Wednesday, June 30, 2010

Gold Or Precious Metals Stocks?

Recently, I proudly and confidently proclaimed that GOLD was ready to head for $2,000.  As Bill Clinton's former press secretary, Dee Dee Myers, used to saying when Billy was caught lying, that forecast is "no longer operational".

An interesting dynamic has put itself into motion.  As GOLD continues to hover near its highs, the equity market is rapidly falling apart.  Precious metals mining companies are battling a tug-of-war between higher metals prices versus a vastly more difficult environment for equities.

This sets up a very difficult question:  how does one play the market volatility?  Carefully.

During the financial meltdown of 2008-09, GOLD held up pretty well, gaining a "flight to safety" bid.  Despite the very good action in GOLD, however, mining stocks got blasted for losses of up to 90%.  Any one of a number of events could trigger an explosion in the metal:  war in Iran, a breakdown of the Euro-Zone, more quantitative easing or more problems in the financial system.  This list is hardly exhaustive.

The above notwithstanding, many signs have emerged that another DEFLATION scare is imminent.  The money supply is plunging at un-precedented rates.  DEFLATION.  Bond yields have broken to new multi-generational lows.  DEFLATION.  Bank loans and credit are contracting at historic rates.  DEFLATION.  The dollar, despite all the government spending and low interest rates keeps rallying.  DEFLATION.

The "Gold Bugs" index, also known as the HUI, has been carving out an ascending wedge pattern.  These are normally, but not always, bearish.  The HUI has also approached the 500 level on several occasions, and can't seem to break through.  A material violation of either 475 on the downside or 500 on the upside would provide a pretty good indication of what to do. 

It's possible that GOLD itself could rally while precious metals stocks could decline.  So, for now, the best bet is the metal itself.  I would be VERY cautious about the equities at this juncture.  I tend to think there will be a better buying opportunity down the road.

As to the metal, I would use $1,225 as a stop level.  If it breaks below, chances are that we will see some decent downside and there will be a much better entry point.  For now, the amber light is flashing.
Warning Will Robinson!

So, what to do here?  If you're going to stick with your portfolio of miners, I would at least add a hedge to insulate against equity pressure.  Personally, I like the inverse ETFs FAZ, SKF and TWM.  There are plenty of others you can use.  I would NOT recommend purchasing a GOLD inverse ETF.  What's the point of being both long AND short?

As investors, it is ever so important to not get wedded to a particular point of view or to stay either perma-bull or perma-bear.  The easiest way to lose money in the world is to be stubborn and insist that your pre-conceived notions must be correct.  Minimize your losses and wait until a better opportunity presents itself.

Marko's Take

Monday, June 28, 2010

Chewing Tobacco

The tobacco industry is, by far, the most maligned in the United States.  The animosity to the industry, however, is quite understandable.  Tobacco companies produce a very harmful and addictive product.  The industry is fraught with false advertising and reputedly very shady tactics.

So, tobacco is the only industry characterized by harmful products and often questionable business practices, right?  Sure, unless you want to include spirits distillers, automobile manufacturers, oil companies, drug companies, fast food companies and many restaurants, aircraft maufacturers, nuclear utilities, processed food companies, consumer products companies, mobile phone manufactuers and most of the rest of the Fortune 500!

Despite the product risks, most industries are accepted because the products or services are consumed by so many.  We drive cars, but lots of people die in car accidents.  We drink wine and vodka despite the risk of liver damage and cardiovascular disease.  We live on Prozac and Xanax, which are sometimes fatal, because they help keep us sane.  We love our cell phones despite the brain damage.  Get the picture?

Economically, each of these industries producing harmful products has huge benefits.  They employ millions of people, they pay lots of taxes.  Most of their products are sought-after world wide because alternatives are relatively few in many cases.

The economics are not really controversial, however.  In the case of tobacco. it really gets down to the very emotional health issue.  Anyone with half a brain understands the numerous health problems caused by chronic tobacco use.  About 20% of the United States adult population choose to smoke.  So, what I wonder is:  why does lung cancer trigger more contempt than liver damage or brain damage or death by airplane crash?

The tobacco industry has repeatedly shot itself in the foot over the years.  Critics have unearthed irrefutable evidence of some extremely nefarious business practices.  They market to teenagers, suppress studies that implicate them, employ an army of lobbyists to garner favorable political treatment, ignore health to enhance the likelihood of long term use of their product and are constantly being litigated against.  Them, and just about every other industry! 

Doesn't tobacco kill?  Yes, it most certainly does.  But, so do nuclear reactors, oil rigs, car crashes and Big Macs.  Hmm, I'm still missing the difference.   How is tobacco different?

Oh yes, it kills OTHERS!  It has spill-over effects on non-smokers via second hand smoke.  Cars kill other people than the driver.  So does burning fossil fuels.  So do alcoholics.  What's the difference, again?

The fact that tobacco kills, is actually a double-edged sword.  Yes, the deaths are unfortunate and unnecessary.  But, shortening life spans has some major societal and economic benefits.  Longer life spans are placing major weight on Social Security and other entitlement programs which disproportionately benefit the elderly.  So, the health risks borne by tobacco smokers actually transfers wealth to non-tobacco smokers.  When looked at this way, non-smokers certainly should understand how they benefit from smokers.  Thus, the big picture is not as clear cut as they may have believed.

The tobacco industry is actually operating at some major disadvantages via the rest of corporate America.  For example, what industry is forced to run ads which tell people NOT to use its product?  Only one other as far I can tell:  utilities. 

An additonal high-profile source of negative publicity is the endless lawsuits.  Unfortunately, the tobacco industry is a virtual full-employment act for attorneys.  The industry is continually sued by smokers for the adverse health risks they knowingly chose to ignore.  In addition, some people are quite comfortable arguing that the cigarettes lit themselves and jumped into their mouths.   The same folks who sue because their McDonalds coffee was too hot!  What's the difference?

The mind-set that life should be without risks has been encouraged by politicians for years.  We want no recessions, so we interevene in the economy.  We can't stand health risks, so we pass unnecessary legislation to "protect" us against the consequences of our own well-informed choices.  You can't have that Double-Cheeseburger... it's BAD for you.

If you're a non-smoker, just remember the following:  every person that lights up reduces YOUR tax burden and is less likely to draw scarce financial retirement resources.  Chew on it, and see what you think.

Marko's Take

Friday, June 25, 2010

Obama's Latest Folly: Financial Reform

It simply amazes me that politicians believe that any problem can be fixed by more regulation.  Uncle Sam is right in the middle of the Federal National Mortgage Corporation (Fannie Mae, or FNM) and Federal Home Loan Mortgage Corporation (Freddie Mac, or FRE) fiascos.  Senator Chris Dodd (D-CT) and Representative Barney Frank (D-MA), both beneficiaries of lavish campaign contributions, made sure that these two entities could operate in the most favorable possible business environment, that is, before their help led to the two firms' demise.

Then, of course, we have the cushy relationship between Goldman Sachs, aka "Government Sachs" (GS), and the entire Obama Administration.  Gotta be something in it for them!

The Securities and Exchange Corporation (SEC) completely ignored warnings about Bernie Madoff.  So now that we've established the government's expertise at regulating various aspects of investing, the answer is to regulate MORE??

Let's not forget the Federal Reserve (Fed).  Keeping interest rates way too low and for too long directly led to the twin asset bubbles:  real estate and tech stocks.  The solution?  Keep interest rates even lower and for longer!  See the logic?

The Financial Reform Bill was passed this morning.  The Obama Administration pushed hard for this legislation to "protect the consumers" that it has, thus far, been completely unable to do.  This is how governments think:  create a problem, then justify even more intervention to solve the very problem they created.  Think we have too much debt?  Issue MORE of it!  Regulations failing to do their job?  Create more bureaucracy and more regulations!  Simple.

Major provisions of the bill include:

New regulatory authority for federal officials to seize and break up large troubled financial firms without taxpayer bail-outs in cases where the firm's collapse could destabilize the financial system.  U.S. Department of Treasury would supply funds to cover the up-front costs of winding down the failed firm, but the government would have to put a "repayment plan" in place.  Regulators would recoup any losses incurred from the wind-down afterwards by assessing fees on financial firms with more than $50 billion in assets.

The establishing of a new, 10-member Financial Stability Oversight Council, comprising existing regulators charged with monitoring and addressing system-wide risks to the nation's financial stability. Let me guess.  Members of the council will be alumni of Government Sachs?

The so called "Volcker Rule" would curb propriety trading by the largest financial firms, though banks could make small investments in hedge and private-equity funds.  Of course, we should all expect "Government Sachs" to be exempted.  If they can't insider trade ahead of their clients, how are they going to make money?  Lend?  Nahhh!

Derivatives would be subject to comprehensive regulation, especially in the over-the-counter market, including the trading of the products and the companies that sell them.  However, the riskiest derivative trading operations would have to be spun-off into affiliates.

A new Consumer Financial Protection Bureau within the Federal Reserve will be created, with rulemaking and some enforcement power over banks and non-banks that offer consumer financial products or services such as credit cards, mortgages and other loans. The new entity will be staffed by alumni of "Government Sachs".  (Sarcasm intentional!)

The bill would also provide for a complete "sham" overview of the Fed, by mandating a one-time audit of all of the Fed's emergency lending programs from the financial crisis.  The Fed also would disclose, with a two-year lag, details of loans it makes to banks through its discount window as well as open market transactions - activity the Fed currently doesn't disclose.  I'm holding my breath.  (Sarcasm intentional!)

The legislation would set new size- and risk-based capital standards, including a prohibition on large bank holding companies treating trust-preferred securities as Tier 1 capital, a key measure of a bank's strength.  Since former capital requirements were set by Uncle Sam, naturally the new standards are likely to be just as effective.  (Sarcasm intentional!)

Larger banks would be subject to a special assessment to raise up to $19 billion to offset the cost of the bill.  The fee would apply to financial institutions with more than $50 billion in assets and hedge funds with more than $10 billion in assets, with entities deemed high-risk paying more than safer ones.

Let's not forget the credit-rating agencies!  The bill would establish a new quasi-government entity designed to address conflicts of interest inherent in the credit-rating business after the SEC studies the matter.  It would also allow investors to sue credit-rating firms for a "knowing or reckless" failure to conduct a reasonable investigation, a lower liability standard than the firms were lobbying to get.  Never mind that no one actually CARES what the Standard & Poor's and Moody's think.  We MUST regulate them!

What will be the effect of this bill?  Simple!  Whatever the bill was designed to accomplish, expect the opposite.  We can expect less systemic liquidity, a renewed credit crunch and either a obscenely profitable banking sector, or one that goes out of business!  The good news?  More employment, power and bonuses for all our friends at "Government Sachs"!

Marko's Take

Thursday, June 24, 2010

Fund Of Hedge Funds Becoming Obsolete

We've written before about some of the issues with Hedge Funds that are less than desirable for prospective investors, especially the fee structure which creates an element of moral hazard.  Even more egregious are the "Funds of Hedge Funds" (FOFs), which charge an additional layer of fees for the "value-added" of selecting individual funds and combining them into a basket.

FOFs were designed to accomplish several objectives that an individual investor might not have the resources to achieve on his or her own.  They pride themselves as "experts" on each individual fund by performing extensive due diligence and detailed statistical analysis of their return profiles.  In addition, they create better diversification by placing 10 or more funds in a pool.  Investors are also given access to funds that have closed to new investment, except through the fund baskets.

Great concept in theory, but like so many others, often fails miserably in practice.

FOFs, for their services, usually charge both an additional management fee and often take a modest performance fee.  The hedge fund norm is a 2% management fee combined with a 20% performance fee.  The FOF often adds another 1% and 10%, respectively, brining the total to a very steep 3% and 30% of profits.  This fee structure, in a world of single digit returns, makes the entire FOF concept ensure that investors will achieve sub-standard returns.

In addition, despite the claims of great due diligence, so many FOFs have been caught in manager wipe-outs.  Industry fixtures Tremont and Ivy Asset Management, two firms that were former clients, both got trapped by Bernie Madoff.  In fact, every hedge fund manager meltdown, beginning with Askin Management in 1994, Long-Term Capital Management in 1998 and then the slaughter in 2008-09 has exposed the weaknesses of the FOF industry.

The bloom is off the rose.  In year-end 2007, FOFs represented a massive 43% of assets.  Currently, it is down to 34% and shrinking.  FOFs have a growing list of detractors.

David Swensen, the long-time manager of Yale University’s endowment, recently slammed FOFs, claiming among other things, they “are a cancer on the institutional investor world”.

Although Mr Swensen has a well-renowned track record, his group isn't the only one to have added value over the past couple of decades.  In fact, as a substitute for equity investments over the past 10 years, the Hedge Fund Research (HFR) FOF Index has performed remarkably well, returning 5.4% a year versus a return of minus 1.4% for the S&P 500, with a volatility of 6.2% versus 15.1% for large cap equities.

Nevertheless, the very public failures have stuck a knife in FOFs.  According to a recent report by HFR, FOFs are liquidating much faster than they're being created.

Hedge fund liquidations rose in the first quarter of 2010 with 240 funds closing during the period, according to the HFR Market Microstructure Industry Report recently released.  Liquidations were disproportionately skewed towards FOFs, with 102 closing in the quarter.  This marks the 7th consecutive quarter in which FOF liquidations have exceeded new launches.

Fee pressure is finally making itself present in the industry.  Average incentive fees declined by 8 basis points to 19.12% in the 1st quarter of 2010, the steepest drop since the 2nd quarter of 2008, although average management fees were unchanged at 1.58%.   Variance between the best and worst deciles of performance narrowed in the less volatile period, with the top decile of all hedge funds returning an average of 15.2%, while the bottom decile lost an average of 8.6%.

“Both investors and fund managers are continuing to exhibit a heightened sensitivity to leverage and risk, even with the benefit of the performance recovery from 2009,” said Ken Heinz, President of HFR.  “Managers are employing lower levels of leverage in response to higher realized asset volatility and higher costs of obtaining leverage, as well as investor preference for a less volatile return profile.”

Caveat emptor.  What this all should tell you is that if the people who spend every day talking to hedge funds, analysing their returns and statistically measuring how much value they add can be fooled, so can you.  Another reason to avoid this entire industry.

Marko's Take

Wednesday, June 23, 2010

New British Petroleum Bond Issue Very Interesting

After being strongly "encouraged" by the Obama Administration to pledge $20 billion into an escrow fund, British Petroleum (BP) is now looking to raise new capital through an upcoming bond issue.  The debt is expected to yield 8-9%.  BP should be happy, Tony Soprano charges 2 points a week.

BP has rapidly descended to the 2nd company "America loves to hate".  And yes, the 1st, "Government Sachs" is participating in the underwriting. 
The obvious question is how well the proposed yield compensates investors for BP's very uncertain credit risk and future liabilities.  The less obvious answer is that it does.

One need not do a comprehensive analysis to determine the attractiveness of these bonds.

Despite a loss of 50% of its market capitalization in 2 short months, BP is still worth nearly $100 billion.  The current value already takes into account expected liabilities from the oil spill.  There are no more than a handful of companies in the world with market capitalizations of that magnitude.

BP's total debt at the end of the 1st quarter of 2010 stood at $32 billion, giving it a very comfortable debt/market cap ratio of about 0.35.  The company's leverage is consistent with an investment grade borrower.

The company earned $16 billion in 2009 with much lower oil prices, and another $6 billion in the 1st quarter from operations.  The recently enacted dividend cut provides another $2 billion in cash flow.  At the current earnings rate, the total debt issue is less than annualized earnings.  BP's price/earnings ratio is now less than 5.

But what about the future unknown liability from shareholder lawsuits?   Tobacco companies have faced them for decades, but none have defaulted.  Remember 20% plus yields on Phillip Morris (MO)?

Drug companies have faced them for years, but none have defaulted.  The auto companies DID default, but not from litigation.  Instead, it was from poor operations and mounting pension and health care liabilities.

In the 1970's, Texaco, then rated Triple A, filed Chapter 11 to restructure onerous pipeline contracts.  No one lost any money.

At 8-9%, BP's bonds would yield more than approximately 40% of the entire junk bond universe, and more than troubled sovereign credits Portugal, Ireland and Spain.  Only Greek debt is higher.

Highly charged incidents like oil spills tend to swing investor sentiment to un-justifiable extremes.  Those who can ignore the market noise from all the hand-wringing stand to make great profits.

Marko's Take

Tuesday, June 22, 2010

Some Considerations For Selecting Junior Miners

Now that the investment clarion has been sounded, investors may wish to do their own homework for evaluating candidates for investment.  Among the several dozen decent publicly traded companies how does one decide which ones to invest in?

While not an exhaustive list, here are some things every investor ought to keep in mind.  Follow these rules, and your chances of getting in trouble will be greatly diminished.  

Ask and answer the following questions:

1.  Where Are The Operations Located?

In my opinion, the biggest risk currently is geo-political.  Some countries are dependent on their mining industries and are not terribly interested in having foreign interests, i.e. us, coming in and pillage their resources for our own profit.  The risk is nationalization.

A recent case is that of Crystallex International Corporation (KRY), whose mining interests were nationalized by Venezuela.  KRY stock sold for more than $4 per share as recently as 2007, before losing a mind-numbing 98% of value to hit 10 cents per share.  It has recovered somewhat to trade at $0.45 today.

Personally, I prefer to stick to North American companies which operate in some combination of Canada, the United States and Mexico.  I tend to avoid companies with the bulk of their operations in Africa, whose countries tend to be perpetually unstable and subject to ethnic conflicts and new governments.  It's impossible to predict which country in what continent will be unsafe, so I stick to where I believe the business environment will not be subject to change without warning.

2.  What Aspect Of Mining Is The Company Involved With?

The junior mining sector is basically divided into explorers, developers and producers.  The explorers are like oil wildcatters.  They can have the greatest gains and the most severe losses.  Some junior explorers to consider are U.S. Gold Corporation (UXG), Explor Resources Inc. (EXSFF) and Vista Gold Corporation (VGZ). 

Most explorers wish to develop their projects, but some don't.  Vista Gold successfully developed its Nevada-based operations to form Allied Nevada Gold Corp. (ANV), which was later spun-off to shareholders at a tremendous profit.

The key risk to an explorer is that its projects turn out to be not viable economically.  NovaGold Resources, Inc. (NG), which has a 50% interest in the Galore Creek project, had to suspend development in late 2007 as cost estimates proved way too low.  The stock lost 99% of its value from more than $20 per share to about 25 cents in one year.

3.  Is The Company Profitable?

The only companies that can report profits are producers.  Some geo-politically safe producers include Aurizon Mines Ltd. (AZK), New Gold Inc. (NGD), ECU Silver Mining Company (ECUXF) and Hecla Mining Company (HL).  Each of these is profitable and getting more so, based on recent financial reporting.

Given the very favorable mining economics prevailing today, the list above is far from extensive.

4.  Is There An Asset Play?

Some companies are primarily an asset play.  They hold already drilled and largely delineated projects.  Probably the best asset play out there is Seabridge Gold (SA), which boasts more than 60 million ounces of economically viable Gold, in addition to a slew of other minerals such as Copper.

Producers can also be terrific asset plays.  ECU is not only currently producing and profitable, it also boasts what is now the 4th largest resource base of Silver, at a fraction of the market capitalization of high-quality giants such as Silver Wheaton Corp. (SLW) and Pan American Silver Corp. (PAAS).

5.  Does The Company Have Sufficient Financial Resources?

Miners who are not generating cash flow are dependent on the capital markets.  The financial meltdown of 2008-2009 placed these companies under extreme financial duress.  Developing, drilling and exploring is capital-intensive and requires regular infusions.

It's important to note both how much liquid resources a company has and its offsetting debt obligations.  If too much debt is coming due and the financial markets are frozen, the company may have to raise additional funds at extremely bad terms.  Companies with limited financial resources got particularly bludgeoned in the 2008-2009 meltdown.

6.  Is This Company Likely To Acquire Or Be Acquired?

Undoubtedly, as the mining industry starts to boom, there will be a slew of mergers and acquisitions.  Any company making an acquisition will typically do a "stock-for-stock" transaction, which will dilute the acquiror while paying a premium to the acquiree. 

This is why I tend to avoid the larger companies.  To remain competitive, it's more cost-effective to acquire in-ground assets than to go through a long and expensive exploration, drilling and development process.  Existing projects have far less risk.

The companies most likely to acquire are primarily the majors such as Newmont Mining Corporation (NEM), Barrick Gold Corp. (ABX), Yamana Gold Inc. (AUY) and Goldcorp. Inc. (GG).  Even higher-quality intermediate producers such as IAMGold Corporation (IAG) or Eldorado Gold Corp. (EGO) can be expected to join the acquisition race.

If you hold a company that gets acquired, you receive an instant windfall.  While you may be disappointed that the ride to much higher prices has been cut short, you can easily re-deploy the gains you just received in another junior.

Naturally, this is just a brief checklist of the items to look into prior to making a sizable investment.  There are many more items to consider such as quality of management and liquidity of the stock.  And, a technical review of the stock would also be a very important criteria. 

Great fortunes can be made in the next several months for investors who can make good decisions as to the horses they choose to get them to the finish line.  Most important is to avoid the big loss.  Another obvious factor to incorporate is good diversification.  For those investors who are not comfortable with making these choices, an excellent vehicle which includes 40 juniors and intermediates, is the Exchange-Traded Fund GDXJ.

Marko's Take

Sunday, June 20, 2010

The 12 Steps Of An Empire

Every empire goes through what appears to be an inevitable series of conditions which accompany its rise to dominance and then its fall to ashes.  This has proven especially true for the 3 key modern empires:  the British, the American and the Soviet Union.

So, what are the signs of a rising or falling empire?  They all seem to progress in 12 repeating steps:

1.  Escape From Tyranny Through Revolution Or Civil War
Every empire begins from the ashes of either a civil war or revolution which results from the unacceptable societal, economic or political conditions preceeding it.  In America, we had the Revolutionary War, which was brought about as the colonists sought to escape religious persecution.  It could also be an economically-inspired uprising such as the worker's rebellion in the Soviet Union, leading the rise of the "utopian" Marxist state.

2.  Dawn Of The Age Of Idealism, Hope And A New Political Doctrine

In the United States, the American Revolution led to the writing of the Constitution, probably the greatest document ever written.  In the Soviet Union, by comparison, Karl Marx' "Das Kapital", outlined the ideal worker's state where everyone was to contribute according to their abilities and receive according to their needs.  In Britain, it was Adam Smith's "Invisible Hand" from "The Wealth Of Nations".

Das Kapital sounds great in theory....terrible in practice.

3.  Rise Of Economic And Military Power

The adoption of complete laissez-faire capitalism, combined with a new frontier of rich, unexploited resources ushered in the American rise to power.  By World War I, the United States was a major economic and military power.

By World War II, America stood alone as the sole nuclear power.  The Soviet Union, which never quite achieved economic power as a result of its centrally-controlled economy, nonetheless became a huge military power and soon joined America as the 2nd atomic-ready nation.  Prior to the United States' rise to number 1, Britain ruled the skies of Europe with its Royal Air Force.

4.  Political Stability

In the early growth stages of an empire, the vast majority of the population is nationalistic and usually quite devoted to the political system created to address the inequities that characterized the prior system.  It could be the rejection of a class system in the Soviet Union, or the rejection of restricted personal freedoms which led to the creation of our Bill Of Rights.  Either way, the new political system is highly embraced and thought to be the ultimate answer to a perceived notion of fairness.

5.  Gradual Social Decay

Before you know it, other constituencies want to join the party.  In America, there have been the suffragettes demanding gender equality or the civil rights movement which sought racial equality.

In Britain, the various splinter groups of the oppressive Catholic church sought religious equality.  In the Soviet Union, religious persecution led to huge emigration of Jews to ultimately form Israel.

6.  Restriction Of Freedoms

As the Empire grows and progresses, certain groups start to feel left out, especially as the new economic order benefits some more, even much more, than others.  Those groups feeling left behind, will begin to form a political majority and learn how to use the new political system to take resources from others.

President Franklin Delano Roosevelt, during his administration, fundamentally changed the political system and destroyed the Constitution with the New Deal.  In it, freedom-destroying institutions such as Social Security were created, a juggernaut that was set in motion for which we are now paying a dear price.  In addition, Roosevelt changed the Supreme Court in such a way that the Constitution was rendered invalid by the ultimate law-making body.  That beautiful document, sadly, will never recover.

7.  Quantum Economic Or Military Change

In order to become an Empire, any country must, at least lead either an economic or military revolution, but preferably both.  In the United States, the "assembly line" led to our own "manufacturing revolution".  The advent of nukes, led a military revolution.  But, that wasn't all.

This country also led the "high-tech" revolution begun with computer technology and carrying through Al Gore's invention:  the internet.  The Soviet Union, because of its inefficient economic system, had to resort to a massive military buildup which resulted from its fear of Adolph Hitler's Germany.  The Brits controlled a global trading empire with interests in virtually every continent.

8  Rise Of Colonialism

Every Empire, as it gets more powerful, with the population still supporting it, will seek to protect or expand its reach.

The Soviet Union annexed the East Bloc creating the Warsaw Pact, including East Germany, Romania, Czechoslovakia, Poland, Bulgaria and Romania.  The English presence was felt in far away places such as India, Australia, South Africa, Rhodesia, New Zealand, Canada, Scotland and Ireland.  The United States created NATO (North Atlantic Treaty Organization) in response to the Soviet Bloc.  During the aftermath of World War II, the entire planet fell into "spheres of influence", a code word for which military power you were aligned with:  The Soviet Union's or America's.

9.  Asset And Monetary Inflation

Every military buildup proves a huge boom to the economy and is supported politically.  Politicians refuse to acknowledge the "law of diminishing returns" since they will buy arms and expand forces until increased expenditures begin to create economic distortions.  The population will increasingly question the government's resource allocation decisions.  Remember "Guns And Butter"?  New thinking political doctrine held that you could spend lavishly on both domestic welfare programs AND have an unlimited defense budget.  It was wrong.

Politicians learn that they can remain in office by promising everything, regardless of truth.  They all arrive at the perfect solution:  PRINT MONEY!  What debt?  Let's pay our bills in paper we just created.

10.  Economic Decay

The growing burden of providing escalating social programs and military expenditures will start to affect the economy in an irreversible fashion.  Budgets, that were formerly routinely balanced, will now start to have increasing deficits.  Of course, deficit spending will be defended and, for a long period of time, money creation will seem to lead to great wealth.

The result of monetary solutions is that they lead to increasing inflation and ultimately destructive asset bubbles.  The currency will lose value.  The process will repeat as deficits get greater, money creation increases, inflation gets higher and the economy gets weaker.  The process repeats.

11. Societal And Political Decay

As economic distress begins to be noticed, various interests begin to align.  A united society becomes divided along gender, racial, demographic and economic lines.  Each views the others with contempt and seeks to use the political system to combat the others.

Eventually, the combat turns to other forms of protest such as violence and civil unrest. The political authorities, in order to stem the violence, will restrict personal freedoms, perhaps even creating an internal security force such as the Department Of Homeland Security.  Adolf Hitler had such a department.  They knew it later by a different name:  The Gestapo.

12. Escape From Tyranny Through Revolution Or Civil War

Yes, you can assume it's coming to a theatre or drive-in near you.

Marko's Take

Friday, June 18, 2010

Gold Begins Historic March To $2000

Major fortunes are about to be made and lost.  As Gold gapped through the $1,250 level this morning, the final hurdle to the imminent hyper-bolic growth phase was crossed. 

Many investors find it psychologically intimidating to purchase an asset making all-time highs, but history is full of examples of huge wealth creation from doing exactly that.  When the Dow Jones Industrial Average (Dow) crossed the seemingly insurmountable 1,000 barrier in 1982, it was met with widespread disbelief.  Yet, that proved to be one of the greatest buying opportunities ever for stocks.  Oops!

The primary reason for this stumbling block is that investors are told to "buy low" and "sell high".  Kinda hard to do when an asset has never been higher.  Of course, following that logic, one would have missed every single bull market in history.  Oops!

Former Federal Reserve chairman Alan Greenspan warned about "irrational exuberance" in 1996 with the Dow at about 6,500 and Nasdaq at 1,000.  A few short years later, the Dow doubled and the Nasdaq rose 5-fold!  Despite issuing that warning, Mr. Greenspan embarked on reckless monetary policy which led to the twin bubbles of tech stocks and real estate.  Oops!

You can expect a drumbeat of "experts" telling you that Gold is in a bubble, that the fundamentals don't warrant higher prices and the regurgitation of that idiotic argument that the yellow metal has no intrinsic value.  But, instead of hating the nay-sayers, like Kitco's Jon Nadler, we should stop and tip our hats to them.  Their mindless drivel serves to keep sentiment from getting too bullish too quickly and, in so doing, adds life to the market.  Hey Jon, how's that $800 per ounce forecast looking?  Oops!

And of course, let's send some thanks to good old Robert Prechter, chief proponent of the completely useless Elliot Wave Theory, for his ongoing prediction of a crash to $400 dollar per ounce, or so.  Prechter, as far as I can tell, has made ONE and only one, correct prediction in his entire life.  He did warn of the 1987 market crash, which got him major notoriety.  He hasn't been right since.  Oops!

Bull markets are famous for extending far longer than anyone possibly believes.  Who'd have thought that dot coms, with barely any revenues, let alone profits, would ultimately achieve multi-billion dollar market capitalizations only to be followed by a round-trip to zero?  Oops!

Let's not forget current FED chairman, Ben Bernanke.  Time and time again, he has said that he doesn't understand why Gold is so high given tame inflation.  Psst, Ben, markets ANTICIPATE!

Looking forward, here's what every investor needs to know:

1.  Prognosticators and technicians will be calling market tops all the way.  They will be repeatedly wrong. 
2.  Gold's role as the "canary in the coal mine" will be talked down by all the financial geniuses of the Obama Administration.  They will be repeatedly wrong.
3.  Efforts to suppress the price the Gold will be increased in variety of market-interfering ways.  They will be repeatedly wrong.
4.  "Experts" will increasingly tell us that Gold is in a bubble and that investors are risking the type of wipe-outs that occurred in both real estate and tech stocks. The comparisons to tech stocks are completely invalid, since mining companies are producing record profits.  They will be repeatedly wrong.

We have long maintained the posture that Gold is heading for $2,000 an ounce later this year on its way to an ultimate top of $5,000 or so.  Investors smart enough, lucky enough or brave enough to place a substantial portion of their assets in either the bullion itself, or in junior precious metals mining stocks, will be in a far better position to ride out the coming financial storm.

It's not too late.  In fact, the party is just about to begin.

Marko's Take

Thursday, June 17, 2010

Investors Refrain From Spain

Now that the Greek bail-out is being hailed as the tremendous success it is (sarcasm intentional), Spain is reportedly seeking a similar, but far bigger, rescue package of its own. 

Sentiment towards Spain was hit by press reports, later denied by the European Commission, that the European Union (EU), International Monetary Fund (IMF) and U.S. Department of Treasury were drawing up a liquidity plan for Spain, including a credit line of up to €250 billion, about twice the amount made available to Greece. 

Yields on Spain's sovereign debt are rising, but are still far below levels which would indicate immediate and irreversible distress.  Spanish 10-year bond yields rose 12 basis points to 4.85% yesterday, the highest since July 2008, taking the spread over German Bunds to 2.21% – the highest since the introduction of the Euro in January 1999.

Spain faces a significant refinancing hurdle next month when €16 billion of bonds will need to be re-financed.  While memories of the Greek crisis are at the forefront of investor minds, Madrid is nowhere near the crisis situation experienced by Athens.  Spain's 10-year bond yield is still below 5%, which is less than Greece is paying on its IMF facility.  Greece didn't seek emergency funding until its two-year bond yield reached 10%.  By comparison, Spanish two-year bonds currently yield a very comfortable 3.3%.

Madrid's banking system, however, is a completely different story.  Spanish banks borrowed €85.6 billion from the European Central Bank (ECB) last month.  This was double the amount lent to them before the collapse of Lehman Brothers in September 2008 and one sixth of net Euro-Zone loans offered by the central bank.

This is the highest amount since the launch of the Euro-Zone in 1999 and a disproportionately large share of the emergency funds provided by the Euro’s monetary authority, according to an analysis by Royal Bank of Scotland (RBS).  Spanish banks account for 11% of the Euro-Zone banking system.

The rise in borrowing from €74.6 billion in April, which makes up nearly 15% of the net liquidity pumped by the ECB into the Euro-Zone financial system, provides further evidence of the acute distress in the Spanish financial sector.

RBS estimates the total amount of Spanish liabilities held by overseas investors is €1.5 trillion, or 142% of the country’s Gross Domestic Product (GDP).  By comparison, Madrid's budget deficit is fairly tame, at approximately 60% of GDP - a far cry from Greece, which is well in excess of 100%.  Of the total debt held by external investors, more than half, or €770 billion, has been issued by Spanish banks.

While investors have not yet required high yields on Spain's sovereign debt, the concern is that the situation in Madrid will continue to deteriorate.  With austerity measures in place which will undoubtedly weigh on the Spanish economy, 4th largest in the Euro-Zone, investors have every reason to doubt that the situation will turn around anytime shortly. 

Every European country that gets in financial trouble causes every other country to suffer.  So goes Greece, so goes Spain, so goes Portugal, so goes Ireland and on and on.  Even France and Germany can only absorb so much.  With such low yields on its sovereign debt, it's no wonder that investors are beginning to refrain from Spain.

Marko's Take

Wednesday, June 16, 2010

Mutually Assured Economic Destruction

The concept of Mutually Assured Destruction (MAD), developed during the Cold War, is a doctrine of military strategy in which two opponents possessed the ability to destroy each other.  As nuclear arsenals within the United States and the old Soviet Union grew during the arms race, it was understood that neither side could "win" a nuclear war, regardless of the relative amount of weaponry built. 

If either side were to launch missiles, the other side would still have a deadly capacity to virtually completely destroy the other.  Thus, this precarious balance kept the peace in that neither side could actually "win".  In fact, the radioactive fallout from any type of strike would prove so injurious to the global environment, that nuclear war was believed to be impossible.

MAD was applicable when there were relatively few world nuclear powers.  However, the number of nuclear-capable nations has expanded significantly, thus the doctrine is vastly more complicated.    Additionally, the concept of defense systems such as anti-ballistic missiles, hardened silos and guided lasers ("Star Wars") makes it possible, although highly unlikely, that a first-strike could be defended. 

MAD is now more applicable to the subtle economic war between the United States and China.  Washington is a major importer of Chinese goods while Beijing holds vast amounts of dollar-denominated American debt. 

China needs the vast U.S. consumer market to keep its poverty-stricken populace employed, while America needs a willing lender to purchase and hold is mounting external debt.  Beijing has become such a large holder of Treasury Bonds that reducing its position would cost it dearly if it tried to dispose of a significant portion. 

China is at risk of the enactment of trade barriers by the American political constituency which plays up to trade unions and enterprises crying foul over losses of jobs and business to "subsidized" Chinese manufacturers.  In turn, the United States is at risk that Beijing will opt to reduce its holding of Dollars and put pressure on interest rates and the value of our currency.  Mutually Assured Economic Destruction.

According to newly released data from the U.S. Department of Treasury, total external debt is now nearly $4 trillion, up more than 20% in the last year alone, as Washington has engaged on a spending orgy to stimulate the moribund economy.  Of this total, China holds $900 billion followed by Japan with nearly $800 billion.  In total, Asian exporters hold more than half.  No other nation has in excess of 10%.

China's Treasury holdings represent nearly 20% of  her annual Gross Domestic Product which is approximately $5 trillion.  Mutually Assured Economic Destruction.

Curiously, the United Kingdom has recently moved into 3rd place as its holding of Treasuries has tripled in the last 6 months from about $100 million to more than $300 million.  The total of all oil exporting nations is  4th at $240 million.

Mutually Assured Economic Destruction is merely another facet of World War III, a concept posited here that future wars will be waged not with cannons and bazookas, but economically and financially, through terrorism, cyber-hacking, ecological destruction and trade sanctions.  For a brief background, click here

Marko's Take

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Avalon Rare Metals, Inc.: A Rare Opportunity

While investors are starting to wake up to the incredible opportunity in precious metals mining stocks, the sub-category of rare earth metals remains largely unknown.

Both "light" and "heavy" rare earth elements represent a family of minerals found in consumer products such as TV displays and cell phones, as well as environmental applications such as hybrid engines and wind turbines  Rare earths are also instrumental to medical equipment such as X-ray machines and MRI machines

U.S. military technologies such as guided bombs and night vision rely heavily upon rare earth elements currently supplied by China.  Securing an independent U.S. supply could take up to 15 years, according to a new report by the U.S. Government Accountability Office (GAO).

New rare earth mines in the U.S., Australia, Canada and South Africa won't commence operations until at least 2014, based on industry estimates.  The GAO report listed rare earth deposits in states that include California, Idaho, Montana, Wyoming, Colorado, Missouri and Utah.

Of particular concern is that many U.S. deposits lack the "heavy" rare earth elements critical for much of today's technological innovations.  In addition, Chinese corporations are using their vast dollar holdings to buy mining companies that hold various U.S. deposits.

China has set quotas limiting rare earth exports and added on export taxes, despite supplying as much as 97% of the world's rare earth oxides.  Over the last 7 years, China has reduced the quantity of rare earths for export by 40%.  Even more troubling is Beijing's official plan through 2015, in which it warns that its own industrial demand might force it to stop exporting entirely.

There are very few publicly traded miners of rare earth metals, although investment in building capacity is growing rapidly.  One such company of note is Avalon Rare Metals, Inc. (TSX:AVL)(OTCQX:AVARF).

Avalon is a mineral exploration and development company focused on rare metal deposits in Canada, including a wholly owned project known as Nechalacho, which is emerging as one of the largest undeveloped rare earth elements resources in the world.  Nechalacho is particulary well endowed with the more valuable heavy rare earth elements, which are critical to environmental and high-tech applications. 

Avalon presently owns 4 other rare metals and minerals projects in Canada including a lithium project in Ontario, an inactive calcium/feldspar project in Ontario and a tin-indium-gallium-germanium mine in Nova Scotia.  None of these are expected to be operational any time soon, however.

The Nechalacho deposit now ranks as the second largest rare earth element deposit in the world, after the giant light deposits of Bayan Obo in China, yet the full extent of the Nechalacho deposit is still undefined.  Especially important is the fact that Nechalacho has the highest proportion of heavy metals of any major known deposit, giving it a higher value per ton.

The Bayan Obo deposit in China is believed to contain 56.9 million tons, but with a proportion of heavy metals of only 2%.  By comparison, Nechalacho has a much smaller resource base of 2.5 million tons, but contains a bountiful 22% of the more valuable elements.  Thus, in the heavy category, Nechalacho has nearly half the resources of the giant Chinese mine.

The 2 largest other deposits in the world lie in Kvanefeld, Greenland with 2.15 million tons (14% heavy) and Mountain Pass, U.S. with 1.84 million tons (0.98% heavy).

Avalon has 77 million shares and closed yesterday at $2.43, giving it a market capitalization of less than $200 million.  The company has no debt, but a relatively small cash balance of $10 million. The stock is reasonably liquid.

As a disclosure item, I have a position in Avalon and expect to for the forseeable future.  While this is a higher-risk investment, it is well worth looking into and possibly adding to one's porfolio of mining companies.

Marko's Take

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Tuesday, June 15, 2010

Euro-Zone Sovereign Debt Continues To Stumble

Moody's, that venerable credit rating agency, just acknowledged what the entire financial universe has known for months:  Greece is not an investment grade credit!  Really?  Even Standard & Poors figured that out nearly two months ago.

In making the 4-step downgrade to Ba1 from A3, Moody’s cited risks to economic growth from the austerity measures tied to a €110 billion ($134.5 billion) aid package from the European Union (EU) and the International Monetary Fund (IMF). Obviously, the Moody's analysts must be regular readers of Marko's Take.

Greece has cut spending, raised taxes and trimmed public-sector wages and benefits to reduce the deficit, which ballooned to 13.6% of Gross Domestic Product (GDP) last year, more than four times the EU maximum.  The government pledged to trim the shortfall to 8.1% of GDP this year and bring it back under the 3% EU limit by 2014.

Spain's problems, which are far less severe than those of Greece, is struggling to raise financing for debt maturities of €16.2 billion by July.

Spain disclosed yesterday that the European financial crisis is taking a toll on the country's banks, with foreign banks refusing to lend to some, while Germany said the EU stands ready to help if Madrid needs a Greek-style rescue.

With the 4th largest economy in the EU, Spain is coping with 20% unemployment and an 11.2% budget deficit.  Spain has among the lowest sovereign debt ratios in the Euro-Zone, at less than 60% of GDP.

Despite growing investor concerns amid a tougher credit environment, Madrid was able to place €5.2 billion at its 12- and 18-month bill auctions, but investors demanded a big yield premium.

Spanish 10-year bond yields rose nearly a quarter of a point yesterday, to 4.67%, while financial sector shares also came under pressure, down nearly 1% as they underperformed the broader market.

The demands on Germany and France, the EU's most healthy countries, continued to exert political problems.

German chancellor Angela Merkel's center-right coalition government may be close to collapse, stung by a string of disagreements and intense infighting over austerity cuts, policy reform and the departure of senior conservatives.  With elections coming up in the next few weeks, German voters appear inclined to make wholesale changes.

The bail-out package has also raised the ire of Merkel's French counterpart, Nicolas Sarkozy, who has accused the Germans of creating an atmosphere that will thwart growth in Europe at a time when it should be stimulated.  Relations between the two politicians are at an all-time low.

Ireland was also able to sell €1.5 billion of new debt, but at much higher yields than in previous auctions.  The average yield on the 2016 bond rose to 4.521% from 3.663% at the last comparable auction in April.  The 2018 bond had a yield of 5.088%, up from 4.55% last August.

The credit window is still open for European sovereign debtors but could slam shut at any time.  If, and when it does, the toll on the world financial system will be particulary acute as governments will be forced to make substantially greater cuts to bolster investor confidence.  Marko's Take?  Avoid these issuers and focus on the only winner in this entire financial crisis:  Gold.

Marko's Take

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Monday, June 14, 2010

Euro-Zone Trapped In Vicious Cycle

What should a country do that has WAY too much debt and WAY too little economic growth?   If it spends money it doesn't have to generate economic stimulus, it worsens its deficit and adds to the risk of default.  If it embarks on austerity, thereby reducing spending, it imperils economic growth, which worsens its deficit and adds to the risk of default.  Talk about being between "Ba-Rock and a hard place"!

The increasingly struggling Euro-Zone nations and the U.S. have taken diametrically different paths to addressing their economic and financial problems.  After the passage of the huge International Monetary Fund (IMF) led rescue, European Union (EU) nations are each passing significant budget cuts to bring their gaping budget deficits under control.  

The United States is taking the opposite approach.  With policy makers fearing a re-newed slip into the second dip of this "Double-Dip Hyper-inflationary Depression", the Obama Administration is putting the final touches on a new $200 billion stimulus package.  In addition, because of the desperate situation of so many municipalities, another $50 billion is being considered to save the jobs of teachers, police and firemen, whose jobs are being cut to balance city and state budgets.

In Europe, austerity is being reluctantly accepted by Greece, Italy, Portugal, Spain, Ireland, Germany, Great Britain, Hungary, Romania, the Netherlands and Iceland, as well as others.  The only major exception has been France.  In each case, austerity comes at the cost of future economic growth.  The reduced presence of government will trim about 0.5-1.0% off from future economic growth, but satisfies the conditions laid out by the IMF.  This identical approach, imposed on Argentina in 2001, failed miserably.

The United States is desperate to jump-start the employment situation, which has yet to show much signs of reversing, unless of course, we as a nation, decide that having an army of census workers is a good use of limited government funds.  After having spent some $2 trillion on various bailouts and stimulus, all we have to show for it are roughly 400,000 new civil servants, a budget deficit of $1.5 trillion and rising, more than 8 million jobs lost in the last two years and rising personal backruptcies.

How long will it be before some nation tries that tried and true approach of starting a military war?  It worked to bring the world out of the "Great Depression", perhaps it can work again.  Sadly, the world is running out of peaceful options.

A better solution is the combination of both approaches.  The austerity programs in Europe target the overblown government sectors and trade unions, who have enjoyed an un-deserved free ride for decades.  No nation can have a large part of its citizenry living off a diminishing pool of productive workers.  Ultimately, the productive ones will balk at the higher taxes imposed on them combined with the use of funds to support those that are living on the dole.  A recipe for class war?

Government spending needs to be targeted at areas that produce Gross Domestic Product (GDP) and employment NOT on transfer payments to people who are not motivated to add to society.  The biggest reason for problems with budgets is runaway entitlement spending on those who receive from others yet produce nothing.  In exchange for any govenment handouts, the recipients need to do something to earn their keep such as repairing our nation's crumbling infrastucture or performing community service.  Subsidizing sloth. or dependenc, merely generates much more of it.

Countries can simultaneously reduce spending and get more out of less if they prioritize it correctly.  We need to be cognizant of how much GDP each dollar of spending creates, and emphasize those activities.  If spending merely transfesr money from the productive to the un-productive, it should be phased out over time, and ultimately, entirely eliminated. 

The choice of policies does NOT have to be either/or.  Unfortunately, it is highly doubtful that government will ever get smart about spending OUR money.

Marko's Take

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Saturday, June 12, 2010

Showdown With Iran Looms Closer

Last Wednesday, the U.N. Security Council approved a resolution for a fourth round of sanctions against Iran, which includes prohibiting Tehran from buying heavy weapons, tightening financial transactions with Iranian banks and new cargo inspections.

The main thrust of the sanctions is against military purchases, trade and financial transactions carried out by the Islamic Revolutionary Guards Corps, which controls the nuclear program and has taken a more central role in running the country and the economy.

It also authorizes nations to conduct maritime inspections of vessels suspected of transporting prohibited items for Iran and adds 40 entities to a list of people and groups subject to travel restrictions and financial sanctions.

The resolution followed five months of strenuous negotiations between the United States, Britain, France, Germany, China and Russia.  With 12 votes in favor, it received the poorest support in the 15-nation council of the four Iran sanctions resolutions adopted since 2006.  Turkey and Brazil voted no, while Lebanon abstained.

After vehemently opposing sanctions, Russia appears to be taking a tougher line with Iran.  Officials said yesterday that Moscow would comply strictly with the new UN sanctions and signalled that a deal to supply Iran with air-defense missiles was now off.

Predictably, Iranian President Mahmoud Ahmadinejad said Israel was "doomed" and singled out U.S. President Barack Obama for derision, blaming Washington for orchestrating the sanctions. 

The Obama Administration has hailed the sanctions as a key diplomatic victory despite having its proposals watered down in order to gain Chinese support and only garnering 12 votes.  Domestically, however, the administration is reportedly working with Congress to ease restrictions.  According to the L.A. Times, administration officials have begun negotiations with congressional leaders, who are working on versions of House and Senate bills that would punish companies that sell refined petroleum products to Iran or help the country's oil industry. 

Unlike the U.N. measures, congressional action would pertain only to U.S. policies and agencies and would not be binding on other countries. Other countries and groups of nations are also considering additional measures.

For its part, Tehran has completely dismissed the sanctions.  For months, President Mahmoud Ahmadinejad has warned that Iran would respond aggressively, even militarily against U.S. and Isaeali interests in the region.  Any military action by Iran would undoubtedly be targeted at disrupting oil supplies through the Straits of Hormuz, an outcome the world hopes desperately to avoid.

Saudi Arabia, no friend of Israel, views Iran as the bigger threat.  Sources in the Gulf say that Riyadh has agreed to allow Israel to use a narrow corridor of its airspace in the north of the country to shorten the distance for a potential bombing run on Iran.

Sources in Saudi Arabia say it is common knowledge within defense circles in the kingdom that an arrangement is in place if Israel decides to launch a raid.  Despite the tension between the two governments, they share a mutual loathing of the regime in Tehran and a common fear of Iran’s nuclear ambitions.

The 4 main targets for any raid on Iran would be the uranium enrichment facilities at Natanz and Qom, the gas storage development at Isfahan and the heavy-water reactor at Arak.  Secondary targets include the lightwater reactor at Bushehr, which could produce weapons-grade plutonium when complete.
Israeli officials refused to comment on details for a possible raid on Iran, which Prime Minister Binyamin Netanyahu, categorically refuses to rule out.  Asked about the possibility of a Saudi flight path for Israeli bombers, Aharaon Zeevi Farkash, who headed military intelligence until 2006 and has been involved in war games simulating a strike on Iran, said: “I know that Saudi Arabia is even more afraid than Israel of an Iranian nuclear capacity.”
It looks like "show time" in the Middle East is at hand.  In the last several years, Tehran has built an impressive aresenal of advanced Russian-made weapons which make Iran no pushover, even with a massive military presence by the U.S. across the border in Iraq, as well as the potent military capability of Israel. 
Should any military action ensue, its economic effects may be life-changing for the entire planet.  Disrupting oil flow will not be that difficult, with severe repercussions for the world.  For investors, companies engaged in the production of energy outside of the Middle East ought to be huge beneficiaries.  In addition, the uncertainty caused by any altercation ought to be explosively bullish for Gold.
Marko's Take
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Friday, June 11, 2010

U.S.-Sino Trade Frictions Intensify

Chinese trade figures released yesterday showed exports exploding by 48.5% in May over the year before, way ahead of estimates.  China recorded a huge $19.5 billion surplus, which was dramatically higher than the $1.7 billion recorded in April and the slight deficit in March.

Imports rose 48.3%  over the same month last year.  After taking into account calendar adjustments for the number of working days, China said that exports had risen 45.3%  in May from a year earlier and were up 10.9%  from April.

In direct trade with the U.S., China's surplus expanded to $19.31 billion in April from $16.90 billion in March, stoking political pressure on Beijing to accelerate appreciation of the Renminbi.  China has been very reluctant to heed U.S. pressure despite seeming to send signals that it would agree to adjustments in its currency since the beginning of 2010.

Domestically, the Commerce Department said the U.S. deficit in international trade of goods and services increased 0.6% to $40.29 billion from a revised $40.05 billion the month before.  Exports fell by $813 million, while higher oil prices helped to drive imports up by $1.61 billion.

Trade has been one of the few strengths in the U.S. economy during the recent recession, but has now become a drag on the recovery as imports have outpaced exports. The recently ballooning deficit subtracted 0.66% from Gross Domestic Product (GDP) during the first quarter.

The Treasury has been pursuing diplomacy with Beijing to allow the Renminbi to appreciate, but Treasury Secretary Tim Geithner told Congress yesterday that he had no idea when that might happen.  Geithner, confident that a change in Chinese policy was imminent last March, now has signalled that he shared much of Congress's frustration and suggested that China needed to be aware that the U.S. was close to legislation.

Charles Schumer, a senior Democratic senator, vowed to press ahead with legislation to punish China if Beijing did not increase the value of the Renminbi. 

The Renminbi has been pegged to the Dollar for nearly two years but has appreciated nearly 20% against the Euro since last November.  Given the importance of the European market to China,  the Renminbi’s sharp appreciation relative to the Euro provides China with an opportunity to begin the process of allowing its currency to fluctuate within a wider band.

The de-facto rule was that the rate of appreciation would not exceed 6-7%  a year.  As pressure has built over the past two years, market participants have been speculating that the needed adjustment is much larger than a gradual appreciation of 6 to 7%.  Still, Beijing remains adamantly against any major or sudden adjustments and reluctant to embark once again on a gradual appreciation.

In times of extreme financial distress, such as The Great Depression, free trade becomes one of the first casualties.  While it is virtually universally recognized that trade barriers help no one except for the industries protected, they become more politically popular as workers fear that "unfairly" priced imports will cost them their jobs.  China is especially sensitive to the repercussions of high unemployment domestically, which will only get worse if exports suffer.  Thus, a resolution to this issue is neither likely to be immediate nor sufficient to address growing U.S. outrage. 

Marko's Take

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Thursday, June 10, 2010

Hedge Funds Fail To Prevent Large Losses In May

While many, if not most, hedge funds don't actually "hedge", they do promote themselves as un-correlated to the market, thereby theoretically providing investors with less risk.  Unfortunately, their performance during market meltdowns demonstrates quite the opposite.

Nearly every market correction or bear market has been accompanied by overall poor returns and often complete wipe-outs of these believed-to-be elite vehicles.  Is this asking too much?  Possibly, but since most funds charge premium fees, shouldn't investors expect premium performance?  Especially during the most volatile and difficult periods?

The month of May, which included a 1,000 point intra-day loss for the Dow Jones Industrial Average, was a perfect test case.  Volatility, which had been subdued for a year, suddenly exploded.  If there was any time for a hedge fund to strut its stuff, it was last month.  How'd they do?

Terribly!  May was the worst month for hedge funds since November 2008, according to Hedge Fund Research Inc. (HFR).  Virtually every strategy was down.  Larger funds managed by SAC Capital, Paulson & Co. and Third Point Management lost between 2.3% and 5.6% in the month, say people familiar with the funds. Their mistakes ranged from concentrated bets on consumer companies to financial-company wagers.

Louis Bacon, who founded Moore Global Investment, had scored annual gains of about 20% on average over the past two decades.  His largest fund endured losses of 9.2% in May, way underperforming the average decline of 2.3%, according to HFR's index.

The average hedge fund was up 1.3% for 2010 through May, compared with a 6.4% decline for the big Moore fund.

Eurekahedge, a Singapore-based fund tracker, publishes a series of indices on a monthly basis, measuring the returns of hedge funds by region and investment strategy.    Its indices showed hedge funds focusing on Asia (excluding Japan) lost an average of 4.86% during the month of May, pushing total returns for 2010 to minus 3.15%.

Barclay's index of hedge fund returns for May, which encompasses more than 1,300 funds, showed a loss of nearly 3%, nearly wiping out all returns for 2010.  The Credit Suisse/Tremont Index revealed a drop of 2.26%.

But money still poured into hedge funds for a second consecutive quarter, making the industry reach $1.66 trillion of assets under management, up from $1.60 trillion in the last quarter of last year, HFR reported.  The hedge fund industry reached a record $1.8 trillion under management at the peak of the market in 2007, but the figure is now lower following client withdrawals and the credit and equity losses suffered during the credit crunch.

While hedge funds advertise themselves as sophisticated investors, they are still prone to huge losses which can easily become complete wipe-outs.  This is the result of the use of massive leverage in combination with risky trades.  Since they make their compensation by taking a portion of gains, but don't always cough up money when they lose, hedge funds are incentivized to roll the dice.  Heads I win, tails you lose.

Everyone who still has assets in my fund, please step forward.  You, not so fast!

Of course, if they screw up, they are the first to accept responsibility (sarcasm intentional).  Goldman Sachs  (GS) was sued for $1 billion by Basis Yield Alpha Fund (Master), an Australian hedge fund, claiming that the bank made “misleading statements” in connection with Timberwolf, a complicated mortgage security the bank underwrote in 2007.

A spokesman for GS said: “The lawsuit is a misguided attempt by Basis, a hedge fund that was one of the world’s most experienced CDO investors, to shift its investment losses to Goldman Sachs."  Loathe as I am to agree with "Government Sachs", they have a point.  How does an entity claiming expertise in CDO's get taken advantage of to the tune of a total loss?  Goldman did NOT force them to over-leverage.

A spokesman for GS went further: “At the time of the Timberwolf transaction, Basis specifically stated that it would not place any reliance on Goldman Sachs.  Basis is now trying to recoup its losses based on false allegations that it was misled about aspects of the transaction and market conditions.”

Sorry Basis, you can't have it both ways.  You either know what you're doing, or you don't.  You can't claim to be an expert, sign a "big boy" letter attesting to that and then claim to have been duped.

Of course, if the trade had worked out for you, and GS lost money, you'd have no problem with the "misleading statements".  Or, would you give it back to Goldman?  Point made.

If you're invested in hedge funds, caveat emptor.  

Marko's Take

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Wednesday, June 9, 2010

Ambac: Another Triple A To Bite The Dust

As the global financial authorities wrestle with the incredible mess known as the world economy, credit rating agencies Standard & Poors, Moody's and Fitch have come increasingly under fire.  Of particular interest is the sheer volume of over-rated issuers who have subsequently defaulted

Now, we're NOT talking about junk-rated paper.  Investors, who made the mistake of paying attention to ratings,  have been stung by buying Triple A-rated paper which then was either downgraded to junk status or defaulted, resulting in massive capital losses.

To re-iterate, the Triple A designation means that the issuer has an infinitesimal probability of default for the forseeable future.  Only 4 U.S.-based corporate issuers carry that rating:  Johnson & Johnson (JNJ), Microsoft (MSFT), Automatic Data Processing (ADP) and ExxonMobil (XOM).  Even Uncle Sam, who owns a printing press, is in danger of losing this elite status.

ABK was itself rated Triple A until 2008.  The company is now facing bankruptcy, according to a recent filing with the Securities and Exchange Commission (SEC).

Ambac (ABK), however, takes this ratings lunacy to an entirely different level.  At issue is MUCH more than ABK's own $1.2 billion in outstanding debt.  The company, known as a "mono-line insurer", provides credit insurance for hundreds of billions of outstanding bonds.  ABK, along with rival MBIA (MBI), are the two key companies providing this "service". 

Issuers, who would NOT qualify for a Triple A, but would wish to carry that rating, pay a premium to the mono-line insurers to provide a guarantee to establish the soundness of their debt.  In effect, ABK and MBI act as additional security to prospective investors who insist on purchasing only the very safest of bonds.

If the mono-line insurers default, their insurance becomes worthless and affects huge swaths of debt, including municipalities and mortgage-backed, collateralized obligations.  If this insurance becomes unavailable, or is perceived to have no value, many prospective issuers will have to access the capital markets at a complete disadvantage.  Not to mention the fact that the outstanding issues already insured will become far less liquid, resulting in extreme price pressure.

To be fair, the affairs of the operating company will be separated from that of its insurance unit, Ambac Assurance.  However, a bankruptcy of a mono-line insurer would be un-precedented and, at the very least, throw its customers into disarray during what may be a highly contested process.

The big three rating agencies, whose self-serving methods have been completely exposed as fraudulent, continue to maintain that their business models are viable.  What's wrong with having issuers shop for a rating that is to their satisfaction?  Everything! 

What investors are learning from the credit fiasco of the last 3 years is that the rating agencies provide ZERO information.  In so doing, they have sown the seeds of their own demise.  As investors learn to place no value on a credit rating, issuers will stop paying for these ratings and the problem will take care of itself.  Any financial regulatory policy will be purely window dressing for public consumption and to curry political favor.

Washington, where WERE you?  Oh, yes.  Our friends at the SEC were too busy preventing the Bernie Madoff scam from duping investors.  Or, preventing the investment banks from creating misleading derivatives, that led to massive financial system dislocations. 

The irony of the financial meltdown is that there are so many villians, that each of them can easily point the finger at someone else.  It was the investment banks' fault.  It was the credit rating agencies' fault.  It was the regulators' fault.  It was the Senate Finance Committee's fault.  It was the Federal Reserve's fault.  It was George Bush's fault.  On and on.

Systemic financial crises are not created without the participation of MULTIPLE parties, each of which is acting in their own interest.  The only common thread is that, while all the villains cashed in, the investment world lost.  America lost.  The global financial community lost.  At least the villians got their bonuses!

Marko's Take

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Tuesday, June 8, 2010

The Next Euro-Zone Domino: Hungary

First, we had the "PIGS" (Portugual, Ireland, Greece and Spain).  Then, with the addition of Italy, the acronym for troubled European countries becames PIIGS.  Hold on a second.  Hungary has applied for membership to this very elite group.  Get ready for PHIIGS.  PHIIGS?

Fears escalated yesterday that Europe's debt problems were spreading beyond the core Euro-Zone after Hungarian officials warned for a second day that the country was at risk of a Greek-style fiscal meltdown.

A government spokesman for new prime minister, Viktor Orban, said on Friday that even default was possible given the economy’s problems.  This sent Hungary's currency, the Forint, tumbling and credit default swaps surging by more than 100 basis points to 425. 

The latest comments are likely to increase skepticism of the new administration among investors.  Markets initially welcomed the center-right party's election victory in April.  However, they have been unsettled by repeated government clashes with the central bank and calls for foreign-currency loans to be converted into Forints.

Hungary's debt last year was 78% of Gross Domestic Product (GDP), the highest among the European Union's newest members.  But it remains very close to the 74% European Union (EU) average, and well below Greece's 115%.

Budapest has yet to draw down all of a €20 billion support package with the International Monetary Fund (IMF) and the EU in October, 2008.  The previous Socialist-backed government last year cut the deficit to 4% of GDP and stopped drawing on the credit line when market conditions improved.

Hungary’s cabinet met for a third day on Monday to discuss a range of fiscal measures designed to trim an estimated 1-1.5%  of GDP.  The government promised to announce its action plan today at the latest.

European problems don't stop there.  Let's not forget Romania.  Analysts have talked down the relevance of Hungary’s problems to others in the region, but neighboring Romania, a fellow recipient of a €20 billion credit line from the IMF and the EU, is suffering from its own set of fiscal problems.

Prime Minister Emil Boc has presented a bill in parliament that would cut public sector wages by 25% and pensions and unemployment benefits by 15%.

The austerity measures are among the most severe in the EU and have unleashed a maelstrom of protest in one of the bloc’s poorest members.  The package will face a vote of confidence next week that could bring down the government, which holds a razor-thin majority.

The government insists that the wage cuts are necessary if Romania is to meet its revised 6.8% deficit target agreed with the IMF and the EU.

Another day, another country in crisis.  Where will it end?  Not with more debt, not with bail-outs.  Only a return to a market-based system with incentives for people to work, rather than retire, will prove to be a permanent answer.  Sadly, all the civil servants, who have enjoyed a cushy ride, are loathe to make the changes necessary. 

Marko's Take

Want more background on the Euro-Zone's problems?  Use our search engine at the top-right of this site to obtain the latest information on everything financial and political.  And, if you have a more political bent, we will be expanding the You Tube videos.  You can access them by clicking here  Bone up on topics such as The Federal Reserve, Peak Oil, Personal Income Taxes and Social Security.

Monday, June 7, 2010

Economy Turns Lower

The Second Dip of the "Double-Dip Hyperinflationary Depression is now here.  Economic data, which had pointed to a weak recovery, is now showing renewed signs of falling off a cliff.

This downturn was not too difficult to anticipate.  We have reapeatedly pointed out how the unprecedented annual drop in money supply aggregate M3 would, with virtual certainty, lead to a more severe and aggressive downturn.  Despite all the stimulus and near ZERO interest rates, the horrendous worldwide debt levels are keeping consumers and business in check. 

The April retail sales report was the first sign of a sputtering economy. While sales showed a gain of 0.4%,  the pace of gain slowed from February and March.  The April weakness was naturally blamed on factors such as the weather and an early Easter, which had the effect of pulling sales into March.

The upcoming report for May is scheduled for release on Friday, June 11th.  Consensus data for May is indicating a gain of 0.2% versus an earlier estimate of 0.5%.  

Topping off the disappointment parade was Friday's jobs report, which had a headline number of 431,000 added to payrolls.  On the surface, a pretty good number.  Unfortunately, all but 20,000 of these were temporary census workers who will be laid off at the end of the month.

The household survey, which counts the number of people with jobs, as opposed to the payroll survey that counts the number of jobs, showed a seasonally-adjusted monthly employment contraction of 35,000 in May, after adjusting for the census increase.

The Bureau of Labor Statitistics (BLS) has made a science of creating completely obfuscating employment data.  One of their assumptions is that jobs created by start-up companies in this downturn have more than offset jobs lost by companies closing down.  So, if a company fails to report its payrolls because it has gone out of business, the BLS assumes it still has its previously-reported employees and adjusts those numbers for the trend in the company’s industry.   Huh?

The additional jobs created by start-up firms, which get added on to the payroll estimates each month, were revised lower in the most-recent benchmark revision.  According to the econometric work of Dr. John Williams of ShadowStats (,  this monthly bias should be negative by approximately 200,000 on average.  Therefore, in Dr. Williams' estimation, the BLS continues regularly to overestimate monthly growth in payroll employment by roughly 200,000 jobs.

The one bright note is the recent jump in both new home sales and existing home sales.  Reported numbers showed some increase in activity in April relative to March.  Unfortunately, this appears to have been due primarily to the April 30th expiration of tax breaks for home buyers.  A similar, but larger spike, was evident for existing home sales with the November 2009 expiration of initial tax incentives.  To the extent this stimulus has pulled in sales from the future, monthly sales should fall off in the months ahead, starting with May 2010 reporting.

Of great concern, despite the blip in home sales, is foreclosure activity. The National Association of Realtors (NAR ) estimates that 33% of new home sales for April were in the "distressed" category.  With foreclosures on the rise, price pressure remains on the pricing of new and existing homes. 

The Obama Administration, despite their cheerleading of the April jobs gains, is busily preparing yet ANOTHER stimulus package.  Reportedly being pushed by economic adviser Larry Summers, the new package is expected to be $200 million.  The Federal Reserve has done all it can.  The only remaining weapon is more fiscal spending, which, given a deficit already in the $1.5 Trillion range, will have some very nasty side effects.

Marko's Take

The top Federal personal tax rate is scheduled to increase to 39.6% from 35% in early 2011.  For an interesting review of the consitutional issues regarding the income tax, we invite you to check out our You Tube video on "The Legality Of The Personal Income Tax" by clicking here

Sunday, June 6, 2010

Outlook Brightens For Madoff's Victims

So, I took off my "the world is falling" hat and found something upbeat to write about today.

Once upon a time, things looked like the victimized investors in Bernie Madoff's trading programs would be completely wiped out.  Now, it appears virtually certain that a material recovery of assets is in the offing.

Last month, the estate of Jeffry Picower, an investor in Bernard Madoff's Ponzi scheme, who died last fall, is expected soon to pay at least $2 billion to other Madoff investors burned by the fraud, according to a court order.

The potential recovery from the settlement would more than double the $1.5 billion gathered so far by trustee Irving Picard, who represents investors.

A lawyer for Mr. Picard previously said in court that he might be able to recover as much as $10 billion for investors, or about half the amount they collectively lost from the fraud.  Of course, that assumes that the total size of claims is NOT the $50-$60 billion originally estimated, but closer to $20 billion as the trustee maintains.

William Zabel, a lawyer for the Picower estate, previously said the estate would hand over at least $2 billion. That is approximately the amount Mr. Picower and other entities associated with him withdrew from Mr. Madoff's investment firm in the six years before it collapsed, in December 2008, Mr. Zabel said.  The trustee has a strong claim to that money under bankruptcy law.

As a result of the virtual certainty that assets will be available to distribute, the free market has now created a mechanism for victims to get liquidity in advance of the final settlement, which still may be years in the offing.

ASM Capital, a firm which makes markets in various contingent claims, is offering either to make an immediate payment of 20% of claims in exchange for the full claim, or make an upfront payment of 16% of the claims, with the investor keeping 33% of future recoveries.  For those with claims less than $1 million, the payout could be slightly less, ASM says.

For an investor with a claim of $1 million, for example, ASM will write a check for $200,000 in exchange for the full claim; or the investor could take $160,000 plus 33% of future proceeds ASM receives above that amount.  Those sums would be in addition to any $500,000 payouts made by Securities Investor Protection Corporation (SIPC) to investors.  Any amounts covered by the SIPC, however, are thought to apply to very few investors and are expected to be limited.

If all works to Mr. Picard's plan, investors might see as much as 50 cents on the dollar.  Mr. Picard acknowledges that this is far from certain, but it is giving some investors hope.

ASM says it is working on deals with about a dozen or so Madoff investors, including individuals, charities and foundations.

As for losses, Mr. Picard has said they could top off at $20 billion or less.  But, litigation currently under way challenges Mr. Picard's methodology determining which victims of Mr. Madoff should be entitled to claims.  So far, a court has affirmed Mr. Picard's view, which yields a smaller pool.

Given these factors, victims could see anywhere from around 50 cents on the dollar (if the recovery is $10 billion and the pool $20 billion) to less than 15 cents (if the pool is considered $60 billion), Mr. Picard says.

Either way, a verified claimant today could receive a guaranteed 20% and forego the timing uncertainty.  While this is a far cry from a complete recovery, it is a far better outcome than investors could expect even a few months ago.

Marko's Take

Speaking of Ponzi schemes, there is no one bigger than our very own "Social Security".  For a 7-step solution to fix this problem, please visit our latest You Tube video blog, entitled "Social In-Security:  The Solution", by clicking here

Saturday, June 5, 2010

The H1N1 Virus: The Audacity Of Hype... Part 2

Last January, we first wrote about the tremendously over-hyped "Swine Flu"  The irresponsible handling of this virus has now ensnared the World Health Organization (WHO).

European criticism of the WHO's handling of the H1N1 pandemic intensified yesterday with the release of two reports that accused the agency of exaggerating the threat posed by the virus and failing to disclose possible influence by the pharmaceutical industry on its recommendations for how countries should respond.

The WHO's response caused widespread, unnecessary fear and prompted countries around the world to waste millions of dollars, according to one report.  At the same time, the Geneva-based arm of the United Nations relied on advice from experts with ties to drug makers in developing the guidelines it used to encourage countries to stockpile millions of doses of antiviral medications, according to the second report.

A spokesman for the WHO, along with several independent experts, however, strongly disputed the reports, saying they misrepresented the seriousness of the pandemic and the WHO's response, which was carefully formulated and necessary given the potential threat.

The second report criticized 2004 guidelines developed by the WHO which were based in part on the advice of three experts who received consulting fees from the two leading manufacturers of antiviral drugs used against the virus, Roche and GlaxoSmithKline.

Despite the proclamations from the WHO, H1N1 has been a non-event with the exception of the extraordinary attention received by the media and public health organizations, such as the Center For Disease Control (CDC). 

What is a pandemic?  There is no official "death toll" criteria, but it is generally thought of as an epidemic over a widespread area.  To some extent, H1N1 qualfies, but if we look at some statistics, we can see that the "swine flu" was really nothing.

There are several excellent precedents for flu pandemics.  The "Spanish Flu" pandemic lasted from March 1918 to June 1920, spreading even to the Arctic and remote Pacific Islands.  Between 50 and 100 million died, making it the deadliest natural disaster in human history.  There were less deadly outbreaks of various flus in 1968-69 and 1957-58, from which 1 million and 2 million people died, respectively.  So how does "Swine Flu" rate?  The WHO estimates 18,000 deaths worldwide, of which 12,500 have occured here in the United States. 

To put 18,000 in perspective, that represents about 5% of all annual influenza deaths.  For the United States, the Swine Flu was responsible for less than 20% of all influenza-related deaths last year which are believed to be approximately 66,000. What pandemic?

The WHO was equally irresponsible in its predictions of deaths from the "Avian Flu", also known as SARS (Severe Acute Respiratory Syndrome).  That flu was predicted to kill 750 million people.  To date 744 deaths worldwide and NONE in the United States.  Oops!  Only exaggerated by 1 million times!

The United States has reportedly spent more than $1 billion to procure vaccines.  While no official count exists, the vaccine itself has proven deadly to some people who have taken it.  Sweden, however, has looked into the efficacy of the vaccine in some detail.

There have been more than 350 reports of vaccine side-effects reported to the Swedish government.  It is reported by, a Swedish health organization, that side effects are more common with the swine flu vaccine compared to the regular flu vaccine. 

Unfortunately, both the WHO and CDC must justify their funding and existence based on the need to monitor and control deadly inflectious viruses.  This gives them an incentive to dramatically over-hype any possible concerns about an outbreak.  Still think the government should run healthcare as in Obamacare?

Marko's Take

Interested in a 7-step solution to fix Social Security?  If so, our latest video blog entitled "Social In-Security:  The Solution", can be accessed by clicking here