Saturday, February 25, 2012

Jeremy Grantham: "The Longest Quarterly Letter Ever"

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Gold Bullion Or Cash

A fun visual review of some of the fundamentals driving the gold price higher.

I believe an investor should begin their precious metals portfolio with physical precious metals first, then move onto more speculative assets such as mining shares.  I personally use and recommend Goldmoney.  You can open an account in just a few minutes by clicking on the following link:

GoldMoney. The best way to buy gold & silver

Friday, February 24, 2012

ECRI's Achuthan Stays With Recession Call

Interview this morning with CNBC.  It's interesting that the host says she "feels a lot better," since his previous visit, which is due exclusively to the mirage of the stock market rise.

Click here to see this week's "highlight reel" of financial and economic charts.

Friday Charts: Domestic Banks Deposits - Oil - Debt - Money Supply

A wide variety of charts for your viewing pleasure.  From bank deposits to gas prices, here is the best of this week. 

We begin with the domestic bank deposits for Greece and Ireland. As money flees the country it makes it more difficult for banks to carry adequate reserves.  If Greece or Ireland were to leave the eurozone, funds inside their banks would be converted into a new currency and devalued significantly.  The "smart money" is moving their money out today in anticipation of this. This is a modern day electronic bank run (a preview of what is ahead for the United States).

Up next is a great chart from Chris Martensen, showing domestic oil production in America.  Chris summarizes that the US currently consumes between 8 - 10 million barrels of oil per day and the best case scenario for the Bakken oil shale is for production of 1 - 3 million barrels per day, far short of what our country needs for energy independence.

On a follow up graph, we have the national average gas price chart.  This is a "tax increase" on every American that will greatly impact the general economy and offset a large portion of any stimulus or tax reductions. 

Excellent graph from the Wall Street Journal showing the month over month change in new home prices in China.  In case you were wondering what this means?  Huge trouble.

The following is a look at America's current downturn in housing compared to those in the past.  We have already experienced the worst decline in history and there is more pain ahead.
The following shows the percentage of workers that have been out of work for over 52 weeks.  This is a structural issue and will take years to resolve.

There was a big pop this month in Gallup's poll, which forecasted the BLS unemployment exactly last month at 8.3%.  Does this mean trouble ahead for the coming BLS unemployment report?

The following is a great graph showing the top 7 countries in the world in terms of military expenditures.  It is impossible to even begin to describe the waste that takes place in the United States military budget.

The price of gasoline rising at the pump is due to a combination of Iran fears, supply/demand imbalances, and the recent flooding of additional currency by central banks into the global markets.  The following chart shows this explosion of global money supply (M2).  Central banks around the world continue to pump the banking system with fresh capital to try and offset the debt destruction taking place almost everywhere.  The ECB's next round of LTRO (which I will be discussing in detail soon) should send this chart surging higher.

Then we have a graph showing that America's per capita debt is now worse than all of the PIIGS nations in Europe.  Our sovereign debt crisis is rapidly approaching.

The following shows the world's worst offenders in terms of debt to GDP by looking at total debt that is owed by the country against the size of their economy.  As you can see, it is only a matter of time for the UK and Japan.  The only question is which country and currency the bond market will turn on first.

We finish with a simple chart showing that some investors have taken note of what is taking place around the world and are taking action.  The following shows the highest monthly sales for US silver eagle coins. January 2012 was very  close to the all time record high set last January.  As the American public begins to slowly move into precious metals these sales numbers will continue to surge.

Sources: Zero Hedge, MISH, The Big Picture, Wall Street Journal, Michael Panzner

Thursday, February 23, 2012

Hugh Hendry: Betting On Deflation Through Japan

Very rarely do I engage in a "cut and paste" format on this website as there are plenty of other sites out there that participate in that style of writing.  My goal here is to take in a tremendous amount of information and then restate it entirely in my own words and in a form that is easier to understand.

However, there are a few fund managers today (two specifically) that are head and shoulders above the crowd in terms of their analytical ability on the financial markets and their ability to make a decision that is completely different from "the crowd."  My two favorites are Hugh Hendry and Kyle Bass.

Both fund managers have taken a large short position on Japan through insurance products, but they have used different strategies in where they purchased insurance (Bass is betting directly against the government debt).  Both managers are betting on a deflationary event before a reflationary move higher.  Both love gold and are very pessimistic on the global economy.

Kyle gave a few media appearances this past fall, which were all documented here in detail on the site.  Hendry has been out of the media spotlight for over six months.  Our only way to gain insight into his world has been to follow his financial track record/scoreboard.  His general hedge fund last year was up 12% (most funds were down last year) and he opened another fund focused exclusively on betting against Japan (more on that in a moment) that was up 46%.

He gave an interview with Barrons this week, which you can read in full here, but the following is the highlight reel that I will provide in the very rare "cut and paste" format.

Barron's: What makes a great macro fund manager?

Hendry: First and foremost, an ability to establish a contentious premise outside the existing belief system, and have it go on and be adopted by the rest of the financial community.

Where do you find yourself outside the existing belief system today?

In 2009, I made a YouTube video of the empty skyscrapers in Wuhan, China. Goldman Sachs and others articulate a very reasonable and compelling argument of being invested in China. With the evidence of my own eyes, I concluded that China had a very robust system of creating gross-domestic-product growth, but forsaking the creation of wealth.

When America was having its China moment in the 19th century, it occurred against the backdrop of a gold standard, a hard-money regime, with a public sector that was minuscule versus the overall size of the economy. As an entrepreneur, if your project failed to generate a sustainable level of cash flow, you failed.

China's great opportunity is taking place within the U.S. fiat system, and so the consequences are perhaps less stark than in 19th-century America, which had stops and starts and many depressions, though with an overarching prosperity. China has not had that volatility.

If you talk about a hard landing in China, you talk about GDP growth of 5%, not minus 5% or minus 15%. The Chinese government prints money. It can build superfast railways and overbuild airports, because the rest of the economy can subsidize it. China's swollen public sector is directing asset allocation, rather than pursuing profit maximization. They see [their system] as a success. But it creates a bubble, which can prove quite damaging.

You've already had a hard landing—in the Chinese stock market.
I should add something else that is contentious—U.S. quantitative easing [that eventually sent more money flowing to China], promoted because America had two sharp recessions and pursued orthodox policies, and had very little to show in the creation of jobs. 
The policy was very successful. China now has inflation. Minimum wages have grown 20% annually for the past three years. This has encouraged the Chinese to tighten monetary policy. When you have bubbles and you tighten, bad things happen. China's stock and property markets are weak, a side-effect of quantitative easing. We may now have the pricking of the Chinese bubble. A year or two down the line, it could have enormous repercussions for the global economy.
How does one play it?
The world is very fearful of hyperinflation. Pension schemes have a preponderance of real assets, from forestry to gold to TIPS [Treasury inflation-protected securities], because they are very fearful. The road to hyperinflation is via hyperdeflation. That is why it's proving so difficult for hedge funds to make money. How does the rational mind that anticipates hyperinflation own 10-year government Treasuries yielding less than 2%? It can't. That's why people are struggling. To lay the seeds of hyperinflation, you need really, really bad things to happen. I thought the U.S. housing market having a massive crash would be hyperdeflationary. But then my Chinese friends pumped $1 trillion of credit into their $5 trillion economy, and created a global recovery, which has just come to an end. I'm speculating that hyperdeflation happens before hyperinflation. What's the worst that could happen? But the sum of all my fears would be China having a real hard landing of minus 5% or minus 10% GDP growth. If we had that—and Europe—the Fed would be printing $20 trillion, and I would have gold at $5,000. You can have a modest amount of gold, but you can't have all your assets in real assets, in case we get that hyperdeflation event.
That view would be consistent with interest rates staying low forever.
Last year, our fund made 12%, mostly from investing in the short end of interest-rate curves, on the presumption that rates will remain low forever. The risk premium in fixed income was huge, but the performance of global macro last year was quite disappointing. Most people understood Europe, but chose to bet on the euro being weak, which is a hard trade, because there's no risk premium or carry in foreign exchange.
This time last year, British interest rates were at a 300-year-low at 0.5%, and if you asked an investment bank to guess where rates would be in three years, it was betting above 4%. The figure today is more like 1.3%.
So how do you make money?
Would you believe that the AIG strategy of selling too much credit protection in risky assets like mortgage-backed securities is alive and booming today in Japan? It doesn't concern mortgages. It is credit-default swaps on individual Japanese corporations.
Do you seriously believe Japanese corporations are going to fail?
Clearly, they can and do go bust. I'm buying the CDS on investment-grade Japanese corporations because of the overpricing anomaly. Japan had a bust 20 years ago, and yet today the banking stocks, relative to [Japanese bourse] Topix, are making fresh lows.
If I'm a Japanese bank and I lend money to a new business, I get 1% on 10-year paper. Then the bank gets a call from me, and I'm willing to pay 50 basis points for five-year protection on this same company. So suddenly, the yield has gone from 1% to 1½%. Compare that to five-year Japanese government bonds, yielding 30 basis points. The bank thinks: This is a great trade! Japanese steel companies are investment-grade and won't go bankrupt. So, the bank gets this huge yen yield, and thinks it is not taking any risk. You'd better believe it will sell way too much of that good thing.
One of my partners told me about Japanese steel: Here is a country with no energy, no iron ore or coal, yet it's the largest exporter of steel in the world, exports half its output. To put that in context, China manufactures 700 million tons of steel and exports perhaps 30 million. Japan produces 110 million tons and exports 40 million. As long as Asia is strong, they are fine. But if Asia hiccups or reverses, plant-utilization rates go from very high to very, very low very quickly.
Then we discovered that Warren Buffett owned shares of South Korea's Posco [5490.S. Korea], and that Korea was the biggest importer of Japanese steel, but Posco and Hyundai [5380.S. Korea] are building huge, integrated steel plants. They have a surplus of steel capacity and—guess what?—they're exporting to Japan, because the yen is so strong.
Initially, I wanted to buy a three-year, out-of-the-money put on Nippon Steel. My broker said, "I've been in a 20-year bear market; my boss will kill me." Then I thought, being long credit protection is being long volatility. I redialed his credit counterpart. I said: "I'm thinking of purchasing up to a billion yen of five-year credit-default swaps in Nippon Steel." The first thing he said was, "Would you consider 10 billion?" So one part of the bank is banned from selling volatility, and the other part is having a party. I bought reams of the stuff.
In August 2010, we set up a stand-alone fund to buy this credit protection. You no longer pay 50 basis points, you pay 130 basis points. U.S. Steel credit protection is more like 650 basis points, because in America, people are cautious on selling protection on such volatile businesses. They don't share that worry in Japan. It could make them very, very vulnerable.
Any other potential disaster catalysts?
Continuing yen appreciation; an exogenous shock—like a run on the Italian bond market; a slowdown in China; a sharp Asian recession. Japan is confronted by a European sovereign-type loss of confidence in the JGB market. We bought protection on steel names, and also on businesses with a huge sensitivity to the yen. I think the yen could soar from these levels [about 79 to the dollar] into the 60s, if not the 50s, with further dislocation in European sovereigns or a China hard landing.
From the early 1960s almost, Japan began recording current-account surpluses. Unlike Germany, it always invoiced in dollars.
So Japan is short its own currency, and has an enormous private-sector hoard of foreign assets. If the Nikkei falls, and your hedge and private-equity funds fall, pension funds in Tokyo will have fewer yen assets, but their liabilities will be the same. So they'd have to sell some overseas dollar assets and retrade them back to yen. If we have a series of bad events from China to Europe, that will express itself in a very strong yen rally.
We've barely discussed Europe.
We are partly playing it through Japan. If events kick off again in Europe, the correlation across all [global] asset classes will go to one. So the steel CDS is 130 basis points, while to insure against default by the French government, I'd be paying the same amount. Which is riskier? A very leveraged steel company that can't tax you? Or a government that can? Our bearish bets are largely outside Europe. As for Greece, the end game will be the Greeks rejecting austerity. The euro is nothing but a gold standard lacking flexibility, and all the onus is on private citizens to take the pain. Eventually, a Greek politician will say, 'Vote for me, and I'll get us out of this system.'
For more on "betting against Japan" see:

Tuesday, February 21, 2012

The Greece Bailout: Do Not Trigger The Bomb

**March 9th update** See bottom for link.

You have read the headlines.  Greece has been saved. The world has been saved. Again. As always, there is more to the story than the headlines provide, and as always, I will try to discuss what is taking place in as simple terms as possible.

Greece is a tiny spec in terms of the global economy.  It is even a tiny spec in terms of the European economy.  The issue at hand here in these endless hours of Greece bailout negotiations is not regarding the quantity of money needed to keep Greece alive, it is the terms of the deal that will then be used as a precedent for every domino down the line in the coming European bailouts.  That is why policy makers are walking on eggshells.  A mistake with this Greece/"Bear Stearns" bailout may set the stage for the Portugal/"Lehman" moment that is right around corner.

Right now Greece is bankrupt.  On March 20, they have bonds that will need to be rolled over, which they cannot finance.  Without the bailout that took place last night, that roll over would not have happened and a Greek default would begin on March 21.

The financial leaders around the world desperately do not want a formal default to occur. They have been in negotiations for weeks trying to come up with a way to keep Greece alive for just a little longer.  Why are they so concerned about tiny Greece?  This story has a very interesting twist.

Think of saving Greece as trying to disarm a bomb.  If you make the wrong move the bomb will explode, possibly setting off other bombs that cannot currently be seen.  These "off balance sheet" bombs are called Credit Default Swaps.  CDS in simple terms are an insurance contract that are triggered if Greece is considered in formal "default."

So, not only do the financial leaders have to come up with a way to give Greece money and write down a large portion of their debt, but they must do it without triggering the bomb.  It is like an episode of "24" with Jack Bauer only the story at times is even more unrealistic.

To keep the bomb from going off, Greece bond holders must "agree" unanimously to take a write down.  The bailout last night said that private debt holders should agree to write down 107 billion euros.  The easy part was to put a number on the page.  The more difficult part will now be getting every private Greek debt holder to agree to take a loss.

Here is the first problem.  Many of the investors who bought Greek bonds also simultaneously purchased insurance (CDS) on the debt to hedge their position.  If Greek debt went up in value then they keep the profits.  If Greek debt defaults then they have the insurance payment to help cover losses. Greece's plan is to show up at their office and ask them to "accept" a 50% haircut on their investment, which would then cause their insurance payment not to come in the mail.

What do you think their answer will be?  It will obviously be no.  The hedge funds and investment bankers purchasing Greece debt are killers backed by financial algorithms.  They care very little about the man starving on the streets of Greece.

There is a way Greece can avert this issue.  They can issue a "collective action clause" which means that an agreement by a majority of bondholders would create a write down for all bond holders.

The problem?  As of this moment triggering the CAC would trigger the bomb.

How this will be handled over the coming weeks is the crucial portion of the debt negotiations.  If the bomb is triggered for Greece then it sets the precedent that it will be triggered for Portugal, Spain, and Italy.

While Greece can easily be contained, Spain and Italy are impossible.  The size of both the bailout funds needed and their bomb explosion are like Lehman x 1,000.

The problem, as I have discussed in detail in the past, is that no one can see where the losses will be taking place in the banking system, which means no one will trust anyone.  Money stops moving and freezes.

Where we go from here is impossible to know.  We are so far over the edge of the cliff and into the abyss that it is truly staggering.  The average person has no idea how thin the thread is that our entire financial system hangs on today.

The stock market, just as in the fall of 2007, is completely oblivious to the danger ahead.  I continue to believe that the global debt crisis will not be contained.  I believe we have one more deflationary downdraft ahead of us before the next major re-flation upward.  The process could take years to unfold, or it could begin tomorrow.  I recommend staying in safe assets and remaining patient.  Having capital available when the next "risk-off" moment comes will be extremely important.

Update March 9th: Bomb Triggered: ISDA Determines Greek Restructuring A Credit Event

Monday, February 20, 2012

Global Health Improves: Exponential Population Growth

A friend of mine sent me the following excellent video this morning providing an amazing visual to demonstrate the improvements in our health and living age as a society over the last 200 years.

This concept has importance beyond a general feeling of healthy growth as a society.  As humans continuously live longer and continue to have more children, it has an enormous effect on the consumption of natural resources on our planet; a topic that is relevant to review on a day when oil is crossing $105 per barrel.  The best illustration of this impact can be understood through watching Chris Martensen's "Crash Course."  The following video is his introduction to the concept of "exponential growth." 

You can view the complete Crash Course, an absolute must watch, by clicking here.

Happy President's Day

Before we hit our "Greek Moment" it is always good to look back and be thankful to those that brought us here.  It takes true courage as a leader to always say yes and add it on to the credit card.  Click for larger images: