGBs that they sell to the public, then the ratio of public debt to GDP is guaranteed to rise further. It is currently 196% of GDP with the IMF estimating that it will rise to 234% by 2014.

This situation has not gone unnoticed. The sovereign dollar default swap has doubled to 75bps since August, and Japan is now the most expensive credit to insure against a dollar default in the G10. However, we have been active buyers of corporate debt default swaps. We find it remarkable that one can insure highly leveraged utilities at 23bps despite their considerable yen debt. Consider the Tokyo Electric Power Co. (9501 JP) with a market capitalisation of $32bn and net debt of $81bn. The debt is 7x EBITDA, the interest cover is 1.9x, and the average interest cost for now is thankfully just 1.9% p.a.

The Japanese government has been sensible in one area; two thirds of all their JGB issuance has been in maturities of ten years or more whereas the US has a skew to shorter dated issuance. However, it is probable that the public sector in Japan is crowding out the private sector from the long end, for whilst only 24% of the government debt is of 2-5 year maturity, the corresponding figure for the utility company is 57%. Furthermore, they are dependent on 70% of their debt being sourced from non-banking sources, i.e., from the market place. Clearly there are two prominent risks: debt rollover and higher interest rates. The “cheap” risk is a normalisation of interest rates brought about by a dearth of buyers at these levels. Should Tokyo Electric’s interest cost double to 4.6%, the company’s EBITDA-less-CAPEX would just cover the interest bill. What cost would credit underwriters insist for the CDS in this scenario?

We have a notional exposure representing almost 40% of the Fund’s NAV. It represents a large notional risk exposure with a quantifiable and manageable downside loss of just 9 bps of the Fund’s NAV every year for five years. However, the potential return to the Fund in the event of a default would be 23% of NAV, or 250x our annual outlay. Whilst we would still make 1% point of NAV should it trade in line with the sovereign credit risk, or 1 0x our annual cost. We might get rich but we certainly will not die tryin’.

The above is typical of our portfolio today. Gone are the cavalier days of large gross exposures across multiple asset classes and large monthly volatility. Instead we own a basket of cheap sovereign and corporate default swaps and the asymmetry of interest rate option packages which enjoy high pay-offs should the enormous debt load of the private sector keep rates lower for longer. I began this lengthy letter quoting from Keynes’ Economic Consequences of the Peace. With the benefit of hindsight, future historians might conclude that the major blunder of last year’s bailout was the failure to reduce or even address the economy’s debt burden. If this turns out to be the case, I believe that the Fund is well positioned to make money.

Tags: Art Historian, BRIC, China, Commodities, Dutch Painter Vermeer, Economic Consequences Of The Peace, Economic Lessons, Emerging Markets, Emerging Stock Markets, Entrance Examination, Forger, Forgeries, Global Economy, Gold, Hugh Hendry, Indelible Mark, India, Industrial Commodities, Insightful View, Investment Outlook, John Maynard Keynes, Jonathan Lopez, Management Letter, Monetary Inflation, oil, Timelessness, Van Meegeren
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Eric Sprott: Investment Outlook (November 2009)

Thursday, November 5th, 2009

Eric Sprott’s just released his latest investment outlook, Surreality Check Part Two: Dead Government Walking. Its a follow up to Surreality Check Part One: Dead Men Walking, originally published in November 2007 where Sprott described the ‘bizarro’ market preceding last year’s credit and financial market meltdown. As usual, its excellent reading, as Sprott does his best to make sense of the senseless:

The equity market performance in November 2007 masked the underlying problems plaguing the financial system at the time, and it’s blindingly apparent that it is doing the same again today. The government has assumed most of the financial system’s liabilities in a giant game of ‘kick the can’. The calls for a new bull market are coming fast and furious. Market participants are bidding up the stocks of companies that are demonstrably bankrupt, and government balance sheets have ballooned to unforeseen levels. As respected market commentator David Rosenberg recently wrote, “the stock market is divorced from economic reality”.1 It’s time for another surreality check, but this time it isn’t the publicly traded companies that deserve attention, it’s the governments that have saved them. Make no mistake - the dead men are still walking - they’re just a lot bigger now than they were two years ago, and they don’t generate earnings - they print money and tax their citizens.

Download the whole report here.

Tags: Advertisement, Balance Sheets, Bizarro, Citizens, David Rosenberg, Dead Men, Dead Men Walking, Earnings, Economic Reality, Eric Sprott, Financial Market Meltdown, Game, Governments, Investment Outlook, Liabilities, Market Commentator, Market Participants, Market Performance, Mistake, Money, Stock Market, Stocks
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Bill Gross: Investment Outlook (October 2009)

Thursday, October 29th, 2009

Bill Gross, co-founder and co-CIO of PIMCO, is to my mind one of the shrewdest money men around. His monthly newsletter, this month entitled “Midnight Candles”, therefore always makes for thought-provoking reading.

He concludes the newsletter as follows:

“Asset appreciation in US and other G-7 economies has been artificially elevated for years. In order to prevent prices sinking even lower than recent downtrends averaging 30% for stocks, homes, commercial real estate, and certain high yield bonds, central banks must keep policy rates historically low for an extended period of time. If policy rates are artificially low then bond investors should recognize that artificial buyers of notes and bonds (quantitative easing programs and Chinese currency fixing) have compressed almost all interest rates.

“But while this may support asset prices - including Treasury paper across the front end and belly of the curve, at the same time it provides little reward in terms of future income. Investors, of course, notice this inevitable conclusion by referencing Treasury Bills at .15%, two-year Notes at less than 1%, and 10-year maturities at a paltry 3.40%. Absent deflationary momentum, this is all a Treasury investor can expect. What you see in the bond market is often what you get.

“Broadening the concept to the US bond market as a whole (mortgages + investment grade corporates), the total bond market yields only 3.5%. To get more than that, high yield, distressed mortgages, and stocks beckon the investor increasingly beguiled by hopes of a V-shaped recovery and ‘old normal’ market standards. Not likely, and the risks outweigh the rewards at this point.

“Investors must recognize that if assets appreciate with nominal GDP, a 4-5% return is about all they can expect even with abnormally low policy rates. Rage, rage, against this conclusion if you wish, but the six-month rally in risk assets - while still continuously supported by Fed and Treasury policymakers - is likely at its pinnacle. Out, out, brief candle.”

Click here for the full article.

Source: Bill Gross, PIMCO - Investment Outlook, November 2009.

Tags: Asset Appreciation, Asset Prices, Bill Gross, Bond Investors, Central Banks, Chinese Currency, Commercial Real Estate, Gross Co, Gross Investment, High Yield Bonds, Inevitable Conclusion, Investment Grade, Investment Outlook, Maturities, Money Men, Nominal Gdp, PIMCO, Rage Rage, Treasury Bills, Us Bond Market
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Julian Robertson’s Inflationary Perspective - Bloomberg Transcript

Tuesday, October 6th, 2009

We recently featured Julian Robertson’s CNBC interview, in which Robertson outlines the consequences of a scenario where China stops financing the US Treasury. The ongoing debate that is playing out between the deflationists and inflationists is reaching a fever pitch. Last week we discussed Bill Gross’ deflationist decision to exchange his high grade corporate bond holdings in favour of long-dated treasuries. Robertson’s scenario is a variation of other inflationist outlooks that includes the more extreme ‘what if’ chance that China could opt to stop buying Treasuries.

He explodes the less-than-well-known idea that China cannot abandon its symbiotic marriage to the US. This is where Robertson’s perspective is controversial. At the very least, it is a political play on Robertson’s part, in that it may be his attempt to induce a more serious attitude in government to focus on fixing what is truly wrong with the financial system rather than flushing the system with liquidity. Robertson’s IF, THEN, ELSE doomsday scenario is correct IF China stops buying treasuries, THEN the dollar will crash without support, resulting in hyperinflation that would be destructive - ELSE the government adopts economic policy that are real fixes that address the real systemic problems of America’s overindebtedness.

Bill Gross’ latest investment outlook ” Doo-Doo Economics,” addresses the ELSE agenda as well. Both Robertson and Gross seem to share the same concerns, but differ on what the semantics and treatments need to be, now that the US economy is out of the ER and in the ICU. The debate between the inflationists and deflationists seems to rest on how and what will happen next - Falling prices or falling dollar?

TIGER MANAGEMENT CHAIRMAN JULIAN ROBERTSON ON BLOOMBERG, OCTOBER 2, 2009
SPEAKERS:  JULIAN ROBERTSON, CHAIRMAN, TIGER MANAGEMENT
MATT MILLER, BLOOMBERG NEWS ANCHOR
TOM KEENE, BLOOMBERG NEWS ANCHOR
(This is not a legal transcript.  Bloomberg LP cannot guarantee its accuracy.)

15:07

MATT MILLER, BLOOMBERG NEWS ANCHOR:  He is known as one of the most successful fund managers of all time.  Julian Robertson started Tiger Management in the early ’80s with $8 million and built it to over $22 billion at its peak in 1998.  Now though, all eyes are on Tiger Management 2.0., a unique structure he created housing dozens of independently run hedge funds that Julian financed in his offices at 101 Park Avenue.  Julian has been described as the greatest identifier, backer, encourager, and developer of talent that the hedge fund business has ever seen.  He joins me now onset along with Tom Keene, the host of “BLOOMBERG SURVEILLANCE.”

Julian, thanks so much for coming on.

I find that the new structure that you have developed very interesting.  And I’m wondering, you don’t just find them at the Ivy Leagues, you get a lot of your talent at the University of Virginia and UNC.  And you do not just go with the tried and true, you’ve given, apparently, money to guys as young as 26.  What is it that you see in a young manager that proves to you, that shows you that he’s going to be talented and make money?

JULIAN ROBERTSON, CHAIRMAN, TIGER MANAGEMENT:  Well, we look very hard at being sure that everyone will partner with are thoroughly honest.  We want them to be intelligent.  And we have found through the tests that we give that very competitive people are very good in this business.
Oftentimes, people who are excellent athletes of some sort make great fund managers.

I think also, there is a very good probability, although we have not measured this in tests, that there is a great change by the best hedge fund managers, a strong feeling that they should change the world.  And I think that shows up on the people on Wall Street.

TOM KEENE, BLOOMBERG NEWS ANCHOR:  That means Matt’s going to be a great hedge fund manager, because he walks in here every day ready to change the world.

(LAUGHTER)

But it’s an asymmetric view.  When you go to, say, UNC, you’re beloved UNC, or that evil empire down the street at Duke University, and you’re looking for someone, there’s asymmetric challenge here.  You’re looking for someone that can protect capital in challenging times much more than you are that they can make money, right?

ROBERTSON:  That’s right.

KEENE:  When you do that and you recent time, and you haven’t been actively investing, but how do you grade the young Turks given the financial crisis we’ve had, the economic contraction, that upsilon off the end of the equations, the systemic risk that is out there?  Have they done a good job?

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ROBERTSON:  They have done a superb job, particularly through the break.  We have not performed as well as I would like once the break is over.  But I think that’s one of the things you can see in the tests, is the man risk averse.  And then, almost by definition, in the bad times, he will outperform the markets.

MILLER:  It’s interesting that your leadership approach has kind of changed.  During the first Tiger Management, until 2000, you basically were the man.  You made all of the stock picks, you made all of the rules, everyone did what you said.  And now, you preside over a biweekly meeting, you give advice, you listen as well, but they can make, your managers, all their own decisions, they hire and fire on their own.  Why the change in management?

ROBERTSON:  Well, it’s not — it’s even more clear than that actually.
They own their own companies and I am an investor, but it is their company.
I mean I had a man come today, one of our funds, and one of the employees came in and said what is 9x up?  And I said, you know, that is not something that I can answer.  That is something you have to get from the man who owns your partnership.

MILLER:  But you’ve become a lot more bullish on hedge funds.  I mean, you started out with four guys in the beginning of the decade, slowly seeded them.  By 2004, you had it 10 hedge funds that you were investing in.  And this year, it has exploded.  You have added 10 funds, eight in one month.  Why are you so contrarian here and investing so heavily in hedge funds?

ROBERTSON:  Well, in the past, if you work for Soros and Stan Druckenmiller, you could send up a shingle and it said, worked for 10 years for George Soros thorough, waiting for $2 billion and then I’m closing.
You can’t do that now.  You need some sponsorship.  And we have given that.
We are finding tremendous talent right now and that’s why we have been so expansive this year.

MILLER:  All right, hang on one second, Julian.  We are going to take a quick break.  We’ll come back and talk more with you about Tiger, more about the kind of investors you choose and the kind of investments you’re looking at.

Stay with us, more with Julian Robertson and Tom Keene in two minutes.

15:12

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15:14

MILLER:  All right, we are back with Julian Robertson, chairman and CEO of Tiger Management.

Julian, I want to ask you, you know, a year ago, a lot of people, including Jeremy Grantham, we’re saying maybe half of hedge funds would shut down.  We look back now and the industry contracted by only about 10 percent.  What do you think hedge funds have done?  Have they evolved?
Have they adapted better ways to succeed, to survive through this crisis?

ROBERTSON:  I think hedge funds have always had the huge advantage that they are the best way of paying the best money managers.  And so the best money managers have matriculated to hedge funds.  And I think that’s why they are doing better than the rest of the crowd and I think that’s why they’ll continue to.

KEENE:  Well, Bill Donaldson said this once, I believe when he was at the SEC.  I remember, I was at the meeting and he said, look, it’s a brain drain on Wall Street.  Are hedge funds still a brain drain on Wall Street?
It pulls the elite talent away from the rest of institutional investment?
Essentially, is the institutional Street dumber than it was 20 years ago cause you took all of the talent?

ROBERTSON:  Well, I did not take it all, but a lot has left.  And I think that has happened to great extent.  I know that we would far rather compete with a investment bank or a commercial bank than another hedge fund.

KEENE:  Let’s talk about that, your days with Kidder years ago.  You see this discussion of a utility bank versus non-bank, et cetera.  Can we really make a bifurcation between some form of dream from the 1960s, a conservative institutions versus shadow banking?  Are you optimistic that the government can get it right?

ROBERTSON:  No, I’m not optimistic about the government getting anything right.  And I think that they are very much responsible for the situation which we are in and which, to me, the most damning part of it is the dependence on the Chinese and Japanese lenders for our very existence.
And I think it is a tragedy that that is happened to the United States.
And I think that has been done by a group of politicians over long period of time, you know, 30 years.  And they’ve encouraged leverage.  They thought it was a good idea for everybody to own a great home.

KEENE:  How do you manage leverage within a hedge fund complex?  We see so often it gets people into trouble.  Is it a day-to-day management?
Is it a contractual management?  Or is it just about leadership?

ROBERTSON:  I think it is a great deal about leadership.  And I think that exposure is so much more important to monitor than leverage.  For instance, I think I could make a very good argument that a portfolio that was 150 percent invested, where it was 100 percent long and 50 percent short, is far more conservative than another portfolio which would be 90 percent long and 10 percent invested.

MILLER:  Let me ask you about leadership.  I mean, you’ve always stressed, according to Lee Ainslie, the importance of integrity in your personal conduct and how you represent the firm in evaluating management teams — that’s a direct quote from him there.  How can you reconcile that with that with the sort of gun-slinging, entrepreneurial, hedge-fund culture that we have today?

ROBERTSON:  I think that that gun-slinging approach.

MILLER:  The competitiveness that even you have.

ROBERTSON:  Well, that’s right, but I do not think that necessarily leads to a gun-slinging approach.  I think that if you really look at how to do a good record over the years, it’s not to make the huge amounts of money.  It’s to avoid big losses.  That’s the way to really make money over the years.  And I think that’s really what hedge funds do.  I think that, for instance, our funds far outperform the markets in bad times.  And we’ve had trouble.  We haven’t kept up since the market changed.

MILLER:  What are doing now to protect yourself?  I mean I know you’re fairly concerned about the economy as it is, especially considering the fact that you’re concerned about the Chinese stop buying our debt.  What are you doing to protect yourself against the repercussions of that?

ROBERTSON:  Well, if they do, all these people who are worried about inflation or not, they can just not worry about it anymore because it’s a matter of supply and demand.  I mean, who will buy those bonds and what will the bonds have to yield in order to attract people to buy them?  And I think they’re going to have to — if those buyers are gone, I think they’re going to really have to pump the rates up to get them sold.

MILLER:  All right, hang on a second.  We’re going to take a quick break.  I want to come back, though, and ask you what you’re actually doing to protect your money in the case that Armageddon actually happens, as you said could possibly happen.

More on where to invest your money when we continue our conversation with Tiger Management’s Julian Robertson.

15:20

(COMMERCIAL BREAK)

15:23

MILLER:  All right  we are back with Julian Robertson, the legendary founder of Tiger Management, and Tom Keene, Bloomberg editor at large.

Julian, let me ask you, we were talking about what happens if the Chinese and Japanese stop buying U.S. debt; we see interest rates soar, we see inflation soar, it’s complete Armageddon.  What are you in financially to protect yourself against that?

ROBERTSON:  Well we have bought some very long options called curve caps.  And essentially, they are puts on long-term bonds and the leverage is probably more than what you can get in a put on this thing.

Now, you buy them as an insurance policy.  One, you know what you can lose.  If you go short, the bonds, as you know, the risk is unlimited.  But if you buy puts, the risk is limited to the price of the puts.  But we have bought a lot of those and I think that would insure us in the event of a massive rate increase

KEENE:  I want to get in one question here on your beloved New Zealand.  We’ve got a lot of first-order effects we could sort of sort through.  What dollar dynamics would be, or interest dynamics would be.
Too often, we in the media, we are in a cocoon here.  We don’t worry about what the rest of the world’s second-order effects will be.

How is New Zealand for that matter or China going to respond to the deficit we have, to the dynamics of slow growth, to the job report that we saw this morning?  How do you perceive a nation like New Zealand or a larger player is going to respond to all this?

ROBERTSON:  Well, let me say first, New Zealand they’re even more profligate than we are.  They really spend more than they earn.

KEENE:  Well, when you move down there, you moved to the GDP, didn’t you?

(LAUGHTER)

I mean, you tilted the needle on the GDP, right?

ROBERTSON:  We just brought love, that was all.

But it’s amazing to have picked the two most profligate countries in the world to live in.

KEENE:  How’s a guy from North Carolina do that?  I don’t know how that happens.

ROBERTSON:  I don’t know how it happened either.

MILLER:  How do you take your message down there?  How do you present your message here  in the U.S.?  I mean, you are concerned about the trade deficits that Tom was talking about.  You are concerned about the economic implications of what we’re going through here.  How do we work off this debt?  What should we do?  What should the administration do?

ROBERTSON:  Well I think we really have to almost be Margaret Thatcheresque about it.  When she took over Great Britain, she told the press they would have a long time before things got good again.  And our government is trying to do quick fixes, stimulus packages, this, that and the other.  And basically, what we’re going to have to do, we’ve spent too much as a nation.  We’ve spent too much as a people.  And like anybody else who gets over indebted, we’ve got to cut back until we get back in shape again.

MILLER:  All right, Julian.  Thanks so much for spending time with us.

KEENE:  He’s got to get that voice better.  He’s sounds way too much like me.

MILLER:  I’m going to give him some of my special herbal tea here.

Julian, thanks.  Julian Robertson.

ROBERTSON:  Sure.

MILLER:  Tom Keene, appreciate you joining us as well.

15:27

***END OF TRANSCRIPT***

Tags: Bill Gross, Bloomberg News, Bond Holdings, Canno, China, Cnbc, Cnbc Interview, Corporate Bond, Doo Doo, Doomsday Scenario, Fever Pitch, Hyperinflation, Investment Outlook, Julian Robertson, Matt Miller, News Anchor, Serious Attitude, Systemic Problems, Tiger Management, Tom Keene, Treasuries, Us Treasury
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Bill Gross: Investment Outlook October 2009

Monday, October 5th, 2009

Bill Gross has just released his October 2009 Investment Outlook, titled, “Doo-Doo Economics.” To preface this newsletter, we recently published a note about Gross’ decision to reduce exposure in corporate debt in favour of longer-dated treasuries, to address his concerns of deflation.

You may also listen to Bill Gross read his latest newsletter by clicking play here.

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In his latest issue, Gross goes to great lengths to make his point, this time using the analogy of the doggie bag.

In those days, a doggie bag was something you asked for in a fine restaurant to take home the steak bones. Now it’s a blue plastic reminder that the world is changing and in many respects our daily routine is becoming a dog’s life.

In better times, economic policy sought to re-allocate the spoils of economic success (steak bones for Bowser), and today it is relegated to cleaning up messes (Picking up after Bowser).

Propositions from conservatives and liberals alike have locked up much of the budget, with Proposition 13 in 1978 reducing property taxes by 57% and Prop. 98 in 1988 requiring 40% of the general fund to be spent on schools. Recently, much of any excess has been gobbled not only by teachers, but unbelievably by a prison lobby that would be the envy of any on Washington’s K Street.

California was once a thriving entrepreneurial bastion, has become a bloated, and broke(n) bureaucracy. Gross points out that it’s critical to recognize that the problem is that California and the US, as well as the UK, Spain, and Eastern Europe are in no position to compete globally.

What is critical to recognize is that both California and the U.S., as well as numerous global lookalikes such as the U.K., Spain, and Eastern European invalids, are in a poor position to compete in a global economy where capitalism is morphing from its decades-long emphasis on finance and levered risk taking to a more conservative, regulated, production-oriented system advantaged by countries focusing on thrift and deferred gratification. The term “capitalism” itself speaks to “capital” – the accumulation of it and the eventual efficient employment of it – for growth in profits and real wages alike.

Gross’ point is that today’s economic policies amount to band-aids, that policy makers are just treating economic symptoms, but not the illness. Capital, both monetary and human are in flight:

What California once had and is losing rapidly is its “capital”: unquestionably in its ongoing double-digit billion dollar deficits, but also in its crown jewel educational system that led to Silicon Valley miracles such as Hewlett Packard, Apple, Google, and countless other new age innovators. In addition, its human capital is beginning to exit as more people move out of the state than in.

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Gross wonders whether Schwarzenegger and Obama have the vision and capital to reverse the economy, but maintains that although the doggie bag is can be used to carry steak bones home, they are currently being used to clean up after Bowser.

Bottom Line: Stick to high grade bonds and high quality dividend stocks that can weather the transition to the “New Normal.”

For now investors should be holding their noses, their risk orientation, as well as their blue bags, until proven otherwise. Specifically that continues to dictate a focus on high quality bonds and steady dividend paying stocks that can survive, if not thrive, in our journey to a  “new normal” economy of slower growth, muted profit gains, and potential capital destruction via default, abrogation of property rights, and dollar devaluation.

Read the whole newsletter here, and download the PDF here.

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Bill Gross: Investment Outlook September 2009

Friday, September 4th, 2009

Bill Gross, co-chief at PIMCO, has just published his latest missive, On the “Course” to a New Normal.

You may listen to the newsletter in Bill Gross’ own voice here: Click play to listen:

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Gross asks, “Is a hole-in-one a hole-in-one if no one sees it?” He makes a humorous and interesting point. If no one witnesses your hole-in-one, its not a hole-in-one. On one hand, perhaps Gross’ point here is that economic policy makers need us to believe they’ve have hit a hole-in-one, and while many of us want to believe this, we’re still standing there with that funny look in our eye, like Gross’ wife, when he explained to her that he hit a hole-in-one, one hot June day, when he was out at the links by himself.

Or is it on the other hand, the hole-in-one was real, and though no one believes it, it is real, like the “new” normal.

For the better part of this year, Gross and El-Erian, his co-chief, have presented their “New Normal” thesis, suggesting that the world as we know it is changing, and that we need to re-tool for it. Will we change with the times, or be changed by them?

Gross says that the DDRs - Delevering, Deglobalization, and Reregulation - will be the new molds that shape our world over the next ten to twenty years.

“D,D, and R lead to a number of broken business or economic models that may forever change the world we once knew,” as follows

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

Here are Gross’ conclusions:

As of now, PIMCO observes that the highest probabilities favor the following strategic conclusions:

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

Read the complete letter here.

Listen to it here, click play:

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Source: PIMCO, September 2009

Tags: American Capitalism, American Style, Bill Gross, capitalism, Ddrs, Developed Countries, Developing Countries, Economic Models, Economic Policy Makers, Ethic, Funny Look, Golfing, Gross Co, Gross Investment, Gross Point, Hole In One, Investment Outlook, Missive, Moderation, Molds, Paper Assets, PIMCO
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Hugh Hendry: Investment Outlook August 2009

Thursday, August 27th, 2009

Hugh Hendry, CIO, Eclectica Asset Management, has recently published his investment outlook for August 2009. Since the Summer of 2008, Hendry has been a strong proponent of deflation, and continues so, even though his thesis has been getting a thrashing lately. Hendry has discussed investing in long bonds fervently in the past, but had no choice in Late March to reconsider his positions and sell them off, as yields on long term government paper started to climb sharply and the recovery rally of the last 5 months began to take shape. Hendry’s flagship fund was up 40% for the calendar year in 2008, and most of that came from his bets in long term government bonds.

We would note that Hendry is the first to pull the plug when he is wrong in the short term, as he did in March-April. He is no buy and hold investor, nor does he wish for the economy to enter a depression, but he does feel that it is inevitable given the debt deflation that he believes is ahead. One of Hendry’s main assertions is that it will take many years for the developed world to correct its over-indebtedness.

Having said that, here are the first 4 paragraphs from his letter:

Good people are becoming desperate. I know a man who is planning to capitulate and buy stocks. He cannot comprehend what is happening today. He is, to employ Churchill, a fanatic; he won’t change his mind and he can’t change the subject. But, fearing the loss of his franchise, he will change his portfolio. He laments that it is as though last year’s events never happened. Rhetorically, he asks whether we have all been sent through time to invest in equities at the end of the 1970s when stocks were cheap and society had thoroughly deleveraged (the opposite of today). “Why do other investors not contemplate the prospect of further household deleveraging when building their profit forecasts?” he fumes. “Can they not see that the private sector’s deleveraging is more than offsetting the public sector’s expansion?” Despite such ranting my Minskian friend remains a most entertaining and charming individual.

Now I know I have not covered myself in glory these last few months. Stock markets have gained 50% from their lows and the Fund has little to show for it except a modest reversal and no wild swings in our monthly NAV. Nevertheless, I would contend that this game of playing “chicken” with the market is not for us. Our ambition has been modest. To survive the onslaught of a positive change in social mood without being forced to capitulate in the face of a frenzy of optimism; so far so good, I think?

In this regard we have been helped immensely by a quote from Robert Prechter in early April. Having correctly called for a counter-trend rally in stock prices in late February, he then described the most likely nature of the advance, “…regardless of its extent, it should generate substantial feelings of optimism. At its peak, the President’s popularity will be higher, the government will be taking credit for successfully bailing out the economy, the Fed will appear to have saved the banking system, and investors will be convinced that the bear market is behind us.”

So far his prophecy reads well. It is reminiscent of Warburg’s line that the business cycle is “a subject for psychologists” rather than economists. Bernanke is already being compared favourably with Volcker. Continental Europe has apparently “escaped” from recession. Positive economic growth across the world for the remainder of the year seems certain. And yet Prechter went on, “Be prepared for this environment: it will be hard for most investors to resist. But beware… [the next move] will be the most intense collapse in stock prices”

Read more, download here.

Tags: 1970s, 5 Months, Assertions, Bets, Calendar Year, Churchill, Deflation, Eclectica Asset Management, Flagship, Franchise, Government Bonds, Government Paper, Hugh Hendry, Indebtedness, Investment Outlook, Paragraphs, Private Sector, Profit Forecasts, Proponent, Public Sector, Rally
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