Highlights from Warren Buffett’s Letter to Shareholders 2010

Monday, February 28th, 2011

by Trader Mark, Fund My Mutual Fund

Warren Buffett’s much read annual letter is out and I’ve added some links below for those who are interested.

The full letter in pdf format is here.

1) The NYT Dealbook does an overview in As Berkshire Improves, Buffett Sings Praises of U.S.

2) The Associated Press writes Warren Buffett Remains Optimistic About U.S. Future

Billionaire Warren Buffettt wants Americans to be optimistic about the country’s future but wary about borrowing money and the games public companies play with profit numbers they report.  He said a housing recovery will likely begin within the next year.

3) WSJ Dealbook has quotes and quips from the letter below

Discussing why Berkshire keeps so much cash on hand:
Borrowers then learn that credit is like oxygen. When either is abundant, its presence goes unnoticed. When either is missing, that’s all that is noticed.
****

“Money will always flow toward opportunity, and there is an abundance of that in America.”
****

On human potential and the nation’s future
Human potential is far from exhausted, and the American system for unleashing that potential–a system that has worked wonders for over two centuries despite frequent interruptions for recessions and even a Civil War—remains alive and effective.
****

John Kenneth Galbraith once slyly observed that economists were most economical with ideas: They made the ones learned in graduate school last a lifetime. University finance departments often behave similarly. Witness the tenacity with which almost all clung to the theory of efficient markets throughout the 1970s and 1980s, dismissively calling powerful facts that refuted it “anomalies.” (I always love explanations of that kind: The Flat Earth Society probably views a ship’s circling of the globe as an annoying, but inconsequential, anomaly.)
****

One footnote: When we issued a press release about Todd [Comb's] joining us, a number of commentators pointed out that he was “little-known” and expressed puzzlement that we didn’t seek a “big-name.” I wonder how many of them would have known of Lou in 1979, Ajit in 1985, or, for that matter, Charlie in 1959. Our goal was to find a 2-year-old Secretariat, not a 10-year-old Seabiscuit. (Whoops–that may not be the smartest metaphor for an 80-year-old CEO to use.)
****

On hedge funds:
The hedge-fund world has witnessed some terrible behavior by general partners who have
received huge payouts on the upside and who then, when bad results occurred, have walked away rich, with their limited partners losing back their earlier gains. Sometimes these same general partners thereafter quickly started another fund so that they could immediately participate in future profits without having to overcome their past losses. Investors who put money with such managers should be labeled patsies, not partners.
****

Berkshire and the housing/mortgage crisis:
Our borrowers get in trouble when they lose their jobs, have health problems, get divorced, etc. The recession has hit them hard. But they want to stay in their homes, and generally they borrowed sensible amounts in relation to their income. In addition, we were keeping the originated mortgages for our own account, which means we were not securitizing or otherwise reselling them. If we were stupid in our lending, we were going to pay the price. That concentrates the mind. If home buyers throughout the country had behaved like our buyers, America would not have had the crisis that it did.
(Emphasis added)
****

On home ownership
Home ownership makes sense for most Americans, particularly at today’s lower prices and bargain interest rates. … But a house can be a nightmare if the buyer’s eyes are bigger than his wallet and if a lender–often protected by a government guarantee–facilitates his fantasy. Our country’s social goal should not be to put families into the house of their dreams, but rather to put them into a house they can afford.
****

On the worst of the global financial crisis:
As one investor said in 2009: “This is worse than divorce. I’ve lost half my net worth–and I still have my wife.”

****
In discussing the bazaar that is the coming annual meeting:
Remember: Anyone who says money can’t buy happiness simply hasn’t learned where to shop.

Copyright (c) Trader Mark, Fund My Mutual Fund

Tags: Anomalies, Associated Press, Billionaire, Borrowing Money, Commentators, Dealbook, Finance Departments, Flat Earth Society, Footnote, Frequent Interruptions, Human Potential, John Kenneth Galbraith, Letter To Shareholders, Lifetime University, Nyt, Recessions, Tenacity, University Finance, Warren Buffet, Warren Buffett, Wsj
Posted in Credit Markets, Markets | Comments Off

Canada Market Cheat Sheet (February 28, 2011)

Monday, February 28th, 2011

Canada Market Cheat Sheet (February 28, 2011)

TSX and Subgroups – Week Ending February 25, 2o11

TSX and Subgroups – YTD to February 25, 2o11

Past One Year to February 25, 2011

Strengths

Canada Economic Growth Rate Accelerates to 3.3% in 4th Quarter on Exports – Canada’s economic growth rate accelerated more than forecast from October to December on the biggest jump in exports since 2004 and faster consumer spending. [Bloomberg]

OMERS pension fund reports 11.5 perecnt gain for 2010 – Ontario Municipal Employees Retirement System (OMERS), one of Canada’s largest pension funds, said on Monday the value of its net assets rose 11.5 percent last year to C$53.3 billion ($54.9 billion), helped by stronger global financial markets. [Reuters]

Can Canada’s economy keep up its solid pace of growth? The economy grew by 0.5 per cent in December, The Globe and Mail’s Tavia Grant reports today. In the fourth quarter, gross domestic product increased at an annual rate of 3.3 per cent. Both readings were better than economists expected, with December’s pace the best in nine months. Statistics Canada also revised its reading for the third quarter, bringing the pace to 1.8 per cent from its earlier estimate of 1 per cent. Consumer spending also helped pump up the economy in the fourth quarter, according to the federal statistics gathering agency. [Globe and Mail]

Weaknesses

Canadians urged to change spendthrift ways – For the past 15 years, Canadians haven’t been saving money, in large part because there was no pressing need. Rising home prices made people feel richer, and saving for a rainy day was a low priority. But that economic era is fast coming to an end. A new report to be released Monday shows the toll that years of passive savings is taking on the financial picture of Canadians. Having relied overwhelmingly on their homes to build personal wealth, the report says the average Canadian consumer now socks away considerably less than their U.S. neighbours, and will have to start saving more as housing prices moderate. [Globe and Mail]

Household debt surpasses six-figure mark – The average household debt figure at the end of 2010 was $100,879, with the debt-to-income ratio at a record 150 per cent, the report says. That means for every $1,000 Canadian families earn after tax, they now owe $1,500. Mortgages account for two-thirds of that debt at $63,000 per household. The other third is made up of personal loans and credit card debt.

Opportunities

IS Gold Set To Rally? – Despite the fact that Gold is trading near its record high, some suggest that Bullion will outperform Oil as surging inflation will underscore the metal’s role as an investment hedge. The chart to the left shows the price of both Gold and Oil since 2008. The chart below is the ratio of Gold to Oil, or how many barrels an ounce of gold will buy. At its peak in late 2008, an ounce of gold bought you about 28 barrels of crude oil. Currently, oneounce buys about 15 barrels. Notwithstanding OPEC’s spare production capacity, energy markets have priced in a considerable risk premium. If tensions ease and or production comes on stream, oil prices could drop rather quickly. Gold has fallen 1.6% this year following a 30% rally in 2010. Crude is up about 5% this year following last year’s 15% rise.

Trimming Gas: Decreasing Gas Exposure In Favour of Gold (Lee) – For investors wanting to maintain some small-cap commodity exposure, we view gold as having a better risk/reward profile at this point, with bullion recently bouncing off support at US$1310/ounce on January 27, 2010. Small cap gold companies through the BMO Junior Gold Index ETF (ZJG), is an alternative for investors looking for opportunities that have a higher sensitivity to gold bullion prices. For investors wishing to maintain only an equity exposure, we recommend investors consider the BMO Dow Jones Industrial Average Index ETF (ZDJ) given both its technical strength and attractive valuations relative to other major global market indices. (Price-to-earnings ratio of 14.2x and dividend yield of 2.4%)

Auto sector to shoulder big chunk of GDP gains – Forget about the thriving oil patch, booming condo markets across the land or the arrival of the new RIM PlayBook next month: An old standard will give the Canadian economy a major boost in the first quarter – the auto industry.

As the industry recovers, the ripple effects of two companies gearing up to produce two new models in the manufacturing heartland of Southern Ontario are already being felt across the region.

Seeing the big picture with small-cap companies – Michael Decter is a Harvard-trained economist, a former backroom organizer for the New Democratic Party and a former public servant. That background isn’t typical for a Bay Street fund manager, but then neither are his recent returns. The secret of Mr. Decter’s success? A knack for aggressive trading, an emphasis on looking at the big picture, and a strong preference for Canadian stocks. “Canada is a great play on Asia” because of this country’s strength in commodities, says the 58-year-old chief executive officer of Toronto-based LDIC Inc., and author of Ten Good Reasons: Why now is the right time to invest in Canada, published in 2008. “The growth is not just China and India, but 44 Asian nations growing at over 8 per cent a year.” [Globe and Mail]

Threats

Strong Canada growth adds pressure for rate hike – Canada’s economy revved back to life in late 2010 after a period of lackluster growth, supporting expectations of official interest rate hikes by mid year and pushing the Canadian dollar to a three-year high.  [Reuters]

“All told, the last quarter of the year erased the disappointment of a sluggish summer, and points to a healthy start to the new year,” said CIBC World Markets chief economist Avery Shenfeld. “Look for a more hawkish line from the Bank of Canada tomorrow that sets the stage for a rate hike in [the second quarter]. Bearish for bonds, bullish for the [Canadian dollar].” [Globe and Mail]

Tags: 4th Quarter, Avera, BMO, Canadian Market, Cheat Sheet, China, CIBC, Commodities, Consumer Spending, Economic Growth Rate, Employees Retirement System, energy, ETF, ETFs, Federal Statistics, Global Financial Markets, Globe And Mail, Gold, Gross Domestic Product, Household Debt, India, Net Assets, oil, Ontario Municipal Employees, Ontario Municipal Employees Retirement System, Pension Fund, Pension Funds, Personal Wealth, Saving Money, Spendthrift, Statistics Canada, Tavia, Week Ending February
Posted in Canadian Market, Commodities, Credit Markets, Energy & Natural Resources, ETFs, Gold, India, Markets, Oil and Gas | Comments Off

The ‘Crude’ Reality of Unrest

Monday, February 28th, 2011

The ‘Crude’ Reality of Unrest

by David Andrews, CFA-Director, Investment Management and Research, Richardson GMP

Investor sentiment turned decidedly more cautious this week with major North American indexes retreating amid the growing pro-democracy movement in the Arab world. Following the mostly peaceful demonstrations in Tunisia and Egypt, the pro-democracy rallies in Libya turned ugly as protesters were met with a stiff and inhumane response from pro-Gaddafi supporters. Mercenaries and Militia were reportedly firing on unarmed crowds amidst the incoherent ramblings of embattled leader, Muammar Gaddafi. Gaddafi went so far to suggest the protesters were being drugged and under the influence of Al Qaeda. The unstable situation saw the price of Brent crude oil surge to 2-1/2 year highs near $120 a barrel.

As a result, Canadian commuters felt the sting at the gasoline pumps this week as prices seemed to increase a few cents a litre each night. Stock market investors also felt the pinch with the TSX slipping below the recently attained 14,000 level. Three consecutive down sessions on the holiday shortened week (Canadian and U.S. exchanges were closed Monday) were followed by a Friday reprieve as Saudi Arabia announced it would increase its crude oil production in an attempt to offset any global supply disruption from Libya. The influential Materials and Financial stocks surged and helped boost the index by 1.25% on the day and back above 14,000. For the week, the TSX lost a little more than half of one percent. The major U.S. indexes fell about 2 percent on the week as investors bet higher oil costs may unseat the early stages of the economic recovery.

Speaking of the economy, there were a few positive signs of things getting better with U.S. consumer confidence at 3 year highs in February despite higher food and fuel costs. U.S. weekly employment data also showed fewer Americans filed for jobless claims suggesting the employment situation is continuing the slow process of healing. If employment and confidence are a silver lining, housing continues to be the dark cloud. January new home sales were again below already depressed expectations. In Canada, retail sales in December fell but most of that was due to the auto sector. Ex autos, retail sales were up 0.6% which was expected.

IS Gold Set To Rally?

Despite the fact that Gold is trading near its record high, some suggest that Bullion will outperform Oil as surging inflation will underscore the metal’s role as an investment hedge. The chart to the left shows the price of both Gold and Oil since 2008. The chart below is the ratio of Gold to Oil, or how many barrels an ounce of gold will buy. At its peak in late 2008, an ounce of gold bought you about 28 barrels of crude oil. Currently, oneounce buys about 15 barrels. Notwithstanding OPEC’s spare production capacity, energy markets have priced in a considerable risk premium. If tensions ease and or production comes on stream, oil prices could drop rather quickly. Gold has fallen 1.6% this year following a 30% rally in 2010. Crude is up about 5% this year following last year’s 15% rise.

The Trading Week Ahead

Canadian stock market investors are expecting the rest of the Big Banks will be able to follow the solid start to bank earnings season set by CIBC and National Bank. Following a softer second half of 2010, the banks are poised to benefit from better market conditions for their retail and wholesale lending businesses. Investors looking for dividend increases will have to wait on National and Commerce but they may not have to wait on the others. Bank of Montreal reports Tuesday and is followed by TD and Royal on Thursday. (Scotia reports March 8th).

U.S. reporting season has concluded with another upbeat quarter and substantial positive earnings surprises. The biggest positive surprises were in the Materials sector where elevated commodity prices boosted the bottom line. Consumer goods, specifically Automobiles, provided the biggest earnings disappointment in the fourth quarter on the S&P500.

The economic calendar will likely continue with the theme of improving consumer and business confidence but scant signs of improvement in the U.S. housing market. Pending homes sales in January are expected to once again come in lower. The February employment report is released on Friday. For the past three months we have overlooked disappointing results and explained them away by bad weather. We did not have weather issues of significance this month so the non farm payrolls on Friday could be significant.

Commodities prices, specifically oil & gold, will be influenced by the evolving and volatile demonstrations in the Middle East and North Africa. Risk premiums for both oil and gold remain rather elevated helping to push the loonie higher. Watch for no move in policy by the Bank of Canada on Tuesday, but the wording of the statement will be scrutinized for signs of their next move likely around mid 2011.

Copyright (c) Richardson GMP

Tags: Brent Crude Oil, Canadian Market, CIBC, Commodities, Consumer Confidence, Crude Oil Production, Democracy Movement, Employment Data, Employment Situation, energy, financial stocks, Food And Fuel, Gasoline Pumps, Global Supply, Gold, Incoherent Ramblings, Investor Sentiment, Jobless Claims, Muammar Gaddafi, oil, Oil Costs, Peaceful Demonstrations, Positive Signs, Silver, Stock Market Investors, Supply Disruption, Unstable Situation
Posted in Canadian Market, Commodities, Energy & Natural Resources, Gold, Markets, Oil and Gas, Silver | Comments Off

Sentiment Moderates as Market Finds Some Footing

Monday, February 28th, 2011

The comments below were provided by Kevin Lane of Fusion IQ.

The markets found their footing a bit late late last week after three days of selling.  The stabilization occurred in and around key moving averages (the 50-day on the NASDAQ and the 40-day on the S&P 500).  Two factors we noted during this recent run-up still persist; investor fund flows continue to find their way into equity markets and anecdotal sentiment is still doubting and not embracing this rally. That said, measured sentiment also has moderated as seen in the chart below from the American Association of Individual Investors (AAII), which shows bulls have fallen from north of 60% to 36% as of yesterday. It’s hard to have big corrections when liquidity flows are in and sentiment remains skeptical. While logically it may make sense that the markets need to correct, I found out a long time ago, and the hard way, that markets don’t care what we think. Rather they march to their own drums and most times the obvious and logical trade is the wrong trade.

Additionally, markets only correct when trading successes seduce investors into thinking the game is easy and they have it all figured out. This overconfidence lends itself to over-commitment on the long side via leverage, until investors exhaust their buying power. Markets don’t go down when everyone is sourcing for short trades or when the loudest voices in the crowd are the skeptics. Moreover, it also takes persistent distribution to turn the tide from up to down and, other than Tuesday, so far the sellers have only been a one-act (one-day) show.

For now, as uncomfortable as it may be for some, the trade is still up. It you are fully invested and with positions that are significantly lower in cost basis, then firstly, congratulations, and secondly, sit just back and relax.  For those who fit the former description your job at this point is to make sure you have good trailing stops or hedges in place for when the correction does unfold.

The greater risk awaits those who are underinvested (or net short) and adding new positions with at the money or slightly in or out of the money cost basis.  We say there is more risk simply because the S&P 500 is up 24% from the August 2010 lows, just a mere six months ago. As legendary hedge fund manager David Tepper of Appaloosa stated on CNBC just a few weeks ago, any time the market has a big rise there is simply more inherent risk because prices get more expensive.

So, for the latter group of investors, the trick is simple; keep searching for setups on new money positions that have good upside potential (however you measure that, i.e. fundamentally derived targets, point and figure objectives or the next overhead resistance levels) but with limited drawdown risk (i.e. the difference between cost and stop loss/exit point).

Now that we have talked strategy a bit, let’s take a look at some of the markets’ technical levels. As seen below, the S&P 500 found support in the 1,302 to 1,295 support area (red lines). This level also coincided with the index’s up-trend line (green line). Any close below yesterday’s low would open up risk to the next downside support near 1,270.

As seen below, the transports had much more damage done on the sell-off than broader markets, by scoring a false breakout above their previous peak only to rapidly fall back below (purple line) the previous peak.  Subsequently the transports dropped below 5,000 and bounced off support in the 4,960 to 4,910 area (red dotted lines). At this point we view the weakness in the transports as an inverse trade to the rise in crude and  not a buckling economy. Either way, any drop below this recent support level would be a negative on the transports.

To wrap up our mid-morning missive, the trend is up until proven otherwise and a few % points sell-down from the highs are not proof enough to get your bear claws out yet. Before we do that we first need to see how the indices regroup from the recent sell-off and whether they can muster news highs or fail to do so. Then we would need to see a few days of distribution like Tuesday but only with more frequency and persistence.

To use an analogy, when hunting big game it’s better to travel in a pack than be a lone wolf and right now the lone wolf is the one searching for a top.  Wait for more evidence to appear before turning negative and only join the hunt when the pack (the sellers) are in full force.  If you deviate from the strategy you will continually get nicked.

Source: Kevin Lane, Fusion IQ, February 25, 2011.

Tags: Aaii, Act One, American Association Of Individual Investors, Bulls, cost basis, Drums, Footing, Hedges, Iq, Leverage, liquidity, Moving Averages, Nasdaq, Overconfidence, Power Markets, Sentiment, Skeptics, Successes, Trailing Stops, Voices
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Cash and Credit – Implications for the Financial Markets

Monday, February 28th, 2011

by John P. Hussman, Ph.D., Hussman Funds

Last week, the S&P 500 pulled back by less than 2% – certainly not sufficient to clear the overvalued, overbought, overbullish, rising-yields syndrome that we observe in the market, but enough to bring our estimate of S&P 500 10-year total returns from an expected 3.06% to an expected 3.25%.

From the standpoint of prospective investment returns, it is important to recognize that the main effect of quantitative easing has been to suppress the expected return on virtually all classes of investment to unusually weak levels. It’s widely believed that somehow, QE2 has created all sorts of liquidity that is “sloshing” around the economy and “trying to find a home” in stocks, commodities, and other investments. But this is not how equilibrium works.

Here’s how equilibrium does work. Every security that is issued has to be held by someone, in precisely the form in which it was created, until that security is retired. Period. That means that if the Fed creates $2.4 trillion in currency and bank reserves, somebody has to hold that money, in that form, until those liabilities are retired. The money ultimately can’t go anywhere. If someone tries to get rid of their cash in order to buy stock, somebody else has to give up the stock and hold the cash. In the end, every share of stock that has been issued has to be held by somebody. Every money market security that has been issued has to be held by somebody. Every dollar bill that has been created has to be held by somebody. None of these instruments somehow “find a home” by going somewhere else or becoming something else. They are home.

Let me be clear – the additional monetary base created by the Fed certainly is “liquidity” from the standpoint of the banking system, and does amount to funding the U.S. deficit by printing money, until and unless the transactions are reversed. As I’ve noted previously, at what is approaching 16 cents of base money per dollar of GDP, there will also be significant inflationary risk in the event of even modest upward pressure on short term interest rates. The point, however, is that it is incoherent to say that this “cash on the sidelines” will somehow find a home in some other financial market, or anywhere else in a manner that makes it vanish from “the sidelines” – until it is explicitly retired by the Fed.

So what is the effect of creating an extra $600 billion dollars of monetary base by having the Fed purchase $600 billion dollars of Treasury debt? The same thing that happens anytime any security is issued. Somebody has to hold it, and the returns on all other assets have to shift by just enough to make everyone in the economy happy, at the margin, to hold the outstanding quantity of all of the securities that have been issued. In practice, the only way you can get people to willingly hold $2.4 trillion in non-interest bearing cash is to depress the return on all close substitutes to next to zero. So short-term Treasury bill yields have been pressed to nearly nothing.

Of course, people also look at risky assets and ask whether they might be able to get higher risk-adjusted returns by holding those instead. In order to make people happy to hold the outstanding quantity of zero return cash, the prospective returns on other risky securities have also collapsed (securities are a claim to future cash flows – as investors pay a higher price, they implicitly agree to accept a lower long-term return). In my view, this has gone on to an extent far beyond what is likely to be sustained, but thanks to eager speculation, the S&P 500 is now priced, by our estimates, to achieve annual returns of just 3.25% over the coming decade.

Likewise, all of those securities yielding zero or nearly zero returns have to compete with commodities. Here, the markets have responded to the massive deficits of world governments by increasing their expectations regarding inflation. Now, if you’re looking at a zero nominal return on money-market instruments, as well as expected inflation over time, it’s natural to start hoarding commodities. See, if you expect your dollars to buy fewer goods and services in the future, and you’re not earning interest to make up for it, you’d prefer to stockpile goods right now. This, of course, has created terrible problems for people in less-developed countries, who are experiencing soaring prices for food and fuel, but commodity hoarding was a predictable outcome of QE2.

The real question is how high commodity prices have to rise until people are indifferent between holding non-interest bearing cash, and commodities that are elevated in price. The basic answer is that commodity prices have had to “overshoot” the expected future level of broad consumer prices by enough that both cash and commodities can now be expected to suffer a negative real return as measured against a broad basket of consumer goods. This sort of overshoot is necessary to make people indifferent between holding one versus another, and it restores equilibrium in the face of the negative real return available on money market securities. As with stock prices, I believe that this has already gone too far, but the civil unrest in the Middle East has certainly worsened the situation over the short-term.

This is a critical point – commodity prices tend to swing by a much greater amount than consumer prices. You can easily get periods where general consumer prices are advancing, yet commodities prices are advancing slower or even falling. In my view, QE2 has provoked an “overshooting” advance in commodities prices, which has been necessary because the Fed is holding real interest rates at negative levels. In the face of moderately higher consumer price inflation, coupled with short-term interest rates at zero, the only way to get people to be comfortable holding that much cash is to make the prospective returns on every possible alternative just as bad.

If investors don’t understand that this is how QE2 is “working,” they are likely to be as blindsided by the coming decade of weak investment returns as they’ve been over the past decade. It’s notable that the weak returns achieved by the S&P 500 over the past decade were predictable, and our estimates of projected total returns have remained quite accurate in recent years. It bears repeating that our difficulty in 2009 was not that we viewed stocks as overvalued, but that we were forced to contemplate data from periods other than the post-war period, which had generally required much more stringent criteria for accepting market risk. At the 2009 lows, stocks were priced to achieve 10-year total returns in excess of 10% annually by our estimates. The problem is that similar expected returns were not sufficient to end prior declines during much lesser crises even in post-war data.

As for the Depression, stocks were priced to achieve negative 10-year returns, by our estimates, at the 1929 peak. After losing half their value, stocks were priced to achieve 10-year returns in excess of 10%. From there, stock prices dropped by an additional two-thirds before bottoming.

Whatever value was available at the 2009 lows is long gone. Our miss in 2009 was emphatically not the result of inaccurate valuation estimates – it was the result of having to contemplate data outside of the post-war period. I’ve extensively discussed the adjustments we’ve made (see recent commentaries as well as our semi-annual report). Still, there is nothing in recent data, nor long-term historical data, that creates meaningful doubt for us that stocks are priced to achieve bitterly small returns over the coming decade.

As it happened, much of the 10-year prospective returns that were priced into stocks at the 2009 low have been compressed into the advance since then. For long-term investors, there is now a great deal of risk with not much prospective return to compensate them at current prices. There will still be periods warranting at least a moderate exposure to market fluctuations based on shorter-term considerations, but with the market still characterized by an overvalued, overbought, overbullish, rising-yields syndrome, now is not one of them.

Savings, Investment and Credit Market Debt

Having discussed QE2, let’s move on to the broader subject of “credit.” Here also, there is a lot of confusion about how credit creation is related to real economic activity. My hope is that the following discussion will clarify some of these relationships. As usual, the best way to evaluate the merit of somebody’s analysis is if they show you the data, so I’ll also show you the data.

Let’s start by considering an economy that produces 100 units of output. 80 are consumed, and 20 are saved as “investment goods” to increase the ability of the economy to produce more output in the future. On the “income” side, those 20 units would be considered to be “savings.” On the “output” side, those 20 units would be classified as “investment.”

Tags: All Sorts, Bank Reserves, Banking System, Base Money, Commodities, Credit Implications, Dollar Bill, Equilibrium, Financial Markets, Hussman Funds, Investment Returns, Liabilities, liquidity, Monetary Base, Money Market, Printing Money, Quantitative Easing, Standpoint, Trillion, Trying To Find A Home
Posted in Commodities, Credit Markets, Markets | Comments Off

Charlie Maxwell: “We have enough oil.”

Monday, February 28th, 2011

This week on Wealthtrack Extra, Consuelo Mack talks to Charlie Maxwell, the “dean of energy analysts”. According to Maxwell, who is Weeden & Co.’s Senior Energy Analyst, OPEC had cut back oil production before the Middle East turmoil erupted and has about 5 million barrels a day of unused capacity that it could bring on stream in a month. He is not terribly concerned about a domino effect of insurrection spreading to the oil producing countries that he says really count, namely Saudi Arabia, Kuwait, Iraq and Iran.

Maxwell also shares his investment recommendations.

Note: The transcript of this interview is not available yet, but will be posted here as soon as it arrives.

Source: Wealthtrack Extra, February 25, 2011.

Tags: Stocks
Posted in Energy & Natural Resources, Markets, Oil and Gas | Comments Off

GDP: Nothing Is Ever As It Seems

Monday, February 28th, 2011

This article originally appeared on The Daily Capitalist

The revised real GDP numbers for Q4 2010 were a disappointment for most economists who foresaw the third and fourth quarters to be much higher. The BEA’s advance report last month said GDP was up 3.2%. The new numbers show it was only up 2.8%. As I anticipated in my article on the advance report, I expected the numbers to be revised downward and they were. These facts fit into my thesis that we are headed into stagflation.

First, the details. The consensus Q4 estimate of economists was that GDP would be +3.4%. From the BLS release:

The increase in real GDP in the fourth quarter primarily reflected positive contributions from personal consumption expenditures (PCE), exports, and nonresidential fixed investment that were partly offset by negative contributions from private inventory investment [see this on durable goods orders] and state and local government spending [this has to be a positive].

Imports decreased which are a subtraction in the calculation of GDP.  The small fourth-quarter acceleration in real GDP primarily reflected a sharp downturn in imports, an acceleration in PCE, an upturn in residential fixed investment, and an acceleration in exports that were mostly offset by downturns in private inventory investment and in federal government spending, a deceleration in nonresidential fixed investment, and a downturn in state and local government spending.

Final sales of computers added 0.30 percentage point to the fourth-quarter change in real GDP after adding 0.29 percentage point to the third-quarter change.  Motor vehicle output subtracted 0.31 percentage point from the fourth-quarter change in real GDP after adding 0.49 percentage point to the third-quarter change.

For the entire year of 2010:

Real GDP increased 2.8 percent in 2010 (that is, from the 2009 annual level to the 2010 annual level), in contrast to a decrease of 2.6 percent in 2009.  The increase in real GDP in 2010 primarily reflected positive contributions from private inventory investment, exports, PCE, nonresidential fixed investment, and federal government spending.  Imports, which are a subtraction in the calculation of GDP, decreased [-12.4%].  The upturn in real GDP primarily reflected upturns in exports, in nonresidential fixed investment, in PCE, and in private inventory investment and a smaller decrease in residential fixed investment that were partly offset by an upturn in imports.

Prices as measured by the GDP Price Index continued their climb:

The price index for gross domestic purchases, which measures prices paid by U.S. residents, increased 2.1 percent in the fourth quarter, the same increase as in the advance estimate; this index increased 0.7 percent in the third quarter.  Excluding food and energy prices, the price index for gross domestic purchases increased 1.2 percent in the fourth quarter, compared with an increase of 0.4 percent in the third.

The price index for gross domestic purchases increased 1.3 percent in 2010, in contrast to a decrease of 0.2 percent in 2009.  Current-dollar GDP increased 3.8 percent, or $538.8 billion, in 2010.  In contrast, current-dollar GDP decreased 1.7 percent, or $250.1 billion, in 2009.

Just looking at spending measures, you can see the impact of the drop in imports. While real person consumption expenditures (domestic goods only) were up 4.1% in Q4 (versus 2.4% in Q3), real gross domestic purchases — purchases by U.S. residents of goods and services wherever produced — decreased 0.6% in Q4, in contrast to an increase of 4.2% in Q3.

If you need charts to see the stagflationary trend, here:

These charts show a flattening of output and a steady increase in prices. One might ask, with all of the monetary and fiscal stimulus efforts by the Fed and the Administration, why is output flattening out while prices are increasing? The quick answer is that their policies have failed, notwithstanding their protests to the contrary (“Yeah, but things would have been much worse … blah, blah, blah.”).

Is this a trend? I believe so. As I said in my article on the first release:

The bottom line is that we are seeing monetary inflation and it is impacting prices. Real savings is still in short supply and that is inhibiting growth. Spending will not revive the economy, but an inflated money supply will give the impression of economic improvement, but it will be an ephemera. It will further negatively impact real savings. I would expect weaker GDP numbers in Q1 2011 (wait until the revised Q4 come out to see if I’m right). Unemployment will remain high. This is a recipe for stagflation.

There is a new wrinkle in this forecast: oil.

As David Rosenberg said Thursday, rising oil prices reflect a “geopolitical risk premium” which is why bonds jumped this week:

Rosenberg pointed out what is going through the minds of oil traders:

It is estimated that as much as 1 mbd of output has been taken out of the system from the Libya crisis and the outsized move in the oil price is testament to the view of just how tight the global supply-demand backdrop has been. Imagine where the price would be if it weren’t for the spare capacity out of Saudi Arabia. Analysts at Nomura are saying $220 a barrel is achievable if more production is halted in Libya and Algeria. …

Saudi Arabia has the capacity to fill the void left by Libya, but that misses the point. The risk of further unrest is rising, especially with sectarian issues in full force in Bahrain. This means that oil prices at a minimum will retain a geopolitical risk premium — most oil experts now peg this at $10-$15 a barrel. If countries start to stockpile more crude in light of current events, one can expect the oil price premium to rise even further even if the situation calms down overseas. So no matter what, barring a sudden downturn in demand, and the one thing about oil (food too) is that demand is relatively inelastic over the near term, the risk is that we will see further increases in the price of crude even from current lofty levels.

Friday on Bloomberg TV, Rosenberg said he sees rising oil and food prices taking 1% off GDP. He said that 2 of the 3 times that oil and food went up together resulted in a recession. It didn’t happen in 1996, he says, because of the forces of the tech boom.

It all depends, as they say. The issue is: how long will political roiling in the Middle East continue? ¿Quien sabe? My point is that we will see stagflation regardless of oil. As I pointed out in “A Note on Inflation: It’s Here,” the forces of inflation are already in motion and its effects are starting to show up, one of which is price inflation.

Again, we need to be mindful of what is “inflation:” it is always an increase in money supply. One of the effects of inflation is price increases. Other effects, even more serious, include the destruction of real capital (that is, capital saved from production or labor, not from printing fiat money). The destruction of real capital accompanying inflation is the only explanation for stagflation.

The result of an oil shock will add to our economic woes, compounding the recessionary side of stagflation.

There has been a lot of buzz about stagflation in the mainstream media lately. Most economists pooh-pooh the idea. The reason is that they don’t understand inflation, mostly confusing price increases as a cause of something bad rather than aneffect of something bad.

Mr. Rosenberg is one of those who make this mistake. He points to low wages and low capacity utilization as the reason why we can’t have stagflation. Unfortunately that wasn’t the case in the late ’70s and early ’80s. (See this chart showing low cap/u and high inflation at the same time.) Other economists like this fellow have entirely no understanding of the issue:

“The old way of thinking used to be that you’d have a jump in crude-oil prices, leading to an increase in inflationary expectations, and that would push the long end of the yield curve higher,” said Howard Simons, strategist at Bianco Research near Chicago. “Nice theory, but it hasn’t worked over the last 10 or so years.”

The thing I want to leave you with is Fed Vice-Chair Janet Yellen. Ms. Yellen gave a speech Thursday on improving the Fed’s communications and thus our expectations of what the Fed will do. This is the Blah, Blah Theory of economics. The bottom line is that she and the Fed believe they can “jaw” their way to a better economy. By telling us that they are going to continue to be “accommodative” (i.e., “print” money) we will believe them and lend and buy and things will magically improve.

Don’t believe a word she says. This is the arrogance of a central planner talking, believing that she and her co-workers control the economy. Pull a lever here and there, and voila! things are all better. The econometrician’s dream.

I can tell you with some certainty that if things get worse, and if unemployment stays high, which is what I believe is happening, they will panic and pull out all the stops.

Copyright (c) The Daily Capitalist

Tags: Acceleration, Advance Report, Deceleration, Downturn, Durable Goods Orders, energy, Fourth Quarter, GDP, government spending, Inventory Investment, Negative Contributions, New Numbers, oil, Percentage Point, Personal Consumption Expenditures, Private Inventory, Q4, Real Gdp, stagflation, State And Local Government, Subtraction, Upturn
Posted in Energy & Natural Resources, Markets, Oil and Gas | Comments Off

12 Countries Most Likely to go Belly Up

Monday, February 28th, 2011

This post is a guest contribution by Dian Chu, market analyst, trader and author of the Economic Forecasts and Opinions blog.

Risk analysis firm Maplecroft just released its new fiscal risk index ranking of 163 countries. Europe trumps all other regions with 11 out of twelve countries rated as “extreme risk.” However, quite surprisingly, only one PIIGS country–Italy which takes the top spot–is in the top 12.

The others include many big economies in Europe – Belgium (2), France (3), Sweden (4), Germany (5), Hungary (6), Denmark (7), Austria (8), United Kingdom (10), Finland (11) and Greece (12). Japan at No. 9 is the only other country not in Europe within the highest risk category (See map below).

Aging Demographics
While high national debt and public spending are two common denominators, the study finds it is the aging demographics that puts these countries at extreme fiscal risk. An aging population will place increasing pressure on public expenditure such as pension and health care, while a shrinking working-age population means less productivity and less tax revenues to support public spending and debt payments.

High Dependency Ratio
Aging population also means high dependency ratio, or the number of people 65 and older to every 100 people of traditional working ages. For example, according to Maplecroft, the dependency ratio in France is 1 to 47 (i.e. 47%), Germany at 59%, Italy with 62%, and Japan at the very top with 74%, while the ratio in UK is currently 25%, and is forecast to rise to 38% by 2050.

Low Senior Labor Participation Rate
Another problem within Europe is that it has a low labor participation rate in the 65+ age bracket. In fact, the labor market participation of age 65+ amongst the ‘extreme risk’ nations range from 1.4% in France, 7.71% in UK, to 11.7% in Sweden, vs. a 28% average across all countries ranked in the index.

Maplecroft cited pensions and discrimination as two examples that would push people away from the work force.

U.S. – High Fiscal Risk
Although the United States is not ranked among the “extreme fiscal risk,” the nation is nevertheless classified as “high risk”, along with Spain, another PIIGS country, Turkey, Iraq, Australia, Canada and Russia.

Let’s take a look at the two metrics mentioned here.

The dependency ratio in the U.S. is 22 in 2010, but is projected to climb rapidly to 35 in 2030, according to the U.S. Census Bureau, mainly due to baby boomers moving up into the 65+ age bracket. The ratio then will rise more slowly to 37 in 2050.

The labor participation for age 65 and over in the U.S. is at 17.5 according to data at Bureau of Labor Statistics (BLS). This is better than most of the European countries, but below the overall average of 28%.

U.S. in Wave 2
Most people typically associate a country’s fiscal risk to its government’s monetary and fiscal policies, and Lehman Brothers has taught us that banking and housing crisis could push the entire world into the Great Recession.

While these are all definite risk factors, a highly productive labor force and relatively young population makeup tend to ensure more sustainable prosperity and better odds at climbing out of a hole.

The Maplecroft study concludes:

“…in high risk countries, it is increasingly likely that the private sector will be called upon to contribute in the form of pensions and private health care…. Without significant adjustments, such as raising taxes or reducing spending, countries risk going bankrupt.”

So, while Europe is being forced to do all that amid sovereign debt crisis in the middle of widespread protests over raised pension age and austerity measures, the U.S. and other “high fiscal risk” countries seem be set up as the wave 2 of this global fiscal chain of events.

Source: Dian Chu, Economic Forecasts and Opinions, February 25 2011.

Tags: Age Bracket, Age Population, Aging Population, Canadian Market, Common Denominators, Debt Payments, Dependency Ratio, Dian, Economic Forecasts, Europe Belgium, Extreme Risk, France 3, Labor Market Participation, Labor Participation Rate, Market Analyst, National Debt, Public Expenditure, Public Spending, Risk Analysis, Risk Category, Risk Index, Russia
Posted in Canadian Market, Markets | 2 Comments »

Booming Global Auto Market Good For Many

Sunday, February 27th, 2011

Booming Global Auto Market Good For Many

By Frank Holmes and John Derrick

Perhaps no industry has experienced a stronger recovery from the depths of the recession than the global automobile industry. Around the world, cars are rolling off the lot at a pace not seen in years. Global car ownership is expected to rise 17 percent over the next five years, according to data from J.D. Power.

In the U.S., an improving job market is giving consumers confidence to purchase big-ticket items such as automobiles. A recent survey from the Conference Board shows a record number of people (13 percent) are looking to purchase a vehicle in the next six months. That’s triple the amount of a year ago and the highest in more than a decade.

In China, the auto sector is really heating up. January total vehicles sales were up 13.8 percent on a year-over-year basis to 1.89 million vehicles, the highest monthly total on record, according to ISI Group. The firm is forecasting total sales of 20.5 million units this year, up nearly 900 percent since 2000. By 2015, ISI estimates annual sales will total 30 million units.

Two things really stand out from the rise: 1) vehicle sales rose despite a rollback in government subsidies, and 2) passenger vehicles drove sales. ISI says that “persistent double-digit per capita real income growth is creating a ‘car culture’ in China.”

While thriving, the car culture is China is still in its infancy. Currently, there are roughly 3.5 vehicles owned for every 100 Chinese citizens. However, that figure is very low compared to other countries with similar levels of GDP per capita.

You can see from this chart from Main First Bank that China and Thailand have relatively similar levels of GDP per capita, but the rate of vehicle ownership in China is significantly lower. If China were to catch up with the trend of other countries, the ratio would roughly be 10 vehicles for every 100 people. The same can be said for other countries where incomes are rising such as Turkey and India.

When you spot such a powerful trend, it’s important to look for the inter-market relationships. The demand for new automobiles is generating increased demand for auto supplies such as batteries, tires, sensors, aluminum and electronics. It is also driving demand for oil through gasoline and diesel consumption.

The infrastructure needed to handle all these vehicles is also in great demand. Roads and bridges need to be built and congested streets and highways need to be expanded and widened, driving demand for cement and steel.

The stage is set for a booming global auto market over the next several years. This could be a driver for the entire supply chain from basic commodities to high-end components.

Frank Holmes is CEO and chief investment officer for U.S. Global Investors. John Derrick serves as director of research for U.S. Global Investors.

Tags: Auto Market, Auto Sector, Automobile Industry, Big Ticket Items, Car Culture, Car Ownership, China, Chinese Citizens, Commodities, Frank Holmes, Gdp Per Capita, Global Auto, Global Car, Gold, Government Subsidies, Inco, India, Infrastructure, Isi Group, J D Power, John Derrick, Million Vehicles, Next Five Years, oil, Passenger Vehicles, World Cars
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All-Canada, All-the-Time, Part II

Sunday, February 27th, 2011

All-Canada All-the-Time Part IIPrint

Posted on February 25, 2011

By Tom Bradley

As an addendum to my post last week (Risk-free? Be Careful What You Wish For), I want to revisit the words safe and Canada.

An excellent reason for investing in Canada is that it’s a safe(r) way to play the emerging markets, specifically China. Our resource stocks in particular will benefit from China’s unquenchable thirst for raw materials.

Why is Canada a safer way to play China? The argument is that:

• Our capital markets are well regulated.
• Corporate governance is best of class.
• Market transparency and corporate disclosure are good.
• And in general, our companies are well funded, or at least have ready access to capital.

All of this is true and Canada may continue to be an effective way to play China, but whether it proves to be safer or not is yet to be seen. I say that because resource stocks are the most volatile way to play any economic trend. Commodity prices are unpredictable, highly cyclical and cannot be controlled by company management. And relying on one big customer is always a risky strategy (as we’ve seen in the past, China can turn the tap on and off without notice).

The key point here (and in my previous column) is that holding a portfolio that is all-Canada all-the-time may be a safe(r) way to play the emerging markets, but it’s not a safe strategy per se. Having exposure to the world’s growing economies is a key piece of any investment strategy, especially with the developed countries being growth challenged, but it’s a more volatile piece and needs to be apportioned accordingly.

Tags: Addendum, Canadian Market, Capital Markets, China, Commodity Prices, Company Management, Corporate Disclosure, Corporate Governance, Developed Countries, Economic Trend, Emerging Markets, Investing In Canada, Investment Strategy, Key Point, Market Transparency, Raw Materials, Resource Stocks, Risky Strategy, Tap, Tom Bradley, Unquenchable Thirst
Posted in Canadian Market, Markets | Comments Off