The European Crisis Cycle: Hope, Relief… And Always Disappointment

Monday, July 9th, 2012

By now we can only hope (pun intended) that everyone has seen the David Einhorn chart showing the circularity of the European “summit-based” decisionmaking process – somewhat relevant since we have had 21 summits since 2008 and Europe has never been in a condition quite as bad as last week when a historic move by the ECB to lower the deposit rate to zero and the refi rate below the critical threshold of 1.00%… and nothing happened (that’s not quite true: JPM, Goldman and Blackrock all made it quite clear European money markets are now officially dead).

Of course, the chart above can be applied not only to Europe in its current predicament, but to any Keynesian-based “resoution” which attempts to solve debt with more debt: initial improvement, only for the euphoria to fade once the realization that total leverage in the system has increased, actual cash flow has remained flat at best, or likely declined as none was used to generate incremental revenue, while the amount of eligible collateral for future use has decreased, until one day the debt-creation machinery grinds to a halt.

However, as the following empirical analysis from Credit Suisse shows, the “Einhorn” chart is not just a conversation piece at cocktail parties: there is an actual trade pattern which has made traders lots of money, and which makes Eurocrats the best friends of not only Belgian caterers, but short-sellers everywhere: go long into a summit when the clueless algos read headlines and send risk soaring, only to short the inevitable fizzles days if not hours later.

Once the chart above is updated for the most recent failed June 28-29 summit, we will make sure it is reflected empirically (primarily as a convenience for all those who think they can time the bottom in Spanish bonds just right… just like all those who said that Greek bonds yielding 100% was the absolute bottom, until they hit 1000% 3 months later of course).

So… all those hoping to make a quick buck shorting circular European stupidity have just one question: when is the next summit?

Tags: Blackrock, Circularity, Cocktail Parties, Conversation Piece, Credit Suisse, Critical Threshold, David Einhorn, ECB, Eligible Collateral, Empirical Analysis, European Money, European Summit, Greek Bonds, Incremental Revenue, Initial Improvement, Lots Of Money, Money Markets, Predicament, Short Sellers, Thos
Posted in Markets | Comments Off

Between Negative Interest Rates and Record Yields (Credit Suisse)

Monday, June 11th, 2012

by Credit Suisse

08.06.2012

While yields on 10 year Greek bonds have risen above 30 percent, yields on short maturity German bonds were temporarily negative. In the midst of market oscillations, new investment opportunities arise, says Robert Parker, Head of the Strategic Advisory Group at Credit Suisse.

(click on image for video coverage)

Cushla Sherlock: Many investors seem to be between a rock and a hard place. What themes can provide more sustainable performance?

Bob Parker: Since march we’ve seen investors de-risk their portfolios: cash levels have increased. And most notably there has been a significant capital flow into G4 government bond markets, which is why we have historically low yields in 10-year US treasury bonds and 10-year bunds, as well as in the UK gilt market and Japanese government bonds.

What worries investors? They are concerned about the eurozone crisis and worried about contagion risk if Greece leaves the euro. Even more so, they are worried about bank risk in Europe and particularly the problems of bad debt ratios in the Spanish banks. Outside Europe there are justifiable investor concerns about a slowdown in the US, and recently – particularly since April – we have seen weaker economic data out of emerging economies.

Does this unfolding phase of volatility in Europe create an opportunity to enter stock and credit markets on dips?

The case for being in European bonds is very weak. If, for example, you go into German government bonds with these historically low yield levels you’re not being rewarded for taking that risk. Recently, short maturity German bonds were yielding zero even negative for a few days. Conversely, if you go into very high risk areas, like Greek bonds, they do yield 30 percent for 10 years but obviously the risks of a Greek exit are profound.

Elsewhere in Europe there is still a case for being in high-dividend northern European companies. One opportunity is that the weakness in the euro – we have now come down on euro/dollar to around 1.25 – is a strong positive for German and other northern European export companies: capital goods companies which pay high dividends and are underleveraged. Therefore in European equity markets there are obviously opportunities. One key question, however, is what happens if the European Union and the ECB take strong action to defend the eurozone? If we get a further round of long-term refinancing operations (LTRO) from the ECB, which is likely and could be up to a trillion euro, then we will see a bounce in European markets.

How does the second half of 2012 look, compared with the second half of 2011?

Assuming that we will see moderate growth in the US for the second half of the year at just under 2 percent and that China has a soft landing, with close to 7-7.5 percent growth, and assuming that the Brazilian government will be successful in kick starting its economy, we could see some recovery. It is critical that we get a raft of measures to fix – even temporarily – the eurozone problem. The right strategy in fixed income is to continue focusing on corporate bonds and emerging debt.

The defensive strategy in global equity markets has been the right one for the last 2.5 or 3 months, but as we go into July a more aggressive position can be taken – particularly if action is taken by the Europeans. I would barbell that position, focusing on north American and northern European large-cap capital goods, high-dividend companies but then take risk into emerging markets, notably China and Brazil. These markets are cheap, under-owned by investors and the authorities are easing monetary policy. Overall, an increase in risk appetite is probably the right strategy going into late July and certainly the third quarter.

Copyright © Credit Suisse

Tags: Bank Risk, Bob Parker, Capital Flow, Credit Suisse, Debt Ratios, German Bonds, Gilt Market, Government Bond Markets, Greek Bonds, High Dividend, Investor Concerns, Japanese Government Bonds, Negative Interest, Parker Head, Record Yields, Spanish Banks, Strategic Advisory Group, Sustainable Performance, Uk Gilt, Us Treasury Bonds
Posted in Markets | Comments Off

The Ten IPO Commandments

Friday, May 25th, 2012

Via Nic Colas of ConvergEx Group

There’s been a lot of hand-wringing about busted Initial Public Offerings of late, but the process itself is hardly rocket science.  Like Tolstoy’s comment about families, every “Happy” IPO is essentially the same, while every miserable one is different in its own way.  There are rules to the successful IPO, and today we offer up Nic Colas’ manual, a step-by-step checklist for investors to assess if an offering is on track.  From maintaining the illusion of scarcity to managing company and investor expectations, the road from salesforce “teach-in” to final pricing is narrow but well-marked.

I spent the better part of a decade as a senior U.S. equity research analyst at Credit Suisse in the 1990s, covering the auto and auto parts sector.  This was in many ways the heyday of the equity research function at large investment banks, largely because analysts were so deeply involved in capital markets transactions as well as mergers and acquisitions.  In my nine year run I did a variety of lead and co-managed Initial Public Offerings as well as secondary equity issuances for the likes of Chrysler, General Motors, Budget and Dollar Thrifty Rent-a-Car, Goodyear Tire, Ducati, as well as a variety of lesser-known auto aftermarket parts companies and foreign automakers and suppliers.

The process of raising capital in U.S. equity markets has changed very little in the last decade – far less than other parts of the market such as electronic trading.  Companies still choose bankers based on formalized pitch meetings with positioning and valuation discussions.  Analysts do play a smaller role at the front end of the process, but their buy-in is every bit as critical during the marketing of the deal.  And equity salesforces still have an important position in the workflow, pitching the investment merits of the company at hand to first get a meeting and then an order from a long-only or hedge fund client.  Issuing stock is still a basically a specialized house-to-house search for appropriate owners, setting market expectations for near term performance, and getting the equity story out in a consistent and accurate manner.

At the same time, mistakes still happen in even the most well established business processes, as we have seen over the past week.  No need to “Name names” here, because it is not the point of this note to rewarm the leftovers of an already well-publicized failure.  Rather, as I watched the drama unfold in all its can’t-look-away-from-the-car-accident glory, it occurred to me that the wounds of the past week were somewhat self-inflicted.  There are rules to doing an Initial Public Offering.  By and large, investment banks follow these “Commandments” to the letter.  But when they don’t, well, that’s when someone loses an eye.

As I reminisced about the various transactions I witnessed during the 1990s, I started to jot down what I realized are the unwritten, but critical, rules to a successful public offering.  They apply reasonably well to both IPOs and secondaries.  And – conveniently – there are ten of them.

Our “Ten IPO Commandments” are as follows:

1)      Create The Illusion of Scarcity.  The biggest challenge to a successful stock offering is to convince the base of buyers that there is much more demand than supply.  Raising the price range of an offering a good sign.  Increasing the number of shares is much more problematic and requires a “Measure twice, cut once” approach.  It is, after all, a signal that the sellers – who are almost always better informed than buyers – think the price of the offering is compellingly attractive versus their knowledge of the company and its prospects.
2)      Maintain a Consistent and Improving Narrative about the Business.  For an IPO, there is a fairly long window between when you FedEx the initial documents to the Securities and Exchange Commission and the pricing of the deal.  Months, in fact.  Investors’ initial contact with the company comes when they read that initial filing.  From that point on, they want to see and hear an improving story about the business and its prospects.  If that means keeping expectations and commentary about the business modest at first, so be it.  Trajectory is everything.
3)      Make Management Available To Investors.  Chairmen/women and Chief Executive Officers rarely achieve those positions without a healthy dose of self-esteem.  And they often bridle at being quizzed about their company by investors who know much less about the business than they do.  Fair enough, but it is part of the process and investment bankers need to deliver that message and get the most senior people to travel on the roadshow.  My most memorable experience with rocks-star management was Lee Iacocca, the former Chairman of Chrysler, and a bigger-than-life personality.  The key to making sure he was happy on the roadshow was to simply book the biggest hotel meeting space in all the major cities on the agenda.  We called him “Sinatra” and he enjoyed the nickname.  And he was happy to go anywhere and meet anyone after selling out the big rooms.  Investors appreciated that, and I believe they cut the company a lot more slack over time because they had seen Sinatra up close and personal.
4)      Talk to your fellow underwriters.  The best capital markets officers I worked with always maintained an open dialog with their fellow lead and co-manager counterparts.  More information about how the market hears a story is always helpful.  And yet certain investment banks have a reputation for keeping things very close to vest.  Caveat emptor there.
5)      Know Who is Buying.  “Building a book” is the tough part of any stock offering. How much is “Real” – legitimate orders from institutions who want to own the stock – and how much are “Flippers?” Sadly for many capital markets desks, buy-and-hold institutions now trade far less than faster-moving hedge funds.  As deals heat up, customers will try to leverage their importance to the day-to-day trading operation of the underwriters in return for better a allocation.
6)      The IPO is Just the “First Date.”  Many companies think of the IPO as the end of a long journey, which may have started in a dorm room or a garage and ended by ringing a buzzer or a bell.  But for investors, that sound is the beginning of their involvement with the company.  No matter how great the business model or convincing the management team might be, the goal posts have shifted.  Bottom line – as a company, want your IPO to work on day one, week one, and month one.  It will pay dividends when you come back to the capital markets.  And, trust me, you’ll be back.
7)      Know Who is Selling.  No matter how carefully constructed the deal book might be, some significant portion of the accounts will be sellers.  The underwriter needs to have a home for those shares (see Commandment #5).
8)      Retail Is Different.  Most equity offerings allocate 20-30% of the deal to what investment banks call “Retail.” This term connotes individual investors, but can also mean smaller institutions.  If the business is consumer-focused, it will be at the higher end of the range, since these buyers are thought to be customers as well.  And retail is considered “Sticky” money, less likely to sell into any initial stock price pop.  The relationship, however, cuts both ways. A poorly executed IPO stands the chance to alienate customers and damage the company’s brand.  All of which means retail-heavy stock offerings need to be especially well run.
9)      Bankers – Manage Your Client.  The best bankers I have worked with over my career had one thing in common: they established themselves as a financial expert with their clients and never let go of that position.  This is not an easy thing to do, but the reason bankers add value to the process of raising capital is not their ability to socialize or play golf or feign enthusiasm for a company in a pitch.  Their value is that they know more about the intersection of business analysis and capital markets than the clients they serve.  If the client comes to feel that they know more about the process than their bankers, and is allowed to act on that impulse, you can turn out the lights and head home.  The deal isn’t going to work.
10)   Don’t be Afraid to Walk Away.  This applies to both buyers and bankers alike.  The stock market in the U.S. is open from 9:30am to 4:00pm every day.  If you are unsure about the deal, you can still buy it the next day, or the next week, or the next month.  The illusion of scarcity is just that.

And for my hustling banker friends, a story to close out this note…

The most stressful 24 hours of my professional career occurred when I found out a company I was working to take public had inadvertently hired a senior person with falsified credentials.  I took the information to the head of equities, a tough as nails West Point grad.  He immediately called the head of the firm and said the deal was off unless the individual with the fake resume was removed from the transaction.  This was a courageous move, for the deal was extremely high profile and we were the lead manager.  No one argued.  I never saw the fellow again.  I think he is a potato farmer somewhere.

Tags: Auto Aftermarket, Automakers, Capital Markets Transactions, Colas, Credit Suisse, Electronic Trading, Equity Research Analyst, Goodyear Tire, Initial Public Offerings, Investment Banks, Investment Merits, Investor Expectations, Issuing Stock, Last Decade, Managing Company, Mergers And Acquisitions, Rocket Science, Secondary Equity, Step Checklist, Thrifty Rent A Car
Posted in Markets | Comments Off

The Good Life Comes at a Cost (Bill Mann)

Monday, April 23rd, 2012

There are plenty of ways to get ahead. The first is so basic I’m almost embarrassed to say it: spend less than you earn. – Paul Clitheroe

I am drafting this letter from a park in Paris. It is early on a Wednesday afternoon, and the park is full of families. Nearby, men gather to play boule, have a smoke, and enjoy a drink with friends. It is glorious. It’s a scene that is repeated throughout France and Western Europe (OK, replace the boules with something else depending on your country). It’s much less common in the United States. It is exceedingly rare in Asia.

According to a Credit Suisse study, in 1980 Europe accounted for as much as 35% of global GDP growth per year. This year it will be 12%. Yes, some of this is due to the advent of economic development in countries like South Korea, Brazil, and China, but the share of world GDP attributable to the U.S. has held much more stable. And keep in mind that at the same time, the debt levels of many European countries have soared, as has unemployment. This debt has purchased lots of things, but it has not been sufficient to keep Europe up to speed with the rest of the world in economic development. And generally speaking, debt must eventually be repaid, a process that removes economic capital from a system. That process is currently underway. In France in 2011, more than 10,000 businesses declared bankruptcy, while fewer than 600 were formed.

All your bras are belong to us

It’s not getting better, either. France has long been associated with sophisticated lingerie, but news that a bra factory in Yssingeaux, a small town in south-central France, will close in favor of outsourcing production to Tunisia has made women’s underwear both a symbol of everything wrong with the French economy and a touch point of the ongoing French election campaign. As one journalist put it bluntly: If France can no longer make bras and lace knickers, what can it make?

None of this is to dismiss the attractiveness of the European way of life. Let’s face it — if living is in itself a pursuit, then the Europeans are better at it than anyone. (Take a deep breath, Californians — it’s not even close.) Their cities are pleasant, their infrastructures mighty, their social structures extremely robust, their vivre full of joie. If I could figure out how to live in Europe but work in America, I’d do it. In a heartbeat.

But traveling back and forth between Europe, Asia, and the U.S. (which I’ve had the pleasure to do, all in the past month), I find the spectrum of the striving nature of Asian commercial activity to the languid attitude Europeans have toward hard work to be nothing short of amazing. Greece offers state employees a thirteenth month of pay. Paid maternity leave in Sweden can be as much as two years. A full work week in France is 36 hours.

Meanwhile in Korea, children attend intense cram schools, both after class and on weekends, preparing to take the standardized tests that determine how prestigious a college they can attend. Chinese workers endure long hours doing, in some cases, backbreaking work. Best of all, in country after country in Asia, systems are being put into place to help bring economic development to a wide portion of the populace. In Europe, they’re simply trying to minimize failure. A noble pursuit, indeed, but not particularly effective as a strategy to remain competitive.

The end of the story here is that the rapid growth of Asia and the stagnation of Europe seem to me to be outcomes of broader policy. It is not a sure thing that a society predicated on hard work will outperform one that has perfected the art of leisure, but that’s probably the best way to bet.

So where is America in all of this?

Both in Asia and in Europe I heard the same thing (which makes it so strange that I heard the opposite when I was in North Dakota): America is viewed by much of the world as having a nearly absurd amount of creative spirit, something that neither Europe nor Asia have been able to match.

And if you think about this, just focusing on three vectors — entertainment, technology, and brands — evidence suggests this is true. America has 5% of the world’s population, but an entrepreneurial capacity that is many times higher. In the past I’ve argued that American schools are much more effective than statistics would suggest, so I won’t rehash that here. But suffice it to say that America’s educational system does a really good job of educating high achievers. Now no politician could ever say such a thing without being accused of ignoring the needs of all American children. But the world is not looking to South Korea — the country with the highest average scores in math and science aptitude tests – for the next great creators of economic wealth; it’s looking to America. Ability at the mean to perform well on a standardized test and encouragement of entrepreneurial creativity are two very different educational pursuits. The scoreboard suggests we do the latter very, very well.
Over the past month the market has continued to soar higher as economic growth in the U.S. and a reduction of fears in Europe have convinced many investors that the water is indeed OK for risk assets. Where these people were several months ago when the stock markets were much weaker is beyond me, but there you go. The problem, of course, is that the absence of fear of risk is far different than the absence of risk. European politicians seem to believe that things are improving (and they are), and that they have done all that they can (they have not) to solve the myriad problems Europe faces. In the last week of March, we began to see some of the results of European complacency as the Spanish government’s bond auction went absolutely horribly, sending markets back into a tailspin.

Lest you wonder if we’ve seen this pattern before, rest assured that we have. Politicians have very little capacity to solve problems before they become crises, for the simple fact that they tend to not act with great courage until all other avenues have been exhausted. This isn’t a slap at politicians (not a direct one, at least), but a recognition that no politician has ever gotten credit for averting a crisis that is unseen by the general populace, and even then there are entrenched interests in maintaining the status quo as the plane flies into the ground. It’s a simple bedrock principle of the “economics of politics.” So while Europe remains in a state of relative calm, little will get done.

So why do we have money in Europe?

If we see so little vitality from Europe, why do we invest there? First of all, the fact that Europe has been in crisis is obvious, which means that investors everywhere — including in Europe — have been looking for other places to put their money. When this happens, investors tend not to differentiate between the great and the not-great. And second, even if Europe were toast (which it isn’t), that doesn’t mean that every company in Europe is equally hosed. Many of the world’s great brands are European, and many of them generate much, if not most of their revenues in other markets around the world. I was shocked by the low level of GDP growth that Europe accounts for, because Europe accounts for so much mindshare everywhere in the world.

Last month we met with managers from several Chinese sports apparel companies, and left the meetings thinking, “Adidas is going to crush these guys.” (As an aside, meeting with competitors of one of our portfolio companies is often more informative than meeting with the company itself.) European companies have not forgotten how to make money, and European managers have not forgotten how to run these companies well. This is meaningful, and as long as the world’s investors view Europe as a basket case, we believe there will be opportunity for those who focus on individual companies rather than on broad-based markets.

Consider, for example, Italian leather goods maker Tod’s SpA, which happens to not only be our largest holding in the Epic Voyage Fund, but also our best-performing holding during the month. Although the Italian market continues to get (rightfully) shellacked, Tod’s continues to outperform sales expectations in emerging markets and throw off cash at a magnitude that should be the envy of most other Italian and/or luxury consumer goods companies.

Monthly Results
It was a good month for domestic stocks and a weak one internationally. Our funds followed those results, with excellent returns domestically (Great America Fund), decent results globally (Independence Fund), and flat results internationally (Epic Voyage Fund). All three funds outperformed their benchmarks by varying degrees, reversing results from February when all three underperformed.

For the month, the Independence Fund gained 1.38% vs. 1.34% for the benchmark MSCI World. Little changed in the portfolio, and some of the usual suspects in our Top 11 holdings were among the biggest contributors to a good month, such as Yum! Brands (on general enthusiasm for the consumer sector) and a big comeback from WellPoint on speculation that the Supreme Court would overturn the Patient Protection and Affordable Care Act. Recent addition Crucialtec joined Posco in having a poor month, largely on the back of weakness in the Korean market. As we’ve noted in the past, South Korea is the largest component of the MSCI Emerging Market Index. As such, when thematic investors “reduce exposure” to emerging markets, companies in the Korean market tend to be hit disproportionately hard. Add in the prospect of a North Korean missile test, and you have the makings of a tough market environment.

The Great America Fund increased in value by 2.44% vs. a 2.24% performance for its benchmark. Little changed in the portfolio. We liked what we owned, though by the end of the month, given the increase in prices across the market, it was becoming harder to find things we were especially interested in adding.

Despite turbulence in international markets, it was a fairly quiet month for the Epic Voyage Fund, which was a dead flat 0.00% in March versus a 1.36% decline for its benchmark, the Russell Global ex-US. Our only transaction of note was to sell our shares of Canadian yoga apparel maker Lululemon. You may remember that when we talked about Lululemon during our January shareholder conference call (and compared it to craft beer), it was already quite an expensive stock. And while we endeavor to be long-term owners of great businesses, it’s also true that our stocks are on sale every day — and we believe we received a price that more than compensated us for the value of Lululemon’s brand and growing store franchise. We would love to own this company again at the right price, but we think that the shares are currently valued for absolutely extraordinary future results.

As always, the entire portfolio team joins me in thanking you for entrusting your money with us.

Foolish best,

Bill Mann

Tags: Bill Mann, Boules, Central France, Credit Suisse, Debt Levels, Economic Capital, Election Campaign, European Countries, French Economy, French Election, GDP Growth, Global Gdp, Knickers, Park In Paris, Paul Clitheroe, Sophisticated Lingerie, South Korea, Wednesday Afternoon, Western Europe, World Gdp
Posted in Markets | Comments Off

On China and the End of the Commodity Super-Cycle

Wednesday, March 7th, 2012

China had a massive surge in its demand for commodities over the past decade, fueled by its housing boom and infrastructure investment boom. From 2000 to 2010, China’s imports (in value terms) of iron ore surged by 42.5 times, thermal coal 248 times and copper 16.2 times. During the same period, its production (in quantity terms) for aluminum jumped by 441.8%, cement 219.5% and steel 396.0%. It is the biggest consumer in virtually all commodity categories in the world. In Credit Suisse’s view, China was the key factor behind the global commodity supercycle. After a period of economic slowdown, all eyes are on China, hoping that the middle kingdom can return to its might in commodity demand. CS cuts through all the cyclical factors and asks whether China’s mighty demand for commodities will return in the medium term – their answer is ‘No’. As the economy shifts its growth engines away from infrastructure, construction and exports toward consumption, especially service consumption, the propensity of demand for commodities is bound to decline. Getting a massage simply does not use as much steel as building an airport.

Credit Suisse: Can China’s mighty demand for commodities return?

In this note, we ask whether China’s mighty demand for commodities will return in the medium term. We think the answer is “NO.”

• The golden age of infrastructure investment is behind us now.
• The golden age of the housing boom is behind us now.
• The golden age of exports is behind us now.
• The golden age of policy stimulus is behind us now.

but…

• One more leg of urbanization is expected.
• Further acceleration in policy housing is likely.

still…

• Trend growth in the next decade is projected at 7% to 8% versus 10.7% in the past decade.
• Growth engines will likely shift from exports and infrastructure to consumption.

which means…

• It should take less commodity consumption for each unit of GDP.

1) The golden age of infrastructure investment is behind us now.

After ten years of very aggressive build up of infrastructure, the penetration of highways, railways, airports and power stations has surged. Infrastructure investment is down by 25% in the 12th five-year plan from the 11th five-year plan, after adjusting for inflation. The actual moderation could be much bigger, in view of the very aggressive infrastructure investment by the local governments as part of the fiscal stimulus in 2009.

2) The golden age of the housing boom is behind us

Home ownership in China has reached 67% in the urban sector, above the world average now, and would be much higher if the rural area were included. Housing prices are getting out of reach for those who rely on a regular salary. An average person in China needs to spend ten years of salary to pay for an average apartment, versus the world’s average of about six years. The affordability ratio for local salary earners in most tier 2 and tier 3 cities is not much better.

3) The golden age of exports is behind us

Cyclically, exports seem to be on a rebound, but structurally, China’s competitiveness has been weakened because of surging salaries among the migrant workers and continued appreciation of the RMB. It may take ten years before the legend of the “world’s factory” disappears, but the best times are certainly behind us.

4) The golden age of policy stimulus is behind us

Beijing may launch some minor fiscal subsidies for consumption and reshuffle the tax code. Restrictions on bank lending has eased a little too. But there is no way that the government will launch another massive stimulus similar to what it did in 2009. The consensus among the decision makers is that the package of stimulus in 2009 did more harm than good to the long-term sustainability of growth.

What is not over and what may accelerate in the next few years?

1) Urbanization has another leg to go.

The industrialization model in China is changing. Over the past two decades, industrialization and modernization has been done through funneling rural labor to the coastal areas and export industries. In the next two decades, we believe industrialization and modernization will take place locally, at the village level. That would create new needs for commodities.

2) Policy housing construction will likely accelerate.

The central government realizes that high housing prices have become a source of social instability, so it is committed to provide subsidized housing to its citizens, with a target of building 36 million units during the 12th five-year plan (2011-2015). Progress was disappointing last year, as local governments have neither the money nor the incentive to deliver. We think policy housing construction is likely to accelerate over the next two years, though it is not clear who will pay the bill at this moment.

The big picture is that China’s trend growth is expected to slowdown to 7% to 8% over the coming decade, from 10.7% recorded in the previous decade. As the economy shifts its growth engines away from infrastructure, construction and exports toward consumption, especially service consumption, the propensity of demand for commodities is bound to decline. Getting a massage simply does not use as much steel as building an airport. In 2011, it took 71 million tones of steel for one percentage point of GDP growth – that is unheard of in the world’s modern history. We project that the ratio should moderate to 30-40 million tones for every percentage point of GDP growth by 2020. There will be cyclical ups and downs, which may affect China’s demand for commodities and commodity prices, but we think China’s supercycle for commodities is behind us.

Tags: Acceleration, Commodities, Commodity Categories, Commodity Consumption, Credit Suisse, Demand Cs, Economic Slowdown, Global Commodity, Growth Engines, Infrastructure Construction, Infrastructure Investment, Investment Boom, Iron Ore, Massive Surge, Medium Term, Propensity, Stimulus, Supercycle, Thermal Coal, urbanization
Posted in Markets | Comments Off

Will Oil Continue Higher?

Sunday, March 4th, 2012

Will Oil Continue Heading Higher?

By Frank Holmes, CEO and Chief Investment Officer, U.S. Global Investors

Does it feel like it costs an arm and a leg to fill your car these days? While consumers may continue to feel the bite from higher gasoline prices, investors can use these rising prices to their advantage.

Beginning in March, crude oil has a seasonal wind at its back. For nearly 30 years, the third month of the year has been the best month for crude oil. As you can see in the chart below, over the past 5-, 15- and 30-year cycles, West Texas Intermediate crude oil prices head higher in March, and have generally continued to climb through September.

On Yahoo! Finance earlier this week, Daily Ticker host Aaron Task and I discussed the many factors that should continue to drive oil higher over the next year. While many would like to attribute the rise in oil to the geopolitical developments in Iran, there are more global supply and demand fundamentals to consider. Credit Suisse points to the world’s dwindling inventories of oil as an example. Currently, the number of days of oil demand cover is at a low of about 57, the same level we saw in 2004 and late 2007. This low supply to cover demand means that any disruption in supply will likely drive prices higher.

We expect inventories to be further depleted, as demand continues, especially from emerging markets. Inventories for February and March should show a further reduction, as “oil demand growth was building positive momentum in the fourth quarter in all our regions except Europe,” says Credit Suisse.

According to Bloomberg News today, China plans on stockpiling more oil to reduce its local price fluctuations. Countries such as the U.S. generally store emergency oil to ensure its residents, businesses and manufacturers have plenty of stock at a price that’s not too high. As part of a three-phase program to increase its strategic petroleum reserves, China is building four emergency oil-storage facilities across western China, in the east and in the south. By the end of this year, its oil facilities are “expected to bring national crude-storage capacity to 270 million barrels” when construction is complete, says Bloomberg.

By comparison, the U.S. currently has the largest emergency petroleum supply in the world, stockpiling about 570 million barrels of crude oil at four sites located along the Gulf of Mexico.

China is not the only emerging market expected to consume more oil. When I was in Bogata, Colombia a few weeks ago, I saw gas stations posting prices around $5 a gallon. And its citizens can only fill up their gas tanks a few times a week. Yet the economy is booming and the streets are jammed with cars. There’s still tremendous demand in this country, as well as many other growing emerging markets, even with higher gasoline prices.

One question I’m asked when oil jumps in price is, will it hurt the U.S. economy? I don’t believe so. Many analysts believe the economy is in a better position to adjust to higher prices, especially when you compare last year’s oil spike to this year’s.

In 2011, fuel prices rose more than 50 percent in a matter of only a few months, says BCA Research. This “very quick and forceful advance” occurred at the same time that U.S. consumers were driving more miles, the number of unemployed workers was at a high, and job creation was nonexistent, says BCA.

This year, the rise in fuel costs has been more gradual, says BCA. What’s more important to BCA is that “consumers are in better shape than they were last year,” with job creation, unemployment, and income expectations all posting improved numbers. In addition, the U.S. has experienced an unseasonably mild winter, giving furnaces a welcome respite and their owners lower heating bills, making the higher payment at the pumps a little more palatable.

In addition, central banks around the world are in “full-on expansion mode,” says BCA. This needed liquidity and support for growth provides an injection of confidence directly into the global consumers’ veins.

Beware of biases by oil analysts: Deutsche Bank research going back to 1999 found that analysts “consistently underestimate” the Brent oil price by an average of 27 percent. The chart below shows the forecasted price made by analysts compared to the actual Brent oil price outturn. Every year, analysts have underestimated how strong Brent will be, ranging from as little as 2 percent to as high as 54 percent. Using the average forecasting error, Brent could be as high as $135 a barrel.

We expect there to be corrections in the price of oil throughout 2012, just like the ups and downs commodities experience from year to year. While the world is hungry for energy, there’s no free lunch on the Periodic Table of Commodities, and historically, from year to year, commodities fluctuate. Crude oil, for example, has seen its share of ups and downs: In 2008, oil lost 53 percent; in 2009, it increased a substantial 78 percent.

On our interactive version of the Periodic Table of Commodity Returns, you can see this for yourself. Click on a particular commodity and see how it has performed each year over the past 10 years.

See the interactive table now.

While oil may remain elevated, use these higher prices to your advantage by owning natural resources companies that benefit from higher prices. The Global Resources Fund (PSPFX), which invests in global materials and energy stocks, gives investors a way to potentially offset those higher gasoline bills.

Tags: Chief Investment Officer, Credit Suisse, Crude Oil Prices, Disruption, Emergency Oil, Emerging Markets, Fourth Quarter, Frank Holmes, Gasoline Prices, Global Supply, Inventories, Month Of The Year, News Today, Oil Demand, Oil Storage Facilities, Phase Program, Price Fluctuations, Strategic Petroleum Reserves, Supply And Demand, U S Global Investors
Posted in Markets | Comments Off

The Great Market Disconnect Seen All Around The Globe (Business Insider)

Thursday, February 9th, 2012

via Business Insider

We’ve spent a lot of time this year discussing this chart.

Bloomberg

The green line is the S&P 500. The orange line is the yield on a 10-year US Treasury.

It’s weird because you’d think that as stocks rose — indicating increased risk appetite and expectations of growth — that yields would rise too, since demand for risk-free instruments would want. But that hasn’t happened. Stocks have had a really nice run, but yields have gone nowhere.

In a note out this morning, Credit Suisse’s Andrew Garthwaite listed this as his top anomaly in the market right now.

There are various theories as to why this disconnect is in place: Some blame the Fed and “financial repression”, artificially depressing rates.

But one thing you’ll notice is that to a varying degree, this is a global phenomenon.

So for example, check out Australia.

The green line is the Australian All Ordinaries Market and the orange line is the yield on the Aussie 10-year.

Once again, the great disconnect emerges, and it’s especially apparent since mid-December.

Bloomberg

And here’s Sweden.

Bloomberg

And here’s Germany. Once again, you see a massive disconnect beginning in December.

Bloomberg

And finally Japan. Again, the equity-bond disconnect begins in December.

Bloomberg

So this is a global phenomenon, which strongly suggests that this isn’t just about the Fed buying Treasuries in the US, though naturally all markets are connected.

One thing that all these countries have in common is their borrowing is done in their home currencies, meaning they’re essentially risk-free except from a currency perspective.

A decent theory is that despite the big pickup in optimism, there’s still a shortage of vehicles available to investors looking for “risk-free” assets. So the countries that can offer these bonds are still seeing unusually high demand. That’s just a theory. Bottom line though: This isn’t just an S&P/Treasury phenomenon. It’ global.

Tags: Amp, Anomaly, Assets, Bloomberg, Bonds, Bottom Line, Business Insider, Credit Suisse, Currencies, Decent Theory, Financial Repression, Free Instruments, Global Phenomenon, Globe, Optimism, Orange Line, Risk Appetite, Stocks, Treasuries, Treasury
Posted in Markets | Comments Off

Striking Portfolio Balance with Gold Stocks (Holmes)

Sunday, December 18th, 2011

Striking Portfolio Balance with Gold Stocks

By Frank Holmes, CEO and Chief Investment Officer, U.S. Global Investors

It wasn’t a pretty week for gold prices. The eurozone’s epic endeavor to conquer its sovereign debt issues forced some institutional investors to liquidate profitable gold positions to meet a rising need for liquidity.

In addition, falling confidence in the euro and other global currencies pushed investors tumbling toward the relative safety of the U.S. dollar. As we outlined for you last week, the key phrase is “relative safety” because we know that it could only take a slight breeze to blow the dollar’s house down.

Back on August 22, I wrote that gold was due for a correction and that it would be a non-event to see a 10 percent drop in gold. I wrote, “This would actually be a healthy development for markets by shaking out the short-term speculators.”

This morning’s gold price of $1,590 is about 15 percent from the high, which is a little greater than predicted, but a non-event just the same. I believe the long-term story remains on solid ground.

In a report this week, Credit Suisse reiterated the bull market for gold is not over, saying, “We do not believe the key fundamental drivers of the [gold] bull market have dissipated. While there are risks, in our opinion gold is getting close to attractive levels for new longs to be initiated.”

Gold Stocks vs. the Federal Budget

This chart, which we’ve highlighted several times, shows the size of the surplus or deficit in the federal budget. When the federal government is spending more than it takes in, gold and gold stocks tend to outperform the broader market. It’s important to point out that it’s the political policies, not political parties, that drive this phenomenon. During the 1990s, when President Clinton was in office, there was a budget surplus and investors could earn more on Treasury bills (about 3 percent) than the inflationary rate (about 2 percent). This gave investors little incentive to embrace commodities such as gold, and prices hovered around $250 an ounce.

Since 2001, increased regulation in all aspects of life, negative real interest rates, welfare and entitlement expansion funded with increased deficit spending have created an imbalance in America’s economic system. It’s this disequilibrium between fiscal and monetary policies that drives gold to outperform in a country’s currency. The Federal Reserve capped interest rates near zero back in 2008 and the federal budget deficit ballooned to $1.4 trillion. In fact, both the deficit as a percentage of GDP (negative 11 percent) and federal government debt as a percentage of GDP (nearly 65 percent) are at the highest levels since 1950. This has helped fuel gold’s rise through $1,000 and $1,500 an ounce.

Striking Portfolio Balance with Gold Stocks

Gold stocks have historically ranked among some of the most volatile asset classes. Over any given one-year period, it is a non-event for gold stocks to move plus or minus 38 percent. This DNA of volatility is about three times that of gold bullion, which carries an annual volatility around 13 percent.

Despite this volatility, our research shows that investors can use gold stocks to enhance returns without adding risk to the portfolio.

In 1989, Wharton School finance professor Jeffrey Jaffe completed an academic study that illustrated the effects of portfolio diversification into gold stocks. Jaffe’s original study covered the period from September 1971, just after President Nixon ended convertibility between gold and the dollar, to June 1987.

Tags: Budget Surplus, Chief Investment Officer, Credit Suisse, Debt Issues, Eurozone, Federal Budget, Frank Holmes, Fundamental Drivers, Global Currencies, Gold Price, Gold Prices, gold stocks, Institutional Investors, liquidity, Political Policies, Relative Safety, Sovereign Debt, Speculators, Treasury Bills, U S Global Investors
Posted in Markets | Comments Off

Emerging Markets Cheat Sheet (October 3, 2011)

Sunday, October 2nd, 2011

Emerging Markets Cheat Sheet (October 3, 2011)

Strengths

• In China, industrial companies’ profit rose 28.2 percent in the first eight months from a year ago. Net income climbed to 3.2 trillion yuan ($500 billion), the National Bureau of Statistics of China said this week.
• Korea has sufficient foreign-exchange reserves to cope with a potential financial crisis even if European investors take their money out of the country, central bank Governor Kim Choong Soo said.
• Indonesia has foreign reserves of $120 billion, while foreign debt funding is about $30 billion, according to CLSA research. The reserves should provide Indonesia enough liquidity in the event that foreigners withdraw their money as a result of an escalation of the European sovereign debt crisis.
• China’s hog herds are “firmly bouncing back,” with the total number of pigs rising for six months and the number of breeding sows rising for four months, according to the Ministry of Agriculture in Beijing. The pork price increase was the largest contributor to rising inflation in China. Also this week, China Premier Wen Jiabao said China food prices are stabilizing.
• Korea’s industrial production rose 4.8 percent in August from a year ago after rising 4 percent the previous month, but it declined 1.9 percent sequentially month-over-month.
• Exports in India have been steadily growing and are on course to reach the government’s target of $300 billion for the current fiscal year, driven by increased government support to exporters to tap into new markets in Latin America and Africa.
• Turkey is three times more efficient in using energy than China, Russia, or South Africa, according to Credit Suisse. Also, Central European countries (the Czech Republic, Hungary and Poland) made the most incremental improvement over the last decade.

• Turkstat reported that the Turkish economy added 2.2 million new jobs in the first eight months of this year.

Weaknesses

• Korea’s consumer confidence index fell to a five-month low of 99 in August, down from July’s reading of 102.
• Investors are worried about China’s shadow-banking loans, due to intensified news that many small- and medium-sized enterprise (SME) debtors are bankrupt, and therefore bank shares are under pressure. A China International Capital Corporation Limited (CICC) bank analyst estimated private lending went up 38 percent to RMB 3.8 trillion in total loans outstanding in the first half this year, and he further estimates that non-public loan (NPL) increases from small enterprises would reach RMB150 billion, 0.46 percent of corporate loans, not as bad as many media reported.
• Economic growth in South Africa slowed significantly in the second quarter of 2011, to 1.3 percent from 4.5 percent in the first quarter. This can be largely attributed to the ongoing sovereign debt crisis in Europe and an overall negative global economic outlook. Currently, unemployment is just above 25 percent of the labor force.

Opportunities

• Merrill Lynch expects record 2010 construction permits in Turkey to translate into a significant increase in demand for kitchen appliances. Typically, construction permits lead house deliveries and white goods sales by 12 to 18 months.

• As railway investments decline, China’s next bright spot in fixed asset investment is water conservancy investment. The Chinese government is said to invest Rmb 4 trillion in the next five years in water and environment infrastructures. This chart shows the water conservancy investment has increased in recent years after being neglected for the last 10 years, after frequent droughts, floods and food shortages in recent years. In the twelfth five-year plan, water infrastructure investment is expected to be at a cumulative average growth rate (CAGR) of 23 percent, according to CLSA China strategist Andy Rothman.



• According to The Beijing Axis, the global balance of power is shifting into the hands of rapidly industrializing emerging growth giants, especially Brazil, Russia, India, China and South Africa. Today, these countries are fuelling the global recovery with their huge demand requirements, high growth multiples and vast deployment of capital. The report also highlighted that these emerging powers are becoming more present in securing a foothold in Africa’s vast and rich resources.
• Bloomberg reported that Bovespa, the operator of Latin America’s largest securities exchange, is planning to start a bond trading platform by the middle of next year. Marcelo Maziero, Bovespa’s head of product and customer development said, “We are developing a platform. We are accelerating the fixed-income side, so it gets to the same level as stocks.”

Threats

• In China, SMEs are very much underdogs when it comes to bank lending; therefore, they borrow from shadow banks, i.e., private loans and entrusted loans, to expand their growth. With the economy slowing down and loan price going up (see chart shown below), many of them are leveraged at a wrong time. Many SMEs are now financially stressed.

• The La Nina storm is threatening record South American crops. Rabobank International reported that La Nina runs the risk of bringing dry weather to parts of South America, threatening record crop production on the continent. Analysts have speculated that because weather forecasts indicate that La Nina conditions are expected to strengthen, this would likely have a negative impact on corn planted area and yields. Corn production is expected to rise 12 percent this year and soybean output may gain 1 percent.
• Colombia’s policymakers will probably leave borrowing costs unchanged for a second straight month and end a dollar-purchase program as slowing inflation allows them to gauge the impact of the European debt crisis on global growth, Bloomberg reported. Currency “intervention isn’t needed at these levels,” head analyst at Banco de Bogota SA Camilo Perez said, “What is the general driver in markets now is risk aversion and that means a weaker peso.” We continue to see emerging markets leaving their rates unchanged in response to global economic uncertainty.

Tags: Brazil, Central Bank Governor, Central European Countries, China Food, China Russia, Consumer Confidence Index, Credit Suisse, Current Fiscal Year, Debt Crisis, European Investors, Foreign Exchange Reserves, Incremental Improvement, India, Inflation In China, Infrastructure, Last Decade, Ministry Of Agriculture, National Bureau Of Statistics, National Bureau Of Statistics Of China, Outlook, Premier Wen Jiabao, S Industrial, Target, Turkish Economy
Posted in Brazil, India, Infrastructure, Markets, Outlook | Comments Off

Energy and Natural Resources Market Cheat Sheet (August 8, 2011)

Sunday, August 7th, 2011

Energy and Natural Resources Market Cheat Sheet (August 8, 2011)

Strengths

• Due to recent defensive positioning of the portfolio, the Global Resources Fund weathered this week’s market’s turmoil relative to its benchmark, the Morgan Stanley Commodity Related Index.
• In spite of escalating macro fears, analysts at Credit Suisse find that many of the ‘real economy’ data points that they track are actually showing improvement. Specifically, rail carloads posted the second-highest level year-to-date during the week ended July 30; the Cass Freight Shipment Index increased 11 percent year-over-year in July (comparable to +5 percent in June); and the ATA Truck Tonnage Index rose 7 percent year-over-year in June (accelerating from the +3 percent in May).
• According to Mineweb, the U.S. car market is rebounding off an annualized rate of 9.5 million units at the 2009 bottom, and could reach 13 million units this year. This may rise as high as 15 million units by 2015.
• Analysts at Macquarie highlighted that commodities for which China sets the market price remained strong, with iron ore holding at $179.5 per ton CFR China (62 percent Iron) in the latest Platts assessment, the highest level since mid-May. Meanwhile, Platts’ assessment of Chinese hot-rolled steel coil prices rose $5 per ton week-over-week to $707.50 per ton.

Weaknesses

• The S&P energy sector was one of the weakest sectors this week, falling approximately 10 percent on a slide in crude oil and mixed results from earnings reports. Small cap exploration & production was one of the worst performing sub-sectors, down 12.7 percent for the week, negatively impacting the Global Resources Fund.
• Crude oil was down approximately 9 percent, to $87.03 per barrel, the lowest close since February. Traders are concerned with slowing global economic growth and worries over contagion of European sovereign debt problems.
• China’s Purchasing Managers Index (PMI) fell to 50.7 last month but the HSBC PMI fell to under the 50-mark for the first time in one year. This indicates that shrinkage in that country’s manufacturing sector is underway according to Kitco Metals.
• Chinese imports of uranium slowed during the first half of the year, amid industry uncertainty caused by Japan’s Fukushima nuclear crisis. China imported 5,356 tons of uranium in the first six months of 2011, a 13 percent drop year-over-year, according to figures released by the General Administration of Customs. In contrast, China had tripled its uranium imports from 2009 levels to 17,136 tons in 2010.

Opportunities

• Chile’s Escondida mine workers accepted a company offer to end a two-week strike that shut the world’s largest copper deposit and raised fears of a supply shortage, according to Reuters.
• Ernst and Young predicts a record $120 billion in transactions this year as the pace of deals within the resource sector have picked up in recent weeks, putting the sector on track to top a record.
• Because of ongoing nuclear power development in China, Africa and the Middle East, uranium prices could bounce back to pre-Fukushima levels of $70 per pound in 2012 according to the Energy Report.
• According to JP Morgan Market Intelligence, China is aiming to increase its self-sufficiency in non-ferrous metals over the next 5 years by increasing domestic exploration and making overseas acquisitions.

Threats

• In Rio Tinto’s first half of 2011 results, the company noted an approximate 30 percent increase in capital intensity for its cornerstone Pilbara expansion to approximately $175 per ton annual capacity. This is in line with previous hikes noted by BHP Billiton, and provides yet another example of spiraling capital costs afflicting Australian iron ore projects.
• Chile’s copper output may be 5 percent below the target of 5.6 million tons this year on the back of various unforeseen events, according to the CEO of the world’s largest copper producer, Codelco. Year-to-date, Chile’s copper production has already been 2 percent below comparable figures for the previous year.

Tags: Car Market, Cheat Sheet, Commodities, Contagion, Credit Suisse, Crude Oil, Debt Problems, Earnings Reports, Economy Data, energy sector, Global Economic Growth, Global Resources, Hot Rolled Steel, Iron Ore, Morgan Stanley, Platts, Purchasing Managers Index, Resources Fund, S Market, Shipment Index, Sovereign Debt, Steel Coil
Posted in Commodities, Markets, Oil and Gas | Comments Off