The MasterCharts: June 2010
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Monday, June 28, 2010

Changing Central Bank attitudes: gold to be strongest asset class - GOLD ANALYSIS | Mineweb



Changing Central Bank attitudes: gold to be strongest asset class

Poll of Central Bankers suggests they expect gold to outperform equities, bonds, currencies - and oil. If they aren't selling gold it's probably a good job that no-one wants to borrow it either.
Author: Rhona O'Connell
Posted:  Friday , 25 Jun 2010 


LONDON - 
At its recent annual seminar for reserve management, investment bank UBS polled over 80 reserve managers from the official sector as to their views on different reserve assets.  One outcome was that gold was expected to be the strongest asset class in the second half of this year, while 22% of those polled thought that gold would be the most important reserve asset over the next 25 years.
This may seem like a long time horizon, but central bankers have to think in the long term as custodians of national wealth (expect, of course, when governments get in the way and insist on, for example, gold disposals with prior publicity).  The view underpins the swing in attitudes towards gold in the official sector that has been evolving.  Clearly the shifting tides in sentiment are informed by increased concern over fiscal imbalances, currency dislocations and sovereign risk, all of which have escalated over the past eighteen months, and which are therefore helping to change a trend of sales that was most-recently re-established in 1989.
Figures from Consolidated Gold Fields (as was) and GFMS Ltd, which assumed responsibility from Consolidated Gold Fields for compiling the Gold Survey when the former company was taken over by Hanson Trust (after a mighty tussle with Minorco) in 1989, show that over the 62 years 1948 to 12009 inclusive, the official sector has been a net seller for 34 years, or 55% of the time.  The sector was a net buyer from 1948 through to 1966, during which time it absorbed almost 8,000 tonnes.  Since then it has offloaded just over 10,000 tonnes, with world holdings, as reported to the IMF, standing at a shade below 30,200 tonnes.  The latest figures for world holdings, which relate to end-March, show a tonnage of 30,463t, reflect a 180t reclassification of Saudi's holdings, while much of the balance of the increase registered to "all countries", some 39 tonnes, comes from the acquisition programmes of Russia and the Philippines, plus, to a lesser extent, Venezuela. 
Annual and cumulative changes in the official sector's gold mountain (metric tonnes) - back to the post-world war II position?

CBGA signatories have, since the first Agreement was signed in September 1999, been responsible for 3,906 tonnes of the official sector's net disposals, equivalent to approximately 90% of the total. CBGA sales have collapsed this year with less than one tonne coming onto the market under CBGA3 so far this calendar year.  The majority of sales into the market since January have come from the IMF, which has sold almost 39t into the open market this year, leaving almost 153t to go. 
The implication from official statements from both the CBGA signatories and the IMF itself suggest that any further disposals into the open market (and it would look likely that the balance of the metal will come on-market unless a fresh central bank suddenly appears on the scene) will be worked, at least on a de facto basis, under the auspices of the CBGA.  Once this metal is out of the way then it s entirely possible that the official sector will become a net buyer of gold again for the first time since four years of purchases that amounted to over 630 tonnes (9% of mine supply) in 1985-1988. This was when producing countries were absorbing local production and others - notably Taiwan, amid much publicity, were - wait for it -diversifying away from the dollar....



http://www.mineweb.com/mineweb/view/mineweb/en/page33?oid=106888&sn=Detail&pid=102055

Friday, June 25, 2010

NYTimes: Analysts Question a Threat by Fannie

From The New York Times:

Analysts Question a Threat by Fannie

Experts wondered what Fannie Mae, the mortgage finance giant, hoped to achieve by announcing it would punish owners who strategically defaulted.

http://nyti.ms/9siHcc

Get The New York Times on your iPhone for free by visiting http://itunes.com/apps/nytimes


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Tuesday, June 15, 2010

Print baby, print ... emerging value and the quest to buy inflation

Print baby, print ... emerging value and the quest to buy inflation
by Dylan Grice

The eurozone's fiscal farce offers a revealing glimpse of the future: sovereign crisis begets banking crisis begets central bank nose-holding while the printing presses roll!! More immediately though, it's making equities look interesting again. Markets overall merely look less overvalued than they did. But undervaluation is emerging in some areas. And the VIX recently traded at 40. Selling out-of-the money puts at such levels (or higher), on companies you're happy to own anyway is a good way to be paid for your patience
.

* The chart below shows the UK RPI from year 1300. From it, we can see that there have been inflationary episodes - the 16th century influx of new world gold and silver, the 18th century timber shortages, the early 19th century Napoleonic Wars - but that systematic CPI inflation is relatively new, and only started in earnest after WW2. This structural break coincides with the attainment of a voice in politics by ordinary people in developed economies: since voters rarely opt for economic pain, their elected representatives soon found they had to avoid it at all costs. Hence the relatively modern inflationary bias of "macroeconomic policy."


* When that inflationary bias dictated lowering rates in the face of a threatened recession more quickly than you raised them in a recovery, it seemed harmless enough. But the crash of 2008 and its sovereign debt aftermath have changed everything. It's difficult to exaggerate just how dirty the phrase deficit monetisation was when I studied economics at university: loaded with evil images of political irresponsibility and short-sightedness, it evoked the haunting spectre of catastrophic and ruinous hyperinflation. It's what they did in Weimar Germany; it helped cause WW2; to say it had an image problem would be a grotesque understatement. No wonder it's been rebranded as quantitative easing.



When faced with the prospect of a financial crash causing a nasty recession - or worse, a depression - few doubted that Anglo-Saxon central banks would do whatever was necessary, including breaking the taboo of deficit monetisation ... sorry, engaging in quantitative easing. But the ECB was supposed to be different. The ECB was supposed to be genuinely independent. The ECB was modelled on the Bundesbank - itself forged in the white hot furnace of Weimar's hyperinflationary trauma ... So it was always going to be an interesting collision: what would happen when the unstoppable force of threatened financial wipeout met the immoveable object of the ECB's hard-money dogma?

Well, the force stopped and the object moved ... sort of. The market's panic over eurozone debt subsided ... for a while, and the ECB began quantitatively easing ... kind of. The EU's "shock and awe" $1trillion rescue was certainly a big number and reflected European governments going all in. But going all in is risky if you don't have a strong hand, and the EU's seems weak. Two-thirds of the rescue money comes from the EU itself, which means that the distressed eurozone borrowers are to be saved by more borrowing by ... er ... the distressed eurozone borrowers.

So there is virtually no new money coming into the European financial system. If a small bank goes down, the problem is solved when it is taken over by a bigger bank which injects new capital into it. If a bigger bank goes down, its problem is solved when it is taken over by the government, which injects new capital into it. If a government goes down ... well, then we're stuck. Where does the new capital come from now?

Enter central banks. In 2009, the BoE printed £200bn, thus completely financing the UK government deficit. It can't have felt good about doing it but since the alternative scenario was so scary - financial meltdown and possibly IMF support - it held its nose and did it anyway. It said it was going to sterilise the intervention, but on discovering that such was the financial system distress it was unable to, it just carried on regardless. In the US, the Fed printed $1.25 trillion to monetise the problematic mortgage market. It also said it was going to sterilise the intervention, but like the BoE it soon found it couldn't, and like the BoE continued anyway because the alternative financial meltdown scenario was too scary to contemplate.

Today, the ECB is buying insolvent eurozone government debt which it is promising to sterilise. Yet they face the same stark calculus faced by their Anglo-Saxon cousins in 2008. You can only worry about the economy's ?price stability' if the economy hasn't already melted down! So here's my prediction: they won't sterilise, and the program will expand.

Since banks are typically stuffed full of government bonds (the first chart below shows eurozone financial institutions' holdings of government securities as a share of capital), instability in government debt markets implies instability in bank balance sheets. So sovereign crises and financial crises are joined at the hip (second chart below). And since financial crises affect banks' ability to lend, which poses obvious risks to the rate of employment, the need for a central bank response to the threat of financial collapse
is clear:

  1. Print money
  2. Keep printing until the financial system stabilises
  3. Worry about removing liquidity later (and if removing liquidity stresses the financial system, go back to step 1)







What's interesting is that central banks feel they have no choice. It's not that they're unaware of the risks (although there are profound behavioural biases working against them in their assessment of those risks). They're printing money because they're scared of what might happen if they don't. This very real political dilemma is what is missing from the simplistic understanding of inflation as "always and everywhere a monetary phenomenon." It's like they're on a train which they know to be heading for a crash, but it is accelerating so rapidly they're scared to jump off.

Incidentally, this is exactly the train Rudolf von Havenstein found himself on as President of the Reichsbank during the German hyperinflation. According to Liaquat Ahamed's work on von Havenstein's dilemma, in his majestic book ‘Lords of Finance' " ... were he to refuse to print the money necessary to finance the deficit, he risked causing a sharp rise in interest rates as the government scrambled to borrow from every source. The mass unemployment that would ensue, he believed, would bring on a domestic economic and political crisis, which in Germany's [then] fragile state might precipitate a real political convulsion."

Most economists seem to think that QE puts us in uncharted waters. It doesn't. Printing money to finance government expenditure is a very well trodden path which is as old as money itself: persistent monetisation causes inflation. Of course the current monetisation need not be persistent. Central banks can theoretically just stop it at any time.

But with government balance sheets in such a mess across the developed world (even with yields at historically unprecedentedly low levels), government funding crises are likely to be a recurring theme in the future. Since banks hold so much "risk free" government debt, those funding crises point towards more banking crises which point towards more money printing. When do they stop? When can they stop?

But what does it all mean? The question to my mind isn't whether or not inflation will accelerate from here. If government balance sheets are in as big a mess as I think they are, inflation is inevitable. The more interesting question is what kind of inflation can we expect?

I hope to explore this properly in another note soon, but suffice to say for the time being that the typical framework economists use to think about inflation - which they proxy by changes in the CPI - is narrow, incomplete and fails to do justice to the richness of inflation as a concept. Asset markets (e.g. real estate, equities, etc.) are as prone to inflationist policy as product markets (indeed, in recent decades they have been far more prone to inflation than product markets), so one way of buying inflation - at least in its early stages - is to buy riskassets.

Of course, buying expensive risk assets on the view that they're going to become more expensive is a dangerous game to play, but since government funding crises hammer risk assets while printing money inflates them, such funding crises should present decent value opportunities to buy into beaten up assets before the inflation ride.

Does today represent such an opportunity? We're still nowhere near the distressed "all in" valuation levels I suspect the eurozone crisis merits (let alone the weakness in leading indicators Albert has been pointing out - what will a cyclical downturn do to government budgets?), but value is emerging and there are more stocks worth nibbling on than there have been for a while. The following chart shows the percentage of ‘bargain
issues'1 in the nonfinancial FTSE World index has risen to just over 2% from under 1% a few months ago.



Regular readers know that I estimate intrinsic equity values for each of the stocks in my universe (I now use the FTSE World index and include emerging markets) which I compare to the stock prices. An intrinsic value to price ratio (IVP ratio) greater than one implies intrinsic value is higher than market prices and so equities are undervalued. The first chart below shows the average IVP ratio for France, Germany, Italy and Spain at 0.85 is more attractive than it's been for some time, without being outright undervalued as it became during, say, the ERM crisis in 1992.




The next chart shows the cross section of valuations across all markets. It can be seen that the key European markets that are attractive remain the UK, Italy, and just about Norway.






The table at the end of the document shows stocks with estimated intrinsic values that are higher than current market prices (IVP>1) and these stocks deserve a closer look. I've constructed the intrinsic value model (a version of Steve Penman's residual income model) on the assumption that I want a minimum 10% return. This is quite exacting, but the stocks in the table are all currently valued at levels consistent with such performance.

Finally, the one asset class unambiguously cheap right now is volatility. The VIX and the VStoxx are trading well above their long run averages. That doesn't mean they can't trade higher still but, whether you like my IVP approach or not, you'll probably have a watch list of stocks with a clear price at which those stocks are cheap enough to buy. With the VIX above 40 - as it was earlier this week -- it's might be worth considering writing out-of-the money puts on those stocks. If you want to own them at those out-of-the money levels anyway, by writing generously priced options you're being paid well for y
our patience.




Footnote:
1.  I define a bargain issue as a stock with an estimated intrinsic value (see below) at least one-third higher than its market price (IVP>1.33), positive five year trailing EPS growth and positive expected residual income growth. These stocks have a backtested annualised return of 23% (list available on request).



--
The MasterBlog
http://the-masetrblog.blogspot.com

Wednesday, June 09, 2010

When did Evil Become so Awesome

Betting on the Bad Guys
ESSAYJUNE 5, 2010

Cartoonist Scott Adams's personal road to riches: Put your money on the companies that you hate the most
By SCOTT ADAMS

When I
heard that BP was destroying a big portion of Earth, with no serious discussion of cutting their dividend, I had two thoughts: 1) I hate them, and 2) This would be an excellent time to buy their stock. And so I did. Although I should have waited a week.

People ask me how it feels to take the side of moral bankruptcy. Answer: Pretty good! Thanks for asking. How's it feel to be a disgruntled victim?

I have a theory that you should invest in the companies that you hate the most. The usual reason for hating a company is that the company is so powerful it can make you balance your wallet on your nose while you beg for their product. Oil companies such as BP don't actually make you beg for oil, but I think we all realize that they could. It's implied in the price of gas.

I hate BP, but I admire them too, in the same way I respect the work ethic of serial killers. I remember the day I learned that BP was using a submarine…with a web cam…a mile under the sea…to feed live video of their disaster to the world. My mind screamed "STOP TRYING TO MAKE ME LOVE YOU! MUST…THINK…OF DEAD BIRDS TO MAINTAIN ANGER!" The geeky side of me has a bit of a crush on them, but I still hate them for turning Florida into a dip stick.

Apparently BP has its own navy, a small air force, and enough money to build floating cities on the sea, most of which are still upright. If there's oil on the moon, BP will be the first to send a hose into space and suck on the moon until it's the size of a grapefruit. As an investor, that's the side I want to be on, with BP, not the loser moon.

I'd like to see a movie in which James Bond tries to defeat BP, but in the end they run Bond through a machine that turns him into "junk shot" debris to seal a leaky well. I'm just saying you don't always have to root for Bond. Be flexible.

Perhaps you think it's absurd to invest in companies just because you hate them. But let's compare my method to all of the other ways you could decide where to invest.

Technical Analysis
Technical analysis involves studying graphs of stock movement over time as a way to predict future moves. It's a widely used method on Wall Street, and it has exactly the same scientific validity as pretending you are a witch and forecasting market moves from chicken droppings.

Investing in Well-Managed Companies
When companies make money, we assume they are well-managed. That perception is reinforced by the CEOs of those companies who are happy to tell you all the clever things they did to make it happen. The problem with relying on this source of information is that CEOs are highly skilled in a special form of lying called leadership. Leadership involves convincing employees and investors that the CEO has something called a vision, a type of optimistic hallucination that can come true only in an environment in which the CEO is massively overcompensated and the employees have learned to be less selfish.

Track Recor
d
Perhaps you can safely invest in companies that have a long track record of being profitable. That sounds safe and reasonable, right? The problem is that every investment expert knows two truths about investing: 1) Past performance is no indication of future performance. 2) You need to consider a company's track record.

Right, yes, those are opposites. And it's pretty much all that anyone knows about investing. An investment professional can argue for any sort of investment decision by selectively ignoring either point 1 or 2. And for that you will pay the investment professional 1% to 2% of your portfolio value annually, no matter the performanc
e.

Invest in Companies You L
ove
Instead of investing in companies you hate, as I have suggested, perhaps you could invest in companies you love. I once hired professional money managers at Wells Fargo to do essentially that for me. As part of their service they promised to listen to the dopey-happy hallucinations of professional liars (CEOs) and be gullible on my behalf. The pros at Wells Fargo bought for my portfolio Enron, WorldCom, and a number of other much-loved companies that soon went out of business. For that, I hate Wells Fargo. But I sure wish I had bought stock in Wells Fargo at the time I hated them the most, because Wells Fargo itself performed great. See how this wor
ks?

Do Your Own Rese
arch
I didn't let Wells Fargo manage my entire portfolio, thanks to my native distrust of all humanity. For the other half of my portfolio I did my own research. (Imagine a field of red flags, all wildly waving. I didn't notice them.) My favorite investment was in a company I absolutely loved. I loved their business model. I loved their mission. I loved how they planned to make our daily lives easier. They were simply adorable as they struggled to change an entrenched industry. Their leaders reported that the company had finally turned cash positive in one key area, thus validating their business model, and proving that the future was rosy. I doubled down. The company was Webvan, may it rest in peace.

(This would be a good time to remind you not to make investment decisions based on the wisdom of cartooni
sts.)

But What About Warren Bu
ffett?
The argument goes that if Warren Buffett can buy quality companies at reasonable prices, hold them for the long term and become a billionaire, then so can you. Do you know who would be the first person to tell you that you aren't smart enough or well-informed enough to pull that off? His name is Warren Buffett. OK, he's probably too nice to say that, but I'm pretty sure he's thinking it. However, he might tell you that he makes his money by knowing things that other people don't know, and buying things that other people can't buy, such as entire comp
anies.

People Love Berkshire Hathaway And That Has Don
e Great
I'm not saying that the companies you love are automatically bad investments. I'm saying that investing in companies you love is riskier than investing in companies you hate.

Second, take a look at Berkshire Hathaway's holdings. It's a rogue's gallery of junk food purveyors, banks, insurance companies and yes, Goldman Sachs and Moody's. The second largest holding of Berkshire Hathaway is…wait for it…Wells Fargo.

(Disclosure: I own stock in Berkshire Hathaway for the very reasons I'm describing. And my first job out of college was at Crocker National Bank, later swallowed by Wells Fargo.)

Let's talk about morality. Can you justify owning stock in companies that are treating the Earth like a prison pillow with a crayon face? Of course you can, but it takes some mental gymnastics. I'm here to help.

If you buy stock in a despicable company, it means some of the previous owners of that company sold it to you. If the stock then rises more than the market average, you successfully screwed the previous owners of the hated company. That's exactly like justice, only better because you made a profit. Then you can sell your stocks for a gain and donate all of your earnings to good causes, such as education for your own kids.

Having absorbed all of the wisdom I have presented here so far, you are naturally wondering if I have any additional investment tips. Yes, and I will put my tips in the form of a true story. Recently I bought something called an iPhone. It drops calls so often that I no longer use it for audio conversations. It's too frustrating. And unlike my old BlackBerry days, I don't send e-mail on the iPhone because the on-screen keyboard is, as far as I can tell, an elaborate practical joke. I am, however, willing to respond to incoming text messages a long as they are in the form of yes-no questions and my answer are in the affirmative. In those cases I can simply type "k," the shorthand for OK, and I have trained my friends and family to accept L, J, O, or comma as meaning the same thing.

The other day I was in the Apple Store, asking how to repair a defective Apple laptop, and decided, irrationally, that I needed to have Apple's new iPad. The smiling Apple employee said she would be willing to put me on a list so I could wait an indefinite amount of time to maybe someday have one. I instinctively put my wallet on my nose and started barking like a seal, thinking it might reduce the wait time, but they're so used to seeing that maneuver that it didn't help.

My point is that I hate Apple. I hate that I irrationally crave their products, I hate their emotional control over my entire family, I hate the time I waste trying to make iTunes work, I hate how they manipulate my desires, I hate their closed systems, I hate Steve Jobs's black turtlenecks, and I hate that they call their store employees Geniuses which, as far as I can tell, is actually true. My point is that I wish I had bought stock in Apple five years ago when I first started hating them. But I hate them more every day, which is a positive sign for investing, so I'll probably buy some shares.

Again, I remind yo
u to ignore me.

—Scott Adams is the creat
or of "Dilbert."
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