Volume III, Issue 8 / August 2009
Welcome Letter
Hola from Patagonia. I am sitting in front of a cozy fire with a bottle of Postales fin del Mundo malbec. This has been a dual purpose trip – scouting for opportunities and a family ski vacation. While from time to time I secretly fancy myself an intrepid explorer cast from the same mold as Burton or Fiennes , this past month I have certainly been more akin to another type of traveler – Clark Griswold. We have been exploring Patagonia for the better part of this month. We will detail our experiences and the opportunities we discovered in the Dispatch and AI sections. We also bring you a new stock recommendation from the Southern Cone as well as two private deals in which we are investing and that we are proud to share with a limited number of subscribers. By popular demand, we will bring you an Heiress of the month when ever.
Tim will also weigh in briefly from Australia. By the time you read this he will be off to rural China to visit a few companies and see if there really is a way to invest passively in the much-heralded “Rural China Boom”. Finally, we will wrap up with some thoughts on “Intellectual Property” and how changes in technology and geopolitical prowess will affect the way business will be done in the near future.
Before we jump into the meat of this month’s letter, we want to step back as we normally do and evaluate the economic and geopolitical landscape. While we consciously run the risk of being redundant all over again, now is not the time to be diving head long into the markets. We are convinced that what we are seeing is the tail end of a bear market trader’s rally and that once the summer is over and the grown ups on Wall Street come back from trying to sell their beach homes, the low volume rally will be replaced by heavy volume selling. While we only know that we don’t know how this will play out exactly, we become more confident in our assessment of the situation with each passing day. Our analysis of the data points to a social, economic and political train wreck of unprecedented proportions.
We are on the lookout for a “precipitating event” that may serve as the catalyst for catastrophe. It may come from within the crippled debt ridden economies of the west. When unemployment benefits start running out and pension funds start announcing major shortfalls, we might see civil unrest. Maybe it will turn ugly along racial or ethnic lines. Maybe a white cop caught on camera beating a Hispanic protestor in the southwest? Immigrants are no longer the revered backbone of American society. Rather, with each passing day and with each laid off union laborer, they become part of the ubiquitous “them”. In Europe, it could be an initially peaceful Muslim protest in Amsterdam that sparks violence. More likely, the initial unrest will start along class lines, rather than racial or ethnic lines. Why? First, the younger generation, which ishistorically the one that takes to the streets first, has grown up in the politically correct era. Targeting blacks, Hispanics, Jews, Muslims, or any other ethnic or religious group is not ok or cool. Blaming the moneyed class gets you extra PC points in most circles.
It is possible the precipitating event could be economic news from outside North America and Europe. Last month, as we were going to press we added a last minute note about the Sino American economic meetings in Washington that were almost unreported. We followed up with a couple of close contacts that both came away with similar conclusions. The highlights are:
1. The Chinese know they have been temporarily boxed in by US policy. They are angry, but know it is in their best interest to play along for as long as it looks like the system is stable.
2. The Chinese government already has a plan B that would be very painful for China, but more painful for the US. It would involve curtailing trade relations with the US and Euro zone and increase their focus on Africa, South America and Austral Asia. Plan B would almost certainly include a free-floating Chinese currency, which would be catastrophic for the US dollar.
3. China will adopt plan B if they think the US plan to stimulate the economy crosses the line between emergency measures and an outright effort to inflate their way out of making good on liabilities.
4. The Chinese state-owned companies and sovereign funds have ruled out buying productive assets in the US. When Treasury officials suggested that the Chinese state-controlled companies should become strategic equity partners with US industrial firms, one Chinese official responded with two words: “Dubai Ports”, evidently referring to the US Congress and its all but confiscation of their Arab allies’ investments in 2007. Another openly commented that US investment in China had all but ceased and US lawmakers are actively legislating to make foreign investment activities less attractive.
Both of our contacts said they came away with a distinct feeling that the Chinese are just trying to buy time. One said: “They’re in duck mode – calm above the surface but paddling like hell below”. They want to have as much time as possible to prepare for the time when they have to implement plan B. The other said that the official he dealt with this time was “frosty” and the entire delegation was “terse” and “almost confrontational”. He also said this was a marked change from previous interactions he has had with Chinese officials.
Our take on the geopolitical situation is that every government from Canada to China, and from Ireland to Indonesia is in panic mode behind closed doors. They all know they are playing musical chairs and it is only a matter of time before the music stops and there is one less chair. All heads of state are trying to put on a brave face, but none are capable of doing what needs to be done – allowing the rot to be cut out of the system – while sustaining their political influence. So they just play along, hoping against hope that they can survive their time in office before the bottom falls out. Those who must act will act in a way that firmly points the finger elsewhere. Just like Bernanke’s famous statement about not wanting to be the Federal Reserve Chairman who oversaw the next great depression, no head of state wants to be history’s scapegoat.
So, what’s next? Well, as the recent UBS case and the changes in the IRS tax policies demonstrate, the rich are the easiest targets. We know the revenue gained from chasing tax evaders is a fraction of a drop in the proverbial deficit bucket. Therefore, we think it is more of a proactive measure designed to scare the uninformed. If the headlines link foreign bank accounts with criminal prosecution, then it may stem the future flow of capital flight until things get really ugly. When it does get ugly, you can bet your last shrinking bank note that capital controls will be announced without warning. This is not just in the US; the Eurozone may even beat the US to the punch, if Austria follows the Icelandic path, or if Italy, Spain or Portugal collapse.
But, as you dear readers know, we recommend diversifying your holdings geographically and we recommend you do so sooner, rather than later. Let us stress once again, the way to do it is legally. For privacy and for the best returns, we recommend foreign real estate, private foreign companies and precious metals stored securely. For now, at least, there is no reporting requirement for any of the above asset classes. We firmly believe you will be well served if you have some of your assets outside your home country and a place to go if things go very badly where you presently hang your hat. Perhaps, someday you will join us somewhere for a glass of wine and we can laugh about how the IRS commissioner’s pension check bounced. As I look outside at the white mountains of Patagonia I, for one, am grateful that I can watch the riots on TV and not outside my window.
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