The shift away from assuming US debt
issues are the doom of all things is now underway. Whether we are in a false
bottom ahead of a second broad downturn on more bad financial news is
unknowable. More negative details on the total losses from mortgage based
debt are likely from the banking sector. But we do think the scale of this
mess is beginning to be understood and has become an issue mainly for those
who created it.
The next concern in this area is from the
debt swap market that has grown exponentially as the debt issues surfaced. This
large scale hedging strategy is, at close to $50 trillion, an order of
magnitude larger then the un-Insurance problem. Most of these are off-market
deals that should be paired as hedges, so it is possible that any damage they
do will mainly be seen in reflection. That would be another round of
seemingly random selling to cover the holes bad deals have made in private
equity and hedge fund books.
The last in line for pain is, as usual, the proverbial
“little guy”. No one expects US real estate markets to improve
in the medium, much less near term. Decimation of bank balance sheets and
loan securitization has flattened bank reserves. In a fractional banking
system the ultimate effect of this is lowered lending capabilities. In that
environment banks are going to lend less, and only to the least risky.
Where does that leave all those sub primes,
jumbo and even prime borrowers? Between the proverbial rock and a hard place.
Like everything relating to the credit crisis statistics are hard to come by,
but loans officer surveys have displayed a steady trend of tightening
standards and increased refusals to lend.
Washington is trying to
arrange foreclosure holidays.That won’t mean
much if owners or prospective buyers can’t finance. Foreclosure is
still inevitable if new loans can’t be arranged.
Is there a quick fix for this? Well, yes, but
its going to be tricky in an election year. Short of Washington bailing out banks that means
more sovereign fund money and more foreign ownership of American financial
institutions.
You can already hear the politician’s
howls of outrage over this. Think of it as a twenty first century version of
the Savings & Loan. Asians do the saving and feckless US bankers do
the loaning. The Fed’s rate slashing has steepened the yield curve
enough that banks can, theoretically at least, earn their way out of the
current mess. The only problem is that will take many quarters to accomplish.
If the US
chooses this laissez faire route, don’t be looking for real estate
bargains before 2009 and maybe not even then.
Commodities
v Wall St.
Every conference we have been at in the past couple of months has been
dominated by speakers calling for a price collapse in most metals, and
especially base metals. Metals don’t seem to be reading the script.
Precious metals continue to see new highs and all base metals have had
significant upward moves in the past month. What gives?
We see a couple of reasons for the price
moves. The first is simply that that US centric analysis is wrong. Warehouse
inventories for most metals simply are not building at the speed the bears
had expected.
Commodities that mainly trade through
contract sales like iron ore and coal have had stronger prices than most of their
open market brethren. The nature of the markets for these materials makes
them next to impossible to “speculate” on directly. We therefore
find bubble arguments for more liquid metal markets very hard to believe.
In the past month market traded metals have
all seen good gains. The star of the show has been copper, the metal reputed
to have a PhD in economics. Copper recently traded at an all time closing
high, having just exceeded the “triple top” of 2007. Apparently
copper earned its PhD in Shanghai
or Mumbai.
Do current metal prices imply a bubble? We
don’t think so, though we won’t be surprised if there is a commodity bubble before the super
cycle ends. We do not however see it now. One thing prices do imply is the
renewed interest of funds in the sector.
Investment groups of all types find
themselves in a tough spot and those with the longest time horizons -
insurance and pension funds - face the biggest challenges. Bonds have had a
great few years, but no one expects increases in yields in the foreseeable
future. Current yields just are not high enough. To add insult to injury,
inflation is accelerating again.
One of the best ways to counter a stagflation
environment is commodity exposure. It worked in the 1970’s, and it
looks like ready to do so again now. Last week brought news that CALPERS, the
California teachers pension funds and the
largest of its kind in the US,
will allocate up to 3% of its holdings to commodities.
We expect to see many more announcements like
CALPERS. Fund money in commodities of all types is increasing again. This
will help support the base pricing of many commodity prices, and specifically
those in metals we have recently seen. The argument could be made that this
is just hot money. Some of it is, but we don’t see investment from
funds like CALPERS as the equivalent of hedge fund money. These are long term
investors that are looking for portfolio insurance in a time of uncertainty
and rising inflation.
What goes for base metals and soft
commodities goes double for precious metals. The Dollar is plumbing new
depths and could still go lower. It isn’t wild eyed gold bugs who see
metals and metal stocks as a refuge; it’s anyone who can add. Its no
longer opinion, it’s a statistic. Going forward, more people are bound
to notice this winning sector. We haven't seen the arrival of the real masses
yet, but they are coming.
IMF Gold
Sales
There has been a bit of teeth gnashing over an announcement that the
International Monetary Fund has sought, and will likely get, permission from
its members to sell its gold. The IMF horde was built up when the yellow
metal was a fixed part of the monetary system, and is one of the larger
bank-based gold reserves still on books at 103 million oz (3,217 tonnes). Is
this a big deal?
The total IMF holding is a little over 10
months of current gold demand. Were it simply dumped on the market, it would
obviously depress prices for while. That won’t happen, but a better
context is in terms of other foreign reserve holdings. At current prices the
US$100 billion IMF horde would represent about 6% of China’s
foreign reserve holdings. Given China includes some gold in its official
reserve, a swap of the IMF gold for China-held US treasuries (and a smidgen
of CDO tossed for spice) is doable, at least on paper.
We would see this as a win-win since it fills
the hole in the IMF books with Dollars while generating a gain for China in one
of the few investments likely to appreciate faster then the Yuan over the
next few years. If China
were to spoon out the gold for say oil imports, it could lose it all in a
little over 10 months based on last year’s oil intake rate.
As much as we like the symmetry of the IMF
gold horde being roughly market neutral to China’s oil demand, we
don’t know if this sort of trade will happen. We don’t think the
IMF will be dumping gold onto the market at any rate, since it would be self
defeating. Small economies with significant gold exports would get hurt, and
there is no reason why the IMF would junk its own price base just as it was
about to capitalise on it after 3 decades. In brief, we think the IMF gold
sales will have more impact on commentary then on markets.
From
the February 2008 HRA Dispatch
By : David and Eric
Coffin
Editors, HRA Journal
David Coffin and Eric Coffin are the editors of the
HRA Journal, HRA Dispatch and HRA Special Delivery publications focused on
metals exploration, development and production stocks. They were among the
first to draw attention to the current commodities super cycle and have
generated one of the best track records in the business thanks to decades of
experience and contacts throughout
the industry that help them get the story to their readers first. Please
visit their website at www.hraadvisory.com for more information.
If
you would like to be added to the HRA FREE mailing list to get notifications
about articles like this and other free analyses and reportsplease
click t HERE.
The HRA – Journal, HRA-Dispatch and HRA- Special
Delivery are independent publications produced and distributed by Stockwork Consulting Ltd, which is committed to providing
timely and factual analysis of junior mining, resource, and other venture capital
companies. Companies are chosen
on the basis of a speculative potential for significant upside gains
resulting from asset-base expansion.
These are generally high-risk securities, and opinions contained
herein are time and market sensitive.
No statement or expression of opinion, or any other matter herein,
directly or indirectly, is an offer, solicitation or recommendation to buy or
sell any securities mentioned.
While we believe all sources of information to be factual and reliable
we in no way represent or guarantee the accuracy
thereof, nor of the statements made herein. We do not receive or request
compensation in any form in order to feature companies in these
publications. We may, or may not,
own securities and/or options to acquire securities of the companies
mentioned herein. This document is protected by the copyright laws of Canada and the U.S. and may not be reproduced in
any form for other than for personal use without the prior written consent of
the publisher. This document may
be quoted, in context, provided proper credit is given.
©2008 Stockwork
Consulting Ltd. All Rights
Reserved.
|