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BLOOMBERG EDITION ® Vol. 30, No. 2 Two Wall Street, New York, New York 10005 •
Vol. 30, No. 2
Two Wall Street, New York, New York 10005 •
jaNuary 27, 2012

They ask for nothing

Last week, the U.S. Treasury auc- tioned 10-year inflation-protected notes at a 0.046% negative real yield, while Her Majesty’s Treasury issued four-year conventional notes at a 0.893% nominal yield. Twelve-month T-bills denominated in dollars and yen fetch 10 basis points and 12 basis points, respectively, while the German government, borrowing for the same 12 months in a currency that may or may not be around in the next 12 months, pays 13 basis points. Nothing percent is the topic un- der review. The opportunities to earn nothing in securities denominated in unredeemable scrip, i.e., today’s paper money, is one point of focus. The the- ory of investments returning nothing is another. The contribution of central banks to nothingness and the special case of zero-yielding Japan are others. In preview, Grant’s is bearish on noth- ing, bullish on more than nothing. Seekers after no return—except for the always welcome return of princi- pal—don’t have far to look. Money market funds are a rich mine of zero- percent opportunity. Whether it’s gov- ernment funds, prime funds or tax- exempt funds, the return on offer is one basis point or—at a stretch—two. According to the Money Fund Report, $2.692 trillion is self-incarcerated at those non-rates. For any who are un- willing to accept one or two basis points but still refuse to accept, for example, 351 basis points available on the com- mon dividend of Johnson & Johnson, the U.S. Treasury yield curve presents many choices, including the two-year note priced to yield one-quarter of 1%. In times past, bond salesmen talked about how much a security yielded. Now they talk about how little.

“In this market environment, Trea- surys prove to be of unprecedented value,” the Financial Times quoted a sell-side analyst as saying on Friday. If “unprecedented” means what it seems to mean, the analyst makes a novel case. He is saying that a dozen basis points of return in 2012 trump more than a dozen full percentage points of return at the tail end of the great bond bear market of 1946-81. “He says,” said the FT, trying to explain, “Treasurys give investors an option at a time of great uncertainty by deferring an investment decision on the riskiest assets such as equities.” Only consider the two-year note, the analyst himself continued: “Two years from now, we will find ourselves in a completely different market environ- ment, in which banks, hedge funds and other participants play a different role, new security products are traded and relative value opportunities may

“Just one more unconscionable bonus, and I would’ve been golden.”
“Just one more unconscionable bonus,
and I would’ve been golden.”

exist in a currently unknown form and shape. Surviving until then is key. Treasurys help you do so.” For ourselves, we repeat the wise words of the investor Joe Rosenberg, as quoted in the Dec. 5 Barron’s: “You can have cheap equity prices or good news, but you can’t have both at the same time.” For the patient and not overly leveraged investor, trouble is a friend, provided it isn’t cataclysmic. Do today’s troubles qualify? Or are they the kind—troubles with a capital “T”—that will make prophets out of the nothing-percent bulls? A century ago, Congress convened hearings to expose the concentration of financial power among the big New York City banks. Under questioning, one of the witnesses, George F. Baker, 72-year-old chairman of the eminently solvent and profitable First National Bank of New York, admitted that too many financial resources were prob- ably controlled by too few private

hands. However, he went on, “In good hands, I do not see that it would do any harm. If it got into bad hands, it would be very bad.” The interrogating lawyer, Samuel Un- termyer, seized on that concession. “If it got into bad hands,” he asked hopefully, “it would wreck the country?” “Yes, but I do not believe it could get into bad hands,” Baker replied. And presently he added, “I do not think bad hands could manage it. They could not retain the deposits nor the securities.” This was in 1912, two years before the Federal Reserve opened for busi- ness, 21 years before the founding of the Federal Deposit Insurance Corp. and 59 years before the jettisoning of

(Continued on page 2)


2 GRANT’S/JANUARY 27, 2012

(Continued from page 1)

Road to zero

to 2.706 trillion, up by 37% from a year ago. Over the past three months, the as- sets of the ECB have been growing at an annual rate of 90%.

Italian banks availed themselves of

the ECB’s accommodation more than

the banks of any other euro-zone na-

tion, and Monte dei Pacshi di Siena

was the most eager Italian borrower of them all, based on its takings as a per-

centage of 2012-13 funding require-

ments. According to an excellent new

Morgan Stanley study of the situation

(“Don’t underestimate the impact

of the LTROs,” dated Jan. 18), MPS

secured 100% of this year’s financing

and most of next year’s, 10 billion al- together. “The oldest surviving bank in the world,” as management char- acterizes the 540-year-old institution, survived the Great Recession with the help of a 1.9 billion infusion from the Italian government. It may be said that MPS is not (and possibly never was) a purely capitalist institution, its found- ing charter providing for loans to “poor or miserable or needy persons.” Yet it may also be said that any crisis that can rock the oldest surviving bank to its ancient foundations tells you some- thing about the quality of banking in the era in which the crisis occurred. LTRO isn’t, and couldn’t be, the cure for our manifold sins and suffering. A taker-upper of a three-year loan from the ECB pays just 1%, it’s true, while short-dated Greek debt fetches as much as 392%. But the borrowing bank is un- der no regulatory obligation to commit

5% 5% 12-month obligations of select sovereign bonds 4 4 U.S. Germany 3 3 Japan 2
12-month obligations of select sovereign bonds

source: The Bloomberg

the last remnants of the gold standard. It was 70-odd years before the enunci- ation of the doctrine that some Ameri- can banks are too big to fail. In the world in which Baker and J.P. Morgan did business, “bad hands” couldn’t successfully compete. Today, if employed by a too-big-to-fail bank, bad hands can flourish. Governmental dis- pensations like unchecked money print- ing and the zero-percent funds rate help them over the cyclical rough patches. However, to subsidize something is to get more of it. Subsidies to bad banking have materially increased the number of bad banks. These are the sunshine insti- tutions, solvent in the booms, needy in the busts. In Europe, cyclically solvent banks must number in the hundreds. You can infer as much by the enor- mous bulge in lending by the Europe- an Central Bank. When governments not led by Angela Merkel lost the mar- ket’s confidence, so did the banks that owned those governments’ notes and bonds. Standing on their own, the sus- pect institutions couldn’t fund them- selves. Tellingly, interbank lending virtually stopped—the bankers knew all about each other. The not-needy banks implemented their own noth- ing-percent trade by depositing excess cash in the ECB rather than risking it in the wholesale funding markets. As for the needy banks, to borrow Baker’s phrase, “they could not retain the de- posits nor the securities.” We Americans wake up dreading to hear the news from across the pond

because Europe’s crisis hits home. It’s the crisis of the welfare state of credit. If the system of heavy public borrowing financed by fiat currencies and semi-so- cialized banking is doomed, what about us? It’s our system too. Here, at least, the overused phrase “systemic crisis” is actually descriptive. In December, the ECB extended 489 billion in three-year loans to more than 500 European banks against an encyclopedic list of eligible collateral. “Long-term refinancing options”— LTROs to the cognoscenti—is the name of this massive monetary initiative. On Jan. 20, the ECB’s balance sheet footed

And more where that came from

in billions of euros €2,750 €2,750 European Central Bank’s total assets 2,500 2,500 2,250 2,250 2,000
in billions of euros
European Central Bank’s total assets
in billions of euros

source: European Central Bank

Copyright ©2012 by Grant’s Financial Publishing, Inc. Reproduction or retransmission in any form, without written permission, is a violation of Federal Statute.

its ECB-dispensed funds to purchase Greek, Italian or French debt. “Even if the banks do find the ‘carry trade’ entic- ing at the February three-year LTRO,” write the Morgan Stanley analysts, “they will have little incentive to buy bonds beyond a three-year average maturity (e.g. could include some five years in the mix but unlikely 10 years). It also leaves open an intriguing question of who will buy euro sovereign bonds beyond the ‘sugar highs’ of the December and Feb- ruary three-year LTROs. It may mean beyond February more bearish trades should be put back on in the sovereign curves. We still expect that the ECB will cut the Refi rate by a further 50 basis points during the spring; and will prob- ably need to step in during the sum- mer with full-blown QE (direct buying of government and corporate debt). It may be that a Greek restructuring calls for a quicker need to backstop Italy and Spain with greater vigour.” However, in the absence of the Bakers and the Morgans and the gold standard under which they operated, someone had to do something. In 2012, Morgan Stanley estimates, 470 billion of senior unsecured debt falls due. In no economy is a systemwide banking collapse a mere footnote. In Europe, where 80% of the credit is drawn from banks, the authorities would move heaven and earth to forestall such a disaster. The relatively undeveloped state of the capital markets (and the absolutely impoverished state of the labor market, with the euro zone un- employment rate standing at 10.3%) make imperative a clear and function- ing “bank lending channel,” as the co- gnoscenti also say. Next month comes a second round of LTROs, which may elicit borrowings of 400 billion or more, possibly much more. Note, please, the matter-of-fact tone of the just-quoted Morgan forecast concerning a radical acceleration in the ECB’s already muscular rate of credit creation. Clearly, the ECB is a mis- understood institution. Though poli- ticians complain about its alleged re- luctance to go all-in on monetary ease, the ECB has actually pursued through other means the kinds of policies identified with the Fed and the Bank of England. Eschewing QE, it has in- stead performed LTROs. It has cre- ated the purchasing power with which the Continent’s used-up commercial banks can buy sovereign debt, rather


than—as would occur under QE—the central bank buying that debt outright. But the effect is the same. New liquid- ity and new credit are brought into the world but without—a key point—a corresponding increase in new goods and new services. Taking as it does a conservative, shall we call it, approach to money and banking, this publication sometimes glides too easily over mainstream 21 st - century doctrine. In the matter of cen- tral bank policy, the view of many an

GRANT’S/JANUARY 27, 2012 3

established and thoughtful practition- er is that the Ben Bernankes and Ma- rio Draghis should keep printing, that no harm will come if they do but that great harm may result if they don’t, that harm taking the shape of a defla- tionary depression. Willem Buiter, chief economist of Citigroup, is one of these modern thought leaders. “Potentially infinite money creation is clearly inflation- ary,” Buiter, a former member of the Bank of England’s Monetary Policy


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4 GRANT’S/JANUARY 27, 2012

Not so high, in fact


and 83% for Germany), never mind

160 160 real/effective yen-dollar exchange rate (2010=100) by nonexistent nominal Japanese yields or by the unfavorable
real/effective yen-dollar exchange rate (2010=100)
by nonexistent nominal Japanese
yields or by the unfavorable trend in
the Japanese current account. But the
stockpiling of yen-denominated scrip
becomes more than comprehensible
to a bull on the Japanese currency—
notably, to a yen bull who happens to
be a Japan bear.
One investor who fits this unusual
description is Hugh Hendry, chief
investment officer of Eclectica Asset
Management, London. Having made
its mercantilist bed, Hendry con-
tends, Japan must now lie in it. For
almost a half century, the Japanese
private sector has been accumulat-
ing non-yen assets. Today, it holds a
pile of non-yen claims equivalent to
1/10 12/11
source: Bank of Japan
index level
Committee, acknowledges in a Sept.
9 report, “but as we have argued be-
fore, even the non-inflationary loss
absorption of the ECB/Eurosystem—
assuming that its money creation will
not exceed the level consistent with
the ECB’s price stability mandate—is
likely in the range of €3 trillion. Since
we take the ECB’s commitment to
price stability seriously, we regard
these €3 trillion rather than infinity as
the right constraint on the institution’s
potential contribution to the resolu-
tion of the euro area’s sovereign and
banking crises.”
Since that writing, the ECB has
created € 620 billion. And without
alarming the economics department
of Citigroup, the Bank of Draghi
may materialize 2.4 trillion more eu -
ros. Insofar as the Citi economists
speak for the others—and Citi is
usually not in the vanguard of radi -
cal opinion—the ECB might only
have begun to print. We reason that
the looming euro zone liquidity crisis
is over for the time being. The euro
zone banks will get both funding and
forbearance. There will be more than
enough euros to go around.
Reasoning in this fashion, we con-
clude that the nothing-percent trade
is yesterday’s big idea. As the world
comes to accept that a euro zone
banking crisis is off the menu of im-
mediate risks, there could be a shift,
if not a stampede, into assets yielding
more than nothing. We thus restate
our preference for cheap equities over
the non-yielding alternative. Cheap
gold-mining equities seem especially
attractive, given the habitual central
bank response to meeting crises with
new emissions of paper.
It may not be easy persuading the
bulls on nothing that something is, in
fact, more remunerative, even safer.
Japanese sovereign debt, a mainstay
of the worldwide stock of non-yield-
ing assets, came in for a downgrade
to double-A-plus from triple-A by
the domestic ratings agency, Rating
and Investment Information, on Dec.
21. But the announcement made no
waves in the immense placid sea of
nominal-yielding JGBs. “Noise,” was
the reaction to the demotion by the
Nomura chief investment strategist.
Now comes word that, as of Sept. 30,
ownership of Japanese debt by non-
Japanese residents stood at a record
¥75.7 trillion, or $974 billion, much
of which, according to the Financial
Times, was in the form of zero-per-
cent-yielding T-bills. “[I]t is under-
standable,” the FT reported, “that
foreign money-market funds would
seek shelter in a market where bids
are almost always at least twice the
amount offered, and where the views
of credit rating agencies seem to have
no effect on prices.”
It is not so blindingly understand-
able to anyone who appraises the
value of short-dated Japanese pa-
per based on Japan’s ratio of debt to
GDP (an estimated 233% last year,
as against 100% for the United States
a year’s Japanese GDP or more, i.e.,
on the order of at least $5.9 trillion.
And handy it is in times of trouble—
say, in the wake of the Lehman bank-
ruptcy, or of last year’s tsunami and
earthquake. However, the very act of
repatriating dollars or euros tends to
elevate the yen exchange rate, which
is exactly the opposite of what Japan’s
exporters want. It’s an exquisitely
ironic problem, Hendry relates: the
more foreign exchange the private
sector brings home, the more the
yen tends to appreciate, and the less
price-competitive the very same pri-
vate sector becomes.
At 77.7 yen to the dollar, Hendry
proceeds, the currency only seems
uncomfortably high. In fact, it traded
near that level in April 1995 after the
Kobe earthquake. If the exchange
rate had merely reflected Japan’s su-
perior inflation record from that day
to this, yen/dollar would be quoted in
the 50s today. And it will, Hendry pre-
dicts, finally trade in the 50s or 60s, at
which crisis level the lights will go out
in Japanese industry.
But, in response to the implosion
of Japanese automaking, steelmaking
and chemical manufacturing, the lights
will go on at the Bank of Japan. Only at
such an acute level of exchange-rate-
induced pain, Hendry says, will the
Japanese authorities show the world
how QE is really done. Then, and
only then, will the bear market in the
Japanese currency and in the Japanese
bond market begin in earnest.
And perhaps, at that interesting junc-
ture, the nothing-to-maturity trade will
finally and definitively turn unprofitable.
index level


GRANT’S/JANUARY 27, 2012 5

The right price

No claim as to cause and effect, but Newt Gingrich won South Carolina the day after he promised to name Lewis E. Lehrman and James Grant to co-chair a commission to study the fea- sibility of America’s return to the gold standard. If, of course, he gets to the White House. “While I am not presently commit- ted to any one version of reform,” de- clared the former Speaker of the House of Representatives, “if elected I will be eager to work with Lew Lehrman and Jim Grant in achieving a dollar that once again can hold its purchasing pow- er for many decades to come.” The fundamental conclusions of a Lehrman-Grant commission to con- sider a return to the gold standard may be foregone: We’re for it. As for the technique of getting from fiat curren- cy to the real McCoy, that’s a harder nut. No less a statesman than Winston Churchill bungled the job in Britain in 1925. In place today is a dollar unde- fined and uncollateralized. On the near horizon, let us say, is a dollar defined as a weight of gold and exchangeable on demand into that metallic collateral. Moving from fiat currency to the real thing is the topic under discussion. It happens that Lehrman has writ- ten a book on how to get from here to there: “The True Gold Standard:

A Monetary Reform Plan without Of- ficial Reserve Currencies.” A member of President Reagan’s Gold Commis- sion in 1981, the senior co-chairman of the prospective Gingrich gold com- mission sat down last week for a chat with the junior co-chairman. The gold standard is what the world needs now, the commissioners-in-theo- ry agree. Reason, history and common sense command it. The gold standard tends to deliver price stability over the long run. It tends to check the over-is- suance of credit. It tends to favor no one nation but to knit the nations together. A human contrivance, it has its limits, of course. However, as Lehrman has said, “it is the least imperfect monetary system devised. And it has been proved in human history, the only laboratory that counts, not on the blackboards of Cambridge and Oxford.” And gold is the ideal monetary me- dium, the prospective commission- ers also concur. It isn’t consumed, it’s

rarely destroyed and it’s famously dif- ficult to discover and mine. You know it’s money just by looking at it. For the very reason that elements from Cleopatra’s bangles might be found today in someone’s molar, a given year’s production of gold has no mean- ingful effect on the size of the global gold inventory. According to Thom- son Reuters GFMS, 2010 production of 2,709 metric tons stands in contrast to estimated aboveground stocks of 166,600 metric tons. For every ounce produced, 61 already existed. If slow and steady is the way of the gold standard, fast and furious is the tempo of the fiat regime. To the end

of achieving a 2%-per-annum rate of inflation, the central banks of the United States, the European Union and the United Kingdom are printing money at rates many times faster than 2%. If there’s any rhyme or reason to the system, the Gingrich commission pledges to reveal it. Anyway, the world supply of gold expanded by an average of 1.7% a year from 1900 through 2009, according to the U.S. Geological Survey. The growth wasn’t steady but spotty. In the 1930s, as mining costs plunged, production boomed, with output climbing at the

(Continued on page 8)

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VIX Index

VIX Index BLOOMBERG EDITION 6 GRANT’S/JANUARY 27, 2012 C redit C reation Central bank sleeping pill


6 GRANT’S/JANUARY 27, 2012

Credit Creation

Central bank sleeping pill







Chicago Board Options Exchange vs. Merrill Lynch Option Volatility

VIX Index BLOOMBERG EDITION 6 GRANT’S/JANUARY 27, 2012 C redit C reation Central bank sleeping pill


Federal reserve Balance sheet

(in millions of dollars)


Jan. 18,

Jan. 11,

Jan. 19,




The Fed buys and sells securities…

Securities held outright




Held under repurchase agreements




and lends…





and expands or contracts its other assets…

Maiden Lane, float and other assets




The grand total of all its assets is:

federal reserve Bank Credit




Foreign central banks also buy, or monetize, governments:

Foreign central bank holdings of Treasurys

and agencies $3,391,653 $3,397,718 $3,343,203

Bank oF Japan Balance sheet

(in billions of yen)

Jan. 20, 2012

Dec. 20, 2011 Jan. 20, 2011

The BoJ buys Japanese gov’t. bonds…

Bonds purchased




and lends…

Loans and discounts




and expands or contracts its other assets…

Other assets




Its assets total:





yields 5.0% 5.0% 4.5 4.5 4.0 4.0 3.5 3.5 3.0 3.0 2.5 2.5 2.0 2.0 1.5
3 month
6 month
2 year
5 year
10 year
30 year

source: The Bloomberg


source: The Bloomberg

Money sooth

Evan Lorenz writes:

Since the prior issue of Grant’s, Ja- pan has tapped an additional $6.5 bil- lion from the Federal Reserve’s central bank liquidity swap facility for a grand total of $20.5 billion. As to why Ja- pan’s banks suddenly find themselves starved of dollars, one can only guess. Maybe it’s because, as Bloomberg re- ported on Jan. 23, the Japanese are fill- ing the void in Asia left by the retreat of the undercapitalized French. Or, perhaps, international providers

of dollars, e.g., money market mutual funds, are getting worried. Or maybe the legendary Mrs. Watanabe finds her- self with fewer dollars as Japan becomes a net importer of goods and services. In

the first 11 months of 2011, the Japanese

trade deficit totaled ¥2.9 trillion ($37.9 billion). To fund the shortfall, Japan

must run down its formidable stock of

foreign assets, which, as noted elsewhere in these pages, tends to strengthen the

yen—and enlarge the trade deficit.

The 24/7 hum of the global monetary

printing presses seems to be soothing

rather than not; since the announcement

of liquidity-enhancing measures on Nov.

30, the price of volatility has plummet- ed. The CBOE Market Volatility Index

(VIX), a measure of implied volatility on S&P 500 options, has declined to 18.91


GRANT’S/JANUARY 27, 2012 7
GRANT’S/JANUARY 27, 2012 7

Cause & effeCt

120 SPX Volatility Index (left scale) Estimate MOVE Index (right scale) 110 100 MOVE 90 80
SPX Volatility Index (left scale)
Estimate MOVE Index (right scale)
MOVE Index

es the nerves

from over 30. The Merrill Option Volatil- ity Estimate (MOVE Index), a measure of bond volatility, has declined to 81.6 ba- sis points from over 100. Just in time—if, that is, the focus of your concern is on the world’s second-largest economy. What do Japan, the U.S., Spain and Ireland have in common, posed Bank of Japan deputy governor Kiyohiko G. Nishimura at a June 20 University of Cambridge conference. Why, each of these countries saw a boom in asset pric- es as their “inverse dependency ratio” increased—i.e., as the ratio of working- age population to the non-working-age (dependent) population pushed higher. The demographic tailwind did not cause the bubble, but, rather, supplied “fer- tile ground for the excessive optimism that led many economic agents to take a highly leveraged position to multiply their returns,” Nishimura asserted. “By the same token, the eventual sharp re- versal of the ratio made resolution of accumulated financial excesses particu- larly difficult,” he said. Notable, therefore, is the news that the proportion of working-age Chinese (ages 15 to 64) declined by 0.1% to 74.4% in 2011, as well as this possibly related fact: China’s largest property de- veloper, Vanke, last month registered a 30.3% year-over-year plunge in sales.

annualized rates oF GroWth

(latest data, weekly or monthly, in percent)


3 months

6 months

12 months

Federal Reserve Bank credit




Foreign central bank holdings of gov’ts.




Bank Of Japan




Commercial and industrial loans (Dec.)




Commercial bank credit (Dec.)




Primary dealer repurchase agreements




Asset-backed commercial paper
















Money zero maturity




reFlation/deFlation Watch Latest week

Prior week

Year ago

FTSE Xinhua 600 Banks Index




Moody’s Industrial Metals Index
















Rogers Int’l Commodity Index




Gold (London p.m. fix)




CRB raw industrial spot index




ECRI Future Inflation Gauge

(Dec.) 98.6



(Dec.) 101.2

Factory capacity utilization rate

(Dec.) 78.1



(Dec.) 76.8

CUSIP requests

(Dec.) 1,770

(Nov.) 1,923

(Dec.) 1,607


in basis points 800 800 700 700 latest 600 three months ago year ago 600 500
in basis points
three months ago
year ago
Aa bond
Baa bond
in basis points

*spread over three-month Libor sources: The Bloomberg, Standard & Poor’s LCD

8 GRANT’S/JANUARY 27, 2012

(Continued from page 5)

rate of 7.3% a year. In the 2000s, as min- ing costs soared—over the past few years at rates in excess of 20% a year—pro- duction actually declined, at the rate of 1.1% a year. Still, over the long run, the co-commissioners agree, the Newmonts and the Barricks of the world are more dependable sources of monetary matter than the Federal Reserves of the world. All of which is preface to taking a stab at setting or—just as important at this stage of the game—thinking about setting the rate of conversion. Gold bugs, gold bulls and others with a horse in the monetary race have given the subject some thought and much dis- cussion. However—your editor is about to hand his friend a well-deserved bou- quet—nobody has studied it so well or so long as Lehrman. By all means, read his book ($9.95 on Amazon).


James Grant, Editor Ruth Hlavacek, Copy Editor Evan Lorenz, CFA, Analyst David Peligal, Analyst Charles Grant, Analyst Hank Blaustein, Illustrator John McCarthy, Art Director Eric I. Whitehead, Controller

Delzoria Coleman, Circulation Manager John D’Alberto, Sales & Marketing

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The prime objective, says the author, is to avoid the British error of restoring convertibility at a rate so high as to pres- sure nominal wages. Churchill, taking bad advice, pegged the pound at pre- World War I gold parity, thereby forcing down incomes, gumming up business and setting up an undifferentiated con- tempt of the gold standard in British in- tellectual circles that to this day seasons the pages of the Financial Times. The deflationary error is easily avoid- ed, Lehrman observes. The essential steps include these: No. 1, announce a date certain for resumption of gold convertibility, likely two or three years down the road. No. 2, invite the market to undertake the work of discovering a price. No. 3, assemble the statistics with which to calculate average and marginal all-in costs of gold mining in the United States and elsewhere. No.

4, armed with those data, override the

market’s price if it seems too low to af- ford the higher-cost miners the margin with which to make an acceptable re-

turn. As the gold standard is an interna-

tional monetary mechanism, the wages of no participating nation should come under pressure owing to a poorly calcu- lated conversion rate. “After the pre-resumption market- price discovery period is complete,” writes Lehrman in his book, “the gold value of the dollar should be estab- lished at a level, depending on eco- nomic circumstances, not less than the weighted average of the marginal costs of production, measured in dol-

lar terms, such that the level of wages

would not

fall. . . .

This methodology is

grounded by the fact that the value of the gold monetary system itself—af- ter 40 years of gold price suppression and inconvertible paper currencies— should be restored to a proportional level in the hierarchy of prices and wages such that the level of nominal wages does not fall.” Lehrman, financially disinterested in the gold trade, may not feel the pain of his partner and confrere, who does, indeed, own bullion and mining shares. Speaking for the goldbugs, the editor of Grant’s admits he wouldn’t mind seeing the gold price spike to $10,000 an ounce. Speaking, however, as a prospective monetary statesman,

he anticipates no such leap. More likely, should America actually choose convertibility, there would be a con- version rate of between $2,000 and $3,000 an ounce. At $2,500, to pick a statesman-like compromise, the official American

gold stock of 261.5 million (unaudited) ounces would command a dollar value of $653.7 billion, a number equivalent to 29% of M-1 (currency and check- ing deposits) and 25% of the adjusted monetary base (currency and bank reserves). Britain, the de facto man- ager of the classical gold standard in its 19th-century heyday, made do with a much thinner reserve. Cover alone, however, does not close the discussion. The proper conversion rate is one that answers another need.

in metric tons Not printing but mining 3,000 3,000 worldwide production and trend growth in long-term
in metric tons
Not printing but mining
worldwide production and trend growth
in long-term gold production
trend growth
2000 2009
in metric tons

source: U.S. Geological Survey


GRANT’S/JANUARY 27, 2012 9

It must be high enough to provide the operational headway needed to encour- age the mining industry and other pro- ductive enterprises. As things stand, the mining business looks well encour- aged. Among the 17 constituent com- panies in the NYSE Arca Gold Bugs Index, operating margins in the third quarter of 2011 range from as little as 14.4% for Harmony, a high-cost South African producer, to more than 50% for the lower-cost North Americans. However, the outpouring of dollars, euros, pounds, renminbi, etc. has had its predictable effect on gold-mining costs. From 2005 to date, according to Gold Fields and a J.P. Morgan study of an eight-company sample, costs have climbed at a 23% compound annual rate. At that speed, they would almost double in three years. All-in costs of produc- ing an ounce of gold, according to the same sources, today stand at $1,371 an ounce. All together, a conversion rate on the order of $2,500 an ounce seems well within the realm of possibility. It will be asked—we put the ques- tion to our colleague—whether it is enough simply to avoid deflation in setting a gold conversion rate. Is there not a symmetrical risk of inflation by setting too low a conversion rate? Not at all, Lehrman replies, as it has been proven throughout monetary history. Under a gold standard, “there is no such thing as inflation. When people mine gold for the monetary standard, and monetize it in exchange for cur- rency or demand deposits with which to make investments, yes, the relative

price of gold might have risen. But that is different from inflation where no real good has been produced in the zero-cost marginal production of mon- ey arbitrarily created by the Federal Reserve or any other central bank. It’s

a different process

it’s a different

. . . kind of price-level movement. “It’s a movement of relative prices of real goods,” he winds up. “It’s not a de- mand being made by fictitious money is- sued by a central bank for goods and ser- vices which have not yet been supplied.”

Not fast money

Saints, proverbially long on pa- tience, are exactly suited to the pace of progress at Tejon Ranch (TRC on the Big Board), the California real-estate

development company. Ordinary mor- tals must steel themselves. “Bullish for the long run, though no promises for the short run,” was our call in 2009, and so it remains today: Eat an apple every day, and you’ll likely be around for the payoff. Ruefully but hopefully, we return to Tejon, owner of the largest pri- vate tract of land in the Golden State, 270,000 acres situated 60 miles north of Los Angeles and 15 miles east of Bakersfield. Tejon raises wine grapes, almonds, pistachios, wheat and alfalfa, along with energy, truck stops, ware- houses—and lawsuits. Thwarted in the courts, Tejon missed the great real-es- tate levitation of the early 2000s. Still vexed by the environmental lobbies, the company could yet miss the next up cycle, the starting date of which has yet to be announced (though to judge by the action in homebuilding stocks, someone must think it’s already here). If beautiful vistas were monetiz- able, Tejon might be in the S&P 500 already. If well-conceived plans and managerial persistence were mon- etizable, ditto. But the owner of these wide-open spaces and the steadfast author of these winning architectural renderings is a case study in delayed gratification. At $26.80 a share, Tejon common is quoted just about where it was a dozen years ago. There is no sell- side coverage and, as far as that goes, no dividend. Virtually no debt, either. In the fullness of time, Tejon Ranch anticipates the construction of a pair

of upscale residential communities, Centennial and Tejon Mountain Vil- lage, as well as continued growth in an existing 1,450-acre industrial park. The question, especially with respect to the first named projects, is when. On paper, Tejon Mountain Village comprises golf courses, riding trails, re- tail space, 750 hotel rooms and up to 3,450 residences, all set on 26,000 acres of rolling ranchland (of which 5,000 would be “disturbable” for building). But on paper it remains. For one thing, there are environmental hoops. The Center for Biological Diversity is chal- lenging the California Environmental Quality Act review of the impact report for Tejon Mountain Village. And, the U.S. Fish and Wildlife Service is expect- ed to say yea or nay, perhaps within the next year, to a Tejon Mountain Village Habitat Conservation Plan. For another thing, the economy is punk. Pending the return of prosperity, say Tejon and its development partner, DMB Associ- ates, the project will remain on ice. Centennial, to consist of 6,000 build- able acres set on a total of 12,000 acres, is still more of a gleam in the corporate eye. In 2002, Tejon filed a plan with Los Angeles County to build a master- planned community 30 miles north of Valencia; there would be as many as 23,000 residences. Ten years on, there are none, as the project remains stuck in the formative stages of permitting. Groundwater is the issue in dispute. Tejon Ranch has a market capital- ization of $536 million. No doubt, the

TRC share price Twelve years of nothing 1,700 $65 S&P 500 index (left scale) vs. Tejon
TRC share price
Twelve years of nothing
S&P 500 index (left scale) vs. Tejon Ranch share price (right scale)
S&P 500:
S&P 500:
S&P 500 index level

source: The Bloomberg


10 GRANT’S/JANUARY 27, 2012

projected but unbuilt residential and resort communities command some significant monetary value. Then again, time is money, even when the funds rate is stuck at zero. Concerning Tejon Mountain Village and Centen- nial, Robert Stine, Tejon’s president and CEO, tells colleague David Peli- gal, “there is at least a year of infra- structure construction that would need to be going on before you’d have a lot to sell or a block of lots to present to a builder. The decision to pull the trigger—to begin with the infrastruc- ture, such as roads and utilities, and for everything to get under way—is a year before you’d have any product available for sale. For the moment, it’s certainly not going to be in 2012. And 2013, we’ll have to wait and see.” “Take Centennial alone,” Peli- gal goes on. “Last week came news that CalPERS is selling a portfolio of 28 housing communities, including 16,300 home sites and thousands of acres of land in 11 states, of between $500 million and $600 million. This would value each home site (only the site) at about $35,000 a lot. Clearly, Centennial would be worth more than $35,000 per. But there are, as yet, no finished lots—indeed, no permits to proceed with the creation of unfin- ished lots. One can imagine the se- quence of events by which Centen- nial, and Tejon Mountain Village, too, would go from corporate dream to real- ity. But one must imagine. ‘We believe that the development value for both Tejon Mountain Village and Centen-

nial, on a net present value basis, is worth considerably more than the cur- rent market value of the stock,’ attests one holder.” So does Grant’s, underscoring the verb “believe.” “The third leg of the value stool,” Peligal proceeds, “is Tejon Ranch Com- merce Center, a very fancy name for an industrial park situated at the junction of Interstate 5 and Highway 99, smack dab in the middle of California. From this location, you can reach 97% of the customers in California in a single-day truck turn. If you’re trying to cover northern and southern California and any of the 11 Western states, you’d be hard pressed to find a better location. There’s nothing hypothetical about the Tejon industrial park: IKEA, Famous Footwear, In-N-Out Burger (a personal favorite) and Tejon’s own truck stop, branded the Petro and TA Travel Cen- ter, are among the tenants. On Nov. 7 came news that Caterpillar was pur- chasing 46 acres within the industrial park to build a 400,000-square-foot dis- tribution facility. And just this month, Dollar General Corp. became a lessor of 439,000 square feet in a warehouse owned by Tejon Ranch and Rockefell- er Group Development Corp.” “By owning some of the buildings at Tejon Ranch Commerce Center,” says Stine, referring to the industrial park by its full-dress name, “over the long run we want to generate a cash flow and an income stream from the income-producing real estate. In both of the big travel centers—which is a

Tejon Ranch Co.

(in $ thousands, except per-share data)

12 mos. to 9/30/2011 12/31/10 12/31/09 12/31/08 12/31/07

Total oper. revenues






Income (loss) from ops. before joint ventures






Equity in j.v. earnings






Net inc. (loss) to common






Net inc. (loss) per share, dil.






Total assets






Long-term debt












Price per share


Shares outs. (millions)


Market cap




nice word for the truck stops that we own—we generate very nice cash flow out of our 60% ownership of both of those operations, and, again, it diversi- fies our revenue sources.” A glance at the table shows the growth in revenues as well as the ir- regularity of the occurrence in in- come. The jiggly net profits line looks as if it had drunk one too many lattes. You can understand the absence of analyst coverage. There’s no predict- ing what the next year, never mind quarter, might serve up. Besides, Tejon Ranch issues no debt. It raises such capital as it needs through rights offerings. It carries its land on the bal- ance sheet at 1936 values. It holds no conference calls. “Clearly,” Peligal continues, “the li- on’s share of the value in Tejon Ranch is going to come from Tejon Mountain Village, Centennial and the industrial park. But there are many other pieces

to the puzzle. In fact, it is largely the variety of those pieces, and the poten- tial for finding a winning lottery ticket among them, that makes the invest- ment story so interesting.” “All in all,” relates the chief finan- cial officer, Allen Lyda, “including our land and off of our land, we probably have at least 70,000 acres, plus or mi- nus, of oil royalty rights. We own those


rights. . .


“In general,” adds Stine, “the com- pany has been in no rush to sell any of its mineral rights, which is why in some cases land that, over the last 20 to 30 years, the company once owned but sold for various reasons, we’ve re- tained all the mineral rights. This is why we still get revenues on land that we literally don’t own the fee title to.” “It’s no secret,” adds Peligal, “that Occidental Petroleum, the biggest on- shore oil producer in the continental United States, wants to increase its production in California—the com- pany’s Elk Hills and Buena Vista oil fields are situated less than 25 miles from Tejon property. One can assume that OXY is carefully monitoring what is happening in its own backyard. And it is a fact that the company has drilled four new wells on Tejon acreage.” The Tejon Ranch portfolio is a bag of possibilities. It includes a power- plant lease; a corporate acquaintance with the newly recognized Tejon In- dian Tribe of California, which is said to be weighing its options to enter


GRANT’S/JANUARY 27, 2012 11

the casino business; the sale of hunt- ing rights, a business temporarily suspended after an investigation dis- closed the illegal taking of mountain lions (Stine issued a profuse apology); limestone mining; and farming. On a back-of-the-envelope guess, we reck- on the farmland alone might be worth $75 million. Last but not least in the enumera- tion of the assets and the excellences of Tejon Ranch is the management’s clear-eyed philosophy of finance. “Knowing that excess debt is often the death of many companies, especially those that are land-based,” Stine wrote to the shareholders in 2010, “we were, and are still, committed to maintaining a healthy balance sheet to ensure that the value we build for shareholders is real and enduring.” As for the shareholders, given the slow rate of realization of the compa- ny’s undoubted value, the longer they endure, the better.

Above its weight

Singing the song of Graham and Dodd, the portfolio managers of the Af- rica Opportunity Fund, Francis Daniels and Robert Knapp, had this message to their shareholders at the end of a more- than-respectable year: “We remain fo- cused on investing, at historically low valuations, in companies with minimal debt that sell goods and services in short supply.” Now begins an admiring review of a tiny enterprise. Listed in London, the Africa Opportunity Fund (AOF) had, at year-end, 42.6 million shares outstand- ing, net assets of $39.7 million and a market capitalization of $31.3 million. In a not-great year for investing any- where, NAV increased by 1.6%, includ- ing dividends. The share price fell by 10.4%. At Tuesday’s closing price, the discount to year-end NAV stood at 19%. Attendees at the fall 2010 Grant’s Conference will remember Daniels mentioning Shoprite Holdings Ltd., the “largest, fastest-moving consumer goods retailer in Africa,” as he put it (Grant’s, Oct. 29, 2010). In 2011, Lusa- ka (Zambia)-listed Shoprite, his biggest position, was up by a cool 79%. As for 2012, Daniels says he’s bull- ish on Africa and bearish—he’s a fully paid-up subscriber—on central banks

and the People’s Republic of China. “A big difference between value investing in a continental market like the United States and value investing among 53 countries is [that] I have to think a lot about currency,” Daniels said, speaking on the phone from Johannesburg. “It’s not just that there are 53 countries, it’s that in a lot of countries the economies are very dependent on a few commodi- ties. Or they’re countries which have very little manufacturing and import a lot, and therefore a sharp devaluation of the currency has a dramatic impact on the cost of living.” Working both top-down and bottom- up, Daniels picks companies, countries, currencies and industries. He can go long or short, invest in debt or equity, buy listed and unlisted securities and enter into arbitrage operations. As hard as it is to navigate the mon- etary and macroeconomic rocks and shoals, there are benefits to investing where others mainly choose not to com- mit, he went on: “If one asks, ‘Is there a place on earth where the writ of the central bankers does not run or runs with faint ink?’ the answer has to be ‘yes, in many an African country.’ If a country like Zimbabwe does not have its own currency and lacks a currency board like Hong Kong, there is no writ to ponder. If a country like Cote d’Ivoire, recover- ing from civil war, closes its banks for a few months, there is too little money for the monetary transmission mechanism to function in a classical manner. Fur-

Picture of value

thermore, unlike east Asian economies, African countries tend to have modest foreign-exchange reserve levels, limit- ing the capacity of central banks to in- tervene against market forces.” In the absence of money print- ing, capital tends to be scarce, Daniels pointed out; so much the better for people with capital. Asked for a favorite name, he mentioned Okomu Oil (OKO- MUOIL on the Lagos Stock Exchange), a developer of palm-oil plantations and processor of palm oil, a commodity about which Grant’s can’t seem to stop writing (see the prior issue). On the one hand, Okomu is tiny and illiquid (a $71.9 mil- lion market cap with a 50.4% majority stake held by Indufina SA of Belgium). On the other hand, the stock is valued at 3.8 times earnings. “If you happen to look at its report,” said Daniels, “you’ll find that its net margins are close to 40%. In fact, I commented to some friends of mine that it has the kind of metrics that you’d associate more with an Apple.” “In sum,” wrote Daniels in a follow- up e-mail message, “there are quite a few profitable companies valued as if they had reached U.S. levels of matu- rity, that [in fact] have several years of growth ahead of them. They have large market shares, high returns on assets and equity, little to no debt and trade at P/Es of 12 or less. I have to worry about currency collapses, the euro, elections, droughts and floods, but there is more than adequate compensation.”

earnings per share in Nigerian naira 45 7 Okomu Oil share price (left scale) vs. earnings
earnings per share in Nigerian naira
Okomu Oil share price (left scale)
vs. earnings per share (right scale
full-year EPS*
share price
price per share in Nigerian naira

*analyst estimate for 2011 source: The Bloomberg

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