Hello Pezz,
BTW, here is an excerpt of my 2007 eop briefing to family members whose interest I look out for:
December 23rd, 2007
Subject: 2008 Note
Preamble
... As of December 23rd 2007 the Fund (edit by TJ: defined as everything excluding rental real estate) is up 28+% Year-to-Date.
We have collectively done well in 2007, and aim to do better in 2008.
I believe we are well positioned to navigate the obviously dire financial storm:
Cash @ 65% (1/7 in CAD cash, rest in USD 3-mths T-bills, with a bit in SGD, and a wallop in HKD, which, while a proxy of USD to which it is pegged, is better than USD, given the regime's small and non-interfering nature and genuine freedom practiced)
Gold & silver @ 23%
Equities @ 12%
Review of 2007
For 2007, the stock investors could have realized a paltry gain had they been unable to beat the main USA share indices, which by definition must be true, and would have suffered a genuine purchasing power loss, as measured by pre-Clinton era inflation tracking method (4-8%), as opposed to the black magic applied to inflation ‘half’ measure by the officialdom today (2-3%).
The DOW industrial average index finance.yahoo.com has gone nowhere (8%), especially when accounting for the loss of purchasing value of US$.
The NASDAQ finance.yahoo.com has done not enough (13%).
The S&P500 finance.yahoo.com has done pitifully (7%).
Whereas oil proxy finance.yahoo.com has done great, meaning inflation and global growth, in combination, are strong (44%).
Gold finance.yahoo.com has done fantastic, meaning fear level has healthily increased (28%).
Food proxy finance.yahoo.com has also gone ballistic, meaning everything we need has gone up in price (36%).
We started 2007 primarily high in cash, mostly non-US$, and secondarily high in various energy, commodity, resources, and various gold mining shares.
We held on to the initially losing foreign exchange positions until the USD did what we felt was the inevitable, dropping against the other currencies.
In the past three weeks, we have exited all except CAD foreign exchange positions.
We have also as well as sold much of our stock positions except five notable plus some other positions (Petrobank Energy, Vemilion, Uranium One, SKF Proshare Ultra Short Financial, OilSands Quest, plus Baytex, Bunge, Cameco, Canadian Oil Sands, Cresud, Impala Platinum, Yamana Gold).
The five notable positions are:
(i) PetroBank Energy petrobank.com
We have held PetroBank since first purchasing the stock in May of 2006. PetroBank is a Canada-based oil sand company, and it has been progressing to perfect its now commercial Toe-to-Heel Air Injection (“THAI”) technology, whereby controlled underground fires are started to substantially increase yield of oil recovered from oil sand resources over conventional oil sands mining methods. The advantages of the patented process are (i) substantially increased recovery of oil, (ii) materially decreased use of natural gas and water to recover the oil.
During 2007 the company had signed the first of what it hopes to be many licensing agreements so that other oil sands companies can use PetroBank patented technology. Should PetroBank be successful in signing more such licensing agreement, the company will earn substantially more profit without incurring more cost of operation and without having to commit more capital to buy oil sands reserves.
(ii) Vermilion Energy vermilionenergy.com
We have held Vermilion Energy since the middle of 2004 and had added to our position in the middle of 2005. The company extracts oil and gas from a well diversified reserve base in Canada, Australia and Europe, and explores for oil in Libya. The company pays a monthly dividend that amounts to 10% per annum. We believe the company will continue to do well, especially as Russia continues to play games with natural gas supplied to Europe. Any oil discovery in Libya will be a bonus. And in the meantime, Canadian and Australia operations will continue to distribute cash.
(iii) Uranium One uranium1.com
The company extracts uranium and platinum and gold in South Africa and Canada. How wonderful is that? We have held the shares since February of 2005. We believe that the world will continue to use more of both uranium and platinum even as these two particular minerals are concentrated in only a few countries and by a few companies.
(iv) ProShare Ultra Short Financial finance.yahoo.com
This holding a wager that the financial sector of the USA will continue to be dire, generally heading down, and in the meantime we do generate income from trading Call and Put options due to the inherently volatile process of heading down.
(v) OilSands Quest oilsandsquest.com
We entered into this position during the fourth quarter of 2007. We believe that the Canadian oil sands resources do not stop at the border of Alberta province, and that Oilsands Quest’s concessions in Saskatchwan will yield substantial value. The company is also in a cooperation relation with PetroBank Energy to use the patented THAI process to extract oil from oil sands. May the Force be with OilSands Quest.
Issues and Concerns
I am concerned about the possibilities inherent in the eventual and unavoidable process of financial leverage unwinding in a world very high on debt, both on and off balance sheets, and very high on unfunded obligations (social security, and pension). I have six (6) particular concerns:
(i) The USA housing pricing, supply and debt bubbles are in process of blowing up. The USA housing debt bust is guestimated to cause US$ 450 billion of losses, enough of the losses will be from bank capital, where such capital in USA in sum total amounts to US$ 900 billion. Worse, if and when such a 50% loss of capital materialize and is actually recognized, lending by banks may have to reduce by 10 fold as much, or US$ 4.5 trillion dollars, or about 1/3 the size of USA annual GDP. The mathematically mandated deleveraging process involving this magnitude of sums cannot be benign.
Together with the above effect of banking losses, the USA housing value is expected to go down by north of US$ 1 trillion, and given that a lot of borrowing is leveraged against housing value, the resultant borrowing decrease from the real economy should be shock and awe inspiring.
(ii) The financial derivatives trade must unwind at some juncture, and probably at a less rather than more convenient time. The magnitude of the financial derivatives en.wikipedia.org trade has grown substantially direr since the end of 2006, has tracked an exponential growth curve, and is now measured in the hundreds of trillions of dollars. There are at least two dangers, (i) while losses by one party is a gain by another, the losing party may perish, setting off a chain reaction of disappearing counter-parties around the planet, and (ii) the magnitude of derivative contracts dwarf the real economy by several fold, represents leverage that may not be supported or supportable by the real economy, and the unwinding will likely cause panic the world had never experienced.
For example, there are US$ 45 trillion credit-deriv.com of corporate default derivatives economist.com . These derivatives are essentially two party insurance contracts where the insurer guarantees the face value of bonds issued by some borrowing company that are purchased by another investor / speculator. There are essentially no effective reserves seriously set aside for the potential losses that can be experienced due to bankruptcies during any normal economic recession (never mind a depression). A 5% loss on the US$ 45 trillion of contracts will call for payouts of US$ 2.25 trillion of cash by one set of parties to another set. Do we know of any set of companies with US$ 2.25 trillion of cash handy?
(iii) The one-sided bet of ‘carry trade’ by the financial economy is a bomb that will go off sooner or later. One feature of the globalized financial economy is that of “carry trade” whereby financial institutions and individual borrow from low interest rate nations (Japan, USA, and Switzerland) to invest in higher yielding countries (Europe, Britain, Australia, New Zealand). The idea behind such capital flow is mathematically sound, but for the scale, breadth and depth applied. The exit door is simply not that wide and any exit from the trade based on changing conditions will not likely be orderly, catch enough short and causing panic. The eventually of exit is certain, and when so, ought to make the 1997 Asian Financial Crisis exit seem trivial and unexciting.
(iv) Competitive currency devaluation must be a constant concern because the phenomenon is a given must. Between inherent weakness of the US$ and the impetus of the carry trade, some currencies has rose quite a bit, and perhaps too much, against the US$. Europe is already complaining loudly about the strength of the Euro.
We must remember that the Euro is backed by a collection of socialist and spendthrift nations, mostly all substantially weaker in discipline and stamina than Germany.
The weaker Euro states, say Italy, Greece, Spain, and may be even France will have to sacrifice currency purchasing power in favor of domestic socio-econo-political (employment, social spending, trade friction) imperatives, and when so, when announced on the front page of the Financial Times, will see the start of a disorderly trading day.
(v) Demographic sell-down will become more real. The front edge of baby boomers everywhere is entering retirement era, and they in aggregate need to sell, sell again, sell once more, and sell still more to fund their living, especially if the assets they have to sell is trending down. This selling headwind will be a constant in our face and wear at our portfolio, even as the emerging markets rise in income, consumption, and drive the daily necessities ever higher in pricing.
The makings of a perfect financial storm is in the making if not already baked into the cake, as the simultaneous equations of ever decrease in worth of what we might have spirals down to greet the ever surging cost of everything we need. Not a good calculation.
(vi) Given the above noted big issues and concerns, the electorates and their sponsored politicians will try the apparently easy ways to salvation, namely ever more fiat currency printing (as FED chairman Bernanke had promised many times, that deflation of asset value will not happen, for the USA officialdom has a secret weapon called the printing press that can churn out money at a marginal cost of zero), competitive devaluation, legalized and no-fault default, trade wars, and real wars.
So, having thus stipulated the big worries and main concerns, what do we do to navigate the mess, even as the mess gravitates towards its appointment with the Dark Interregnum of eventual triple waterfall planet-wide downward re-pricing and galactic monetary reset?
I do not know. I cannot know. We have never been in such a situation before. We are in no-man’s land.
Forward, We Must Go
I am concerned, but not paralyzed. I believe we must be:
(i) High agility, be observant, ready to move in large and rapid steps, and to admit mistakes;
(ii) High cash, but in official treasury bills, in case financial intermediary institutions holding our assets go bankrupt or is otherwise not bailed out cleanly. We will at least get back paper with our name on it, even if after a painful time delay. Be ready to ease out of the USD again, into other asset classes, and this time may be for good long time;
(iii) High gold, for gold has performed rather consistently over the past 7 years, and past 6,000 years. However, we must keep in mind that the price of gold had suffered 50% loss in the lead up to its inexorable rise to then all-time high back in 1981;
(iv) High hard and soft commodities, meaning everything useful, like metals and foods, but perhaps wait for a wash out unwinding of currently and uniformly high prices underpinned by possibly unsustainable debt. When and if the speculators are forced to sell, they must sell everything, not just what they want and wish to sell, but also what they prefer holding on to;
(v) High energy, but be cognizant that when the recession (never mind depression) hits, energy will be hit as well;
(vi) High China, but very slowly and carefully, and only after the inevitable bloodletting; and
(vii) High Hong Kong real estate, gradually, over time, and to generate current income while standing a reasonable chance for capital gains. |
