Volume III, Issue 11 / November 2009
Welcome Letter
Welcome Back. We hope our North American subscribers had an enjoyable Thanksgiving. We would have missed Thanksgiving entirely were it not for a reminder from a Chinese investment banker friend and the kind efforts of our friends and subscribers here in Uruguay. In fact one subscriber couple in particular, transplants from Southern California, made the extra effort to cook a proper Thanksgiving dinner with all the trimmings and invited us and another subscriber to dinner. There are so many reasons to be cynical these days. I often worry that I am becoming little more than a full time critic or cynic, and that it is a short step from cynic to curmudgeon. So when we first received the invite to Thanksgiving dinner I am embarrassed to say my initial reaction was a grumpy face, a cocked eyebrow and what my wife tells me sounded something like ¨harumph¨. I am disappointed to say I may have begun to let all the tomfoolery in the markets and the skullduggery of governments get to me. While I do tend to eschew most holidays, as they are little more than marketing campaigns and a few days off when workers are saved from oppression by the largess of government, Thanksgiving had always been my favorite holiday. By the end of the dinner, comprised of memorable conversation and delicious food, I was reminded just how fortunate we are. Although this does not mean I plan on ignoring the subterfuge in today’s politiconomic world, as there will likely be plenty of ¨harumphs¨ in the future, but thanks to the kindness and efforts of friends, curmudgeondom has been held off for a while. There are plenty of positive events ongoing. The ascent of man continues, our family and friends are more important than our balance sheet and as long as we remain prepared the worst of the crisis will serve as an opportunity for us to prosper. Plenty to be thankful for indeed.
The Markets: What´s Going On?
This is a fear driven bear market rally. Fear you say? Yes fear. Market participants ranging from retirees to fund managers are afraid they will not make back what they lost in 2008. Share prices around the world are creeping up on relatively low volume and it doesn´t seem to matter that the global economic situation is precarious at best. While we mostly focus on securities in this letter please remember that our model portfolio is ⅓ cash (weighted at the moment towards US dollars), ⅓ physical gold and silver, and ⅓ financial instruments covered in Without Borders and Flash Cable. There will be a time when we change the allocation dramatically but we are not there yet. Gold and cash will serve us well on the next leg down.
Stocks
The major share markets have been on a tear since March. We have outlined here before the many reasons we think this is nothing more than a dead cat bounce or bear market rally. We keep looking for signs that the rally is justified but sadly we find none. The S&P 500 is selling at a whopping 20 X actual earnings. We suspect much of the rally is driven by trend following program trading. We suspect there are lots of individuals and professional money managers who ¨need¨ to earn back their 2008 losses and it would be unforgivable for them to ¨miss the comeback¨. We suspect the dollar carry trade is pushing global markets higher as hot cheap money chases the trend. There is lots to suspect but what we know is we are absolutely NOT buyers at these levels. In fact, and as you will see in the AI section, we believe now is a time to be an active and aggressive seller.
Bonds
If we think the share market has lost touch with reality, then the bond market is certifiable. You are well aware by now that we think US government bonds are a triple threat to your wealth. The US treasury market is a complete farce; the ultimate example of everyone ¨ignoring the elephant in the room¨. Just today the US government managed to sell debt obligations at the lowest level in recorded history. This is just mind boggling to a rational observer. How can the yield or ¨risk premium¨ assigned to these promises to pay be going down while the issuer has increased its debt load to 7.6 Trillion dollars? We think it may be part of the human psyche to ignore problems that are just too traumatic to comprehend rationally. Perhaps the word ¨trillion¨ is the same as ¨Bizilliongazillion¨ to most people who simply cannot process the sheer magnitude. Who are the players driving these rates down? Mostly those benefiting from the fragile recovery. Large financial institutions from around the world and governments with lots to lose if someone were to scream, ¨Run there is a mad elephant in the corner! Last one out gets trampled!¨ Certainly no rational saver who wanted a reasonable return on his or her money would lend the US government money for ten years in return for 3.2 % interest when the average yield for any ten year period going back to 1969 was 7.31%. Certainly they cannot expect the value of the bond to increase as rates decline. It really does boggle the mind.
Equally disturbing is the narrowing of the yield spread between treasuries and emerging market sovereign debt. It would make sense to us if the interest demanded by lenders to the US government were going up to the historical levels of banana republics, but instead the yield on emerging market debt is decreasing as traders borrow cheap dollars and seek to find arbitrage opportunities abroad. When this happens we rub our hands together like the villain in a silent movie because opportunity almost always follows. We have written about the narrowing of the ¨spread¨ between emerging and developed sovereign debt before as a signal a major correction is coming. The last time was in April of 2008. We would recommend you stay away from all government debt right now. Your mattress is a safer place to keep your cash.
Metals
The third of our portfolio that is presently in gold or silver has done very well for us indeed. Would we be shocked to see gold fall below US$1000 again? No not really. We suspect there will be an ugly unwinding of the dollar carry trade soon and that will force traders to sell gold to raise cash. There is a lot of ¨momentum money¨ in gold right now. Would we be surprised to see gold hit US$1500 in the next month or two? Not really. There are many scenarios under which gold would take off without looking back. So we are not sellers and not buyers at this point. If gold takes a hit we will shift some cash into gold. If it takes off then we are in a good position. We remain comfortable with our metals.
Colored Paper
In the lesser of all evils quest for currency allocation, we think the US dollar remains the best choice. We suspect a big move in the dollar upward when the dollar carry trade unwinds. For the short term the old greenback is the place to be. The next time the dollar rallies will likely be the time to unload them for the foreseeable future but for now the ¨In Geithner We Trust¨ movement keeps us in dollars.
Implied Guarantees?
Is Dubai our much awaited ¨unforeseen¨ catalyst? We are not sure. What we know is that Dubai is not that different from the rest of the Gulf. They are just a more open society which makes it harder to hide the excess. It is possible that ¨Dubai¨ could get the blame for causing the next leg down. It would be nonsense but it is always easier to blame a far away land where rich people wear sheets and launder terrorist money than it would be to blame the banks and government officials who deserve the whipping. So far the big hullaballoo about the Dubai World default has missed the point entirely. The press keeps talking about a ¨Sovereign Default¨ or ¨The Arabian City State´s Spending Spree¨ but nobody seems to be talking about ¨Banks that have been bailed out by the taxpayer lending money to developers that never had a chance to make a profit.¨ As we wrote about in our dispatch on Dubai before the crisis hit, it was intuitively obvious to the casual observer that there was no end user demand for all the new commercial and residential projects. At that time we wrote ¨Two developers in Dubai are competing to be the proud owners of the world’s tallest building. Like Jakarta before, it’s a sure sign that Dubai property is a massive bubble¨.
Unwound Wounds -The Gnomes Know
The days of the green lampshade and leather visor may be gone but there are still a group of gnomes living inside banks and brokerage houses that keep track of margin accounts. We have been talking to some back office professionals at the big US and European banks to determine if there have been any lessons learned since last year. They universally noted that they have been ¨empowered¨ to reign in the carry trade of client accounts at the ¨first sign¨ of a ¨flight to quality¨. Oh how the back office types love the word ¨empowered¨. Empowered in this case means they have been instructed to be quick to reduce margin if the carry trade begins to falter. A ¨flight to quality¨ in bank speak means a return to the US dollar mostly through Treasuries. For the reasons we mention above we don´t think quality and Treasuries go in the same sentence but this does bode well for our US dollar positions. Sooner rather than later something is going to ¨spook the market¨ and all of the hot money borrowed from US banks will come rushing home to satisfy margin calls. Traders have itchy fingers and at the first sign of trouble will hit the eject button. The gnomes will ensure they wield the power to make them should they not do so on their own.
Laugh or Cry?
If you need further proof we are on the other side of the looking glass, take a gander at a new piece of legislation working its way through the House of Representatives. The ¨Share The Sacrifice Act of 2010¨ has been proposed by House Appropriations Committee Chairman David Obey. The title of the bill alone makes us jump up and say, ¨Ayn Rand could have written this!¨ The bill was introduced to ¨…pay for the cost of troop deployment in Afghanistan.¨ What is amazing is that this is a really new idea. Not since the days of Teddy Roosevelt has there actually been a tax introduced to pay for a war. A long time ago politicians realized that increasing taxes to pay for foreign escapades was not rewarded at the voting booth. Therefore governments always borrow to wage war. The Bank of England was chartered in 1694 to reimburse William III who had bankrupted the crown in his pursuit of martial glory. He knew that an increase in taxes would have farmers reaching for their pitchforks but a bit of debt would go unnoticed.
For the US, who had up until the 20th Century been ardently against foreign interference, the ¨patriotic¨ war bond movement caused the government debt to explode from 2 billion to 28 billion during WWI and from 40 billion to 260 billion during WWII. It wasn´t a good idea then but at least the decimation of Europe´s economy increased the demand for US goods and increased the transfer of technology from Europe to North America. Morally wrong perhaps but there was an economic benefit. Explain how spending one million dollars per US soldier deployed to Afghanistan (most of whom are replacing deserters from the Afghan Army who recognize a rabbit hole when they see one) will in any way benefit America. It won´t. It can´t.
However, the ¨Share The Sacrifice Act¨ is a major, albeit unintentional admission, that the government is beyond its capacity to issue debt. Way beyond. Pelosi and Co propose a three tiered tax. It is not surprising that the ¨rich¨ should pay more as they are the ones who will benefit most from less poppy production in the valleys of Afghanistan. Taxes on those earning less than USD 100,000 will pay 1% more in annual taxes. Those earning between USD 150,000 and 250,000 will pay more and those earning more than USD 250,000 will pay even more. How much more? We don´t know. So far the legislation says the amount will be what the President deems necessary to ¨fund the war effort¨. Tomorrow, President Obama will announce his plans at our Alma Mater West Point. How many of those idealistic young men and women will be sent off to die for no reason? When we were plebes at West Point there was a standard response when a plebe asked his squad leader for advice. ” Advice? Yeah, here is some advice, Never start a land war in Asia and Do pushups.¨ The mere idea that President Obama will stand in front of the Corps of Cadets and unveil his ¨plan¨ for further fruitless effort at their personal expense is offensive. The saddest part is that the audience will feel that it is their duty to support the plan.
Private Deals
After several months’ preparation, we have hit a road block on the private deals. Our lawyers now tell us that our prospectus needs to go back to the drawing board. Why? Because the banks we were planning to use as well as two others won´t accept new accounts from a company which has more than 10% US ownership. This development has just popped up in the wake of the UBS court decision. It is not a matter of law but rather a matter of policy for the banks who now believe, ¨US clients pose a direct threat to our franchise.¨ There are several options available and we are looking at them right now. It may be that our US subscribers will have to invest in a US entity which will then invest in the underlying assets. We know this is not ideal but it will serve the intended purpose which is to allow you to have access to good deals outside of your homeland and keep your assets abroad. Non US subscribers will not be hindered by this process other than having to wait a little while. We remain confident we can get this done but it will probably have to wait until the first quarter of next year. We will keep you posted.
This post is just an excerpt from a full issue of Without Borders. If you would like to read the full article and gain exclusive access to all of the actionable investment intelligence that our current subscribers are profiting from every month, then we invite you to try out or subscription, risk-free, for 30 days. So, try it out today and discover a new world of undervalued opportunities – and a fresh new world perspective.