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September 2011
September 2011
5,508.24
3,045.62
Italy FTSE MIB Index September 14, 2010 to September 14, 2011
25,000 23,000 21,000 19,000 17,000 15,000 13,000 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 14,642.72
September 2011
There is, (we were to learn to our horror in 2008) a literary model for the creation of these financial horrors Mary Shelley's classic Frankenstein.
10,500 10,000 9,500 9,000 8,500 8,000 7,500 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11
8,337.90
The financial crisis and crash of 2008 were rooted in American "risk-free" assetsAAA-rated collateralized mortgage securities. It turned out they should have been rated TTTfor toxicity. There is, (we were to learn to our horror in 2008) a literary model for the creation of these financial horrorsMary Shelley's classic Frankenstein. They were confected by amoral geniuses and immoral associates through the blending of small quantities of healthy financial tissues with large dollops of polluted financial tissues to deliver a falsely reassuring appearance, fooling the rating agencies into characterizing them as financial super-entities endowed with the AAA ratings that had previously been largely the preserve of well-run governments fully backed by the taxation systems of strong economies. Under the Basel rules, banks which bought these supposedly superb agglomerations, did not have to allocate any of their regrettably scarce capital to support them on their balance sheets. A typical bank bulking up on these attractively-yielding wonders was, unknowingly, in the position of a US army regiment in Europe during World War I, filling its barracks with recruits off the latest troop ship who were carrying the flu virus. The Crash of 2008 that nearly disemboweled many major US banks was spawned in the toxic relationship between Wall Street's factories and the more demagogic elements of Congress, eager to use Fannie, Freddie and rules against bank "discrimination" to force-feed mortgage lending to or even abovereal home values to borrowers who had little or no evidence of their ability to service such debts. The Ninja Mortgageno income, no job, and no assetswas the crowning achievement of that process. Barney Frank's name is on the legislation passed to prevent future bailouts
September 2011
a wondrously hilarious restatement of financial and economic history. That one of Congress's biggest boosters of bad lending practices should be co-author of laws allegedly designed to prevent repeats of such disasters is a delicious self-parody of Congressional misbehavior. The Made-In-The-USA mortgage catastrophe should have merely flattened financial institutions here. Astonishingly, many major and mid-sized European banks loaded up on these Financial Frankenstein Monsters. Why, we wondered, would banks and pension funds abroad buy these Frankensteinian blends of Wall Street and Washington greed, and disastrous design? That their face value ran into the trillions was rooted in blind faith in AAA mortgage product ratings, without considering that collapsing middle class fertility rates precluded a new housing boom: the naught decade middle class generation was roughly 60% the size of its predecessor, so house prices in aggregate could hardly be expected to go up the way they had when fertility had been strongas it had been since Plymouth Rock. Sadly, the bursting of the US real estate bubble inflicted huge damage on the psyches and balance sheets of leading European financial institutions whose managements had believed, (as a German banker recently told Michael Lewis), that the US was a rules-based society. Result: many leading European banksincluding even some top Swiss bankshad to be bailed out by their governments. "Never again!" was the motto of regulators, risk managers and investors. "From here on, we're going to invest our capital in good, safe government bonds issued by members of the eurozone!" That some members of the eurozone had histories of revolutions, civil wars and/or defaults within living memory was dismissed as irrelevant. In an efflorescence of enthusiasm about the wondrous new currency that would supplant the dollar as the global #1 currency, European banks loaded up on all the risk-free eurobonds they could buy: in particular, they loved to buy bonds from Portugal, Ireland, Italy, Greece and Spainfive countries eager to borrow big at rates ranging to 16 basis points above the rate available on good-as-gold German Bunds. None of the European banks who bought truckloads of these bonds seemed the least concerned that these countries had never previously been able to borrow at such modest premiums to Bunds. The bankers were as gobsmacked by Jacques Delors' effulgent vision of a eurozone that would outperform the USA and ratify the European social contract, as were his fellow elitists who worked with him on the master plan that led to the Maastricht Treaty and the euro. September 2011 5 "From here on, we're going to invest our capital in good, safe government bonds issued by members of the eurozone!"
KBW European Mid & Small-Cap Bank Index (KMBI) January 1, 2008 to September 14, 2011
70 60 50 40 30 20 14.99 10 0 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11
September 2011
The European banking system has been lurching from crisis to crisis for more than a year. Greece, which led the way to the creation of European civilization, is leading the way to European disintegration. As this is written, short-term Greek government debt is yielding 85%, but the European Central Bank (ECB) is holding down rates on longer-term benchmark Greek debts to teens by large-scale buying. The ECB has had to become the buyer of first and last resort for other PIIGS offerings, and investors are already looking ahead to Italy's need to roll over 400 billion in bonds over the next two yearsapart from funding its operating deficits. Jean-Claude Trichet of the ECB is obviously looking over his shoulder at the plight of the big French banks. On Monday, Societe Generale shares fell to a 20-year low, accompanied by double-digit declines for BNP Paribas and Credit Agricole. (Since June, those banks' shares are down, on average, more than 50%.) We have considerable sympathy for the overworked Trichet, who has performed heroically, as the debt of one PIIG after another begins to emit noxious odors. He even had the courage to respond to rising food and fuel inflation by raising the eurozone interest rate in the midst of the latest financial crisis. He has visibly aged, and will be replaced the day after Hallowe-enby a respected Italian, Mario Draghi. Although Greeces unions and leftist radicals still manage to capture headlines and strangle the nation's economy, the real challenges to the survival of the euroand much of the European banking systemcome from Italy and, to a lesser extent, Spain. (Ireland and Portugal are broke, but mostly polite, and don't grab global headlines by trashing cars and buildings or publicly ravaging what is left of their economies.)
Greece, which led the way to the creation of European civilization, is leading the way to European disintegration.
September 2011
...with all his faults, Berlusconi has provided more stability for the fissiparous and barely-governable Italy than almost any of his predecessors...
September 2011
Berlusconi, a TV magnate, had surprising success in raising the national consciousness, using the soccer slogan Forza Italia! as his party designation. Italy may well have been governed better during his tenure than at almost any time since Constantine moved the capital of the Empire to Constantinople in 330. But not by much. Taxes still aren't collected reliably. The far-Left unions continue to block industrial progress and the far-Left civil service unions continue to impede attempts to open up the economy and operate public systems honestly. Those rioters you see on TV are collectively well-paid: according to Bridgewater, Italian unit labor costs since the euro appeared are up more than those in any other large European economy40%. Despite his obvious faults, we are inclined to view Berlusconi as a raffish rogue, with a deep appreciation of the Italian love of the bella figurathe striking face, image, gestures and self-assurance. In the midst of the crisis this summer, responding to a prosecution about his involvement with an underaged woman, he appeared in Sicily and told a crowd, "The latest poll asked 1,000 Italian women, 'Would you like to sleep with Berlusconi?' One-third said 'Yes' and two-thirds said 'What? Again?' " The sands in Berlusconi's hourglass are finally running out; he will probably not survive this latest crisis. Nor, we suspectsadlywill Italy or, ultimately, the euro. Italy is too big to fail and too big to bail.... And too inefficient, indebted and corrupt to succeed. This just in: the Dow is rallying strongly this afternoon because of word out of Italy of a potential new one-off wealth tax of 400 billion that would make Italian bonds look magnificoand do wonders for the beaten-down share prices of those big French banks which collectively have made the biggest French commitment to Italy since Napoleonstuffing their coffers with 400 billion in Italian bonds. To us, the chances of passingand enforcingsuch a tax are equivalent to the chances of making Italian the sole acceptable language at meetings of all eurozone agenciesand the European parliament. But we had a smile as we were reading the breathless stories, seeing the fine hand of the irrepressible Berlusconi at work. He'll be missed.
Italy may well have been governed better during his tenure than at almost any time since Constantine moved the capital of the Empire to Constantinople in 330.
September 2011
...eurozone sovereign debt problems are the biggest problem facing OECD financial markets.
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September 2011
But Merkel's own coalition is unraveling, as it loses one regional election after another. In the most recent vote, in her homeland of MecklenburgWestern Pomerania, her party's vote plunged and the Free Democrat Party, the conservative conscience of her coalition, was annihilated. Merkel's Christian Democratic Union and Christian Social Union supporters are fed up after more than a half-century of picking up the biggest share of the tab for Brussels' vast spending programsand two years of bailouts for profligate PIIGSwith no end in sight. Middle-class Germans note bitterlythat the rest of Europe didn't chip in for the 100 billion costs of rescuing East Germany after the Fall of the Wall. Some analysts report that, despite defections from her own parties, Merkel's Greek bailout bill should pass the Bundestag because of support from the Opposition. But that would be a terrible humiliation for the Chancellor and would probably be the beginning of the end of her government. It might also signal an important shift in European politics: after years of center-right rule in most of Europe, the Left could be on the verge of a major comeback, as voters worry about their politically-promised perks and pensions. In France, even Dominique Strauss-Kahn's implosion has done little to raise Premier Sarkozy's pitiful poll standingwith an election looming next year. The Strauss-Kahnless Socialists are strongly favored. Markets rallied strongly Wednesday on the report that EU Commission President Manuel Barroso will be presenting optional routes for creating and issuing eurozone bonds. (Mr. Barroso, a former President of Portugal, is now Eurocrat-in-Charge atop the vast EU bureaucracy.) Eurozone bondsthe unholy grail of europhileswould be backed by the full faith and credit of all members. This "Solidarity forever" instrument would mean that all members would be, in theory, equal as guarantors, but investors would pay on the basis of Bund yields. Angela Merkel swiftly ruled out such asymmetric involvement, knowing of its huge unpopularity at home. But the eurocrats will try to keep the pressure onthereby protecting their own privileges and pensions. Deutschland ber alles has been cleansed and sanitized to read Deutschland pays for alles. How bad is the situation now? The Wall Street Journal quotes an unnamed executive for Bank Paribas, "We can no longer borrow dollars... Since we don't have access to dollars, we're creating a market in euros...we hope it will work, otherwise the downward spiral will be hell....and no one will lend to us anymore." Deutschland uber alles has been cleansed and sanitized to read Deutschland pays for alles.
September 2011
11
As noted Fabian Socialist George Bernard Shaw long ago observed, "He who promises to rob Peter to pay Paul can count on Paul's vote."
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September 2011
September 2011
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14
September 2011
Yes, Apple (AAPL) and Google (GOOG) have been spectacular performers, but Nasdaq is back to where it was a dozen years ago. Without those two sensations, its performance in recent years would have been dull. Technology became an even bigger part of the global economy in this decade than its most enthusiastic boosters in the 1990s would have predicted. However, ease of entry, ease of technology theft, and relentless competition have meant that most tech products have proved to be commodities that generate lower profits than those received by producers of industrial commodities or precious metals. Dull stuff is outperforming brilliantly-engineered wonder products.
September 2011
15
Bernanke and Obama are challenging conventional economics and winning. At least for now.
16
September 2011
What? We Worry?
With major stock markets across the world in bearish mode, and a new global banking crisis looming, the S&P is not in deeply bearish mode and few economists are predicting a recession.
S&P 500 September 14, 2010 to September 14, 2011
1,400 1,350 1,300 1,250 1,200 1,150 1,100 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11
1,209.11
Naturally, we are being asked daily about our dour outlook for US stocks and the US economy. Are we overdoing it? Eurosclerosis, many of our critics feel, is not necessarily a transmissible disease. We hear several reasons for this calm reaction to bad news. The dollar has stopped plunging and, mostly because of the 58% weighting of the euro in the DXY, has been strengthening recently:
US Dollar Index (DXY) January 1, 2010 to September 14, 2011
90 88 86 84 82 80 78 76 74 72 70 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 76.35
September 2011
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2. American energy costs are the lowest in the industrial world, with Natgas at $4, and West Texas at $89compared with the new global benchmarkBrent$109. 3. America's domestic political fissures are wide and widening, and Obama's political approval ratings have been weak and falling, but (as noted above), incumbency is no political advantage almost anywhere these days. Obama still has unique charm, and, as he showed last week, when he reaches back to the platform dynamism that mesmerized not just the US, but much of the worldincluding the Nobel committee, he is formidable. His approval ratings are falling, but which other OECD leader has such magnetism? And which of the Republican candidates has the right ingredients to knock him off his pedestal? 4. The huge US commitments to Iraq and Afghanistan are trending down and will shrink to mere nuisance range within a year. 5. The rest of the world doesn't have companies such as Apple. The US still leads the world in innovation.
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September 2011
6. US companies' profits have remained strong even as the economy weakensand they hold record levels of cash. 7. Smart young people from all over the world still rush to attend American universities. 8. Thanks to Dodd-Frank, the problems of the US financial system are being addressed, and an economic slowdownor even a mild recessionwill not produce a systemic financial crisis la 2008. 9. Just about the only economists and pundits who are bears on stocks and predict a US economic downturn have been doom-and-gloomers for years. Why believe them now? 10. The run-up in gold is merely a bubble blown up by over aged cranks and is of no economically-predictive value. 11. Finally, (and most often cited), the multiple on the S&P is at bargain levels; only a financial recession could make buying US stocks now a bad idea. Its always darkest just before the dawn. We find the first eight arguments persuasivein varying degrees. We strongly disagree with #10; as for #9, we have deep respect for at least two prominent bearsDavid Rosenberg, of Gluskin Sheff + Associates, and Stephanie Pomboy of MacroMavens who have been consistently and cogently challenging #11.
We long ago lost our confidence in the oft-trumpeted restraint, shrewdness, and honest financial reporting of many of the major banking institutions...
September 2011
19
...bad bankers, when acting in concert with each otherand with bad politicians destroy entire economies.
7.33
20
September 2011
Do Wall Street CEOs have fat wallets and thin skins? Lloyd Blankfein responded to criticisms by saying he was doing God's work.
Each of those three giants was bailed outor substantially helpedby the taxpayers. The rage that would find its expression in the Tea Party camein considerable measurefrom those bailouts. How have the big bailout banks behaved since then? Is the Tea Party merely a collection of ignoramuses who don't understand high finance? JPMorgan has been much in the news this year, partly because CEO Jamie Dimon says he's sick and tired of being criticized by politicians. He also says that Basel III's rules are "anti-American" and it might be wise for the US to pull out of Basel. (Do Wall Street CEOs have fat wallets and thin skins? Lloyd Blankfein responded to criticisms by saying he was doing God's work.)
September 2011
21
Mr. Dimon helps himself to gobs of that stimulus money and the returns on the almost-free FDIC guaranteed deposits to buy back his stock $4.3 billion worth this year.
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September 2011
Citigroup stock is having a somewhat better year than it has had in its recent past: its only down from $49 to $27. (As clients are aware, we consider Citi a multi-strategy hedge fund masquerading as a bank and benefiting from cheap deposits through that role-playing, managed by a former hedge fund manager who got the largest signing bonus of our time, shortly before presiding over a 95% drop in its stock price.) That $49 valuation came when its management finally figured out a way to get the stock price upthrough a mammoth reverse split. (Our chart adjusts for this: the stock never traded at $500: even Apple never got that highSteve Jobs' technique for taking AAPL from $9 to $390 differs somewhat from Wall Street's shareholder value concepts.) Why do we devote such analysis to these three mega-banks? Theyve certainly had better years than most of their European counterparts. But the melancholy reality is that Obama and Bernankeand US equity investorsneed these banks to be big parts of the solution to the problem of microscopic economic growth. We know they all have huge exposures to European banks. Based on their demonstrated expertise in building shareholder value, we would not be surprised to find out that one or more of them is deeply worried about some of his bank's euro-exposure. The Old World may be about to come to redress some imbalances in the New. Returning to our list, as we discuss in the next section, we believe that argument #11 (about a gold bubble) will prove to be 100% wrong. Gold is telling the political and financial elites what they don't want to hear. It is a big bet that the risk-free asset classand the banks who bet on itwill prove to be a delusion almost as grotesque as the risk-free mortgage products that caused the crash. As for the last argument, if the big name Street economists who say the economic pause is past are right, then But we cannot help recalling the story of the eternal Wall Street optimist who fell off the top of the Empire State Building. As he was passing the 65th floor he was heard to shout, "So far, so good!" But a possible politico-economic sea change of opinion might give investors confidence that high gold prices are here to stay. What if Obama and his counterparts in Europe decide to do a Roosevelt?
...we consider Citi a multi-strategy hedge fund masquerading as a bank and benefiting from cheap deposits through that role-playing, managed by a former hedge fund manager who got the largest signing bonus of our time...
September 2011
23
...why don't the big holders revalue their gold to, say, $2,200 an ounce and declare themselves willing sellers at that price?
United States IMF BIS ECB EUROPE Germany Italy France Switzerland Netherlands Portugal United Kingdom Spain Austria Belgium Sweden Turkey Greece Poland
Tonnes 8,133.5 2,814.0 119.0 502.1 3,401.0 2,451.8 2,435.4 1,040.1 612.5 382.5 310.3 281.6 280.0 227.5 125.7 116.1 111.5 102.9
Source: World Gold Council, World Official Gold Holdings International Financial Statistics, September 2011
Perhaps the most enduring paradox in all finance is the way major governments and central banks treat their gold holdings: they ignore them. When nearly all OECD economies are running huge deficits at a time of nearzero interest rates, and nearly all governments are looking for ways to raise revenues without imposing economy-unfriendly taxes, why don't the big holders revalue their gold to, say, $2,200 an ounce and declare themselves willing sellers at that pricein bars or in bonds backed by goldand willing buyers at, say, $2,000? Roosevelt revalued gold from $20.67 an ounce to $35 and declared that the US was a buyer and seller at that price. He also made it illegal for US citizens to own gold. By the end of the Depression, most of the world's visible gold reserves were in Fort Knox.
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September 2011
Apart from all the jobs created in Nevada and other gold-mining states, this attempt to introduce controlled inflation at a time of surging deflation was at least mildly salutary. Having most of the world's gold also proved extremely useful in helping to finance the recoveries in war-torn Western Europe. Gold's roaring run to $1800 must be a huge embarrassment to the central bankers. Why should investors be rushing out of government bonds into bullion? Don't they believe us when we tell them that printing all this money isn't going to debauch the currency? The best way to take gold out of its newfound role as moral arbiter of governments' fiscal and monetary policies may be to cap it. Yes, captious critics would say that this is the equivalent of buying a bathroom scale whose highest reading is three pounds above the buyer's current weight. But desperate times call for desperate measures. The gold bugs have long proclaimed their own version of the Golden Rule: He who has the gold makes the rules." By that standard, Barack Obama could become the leader of the world overnight. Proclaiming a cap on gold and making all the gold in Western central banks' vaults available for saleor as backing for convertible bondswould be a blow to speculators. Ironically, it would be good news for most gold mining stocks. And wonderful news for gold mine prospects that are barely more than a hole in the ground. Why? Back in the 1930s, gold mining stocks were stock market darlings. Who else could sell everything they produced to the government at a guaranteed price? Roosevelt was a hero to miners, prospectors and stock pushers. It was the golden age for penny gold stocks. Anyone could take a flutter on them. There were no lotteries, and the only legal gambling was church basement bingo games. Anybody with a dream and a drill hole was able to peddle his shares, and securities regulation ranged from lax to nonexistent.
The best way to take gold out of its newfound role as moral arbiter of governments' fiscal and monetary policies may be to cap it.
September 2011
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We believe a new era in which gold was back into the very centre of central banks' operations would be a great time for gold prospecting and gold mine development.
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September 2011
found that those lives insured by people who werent personally related to the life insured tended to die violently. So the concept of insurable interest developedjust as the fire insurers had never let people buy insurance on dwellings in which they had no ownership interest. AIG would never have gone down (at a cost to taxpayers of more than $100 billion), if it hadn't violated its insurance principles by going gung-ho into Collateralized Debt Swaps. As the eminent Paul Volcker has said so often, why should economies and taxpayers be at risk for banks that get deeply into newfangled financial products? Western economies grew satisfactorily in the decades before all these monstrosities were developed, and the bank failures that happened were easily managed. Today's announcement that UBS has apparently blown $2 billion in its trading operations is a perfect case in point: UBS had to be bailed out by Swiss taxpayers because it was levered more than 40 to one and had monstrous holdings of putrescent US mortgage paper. A great bank that had survived for more than a century as a pillar of Swiss prudence and rectitude had tried to become Goldman Swissand it lacked both the smarts and the capital for that remake. Less than three years later, it's due to report a quarterly loss it blames on a rogue trader. Axel Weber of Bundesbank fame is due to take charge next year of this organization whose financial structure in recent years seems to have been modeled on Swiss cheese. As the chart shows, he's needed now.
UBS January 1, 2007 to September 14, 2011
70 60 50 40 30 20 10 0 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 11.41
UBS had to be bailed out by Swiss taxpayers because it was levered more than 40 to one and had monstrous holdings of putrescent US mortgage paper.
September 2011
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September 2011
Gold-backed bonds and gold for sale at $2,200 to all bidders would, of course, be selling off "the family silver." But desperate times call for desperate solutions. The biggest and most obvious asset Obama has is the one asset that he supposedly can't touch. Why not? Long-duration Gold-backed Treasurys paying, say, .5% interest would be one way of selling off much of the Treasury's hoard without swamping the cash gold market. Those with long memories will recall when Jacques Rueff, DeGaulle's gold guru, convinced France to issue some gold-backed bonds as proof that the nation didn't face serious inflation risk. Then came stagflation and the runaway gold market and those gold-backed bonds became fabulous investments. Most central bankers know that embarrassing story, which may preclude their willingness to make any recommendations now. To be remembered as the guy who sold gold at $2,000 in a long-term bond and gold went to $5,000 would be ghastly. But the reason why Rueff lost so big was that Nixon closed the gold window in 1971 and then oil prices quadrupled and stagflationwhich had never existed beforetook charge. Under this tentative scenario, the US would transfer all bullion needed to back the bonds, and Congress would pass legislation guaranteeing those gold bond conversions until the bonds matured. Finally, the wise, witty folk at the Leuthold Group have published the Chart of the Year showing the cumulative total return on gold vs. the cumulative total return on the S&P since Nixon closed the gold window, repealing the cap on gold imposed by Bretton Woods. Remarkably, gold's bull market in this millennium has meant that its annualized return has caught up with the S&P9.9% vs. the S&P's 9.8%. If you'd put a bar of gold in a vault and left it there for 40 years, you'd have slightly outperformed most equity investors. The S&P has been long proclaimed as proof of the triumph of American capitalism with its business schools, management training, and superb collection of so many of the world's greatest companies. Buy and hold the S&P and you're going to be rewarded by the very best wealth-generators. Buy and hold gold and you're as outdated as believers in the phlogiston theory.
The biggest and most obvious asset Obama has is the one asset that he supposedly can't touch. Why not?
September 2011
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Why don't the governments bring out their gold and use it to back their bonds?
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September 2011
The franc tracked gold for much of this year, as investors with a sense of history bought the one currency that was a reliable store of value. The franc had that stature during the stagflation era. There were two prime reasons: 1. Switzerland prized its status as an island of financial stability in an inflationary world, and gold was a major component of its foreign exchange reserves. 2. Swiss banks were growing their managed assets rapidly, partly due to the allure of secrecy and tax dodging, but also because the rich wanted to own franc-denominated assets at a time the banks had a firm rule that 10% of each account had to be held in gold. As wealth denominated in other currencies was converted into francs, the upward pressure on the franc became enormous.
September 2011
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It could be deemed the singular case of a crowd rushing from the safety of a dock onto a sinking ship. Or, possibly, leaving Haven for Hell.
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September 2011
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...dividends were overwhelmingly the most important component of equity valuations by major institutions for more than a century after the advent of joint stock companies.
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September 2011
Bernie Cornfeld and his like peddled the growth stock concept to retail and institutional investors at a time when dividends were heavily taxed and capital gains were taxed at lower levels. But the importance of dividends even in the "modern era" was confirmed in a Financial Times survey of long-term equity returns with reinvestment of dividends by industry classification published a few years ago. The winnerby a wide marginwas the big petroleum companies, which routinely distributed generous dividends. Reinvesting those payouts was, over the long term, a superb investment strategy. (It has doubtless dwindled in these days of consultants and investment specialists; an equity specialist rarely gets control of the dividends from the funds under management, so reinvestment is almost an abstract concept.) In a recent meeting with a board of directors, we illustrated the concept of low endogenous risk with bullet-proof dividend payers by asking rhetorically, "Can anyone in this room imagine a world of the near future where Bristol Myers won't be able to pay a dividend? By that test, isnt Bristol Myers a safer income investment by far than, say, an Italian government bond?" We strongly recommend that institutional and retail investors break the shackles of labeling and look at security of incomewhether in dividends or interest. In a zero interest rate environment, there is a long list of great companies with a long record of dividend payments on scheduleand of sustained growth in those payouts. We also recommend that companies' managements consider the changed situation for dividend-payers in a zero interest rate world and decide to eliminate stock buybacks against promises to boost dividends year-in, year outon a five-year time horizon basis. Companies that took that public pledge would, we believe, be then eligible for enrolment in the bullet-proof dividend category, making them eligible to be held within the income section of both pension fund and high net worth portfolios. The new value of dividends is one logical outcome of the etiolation or outright collapse of the Capital Asset Pricing Model. That the Efficient Frontier has become the Deficient Frontier is, to date, understood by surprisingly few investors and commentators. As more come to understand the great void in their analytical processes, we suspect that even more financial turmoil will develop. That the Efficient Frontier has become the Deficient Frontier is, to date, understood by surprisingly few investors and commentators.
September 2011
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1,779.90
1,779.90
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Gold mining shares have, in general, dramatically underperformed bullion, and that has led to more questions than any other from clients this summer. A recent, superbly-researched, study of gold mining companies from BMO's mining team documents how cheap most mines are compared with bullion. Any investor with even a modest interest in precious metals investing should read this report thoroughly. As we have observed in recent Conference Calls, the great gold mines are the cheapest relative to bullion that we have seen in our lifetime. (They tended to be expensive relative to bullion for most of the 21 years of gold's Triple Waterfall collapse that began in 1980. Barrick, in particular, achieved the remarkable feat of selling its annual output well above average bullion prices, thanks to Peter Munk's spectacularly successful hedging program.) In recent years, when most of the mines modestly underperformed the gold ETF (GLD), we commented that we had counseled some members of the World Gold Council not to create that ETF. They rightly pointed out that it would create new, sustained demand for gold, by providing investors with a convenient vehicle that didn't involve storing bullion in basements or bank vaults. Moreover, the liquidity provided by an actively-traded stock exchange vehicle meant that they could trade gold cheaply. They made what certainly appeared to be the right call. We were, it would seem, wrong. But it may now be of some interest to investors to consider the objections we raised. We argued: 1. An ETF is an exchange-traded stock, which means that gold takes on beta risk: in times of sharp stock sell offs, margin clerks can swiftly sell the GLD to raise needed cash. that is in fact what happened during the darkest days of 2008and what happens on many triple digit down days for the Dow these days. 2. Gold's uniqueness as the prehistoric and historic store of value could be pollutedor even lostwhen it became just another stock exchange vehicle. 3. The GLD would eventually compete with the stocks for investor favor. Why buy gold mines with all their operational risks when one can buy the pure play that has, at least in theory, only commodity price risk?
Gold mining shares have, in general, dramatically underperformed bullion, and that has led to more questions than any other from clients this summer.
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To us, the great allure of the great gold companies that investors usually get seeminglyfor free, are the resources.
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One reason may be that mining investors are suffering from a form of sticker shock: gold has gone so far, so fast, that many investors deem it overdue for a huge correction. The Street has of late been teeming with economists and strategists who speak derisively of a bubble in gold. Most of this pack of economists and strategists wasat besttepid about gold and gold mining stocks as bullion rallied from $300 to $1200, and almost never recommended significant weighting in gold or gold mines. They stuck to recommending conventional financial assets. "Put your money into bank stocks, not into holes in the ground" was the wisdom dispensed. Most of them had been trained in elite universities by Keynesian economists and finance professors who dismissed gold as something between a barbarous relic and a bore. There is a certain self-serving logic in this view: gold is, in the physics of modern finance, anti-matter. It is a basic bet that intrinsic value will be a better store of value than a dollar, euro, pound, Swiss franc or yenthose printed paper promises of politicians. (When Nasdaq was in the late stages of its Moon Shot, the Street teemed with economists and strategists who said tech stocks were headed for Saturn. The worst year of our professional career was 1999, when we expressed utter disbelief at tech stock valuationsbefore Nasdaq doubled againto 5200. Nasdaq as the millennium dawned wasn't just a bubbleit was the largestscale collective idiocy in the history of financial markets. Unfortunately, it wiped out muchmaybe mostof the collective savings of the Baby Boomer generation; with retirement looming, too many members of that generation tried to recoup by buying heavily-mortgaged homesbecause, unlike stocks, home prices could never collapse. What they believed was that they were responding to learning acquired late in life. The word for that is opsimathy. Sadly, they had just found one last great way to let Wall Street loot their savings. The word for that is suckers. Had they bought gold with what they had left, they'd have recouped their tech losses. But almost no one of Street significance suggested that.) We believe good gold mining stocks with production and reserves in politically-secure areas will outperform bullion over the next year or more. It may take time before investors are prepared to value reserves at $1800 an ounce, but the disparity will narrow. Gold's 25% leap this summer has actually widened the valuation gap. Maybe gold investors aren't too greedyjust too cautious.
When Nasdaq was in the late stages of its Moon Shot, the Street teemed with economists and strategists who said tech stocks were headed for Saturn.
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KBW US Regional Bank Index (KRX) relative to S&P 500 September 14, 2010 to September 14, 2011
110 105 100 95 90 88.25 85 80 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11
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The TED Spread and the European IOS spread have also been flashing warning signs that the rate of deterioration is accelerating. What has doubtless helped US stocks has been the spectacular performance of Treasurys:
10-Year US Treasury Yields September 14, 2010 to September 14, 2011
4.0 3.5 3.0 2.5 2.0 1.5 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 2.08
That long Treasury zeros have performed like gold is a paradox and a warning.
What makes this rally particularly impressive is that its momentum increased after the S&P downgrade. It almost seemed to be the equivalent of a Hollywood clunker that its backers feared would failuntil the censors announced that movie houses would have to display stern warnings about the levels of nudity and violence that would be disturbing for many viewers. That long Treasury zeros have performed like gold is a paradoxand a warning. Investors are clearly concerned that the levels of endogenous risk in most financial markets are rising even as economic growth rates fall almost everywhere. The wild swings on Wall Street also raise warning alarms for the S&P, which has been so strong relative to European and Asian exchanges. The robo-traders may be profiting in unseemly fashion, but small investorsand serious investorsshould be concerned that volatility is so intense for so long.
September 2011
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...the record of such rebellions is filled with more stories of those that became newand more vicioustyrannies than of those that lived up to the revolutionaries' progressivism...
112.34
Although the revolts spread to another oil-producing nationSyriaoil prices have been in a step decline since the April panic. However, production of Libya's light oil is still seriously constrained and no one knows when normalcy will return. Syrian oil production has also been cut back.
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Tentative conclusion: The governments of Bahrain and Saudi Arabia will not fall, and eventually Libyan and Syrian oil will be flowing out under new management. This is not the kind of oil shock that, of itself, will trigger a recession as did the Arab oil boycott after the Yom Kippur War. At this point, the most disappointing news comes from Egypt, where the Army and the Islamic Brotherhood seem to be the power centers of whatever new government will take over. Those lovely liberals with the big dreams will have even less power in the future than they had under Mubarak. The biggest loser from the Arab Springapart from the fallen dictatorsis Israel. When the demonstrators in Tahrir Square were dominating global TV and the Obama Administration was busying itself in pressuring Hosni Mubarak to shape up or ship out, Benjamin Netanyahu registered strong public concern. The peace treaty with Egypt has been the core of Israeli security since it was negotiatedand both sides have benefited hugely from it. As Hosni Mubarak was carried to trials in a cage, Islamist elements in Egypt came into the open, demanding that its peace treaty with Israel be revised orbetterended. When the Cairo mob swarmed to the Israeli embassy and began chipping at the protective wall with tools, the police and Army stood watching. Then with the wall down, the mob poured into the embassy, reaching the top floorin a seeming replay of the Tehran takeover of the US embassy that would expose the wimpiness of Jimmy Carter and begin 444 days of capture of American personnel. Finally, the Army came in. But one of the most sacred of all laws of diplomacythe sanctity of embassy propertyhad been violated while the army and police stood by. It now appears that the Obama Administration was caught flat-footed by the Arab Spring, and ended up influencing revolutionary events strongly only in Egyptassisting in the political decapitation of Mubarakthe least brutal of the dictators and the best friend of America and Israel. It chose to ignore the Syrian revolt for months, claiming that Assad was "a reformer." When the Libyan rebellion could no longer be ignored, the Administration agreed to a half-hearted anti-Gaddafi policy of "leading from behind" that seemed to please almost no one(but ended up well).
The biggest loser from the Arab Spring apart from the fallen dictatorsis Israel.
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Once again, the most perilous strategy for a leader in a troubled Third World country is to be a friend of America.
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Bond Durations
US Canada International Inflation Hedged Bonds Years 7.00 7.00 5.00 9.00 Change +3.00 +2.75 +1.20 +3.50
Change 1 +9 5 3
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Bond Durations
US (Hedged) Canada: Market Index-Related Real-Return Bonds International Years 7.00 7.00 9.00 5.00 Change +3.10 +3.00 +3.50 +1.00
Change 1 +9 5 3
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