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I just returned from sunny Calgary where I spoke at the Cambridge
Conference (See more details at my Travel Diary here:
http://www.goldmau.com/content/diary/08-04-18.php). It is surprising to me
how many gold analysts predict the complete of fallout of US housing
and how that will crash the stock market, world growth and commodities.
Subprime Securities Firesale finished:
 
As seen by the ABX index above, mid
quality subprime debts are now selling at
10-20cents on the dollar. Those mortgage debts are being sold as if they are
worth nothing.
Let’s not forget those notes have
houses as collaterals. The index is implying that 9 out of 10 subprime mortgages are expected to default, with
investors getting zero back from foreclosures.
Dave in San Diego took out $1 million subprime mortgage at 8% to buy a home from Wells Fargo
with zero down. Let’s assume Dave misses 3 payments and his home is now
worth only $500,000. I, as an investor, can theoretically buy his $1 million
mortgage note from Wells Fargo for as little as $100,000, foreclose the
property and put it on fire sale for $300,000 and make $200,000. Or better
yet, I can restructure to have Dave stay in his home, have him pay 2% instead
of 8%, which works out to be $20,000 a year, or 20% annual return on my
$100,000 investment. Dave still owes me $1 million, which he might eventually
pay me back when housing markets recover. Ok, may be not $1 million, but
I’d be happy to take $700,000, or a 7 bagger with 20% annual coupon.
I am not saying US housing prices
won’t go lower, but rather, the financial markets have fully priced in
50%+ subprime default rate and 50%+ correction of
US home prices.
The markets are completely irrational
selling subprime at 10cents on the dollar, a direct
result from $2 trillion subprime debt sellers
simultaneous wanting to get out. Analysts in hindsight will comment on how
cheaply those subprime assets were selling today.
Banking Crisis is
over and banks on sale:
Above is the chart of combined market
capitalization of America’s
top 5 banks. Citigroup, Bank of America,
JPMorgan, Wachovia, and Wells Fargo.
The combined market capitalization has
gone from nearly $1 trillion to less than $600 billion in the past 12 months.
China can use half of her
foreign reserve to buy all key US banks. Indeed you are seeing
Canadians, Asians, and Arabs buying stakes in US banks at these fire sale
prices. I expect the banking sector as a
whole to bottom shortly if they haven’t already.
Equity Market
Bottomed too:
The $400 billion loss of market capitalization
by top 5 banks translates to 3.5% loss of the entire US market capitalization of
approx. $12 trillion. Factor in hundreds of other mortgage brokers and banks
that have been erased from the market outright, you can reason the general
equity market has held up remarkably very well with just a 10% drop in
S&P500.
Why is it that US equities are seemingly
un-affected by subprime? S&P 500 derive some
30-50% of its revenue from outside of USA, and those international
revenues were mostly unaffected by subprime. World
GDP grew from $30 trillion in 2002 to $55 trillions today, the fastest pace
since WWII. And world population is 15 times that of the US.
Global growth is just one reason why US
equity held up well. The biggest reason in my view however, is the lax
monetary and heavy handed interventionist policy.
US Fed Funds rate is unnaturally low at
2.25%. Bank of Canada is talking of lowering rates further from an already
measly 3% while oil is breaking out $115. We live in interesting times. One
can now borrow at 4% to buy oil trusts paying 15% dividend, or an India ETF
that pays 20% a year.
I certainly would not be bearish of the
equity market as it is measured in dollars. The cost of dollars is next to
free at 2%. Everything is relative, when something is measured in terms of
‘nothing’, it takes a lot of that ‘nothing’ to make
up something. When S&P 500 is measured in gold, you can see S&P 500
is barely half of what it was
a year ago.
Now that we are near the bottom of
interest rates, I expect all the hoarded money to spill out looking for a new
home as it simply does not pay to park money earning 2% with real inflation
running at double digit.
US consumer
spending non-factor to commodity prices and global growth:
Prior to the end of world’s love
affair with the dollar, the driver of the world engine was the US economy,
through consumer spending. US
consumers held the key to creating dollars out of thin air as they handed
those dollars to world exporters. The money from your refinance and cash
advance came out of thin air created by Countrywide and Citibank.
Today, we have too many dollars. No one
wants dollars from India’s
Taj Mahal, to Brazilian
Victoria Secret model. The dollar binge is over in favor of RMB, Brazilian
Real, Philippine Peso, Thai Baht, and the Euro etc. There is no longer de
facto money as money in the form of new darling currencies were created
through borrowing in their respective countries. Mind you many of those
currencies were once unwanted or even hated. This is the new growth engine.
Attention is focused on global citizens, not US citizens. This is such a key
understanding that most US-centric analysts don’t get.
Don’t believe my analysis, China revised their GDP upwards to 11%
throughout 2006 and 2007, commodity prices are breaking record highs by the
day, this is all while US
economy have slowed to a halt. In short, US consumers have greatly diminished
impact on world growth and commodity prices. The US has only 8% of the world
population and the US dollar is ditched by savers and producers in favor of
just about every other currency.
Gold is the new
universal money
Money supply grows by the billions every
second as paper money created out of thin air through borrowing by consumers,
corporations, and governments around the world.
The Fed and ECB printed about $1 trillion
in the last 9 months just to contain the subprime
collapse. All those bailouts create moral hazards. This moral hazards
combining with record commodity prices and fear of inflation are the recipe
for a fierce gold market. This is why my focus right now is on precious
metals.
How ironic the subtitle “Gold is
the new universal money”. Gold has been proven to be the most reliable
and long lasting money, and we can see why. Gold is the same everywhere, it
lasts forever, and most importantly, it can not be created out of thin air. I
travel lots and every time I revisit a country I notice their paper money
changes shape, size, or even colors. How reliable is that?
Asia barely sneezed at subprime
but they sure are catching cold feet on inflation and fever on gold. People
are beginning to sense the threat of inflation, having previously thought
that inflation dragon is dead for ever.
Fundamentally gold is under priced today
to just about all asset classes. Studies suggest a gold price between $1,500
to $2,000/oz based on today's oil and copper price of $110/barrel and
$4/pound respectively.
Technically, at $920/oz Gold is
comfortably above previous all times of $850/oz set in 1980. I am very
confident the downside is $850-$890/oz, while the upside is anyone's guess.
We run an equity fund and my focus is on
mining equities, which mathematically and historically have shown to provide
leverage to the gold price. Although the topic on analysis of gold is for
another day, I invite you to read my past write ups on gold at www.goldmau.com and join me for the bull
ride in gold.
By :
John Lee, CFA
Goldmau.com
John Lee is a portfolio manager at
Mau Capital Management. He is a
CFA charter holder and has degrees in Economics and Engineering from Rice University.
He previously studied under Mr. James Turk, a renowned authority
on the gold market, and is specialized in investing in junior gold and resource
companies. Mr. Lee's articles are frequently cited at major resource websites
and a esteemed speaker at several major resource
conferences.
Please visit www.GoldMau for instant market alerts and stock updates.
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