Volume III, Issue 12 / December 2009
Welcome Letter
The other night I was at the grand opening of one of the trendy new bar restaurants in La Barra. It was an eclectic crowd. We encountered a European countess freely chatting with a local electrician turned jazz musician. In another corner the former CEO of Bayer had an animated but friendly argument with an Australian horse trainer now operating a stable for the Qataris in Uruguay. In the South American summer ¨season¨ La Barra, just across the bridge from Punta del Este, is home to the glitzy and glamourous and those that think they are or want to be. But unlike many other places where people use seasons as verbs, here there is still a sense that all people are welcome as long as they add something interesting to the mix. This little corner of the world breeds and encourages an eclectic mix of eccentrics, hippies, artists, industrialists, financiers, and playboys. It makes for interesting conversation.
The ¨season¨ is just starting, and many of our friends are returning from wherever they spend the Uruguayan winter. The last time I saw my German friend Hans we had talked about the markets and the political economy. Hans is an interesting character. By training he is a master baker and in his life he has made a lot of dough both literally and figuratively. He worked his way up from apprentice baker to senior management in one of Germany´s largest bakery operations. Then with the help of a private equity fund, he and several other managers bought out the long time shareholders. Not that many years later they took the company public and Hans walked away with millions of shares worth many more millions of Euros. Like many entrepreneurs he did not like the hassles of running a public company so he cashed out and moved to Monaco. Up until recently, he and his Russian dancer (classical ballet not pole) fiancee had been splitting their time between a Greek isle and Monaco. Not long ago, when it started to look like the tax haven status of Monaco was in jeopardy he picked up an moved to Uruguay.
Where Are We: 2010?
Naturally our conversation turned to the economy and the markets. The highlights provide a synopsis of where we are and where I think we are going. After a few hours of discussion we both agreed that we are once again amidst financial bubbles across the globe. For those old enough it is the macro economic equivalent of the opening of the Lawrence Welk Show. Governments have flooded the system with liquidity that is not going into the real economy. Instead of fueling commerce the cash is staying at the banks so they can ¨rebuild¨ their balance sheets. The banks are willing participants in the ¨the worst is over¨ sham because they are borrowing from the FED at next to nothing and then lending to the US Treasury generating a ¨risk free¨ spread of about three and half percent. Some of the money does find it´s way into the financial system but not into truly productive ventures run by entrepreneurs. Rather than going to industry the money is ¨put to work¨ by hot money fund managers and bank trading desks. What they are calling evidence of the recovery we would call the dollar cary trade bubble. It has many layers. Here is an example of how it works: Hot Money Hedge Fund Manager (HM) has a prime brokerage account with Too Big To Fail Bank (TBTF) TBTF is borrowing money from Uncle Sam at zero, invests 75% in Treasuries and 25% goes to their proprietary desk or to fund managers in the form of margin lending at rates slightly above treasury yields. HM then chases any asset that will possibly get him back to his past ¨high water mark¨, the point where his investors are back in the black and he can start charging fees again. This leads him to Brazil, China, Thailand, Hong Kong, S&P 500 futures, oil, gold, and anything else that may be going up. This becomes a self reenforcing cycle as others buy ¨what´s working¨ and drive prices higher.
Then the mutual funds and individual investors join in. Individual investors see the markets going up and hear the politicians saying the worst is over and figure they need to get back in the market because ¨everyone knows stocks are the place to be over the long run¨. They see that emerging markets are up and European Stocks are up and Brazil is up and the Dow is up. Then they invest in a few mutual funds that their financial advisor told them will give them exposure to these rising markets. The mutual fund manger receives the individual investor´s check and even if he thinks now is not the time to be investing, his prospectus says they will be 90% or more invested at all times so he buys. This drives the prices higher. At the same time self directed ¨investors ¨ have been listening to talking heads on CNBC or even worse Newsletter writers marketing the latest hot trend and they pile in too. This is where we are today. A fear driven rally caused by hot money chasing a quick move because they can borrow for zero perpetuated by people afraid they will not make back what they lost or even worse that they will be left behind. The casino mentality takes over. Some are desperate and need to win back the mortgage money while others are saying, ¨Why don´t I just try it? That guy over there just won the jackpot. So could I.¨
However, this cycle moves twice as fast in reverse. The hot money is on a short leash and will be called home very quickly if there are signs of trouble. Where will it be called home from? From everywhere, stock, bond and commodity markets around the world.
What´s Next?
There will be some shock to the system. It will probably be something nobody is thinking about now. It will cause some of the fast guns with cheap borrowed money to ¨get out¨. They will start selling their larger positions. After all, they are up on average more than 60% after borrowing costs so who cares if they sell 5% below the current prices. This will scare some of the gnomes in the back of the mega bank´s prime brokerage divisions. They have strict marching orders to reduce margin allowances for their hedge fund clients at the first sign of trouble. This margin reduction will cause the funds to sell off some of their positions; a little gold (up 30% – no big deal), Brazilian stocks (up 100% – so lock in the profit), Oil (Its had a good run) and so on. But this trend is also reenforcing on the downside and very soon everyone is heading for the exits. This will be felt worse in the emerging markets. If I have learned one thing during my career in the emerging and frontier markets it is that capital flows out much much faster than it flows in. And once it starts flowing out all those mutual fund investors and newsletter readers will sell thereby accelerating and intensifying the trend. This is why markets always overshoot. This is the business cycle applied to financial products. And just like the business cycle it is exacerbated by government and protected by regulated institutions. Pretty soon the trend will reverse violently and we will see great buying opportunities.
When To Act?
We have a really successful subscriber from Canada who has lived all over the world. He has made a fortune several times over as an entrepreneur and financier. I met he and his wife recently and he said, ¨Fitz, I have made a lot of money from your picks. But I have learned to take your advice six months in arrears because you are always too early on your calls.¨ He has a point. We at Without Borders are a patient lot. Our most profitable investments are normally so unpopular when we buy them that we normally sit on them for months or sometimes years before they move. That is ok with us. We like to ¨buy ugly¨ as we used to say when managing a fund. We admit we are often bad on the timing and right now we have lots of short positions that are painfully underwater. We also admit to selling early. We don´t like risk. That is why we sold KHD Humboldt for a 34% gain only six weeks after we bought it. It went from being really cheap to not really cheap and given the risks that we see it was far wiser to sell than to hope for greater gains. Its up another 5% since we recommended selling it last month but our recommendation stands. At the end of this edition we will recap the years performance and while we may not have had the triple digit gains that some markets may have we will put our 46% gain against any when adjusted for risk. It has been frustrating indeed to watch the markets once again defy economic gravity in the face of evidence of calamity. But frustrated and liquid beats poor any day.
In This Edition
We have wrapped up our three part series on Argentina for now. We will be covering Cordoba and Mendoza in an upcoming issue. We found there was just too much information on Mendoza and Cordoba to cover well within last month´s article on Northern Argentina and we were fearful some of our readers with less interest in South America might be suffering from Southern Cone fatigue. We are still putting the final touches on the Argentina Residency and Immigration Report and will send it out as soon as we get the last remaining questions answered.
For those of you interested in Asia this month we bring you a Dispatch from Chongqing, China. Tim spent a few weeks there over the last two months and for his money he says this is ¨The Place¨ for intrepid entrepreneurs to make a fortune in China. But China is by no means the savior of the global economy in the near term. As we will discuss there are lots of reasons to be wary of China and especially the Chinese share and property markets.
In the AI section this month we bring you a publicly traded closed end fund that we think is a safe place to park some assets. Cambium Global is an investment company that invests in forests and has a diversified portfolio that will do well when inflation finally kicks in. Best of all it trades at a significant discount to it´s stated net asset value and an even bigger discount to its conservative liquidation value. Like most of our picks this is not an imminent home run but it is a way of buying real assets at a discount that will do well in the coming inflationary frenzy. For our money this is where you need to be.
In the Pulse section we will do a bit of year end situational analysis. We will give you our ¨assessment of the battlefield¨ and in the Over The Horizon section we will wittingly wander into the predictions trap. Some predictions are outlandish. Some less so. Hopefully all will be thought provoking.
If you were to re read the Dec 07 Without Borders you would find our assessment of the situation and our advice eerily similar. This is an opportunity for the patient. We sold ¨too early¨ before the crash. We then bought heavily and now we are mostly liquid. Perhaps we sold ¨too early¨ once again. Perhaps not. Right now our portfolio consists of gold, silver, cash and only a select group of shares. If you follow our model right now you should be 30% in physical precious metals. 45% or more in cash. We are now primarily in US dollars but still hold Canadian and Australian dollars. We have 10% in the remaining WoB recommendations. The remaining 15% is in speculations like the ones we recommend in FLASH CABLE. It is a good place to be. Happy New Year.
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