For Marc Faber The Iron ‘Ore’ Lady Has Sung

Friday, August 24th, 2012

Frustrated with the know-it-all bullish ‘experts’ on the Chinese economy lambasting wise boots-on-the-ground deep-thinkers such as Hugh Hendry and Albert Edwards; Marc Faber (who discussed this in detail in the clip we presented here) today set about correcting some of that vacuous chatter on China’s dominance (with all its current stuffed inventory). Noting that the Chinese stock market is not exactly pointing to the growth everyone is relying on (and we add since the MAR09 lows it is only fractionally better than Spain), Faber brings up one chart (courtesy of The Bank Credit Analyst) to rule them all. Alongside the mega-bubbles of: Gold in 1970s, the Nikkei in the 80s, and the Nasdaq in the 90s, Iron Ore prices since the start of 2000 have them all beat – and recently (as we noted here) have begun to roll over.

The four biggest bubbles of the last 40 years… with Iron Ore the clear winner…

and how is China’s equity market doing?

as Faber adds:

All these indicators [which he discusses at length from electricity production to Macau gaming revenues and consumer spending habits to appliance and air-conditioning volumes] do not necessarily suggest that the Chinese economy is collapsing, but they reliably do suggest that the economic slowdown is more pronounced than official Chinese statistics would have you believe. In addition, these indicators do not imply that the Chinese stock market will decline further (but it could). Perhaps the weak performance since 2008 has already discounted much of the slowdown in economic growth.

Charts: The Bank Credit Analyst and Bloomberg

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The Death Of China Cult

Saturday, August 4th, 2012

Submitted by Also Sprach Analyst

People in Hong Kong have a long history of mistrust of China. This city, after all, was a colony of the British Empire for more than a century, and has only been under Chinese rule (under one country two system, to be precise) for a mere 15 years. In this city, you seldom hear anything bad about Britain (because most have no idea), but you hear a lot of bad things about China, particularly the Chinese Communist Party. We just never trust them.

While the mistrust of the political class of China continues in Hong Kong (and will certainly continue for much longer), the doubts on the strength of the Chinese economy and the doubts on the ability of the political class to manage the economy have more or less evaporated after 15 years of Chinese rule.

It used to be that Hongkongers go to China to purchase really cheap stuff. Now, it is the Mainland Chinese who come to Hong Kong to buy really expensive stuff. Places in China which were farmlands are now full of modern buildings. Infrastructures in large cities are getting better, sometimes even better than Hong Kong. Before the transfer of sovereignty, Hong Kong was already a rich city while China was a very poor country. China used to be poor, dirty, relatively uncivilised, you name it. Today, it almost as if this city would have died if the Chinese economy did not grow at the rate as it did in the past decade. China today, especially for big city like Shanghai, is just like Hong Kong: modern, international, classy.  You can’t say many things bad about cities like Shanghai.

No one would ever dispute the achievement of the Chinese economy.  What we see in China now, on the surface at least, is progress. And the progress was huge indeed.  For 30 years or more, the Chinese economy has defied “gravity”, and has never been in a recession, and has lifted enormous number of people out of poverty. Predictably, the perception on the Chinese economy has changed very dramatically over the past decade, from a market that you wanted to stay away from to a market that no one wants to miss.

Chinese equities as something to be avoided is perhaps a bit of an exaggeration, but less than a decade ago, you could quite easily find people who had some serious doubts on investing in China. On the macro level, the story of “China as the forthcoming greatest economic power” was not yet the biggest story, even though everyone knew that China was growing very fast. On a micro level, many held the impression that Chinese companies were either not well run, or were run by crooks, who cooked up their books and/or produce very inferior products simply to rip people off.  On top of that, the Chinese government cooks up statistics, and doubters spin that in their own favour, suggesting that the economy could not have grown that fast.  Meanwhile, corruptions were rampant.  Businessmen bribed government officials in order to profit, while government officials got rich through taking massive amount of bribes.

If you insisted on that grim view on China in early 2000s (right after the Chinese government lied about SARS, as a reminder of who were the type of people who ran the government), although you would have missed the bull market in stocks (which ended in 2007 by the way), such grim view was not necessarily inaccurate.  Since the beginning of time (well, that’s an exaggeration of course), China has the creativity and necessary skills in creating fake and low quality products beyond anyone’s imagination, which are sometimes dangerous for human consumption. We also knew that corruption in China was horrible since the beginning of time (and this is not an exaggeration, as that has been a recurring theme of the rise and fall of different dynasties ever since Imperial China): you couldn’t possibly not bribe officials if you want to do business and be successful in China, while for government officials, you can’t possibly be not corrupt if you want to have a successful career as a civil servant (and by successful, it really means climbing up the ranks while continuing to be bribed without being caught or something).  Banks would lend to whoever with connections to government officials (i.e. those who have bribed government officials) so that it requires extra faith for investors to believe in banks’ books. And as a businessman, as long as you have great connections with government officials, banks would probably still be willing to lend to your company cheaply even though you are cooking up your books.  Finally, no one has ever believed in Chinese statistics in full at face value, and with a political regime which is obsessed with promoting their own achievements, doubters are justified in believing the statistics are purposefully massaged to make them look great.

These are the problems for China in the past.  But if all these problems with China sound familiar to you, it should, because they are more or less what increasing number of people are talking about. These are not just history, but current reality.  China is still full of businessmen who make crap products that are dangerous for human consumption. Corruption is as serious as it was, if not more so. You still have to bribe officials to achieve your goals successfully (and the costs of bribing officials to achieve your goal, as I understand, are getting ever higher), and government officials cannot have a successful career without being corrupt. Banks have not changed their practices in determining who to lend money to, so as long as you have good relationship with government officials, you can get cheap loans even you did not actually own the collateral you are posting to banks, and as long as you can get loans, you can’t possibly go bust even if you are already insolvent and are cooking up books (as long as the officials that you have connection with are still around and well).  Finally, there is still no one who is willing to believe in Chinese statistics in full at face value.

The only difference between the recent years and  ten years or so ago is that people just ignore it now, because the extraordinary bull market and the seemingly unstoppable economic growth has created a China cult, a cult among investing community that China is the best place to be investing in.  Just as hedge fund manager Hugh Hendry said “10 years are enough to create a cult in capital market”. In fact, China has not seen any year with negative growth for more than 30 years.

Despite the fact that the Chinese stock market bubble has gone bust in 2007, the whole China cult continues to get new followers.  After the bubble went bust and the Lehman crisis hit, quite a number of people were confident that the stock market will surpass the 2007 peak very soon because the Chinese economy has been strong.  The view that China became the best place to invest has become ever more popular as the Western economies looked mortally wounded after the crisis (while they are not).  The ever more popular idea that the economic weight has shifted from the East to the West, or the idea that we are back in a bipolar world for the first time since the end of the Cold War, and among many other ideas, have reinforced many people’s belief that China is the place to go.  Even to this date, we understand that there are a lot of European companies which are still looking to invest in China apparently because China looks “safer” relative to Europe.

In the beginning of the recovery of the global economy, investing in China did pay off well relative to many markets in the rest of the world, reinforcing the idea, once more, that China is really invincible, that China is the best place to invest.  The same doubters who did not invest in Chinese stocks 10 years ago because they thought companies cook up their books started to buy in 2007, 2008, 2009, 2010, 2011, and 2012.  The same doubters who did not invest in Chinese stocks because of the worries on corruption are now accepting corruption as a reality and that it is something which determines whether a company can make money.  The same doubters who thought Chinese banks have understated non-performing loans started to believe that buying Chinese banks is like buying HSBC in the 1980s, which will give you a return in the order of hundreds of times over the next 3 decades.  Investors have also been much less careful about frauds as the cult reaches its climax, even though things have not changed. But instead of identifying the problems related to poor governance, frauds and corruption, some insist that these are isolated cases and have nothing to do with the culture of how businesses are done in China.  Also, while Chinese statistics are not reliable, more and more people are trying to spin the unreliable data to fit their own bullish arguments.  Instead of suggesting that growth is overstated, now they say consumption is understated, and the China consumption will be the biggest investment story of the era.

But Chinese equities outperformance did not last long: first in Shanghai, then in Hong Kong, they have turned from two of the best markets to markets doing even worse than Europe.  While a lot of investors were still very hopeful that stocks could get to the 2007 peak very soon, that is just not happening.  Bears like ourselves started to be ever more vocal about the structural problems in the Chinese economy since late 2010 and 2011, namely, real estate bubble, over-capacity across the economy, over-investment and the associated unsustainable increase debt etc., and we are getting ever more concerned about issues that we did not mention much: corruption and its link of over-investment, and the consequence of lack of inflation.  Bears have got it right for almost 2 years now as far as stock investments are concerned, and the economy is now slowing down rapidly while the real estate market cools, just as the bears have predicted. Unfortunately, people increasingly blame short-sellers instead of admitting that they have been wrong.

Still, the cult has not died yet.  The past few years have produced an impression of the Chinese government that it is invincible, and it has miraculous control over the economic machine, that the slowdown is “intentionally” engineered by the government and everything within the economy is still very much under control.  Unfortunately, most who use this argument to justify that the slowdown is not a big problem have all invariably forgotten that most economic slowdowns in recent memories started with central banks tightening monetary policy to control inflation and slow down the economy, and most, if not all, of the cases ended with recession that they did not want to get into.  Many have also not realised how difficult it would be for China to relate its way out of a debt deflation.  So how different China is in this regard is totally beyond our comprehension, and we are forced to suggest that the believers of China cult have gone delusional.

As the economic slowdown becomes a reality and a hard landing unavoidable, more of the problems we have identified will surface. The cult will surely die within the next few years at most. The only questions are when it will finally die, and whether it will suffer a violent death or slow death.

Copyright © Also Sprach Analyst

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Hugh Hendry’s Greatest Hits

Wednesday, June 27th, 2012

shared by The Trader
 

Hugh Hendry moments worth reviewing every now and then, especially in today’s boring market.

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Hugh Hendry On Europe: “You Can’t Make Up How Bad It Is”

Thursday, May 3rd, 2012

At The Milken Institute conference yesterday, Hugh Hendry delivered his usual eloquent and critical insights on the state of Europe. Beginning with the statement that “All of Europe has defaulted”, the canny-wee-fella (translation: shrewd and cautious young chap) explained that “The political economy in Europe is such that the politicians chose to default on their spending obligations to their citizens in order to honor the pact with their financial creditors and so as time goes on, the politicians are being rejected.” Between France’s election of Mr. Hollande and Luxembourg’s ‘when times get tough you have to lie’ Juncker, Hendry says the only inspiration for Europe is fiction as “you just can’t make up how bad it is” as he goes on to discuss the precedent for a way forward, the grotesque distortions of fixed exchange rate regimes, why Weimar happened, why the transfer union will never happen, Ayn Rand’s reality, and fear politicians are feeling.

The entire discussion is well worth watching for a sense of the underlying reality in Europe.

The underlying reality that what the European monetary union is about is not about preventing a third so-called European civil war, it is essentially about making someone (France, Germany or both) a Great Power, a European Hegemon, and a global player.

Starting at around 12:00, Hugh begins his must-watch discussion…

And begins again at around 30:00, Hendry discusses the British perspective on the impeccable logic of the German mind and why the transfer union will never happen in Europe…and why Wiemar happened…

At around 46:00, Hendry addresses Germany’s emerging housing bubble (and why it won’t occur) and the two forms of leverage in the world.

From 52:40, Hendry takes on the view of (disagreeing with) a weak USD and the US being supplanted as a global leader

Hendry confesses to not being able to finish reading Ayn Rand’s Atlas Shrugged at around 1:02:00 and explains why (apart from its length and lack of pictures)…noting that is too depressingly real in its description of the world we live in today…

We have reached a profound point in economic history where the truth is unpalatable to the political class – and that truth is that the scale and magnitude of the problem is larger than their ability to respond – and it terrifies them.

Concluding at 1:10:10 – “we are single-digit years away from the most profound market clearing moment”

(h/t Stock Bitch)

Tags: Ayn Rand, British Perspective, Creditors, Critical Insights, Distortions, European Monetary Union, Exchange Rate Regimes, Fella, Global Leader, Global Player, Hegemon, Hollande, Housing Bubble, Hugh Hendry, Impeccable Logic, Juncker, Milken Institute Conference, Pact, Political Economy, Politicians
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Hugh Hendry: Investment Outlook (April 2012)

Monday, April 30th, 2012

Hugh Hendry is back with a bang after a two year hiatus with what so many have been clamoring for, for so long – another must read letter from one of the true (if completely unsung) visionary investors of our time: “I have not written to you at any great length since the winter of 2010. This is largely because not much has happened to change our views. We still see the global economy as grotesquely distorted by the presence of fixed exchange rates, the unraveling of which is creating financial anarchy, just as it did in the 1920s and 1930s. Back then the relevant fixes were around the gold standard. Today it is the dual fixed pricing regimes of the euro countries and of the dollar/renminbi peg.”

In the letter the most surprising insight from the perpetual contrarian is his almost predictable contrary view of the dominant investing meme at the moment. To wit: “We are, as a result, long the debt saddled west and short the vastly over vaunted and over owned BRICs.“ More on this: “There is a near consensus that China will supplant America this decade. We do not believe this. We are more bullish on US growth than most. The momentous nature of recent advances in shale oil and gas extraction and America’s acceptance of the unpleasantness of debt and labour price restructuring looks to us as if it is creating yet another historic turning point. By embracing his inadequacies and leaping on his luck, the strong man may have finally broken the binds that had previously held him back. We are also more pessimistic on Chinese growth than ever. This makes us bearish on most Asian stocks, bearish on industrial commodity prices, interested in some US stocks, a seller of high variance equities and deeply concerned that Japan could become the focal point of the next global leg down. On the plus side we also believe that we are much closer than before to the beginning of a bull market of perhaps 1982, if not 1932, proportions. We just need the last shoe to drop.”

We will let readers combs through the narrative that shapes Hendry’s most recent outlook, although one chart worth pointing out is The Eclectica boss’ visual summary of the “New Economic Order” which presents precisely the tenuous relationship between the Fed and the PBOC we have been decrying for so long, and which so many commentators (ooh, ooh, the PBOC is easing any minute now… oh wait, it isn’t) fail to grasp:

Yet one thing we do want to point out is how different compared to your run off the mill 2 and 20 rent collector is the Eclectica M.O. when it comes to generating Alpha (as opposed to everyone else’s levered beta):

As you know, I have a proclivity to make money in a bear market. The Fund’s ten-year NAV progression demonstrates this survivorship bias; when bad things have happened, we have made money. We are very robust. Last year was no exception. Despite the challenges confronting speculators, I am much relieved that we succeeded in making 12% in a rather disciplined manner, and the Fund has now posted a CAGR of almost 10% for the last nine years.

Maybe that was the easy bit. The question now is just how we can make money in the tough business of global macro investing this year. As I am sure you by now know, I am nothing but a worrier. I have, I think, a soul mate in the prolific but often misunderstood Italian soccer player Pippo Inzaghi, the second highest scorer in all European club competitions. He has 70 goals behind him but he recently noted that, “the tension is always the same…I hoped to become less agitated with time, but this is also my strength”. I suspect he would have made a fine macro manager.

I meet a lot of inquisitive and extremely intelligent people in this business and I have come to think that maybe this is something of a problem. Perhaps they are just too smart. Perhaps they just try too hard. Rightly or wrongly, the highest return on intellectual capital of any endeavour in the world today comes from the management of other people’s money. So it is entirely rational (especially if you have never met a hedge fund manager) to assume the industry attracts the brightest, smartest minds. The beautiful mind, if you will. But I am not aiming to outsmart George, Stan, Julian, Bruce or the others. I do not think it is logical to try and outsmart the smartest people. Instead, my weapons are irony and paradox. The joy of life is partly in the strange and unexpected. It is in the constant exclamation “Who would have thought it?”

Why did ten year treasuries yield 14% under the vice like grip of iron-man Volker but yield just 1.8% under the bookish and most definitely Weimar-like Bernanke? Why does France in 2012 flirt with the notion of electing a socialist president intent on reducing the retirement age, imposing a top rate of tax of 75% and increasing the size of the public sector? Why do we hang on the every word of elected politicians when Luxembourg’s prime minister Jean Claude Junker openly admits, “When it becomes serious, you have to lie”?

You cannot make stuff like this up. It is simply too absurd.

That is perhaps a long way of saying that existentialism is alive and well in the 21st century. For, if the last ten years have taught me anything, it must be that the French philosopher Albert Camus, in his search for an understanding of the principals of ethics that can shape and form our behaviour, may have surreptitiously provided us with three basic principles for macro investing. I am perhaps doing him a gross injustice, but I would summarise as follows: God is dead, life is absurd and there are no rules. In other words, you are on your own and you must take ownership of your own destiny.

For me this has always meant being detached from the sell-side community. It is not a question of respect, it is just that I prefer not to engage in their perpetual dialogue of determining where the “flow” is. I cannot be reached by telephone. I suspect that I am one of the few CIOs who does not maintain daily correspondence with investment bankers and their specialist hedge fund sales teams. Not one buddy, not one phone call, not one instant message. I am not seeking that kind of “edge.” Eclectica occupies an area outside the accepted belief system.

I attempt to cultivate my own insights and to recognise the precarious uncertainty of global macro trends. I attempt to observe such things first hand through my extensive travel (I promise no more YouTube videos), and seek to understand their significance by investigating how previous societies coped under similar circumstances. But first and foremost, I am always preoccupied with the notion that I just do not have the answer. I am not blessed with the notion of certainty. Someone once said we should think of the world as a sentence with no grammar. If we do I see my job as putting in the punctuation. But above all, my job is to make money.

In keeping with this theme, I want define the three ingredients that I believe make for an outstanding macro hedge fund manager. These are, in no stringent order:

1. Successful but contentious macro risk posturing.

2. The need to choose the asset class offering the highest probability of payout should the conviction hold true whilst offering an asymmetric loss profile should the original premise prove unfounded

3. A best in class risk technique that stop losses the narrative and responds early with loss mitigation procedures (i.e. a method of staying solvent, rational and disciplined under pressure).

I have always figured that the first is the real key. That success was simply a matter of contentious macro posturing. In other words, going long very rich risk premium or buying cheap stuff. It is my assertion that what makes a great fund manager first and foremost is the ability to establish a contentious premise outside the existing belief system and have it go on to become adopted by the broader financial community. Bruce Kovner expressed the idea more eloquently when he said, “I have the ability to imagine configurations of the world different from today and really believe it can happen. I can imagine…that the dollar can fall to 100 yen”. I am sure you are nodding in agreement, except Bruce was saying this when the USDJPY was well over 200, not today’s rate of 80!

That is the kind of guy I want to be when I grow up. Recall that I have the kind of imagination that can conceive of the yen trading closer to 60. Similarly, if we look back and reminisce about previous years, the Fund’s 50% return in 2003 was derived from a legitimate but certainly contentious view that China’s WTO entry was set to boost the cyclical “old” economy of the West and that fiat hyper-management of the financial economy could propel gold into a super bull market. To think these views were once contentious; plus ça change!

Who would’a thunk it: one just needs some imagination and creativity, the ability to visualize that which most of the other ones cant or are too lazy to do it, and just wait as the bizarro market takes over and makes the impossible not only probable, but conventionally accepted by the herd.

…

And a segment that all the Whitney Tilsons of the world should read:

I fear that our no longer small community has been compromised. Funds are neglecting their hard portfolio stop limits. Last year was generally very tough for long/short strategies and I commiserate with all concerned. But last year witnessed too many world class funds lose over 15% in the space of just two months. Of course today they are celebrated once again for making double digit returns in the quarter just ended yet they still languish below high water marks and their Sharpe ratios are busted.

You could probably live with that if you are a pension scheme or a large, sophisticated fund-of-fund because you have a global macro sub-sector that is typically long gamma (just look at our credit tail fund’s 46% gain last year). The unfortunate thing is this group exercised its stop losses somewhere between 2009 and 2010. That is to say, they honoured the pact they had with clients. They adhered to the terms of their risk budget. I fear that owing to this nasty experience, today no one in macro is running much risk. I suspect daily VaR budgets are anchored at 50 bps or less. That is to say, I fear the financial world is in danger of harvesting a monoculture of fund returns that could prove less than robust should the global economy suffer another deflationary reversal…

Read the full letter below:

April 2012 TEF Commentary

Tags: 1920s, 1930s, Asian Stocks, Chinese Growth, Commodity Prices, Contrary View, Euro Countries, Fixed Exchange Rates, Focal Point, Gas Extraction, Global Economy, Hiatus, Hugh Hendry, Inadequacies, Industrial Commodity, Investment Outlook, Shale Oil, Strong Man, Variance, Visionary Investors
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Hugh Hendry (Eclectica) Discusses Hyperdeflation, Europe, China, and Japan

Thursday, February 23rd, 2012

With the masses screaming their lungs of about hyperinflation, something that is highly unlikely at best, Hugh Hendry of Eclectica Talks About Hyperdeflation, why China might have a hard landing, and various off-the-beaten tracks Japan plays.

Here is clip from a Barron’s interview.

Barron’s: Where do you find yourself outside the existing belief system today?

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

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

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

Barron’s: You’ve already had a hard landing—in the Chinese stock market.

Hendry: I should add something else that is contentious—U.S. quantitative easing [that eventually sent more money flowing to China], promoted because America had two sharp recessions and pursued orthodox policies, and had very little to show in the creation of jobs.

The policy was very successful. China now has inflation. Minimum wages have grown 20% annually for the past three years. This has encouraged the Chinese to tighten monetary policy. When you have bubbles and you tighten, bad things happen. China’s stock and property markets are weak, a side-effect of quantitative easing. We may now have the pricking of the Chinese bubble. A year or two down the line, it could have enormous repercussions for the global economy.

Barron’s: How does one play it?

Hendry: The world is very fearful of hyperinflation. Pension schemes have a preponderance of real assets, from forestry to gold to TIPS [Treasury inflation-protected securities], because they are very fearful. The road to hyperinflation is via hyperdeflation. That is why it’s proving so difficult for hedge funds to make money. How does the rational mind that anticipates hyperinflation own 10-year government Treasuries yielding less than 2%? It can’t. That’s why people are struggling. To lay the seeds of hyperinflation, you need really, really bad things to happen. I thought the U.S. housing market having a massive crash would be hyperdeflationary. But then my Chinese friends pumped $1 trillion of credit into their $5 trillion economy, and created a global recovery, which has just come to an end. I’m speculating that hyperdeflation happens before hyperinflation. What’s the worst that could happen? But the sum of all my fears would be China having a real hard landing of minus 5% or minus 10% GDP growth. If we had that—and Europe—the Fed would be printing $20 trillion, and I would have gold at $5,000. You can have a modest amount of gold, but you can’t have all your assets in real assets, in case we get that hyperdeflation event.

Barron’s: So how do you make money?

Hendry: Would you believe that the AIG strategy of selling too much credit protection in risky assets like mortgage-backed securities is alive and booming today in Japan? It doesn’t concern mortgages. It is credit-default swaps on individual Japanese corporations.

Barron’s: Do you seriously believe Japanese corporations are going to fail?

Hendry: Clearly, they can and do go bust. I’m buying the CDS on investment-grade Japanese corporations because of the overpricing anomaly. Japan had a bust 20 years ago, and yet today the banking stocks, relative to [Japanese bourse] Topix, are making fresh lows.

If I’m a Japanese bank and I lend money to a new business, I get 1% on 10-year paper. Then the bank gets a call from me, and I’m willing to pay 50 basis points for five-year protection on this same company. So suddenly, the yield has gone from 1% to 1½%. Compare that to five-year Japanese government bonds, yielding 30 basis points. The bank thinks: This is a great trade! Japanese steel companies are investment-grade and won’t go bankrupt. So, the bank gets this huge yen yield, and thinks it is not taking any risk. You’d better believe it will sell way too much of that good thing.

One of my partners told me about Japanese steel: Here is a country with no energy, no iron ore or coal, yet it’s the largest exporter of steel in the world, exports half its output. To put that in context, China manufactures 700 million tons of steel and exports perhaps 30 million. Japan produces 110 million tons and exports 40 million. As long as Asia is strong, they are fine. But if Asia hiccups or reverses, plant-utilization rates go from very high to very, very low very quickly.

Then we discovered that Warren Buffett owned shares of South Korea’s Posco [5490.S. Korea], and that Korea was the biggest importer of Japanese steel, but Posco and Hyundai [5380.S. Korea] are building huge, integrated steel plants. They have a surplus of steel capacity and—guess what?—they’re exporting to Japan, because the yen is so strong.

Initially, I wanted to buy a three-year, out-of-the-money put on Nippon Steel. My broker said, “I’ve been in a 20-year bear market; my boss will kill me.” Then I thought, being long credit protection is being long volatility. I redialed his credit counterpart. I said: “I’m thinking of purchasing up to a billion yen of five-year credit-default swaps in Nippon Steel.” The first thing he said was, “Would you consider 10 billion?” So one part of the bank is banned from selling volatility, and the other part is having a party. I bought reams of the stuff.

Barron’s: We’ve barely discussed Europe.

Hendry: We are partly playing it through Japan. If events kick off again in Europe, the correlation across all [global] asset classes will go to one. So the steel CDS is 130 basis points, while to insure against default by the French government, I’d be paying the same amount. Which is riskier? A very leveraged steel company that can’t tax you? Or a government that can? Our bearish bets are largely outside Europe. As for Greece, the end game will be the Greeks rejecting austerity. The euro is nothing but a gold standard lacking flexibility, and all the onus is on private citizens to take the pain. Eventually, a Greek politician will say, ‘Vote for me, and I’ll get us out of this system.’

I certainly agree with that last comment above.

I as I have said and repeated Eventually, Will Come a Time When ….

Eventually, there will come a time when a populist office-seeker will stand before the voters, hold up a copy of the EU treaty and (correctly) declare all the “bail out” debt foisted on their country to be null and void. That person will be elected.

The Barron’s interview is well worth a read in entirety.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com

Tags: Asset Allocation, Belief System, Chinese Government, Chinese Stock Market, Eclectica, GDP Growth, Gold Standard, Goldman Sachs, Hard Money, Hugh Hendry, Hyperinflation, Minimum Wages, Own Eyes, Profit Maximization, Recessions, Robust System, Skyscrapers, Sustainable Level, Wuhan China, Youtube Video
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Hugh Hendry’s Interview with Barron’s

Thursday, February 23rd, 2012

For those in the Hugh Hendry fan club we have an article from last week’s Barron’s where the hedge fund manager espouses his long held view that China will have a hard landing, along with the prospects of hyperinflation, and thoughts on Japan among other things.  As always it is more entertaining to see video of the acerbic Hendry than have to read it, but it is what it is.

Some snippets:

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

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

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

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

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

You’ve already had a hard landing—in the Chinese stock market.

I should add something else that is contentious—U.S. quantitative easing [that eventually sent more money flowing to China], promoted because America had two sharp recessions and pursued orthodox policies, and had very little to show in the creation of jobs.

How does one play it?

The world is very fearful of hyperinflation. Pension schemes have a preponderance of real assets, from forestry to gold to TIPS [Treasury inflation-protected securities], because they are very fearful. The road to hyperinflation is via hyperdeflation. That is why it’s proving so difficult for hedge funds to make money. How does the rational mind that anticipates hyperinflation own 10-year government Treasuries yielding less than 2%? It can’t. That’s why people are struggling. To lay the seeds of hyperinflation, you need really, really bad things to happen. I thought the U.S. housing market having a massive crash would be hyperdeflationary. But then my Chinese friends pumped $1 trillion of credit into their $5 trillion economy, and created a global recovery, which has just come to an end. I’m speculating that hyperdeflation happens before hyperinflation. What’s the worst that could happen? But the sum of all my fears would be China having a real hard landing of minus 5% or minus 10% GDP growth. If we had that—and Europe—the Fed would be printing $20 trillion, and I would have gold at $5,000. You can have a modest amount of gold, but you can’t have all your assets in real assets, in case we get that hyperdeflation event.

The policy was very successful. China now has inflation. Minimum wages have grown 20% annually for the past three years. This has encouraged the Chinese to tighten monetary policy. When you have bubbles and you tighten, bad things happen. China’s stock and property markets are weak, a side-effect of quantitative easing. We may now have the pricking of the Chinese bubble. A year or two down the line, it could have enormous repercussions for the global economy.

What else do you own?

In the next 12 months, we’ll see further pathological swings in investor sentiment. Despite my reservations, I’m modestly long equity-market futures, some nonindustrial commodities, and some bullish fixed-income positions. We are very bullish agricultural commodities and agricultural equities, and hold a global basket of businesses—with interests ranging from fertilizer to farm equipment.

Disclosure Notice

Any securities mentioned on this page are not held by the author in his personal portfolio. Securities mentioned may or may not be held by the author in the mutual fund he manages, the Paladin Long Short Fund (PALFX). For a list of the aforementioned fund’s holdings at the end of the prior quarter, visit the Paladin Funds website at http://www.paladinfunds.com/holdings/blog

Tags: 19th Century America, Acerbic, agricultural, Asset Allocation, Belief System, Chinese Government, Chinese Stock Market, Depressions, GDP Growth, Gold Standard, Goldman Sachs, Hard Money, Hedge Fund Manager, Hugh Hendry, Hyperinflation, Own Eyes, Profit Maximization, Robust System, Sustainable Level, Wuhan China, Youtube Video
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AdvisorAnalyst’s Top 15 Stories of November 2011

Tuesday, November 29th, 2011

1. Mark Holowesko: “Right Now the Opportunities for Investors are Fantastic”
2. Special Report on Merits of Dividend Investing (Lewenza)
3. Hugh Hendry: Irony and Paradox Figure Large in 2011-2012 Outlook
4. Bonds Beat Stocks Over Past 30 Years: First Time Since Civil War
5. Exiting Chinese a Force in Canadian Real Estate
6. Don Coxe: Investment Recommendations (November 2011)
7. Dennis Gartman: Investment Outlook (Late November 2011)
8. Bob Janjuah: Germany Will Walk and the S&P Will Undershoot to 700 in 2012
9. Sprott: Investment Outlook November 2011
10. Jim Rogers: Greek Bailout may be Prelude to EU Zone Collapse, plus News and Views
11. Leading Economic Indicators: Full Steam Ahead
12. Bill Gross: Investment Outlook (November 2011)
13. David Rosenberg (In Depth): Are We in a Recession?
14. Barclays Says Italy is Finished, Mathematically Beyond Point of No Return
15. To Save the Euro, We Must Destroy Germany

Tags: Bailout, Barclays, Bill Gross, Collapse, David Rosenberg, Dennis Gartman, Don Coxe, Exiting, Gross Investment, Hugh Hendry, Investment Outlook, Investment Recommendations, Jim Rogers, Late November, Leading Economic Indicators, News And Views, Point Of No Return, Prelude, Recession, Sprott
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Hugh Hendry and Steven Drobny on Markets and More

Tuesday, November 29th, 2011

Hugh Hendry, Co-Founder and CIO of Eclectica Asset Management, and Steven Drobny, Drobny Global Advisors, discuss various topical matters at the LSE’s Alternative Investment Conference about a month ago.

Hugh Hendry, Eclectica Asset Management and Steven Drobny, Drobny Global Advisors from LSE SU AIC on Vimeo.

Source: Vimeo, October 18, 2011.

Tags: Aic, Alternative Investment, Cio, Co Founder, Drobny Global Advisors, Eclectica Asset Management, Hugh Hendry, Investment Conference, Lse, Topical Matters
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Hugh Hendry: Irony and Paradox Figure Large in 2011-2012 Outlook

Monday, November 21st, 2011

Submitted by Brett of Contrary Investing

Hugh Hendry Channels Irony and Paradox in His Latest Financial Outlook

Yesterday I had the great honor and opportunity to sit courtside for a live one-hour presentation from our favorite contrarian, irreverent hedge fund manager – Hugh Hendry himself.  What a thrill!

Hendry, as you may know, is partner and Chief Investment Officer at Eclectica Asset Management.  While his claims to fame are numerous, his two most notable (for those getting to know him for the first time) are:

1. A 31.2% *positive* return in 2008
2. Some truly hysterical TV clips (See: Hugh  Hendry’s Greatest Hits for four minutes of financial bliss)

Hendry is a big favorite of ours at ContraryInvesting.com.  I also just learned that he was “The Plasticine Macro Chapter” interviewed (at the time) anonymously by Steven Drobny in his excellent recent book Invisible Hands: Top Hedge Fund Traders on Bubbles, Crashes, and Real Money – which profiles a select group of hedge fund managers (all “off the record”) that made money in 2008.  I went back and re-read this chapter the night before Hendry’s presentation, to re-familiarize myself with his investing/trading philosophy.

Hendry electrifies his Sacramento audience.

The Power of Irony and Paradox

Rather than trying to compete pure “intellect-for-intellect” with the likes of George Soros, Julian Robertson, and the other great minds of the hedge fund world, Henry instead relies upon what he calls “the power of irony and paradox” to foil the logically minded and deliver his superior returns.

In other words, he bets on strange events happening – those not anticipated by the mainstream.

This strategy paid off in a big way in 2008, when his out-of-the-money options hit big, and his fund returned 31.2%.  It has tended to underperform, though, when (to paraphrase Hendry) “bad stuff doesn’t happen.”  Fortunately for Eclectica investors, he sees a bad moon rising once again.

Why China is Not 19th Century America

While many economic observers have drawn an analogy between China’s ongoing industrialization and that of America’s, Hendry sees a critical difference.

In the US, he says, capital has always been allocated where it could achieve the highest return.  In the 19th century, when America was the economic upstart on the block, it was also on the gold standard.  Which is very important, according to Hendry, because it allotted entrepreneurs one – and only one – chance to succeed.  It was not a time of bailouts and multiple bankruptcies!

China is different, he believes, because it is industrializing with a fiat currency.  Thus they fall into the trap of misallocating capital – building bridges to nowhere, towers for nobody, and so on.  China’s goal is similar to that of 1980’s Japan in his opinion – full employment, rather than maximizing return on capital.  A critical, and even fatal, difference, in his mind.

The New Model for the Global Economy

You know the old drill – China and Asia produce, the US consumes.  They cycle their greenbacks back over this way, finance our debt, we buy more of their stuff, and the beat goes on.

This model officially stopped with the launch of QE2, Hendry says, as the US officially started rejecting the globalization that had made the global economy hum (perhaps largely at the expense of US employment and manufacturing).  With QE2, dollars were printed and exported – along with inflation – to Asia.

This led to the countries in Asia – and Europe, too – raising rates to combat inflation.  The result, he says, is that global economic growth has essentially ground to a halt.

So what’s next?

A crash, of course.

Europe’s Debt Spiraling Out of Control

Hendry then pulled up a chart of US and Europe non-financial debt to GDP, illustrating that Europe’s debt has been spiraling out of control ever since the formation of the European Union.

Participant nations, he puts it, received initial “ALT-A” rates – nice low German interest rates – for signing on.  But the fixed exchange rate that the euro imposes on the peripheral nations started the time bomb ticking.

Hendry, in fact, is very down on fixed exchange rates, and believes the euro and the dollar/renminbi peg are at the heart of global economic insecurity today.

He believes the recent referendum in Greece could be a very significant event, likening it to a 1931 mutiny in England that forced the Brits off the gold standard.  He things the Greek referendum could be the trigger to disengage from their fixed exchanged rate (and cited everyone’s lack of anticipation for the referendum as a classic example of irony in finance).

Stage Not Yet Set for Hyperinflation and Gold $3000

The high CPI numbers being reported in the UK and other Western nations are “meaningless”, Hendry says, because in today’s economic environment, it does not translate into wage growth.  (In the 1970’s, it did).

Because wage labor is approximately 70% of total business costs, he does not see meaningful inflation without wage inflation.

He’s also down on gold because it is not a contrarian investment today as it was 10 years ago (he had a nice year in 2003 buying gold and gold stocks when nobody wanted them).

The widespread belief among the greatest financial minds today that hyperinflation is inevitable greatly disturbs him.

In the Western world, he sees hyperinflation as a political choice – one that requires the will of the populous.  (Forget Zimbabwe, he says – that might as well be Timbuktu.  It’s not our culture.)

He sees society’s current mood as “dark” (Tea Party, Occupy Wall Street, and social unrest in Europe to name a few), and believes this makes bailouts and money printing very hard.  The only environment that makes hyperinflation possible is “the mother of all depressions” he says.

In keeping with his anticipation of paradox, he quipped that if you believe in hyperinflation, then you should be levered up long on 10 and 30-year Treasuries…because in order for hyperinflation to become a political reality, deflation must arrive first.

2012 Economic Outlook and Investment Positions

Of the many places Hendry doesn’t want to be long, China is near or at the top of the list.  He thinks China could be subject to a 25% (!) decline in GDP over the next five years.

How is that possible?

He draws an interesting analogy: “UK GDP fell 8% in the Great Depression, while US GDP fell 25%.”  Inferring, of course, that today’s China is the upstart US to our current “UK peak empire” role.

In what he calls “the great unwinding”, the strongest economies in the world are also – ironically – the most vulnerable.

But that doesn’t mean he’s bullish on the developed world, either.  He has an aversion to just about everything.

“It’s checkmate.  Everywhere it’s checkmate.”

He believes Italy is insolvent, citing their huge borrowing binge over the last ten years that has only achieved 0% growth.

He loves Japan – as a culture and place to visit – but is especially bearish on several Japanese sectors.  He’s long credit default swaps with respect to cyclical, leveraged Japanese businesses.  He’s also bearish on Japanese utilities, which have issued tremendous amounts of debt since the Fukushima disaster.

Hendry’s favorite sacred belief – which he’s betting against, of course – is the fact that no one believes the ECB will ever cut rates below 1%.

He’s made bets that he says will deliver a 40-to-1 return if the ECB cuts rates below 1% next year.

Big thanks to the CFA Society of Sacramento for hosting the event, and to my pal Jonathan Lederer for landing Hugh and letting me crash the event as his guest!

Tags: Bad Stuff, Chief Investment Officer, Claims To Fame, Drobny, Financial Outlook, Four Minutes, George Soros, Greatest Hits, Hedge Fund Manager, Hedge Fund Managers, Hugh Hendry, Intellect, Invisible Hands, Irony, Julian Robertson, Money Options, Real Money, Select Group, Strange Events, Tv Clips
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