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WHAT I LEARNED THIS WEEK
Table of ContentsDecember 15, 2011
1. 2008 on steroids? The policy makers' errors are reminiscent of the 1930s. We feel we are compelled to watch every scene of a Greek tragedy—knowing full well what the outcome will be. Our position remains the same:
• We are in the early stages of a sovereign-debt-default contagion. We do not think that any western government or Japan will be immune.
• We are in a world of inhuman volatility, which is undermining confidence in markets and investing and long-term commitments to anything.
• U.S. Treasuries, bunds, and gilts are not a place to hide.
• A global recession in 2012 is highly likely.
• U.S. states cannot print money—get out of municipal bonds.
• The western economies and Japan have the highest debt-to-GDP ratios since World War II—with the worst demographics in 500 years.
• Leadership has failed and there is a serious doubt whether democracy is working. Social unrest is highly likely—particularly in countries undergoing austerity.
• There is a potential in 2012 for war in the Middle East and soaring oil prices.
• The U.S. dollar is only a liquidity-haven as capital leaves the euro. The attention could shift at any moment to Japan, and then, the United States.
• Capital controls are likely, especially on the "good" and "bad" currencies—the good to keep you out, and the bad to keep you in.
• There are only two real safe-havens—gold and certain equities, especially those underpinned by hard assets, strong pricing power and good dividends. However, we remain cautious on equities until the exodus from sovereign credits causes a panic rush into the only asset class with enough liquidity to absorb the capital. It is a good idea to keep plenty of powder dry in case buying opportunities develop.
• Bear markets destroy wealth. We are in a time when caution and wealth preservation are paramount.
• No one alive has ever seen the unraveling of such a large debt and credit bubble. Therefore, the outcome is unpredictable and investors must have in mind a number of scenarios and end-games to protect capital and seize opportunities when they arise.
We will continue to expend all our energy and effort to study global markets to bring you new insights, updates and opportunities. These are unprecedented times. But, we have been preparing for this time for many years. We remain committed to do our very best to chart the clearest paths to help you preserve wealth.
2. Buy gold before central banks are forced into major reflation (continued). For nearly eleven years, our mantra has been “buy and hold gold”. Despite the recent correction, that remains our conviction.
“We have written of the threat of global deflation [for more than 3 years]. We are now on the verge of a deflationary crisis… [Fed actions] are too little, too late. The coming crisis will force the Fed and other central banks around the world to reflate. The quicker stock markets decline, or a financial crisis of some kind forces the Fed’s hand, the sooner the reflation will begin… A minuscule shift in money out of financial assets into gold would cause a huge imbalance in supply and demand.”
As timely as the preceding paragraph sounds, it is an excerpt from a report we published on March 14, 2001, when we first turned bullish on gold. Although recent returns reflect the deflationary spiral of austerity, economic stagnation, sovereign debt crises, and liquidity squeezes—and may reflect an increase in market manipulation—fiscal authorities will ultimately be forced to respond with inflationary policies.
3. Iranian standoff moves to a new level of seriousness. Traders have been marking oil prices lower in reaction to a lower demand growth forecast of 200,000 bpd in the latest IEA monthly Oil Market Report (OMR). In our view, the markets are overlooking the fact that non-OPEC output is only going to grow by a mere 100,000 bpd this year, compared to a June 2011 forecast in excess of 500,000 bpd, despite the apparent euphoria over the U.S.’s newly-found shale oil wealth. As we have argued for some time, this means the world will be more, rather than less, reliant on OPEC for incremental oil supply at a time when political and social upheaval is sweeping North Africa and increasingly the Middle East (see section 4). In this regard, it is relatively easy to understand why oil prices remain at such relatively high levels despite the angst over the lack of resolution to the European sovereign debt crisis. Moreover, the political standoff between Iran and the west over Iran&rsq uo;s nuclear ambitions could result in a sharp upward spike in oil price with very little warning.
In the latest round of saber-rattling by Iran, The Jerusalem Post of December 12th reported that the Iranian navy was going to conduct exercises to practice the closure of the Straits of Hormuz. If this were ever carried out in earnest, it would result in the cutoff of some 16 million barrels that are shipped through it every day, representing 40% of the traded crude oil globally. Iran’s notion that oil prices would reach $250 per barrel if Iranian oil exports were embargoed becomes highly plausible under this scenario.
4. What does the rise of electoral Islamist politics mean for the Middle East and North Africa? The revolutions which shook the Arab world this spring were all about modernity and secularism. Armed with Facebook and Twitter, the region’s young and tech-savvy seemingly thwarted any fears that the only alternative to dictatorship in the Middle East was mullah-led theocracy. But, now, just a few short months later, political Islam is emerging at the forefront. Indeed, the emergence of “political Islam” may prove to be one of the most lasting legacies of the Arab spring. Whether this is a positive or negative development remains to be seen. Much will depend on the economic health of each country. Without growth and job creation, any new government in the region’s initial moderation will likely be undermined, allowing more radical elements within the Islamist movement to come to the fore.
Egypt’s well- organized Muslim Brotherhood’s Freedom and Justice Party leads the three-stage election to the country’s parliament, with 46% of the seats so far. Far more alarming is the success of the Nour Party, which took 21% of the seats. The party is dominated by the ultraconservative Salafists, who favor the strictest implementation of Sharia law. They want to ban interest at banks, would like to segregate the sexes in public and would likely ostracize Egypt’s Christian population of about 10 million. Meanwhile, the biggest secular party trailed with just 10% of the seats. Assuming the two Islamist parties do not lose much ground in the next two rounds this month and next—which seems likely given the election are taking place in more conservative areas—they will control a clear majority of the seats.
5. Has another major global reflation already begun (continued)? In addition to the unprecedented ECB liquidity accommodation moves announced last week, we are intrigued by three additional facts that have come to our attention. First, after ECB head, Mario Draghi dampened market speculation that the central bank would step-up its purchases of government bonds, the ECB nevertheless came into the market last Friday to help support Italian debt after a rise in yields—a signal that the central bank is willing to exploit the numerous gray areas within the ECB’s policy framework. Second, the ECB has already been taking on eurozone sovereign debt by accepting these securities as collateral on loans to banks. Third, there is an increasing likelihood that banks could turn from sellers of eurozone sovereign debt into buyers, as funds can now be borrowed from the ECB at 1% and reinvested in government bonds that, in some cases, yield more than 5%. While it is uncertain how long this scheme can be maintained, given the eurozone banking industry’s exposure to counterparty risk through credit default swaps, it has raised the likelihood of a much more engaged and proactive ECB working to ring-fence the contagion in European banks.
6. Dividends gain investors’ attention. Emerging market dividends on the rise (continued). On Monday, Bloomberg reported that Goldman Sachs Asset Management (GSAM) agreed to purchase the mutual-fund business of Dividend Growth Advisors, LLC in order to expand its offering of income-oriented strategies. The purchase by GSAM, with $821 billion in assets, of the relatively minuscule $154 million mutual fund is foreshadowing future growth in equity-income strategies and a renewed focus on dividend paying companies. Because of their lower volatility and income streams, these companies will be looked to as a lower risk way to participate in equities. Indeed, such firms have been shown to outperform on an absolute and risk-adjusted basis over time. We hold the view that in light of anemic economic growth and low interest rates in developed markets, investor focus will wisely shift back to dividend income streams and attractive yields, which has historically provided the bulk o f real investment returns.
7. The new revolution in industrial-water efficiency. In WILTW August 28, 2008, we made the case that growing water scarcity will drive demand for increased water efficiency in industry. Water scarcity is spreading as drought expands (see WILTW October 28, 2010), and companies are realizing the urgency to improve their efficiency of water use, or face economic loss. Texas is a case study in our water scarcity future, as its record drought has caused $5.2 billion in agricultural losses this year alone, and increasingly threatens the state’s energy industry. By 2030, global demand for clean water will outstrip supply by an average of 40%, according to McKinsey. Improvements in agricultural and energy water efficiency makes industry, which accounts for nearly 60% of water use in developed countries, the next frontier. Certain companies are making strides in using less water, but the global trend towards increased industrial-water efficiency remains embryonic. Virtually all companies will increasingly view water resources as a strategic asset and seek ways to use it more efficiently. As water scarcity spreads, industry will be forced to use less pure sources. Providers of specialized industrial water treatment and purification equipment and services may be in the catbird seat.
8. China moves up the value chain. Even though China has largely succeeded in transforming itself from a collection of inefficient state-owned enterprises (SOEs) into what has become the “world’s factory,” its competitiveness is now being challenged by lower-cost countries and a wave of automation that may help bring previously-outsourced operations back home to the developed world. Meanwhile, the Chinese population is getting older, meaning there will be fewer workers to operate those factories in the future, while the number of retirees grows as a percentage of the population. Furthermore, the spreading sovereign debt crisis will require Chinese exporters to shift their focus away from the developed world towards more emerging markets, and maintaining a sustainable rate of growth will require Chinese companies to exploit the “high end,” while they seek to avoid the “middle-income trap.” Over the last half decade or so, China has mad e a number of remarkable achievements in moving up the value chain, and we will discuss the investment implications of these in future issues.
9. Hemingway's Boat: Everything He Loved in Life, and Lost, 1934-1961 by Paul Hendrickson, is one of the saddest, most moving books we have read. There is, of course, the tragedy of Hemingway's life, which is well known, but Hendrickson handles that with a sensitivity and compassion that has been absent. Then, of course, there are the hundreds, if not thousands, of Hemingway scholars and critics and biographers who tried to take the man apart, and as discussed below, felt compelled to criticize him harshly.
We continue our excerpts, as follows:
I have come to believe deeply that Ernest Hemingway, however, unpost-modern it may sound, was on a lifelong quest for sainthood, and not just literary sainthood, and that at nearly every turn, he defeated himself. How? "By betrayals of himself, and what he believed in," as the dying writer, with the gangrene going up his leg, says so bitterly in "The Snows of Kilimanjaro," one of Hemingway's greatest short stories. Why the self-defeating betrayal of high humanistic aspirations? The seductions of celebrity and the sin of pridefulness and the curses of megalomania and the wastings of booze and, not least, the onslaughts of bipolarism must amount to a large part of the answer. Hemingway once said in a letter to his closest friend in the last two decades of his life, General Buck Lanham, whom he had come to know on the battlefield as a correspondent in World War II: "I have always had the illusion it was more important, or as important, to be a good man as to be a great writer. May turn out to be neither. But would like to be both."
I also believe there was so much more fear inside Hemingway than he ever let on, that it was almost always present, by day and more so by night, and that his living with it for so long was ennobling. The thought of self-destruction trailed Hemingway for nearly his entire life, like the tiny wakes a child's hand will make when it is trailed behind a rowboat in clam water—say, up in Michigan.
Many years ago, Norman Mailer wrote a sentence about Hemingway that has always struck me as profound: "It may even be that the final judgment on his work may come to the notion that what he failed to do was tragic, but what he accomplished was heroic, for it is possible he carried a weight of anxiety within him from day to day which would have suffocated any man smaller than himself." The great twentieth-century critic Edmund Wilson, a contemporary of Hemingway's, who admired him early and had contempt for him late, wrote in his journals of the 1960s: "He had a high sense of honor, which he was always violating; he evidently had a permanent bad conscience." A writer named Ella Winter, one of the Lost Generation exiles of Paris in the twenties, said in a letter, seven months after the suicide:
I of course knew Hem as the big-broad-shouldered, dark-haired, most handsome "boy" who walked in that peculiar way not exactly limping but lurching, and who talked writing and ate and drank and dreamed and thought writing—only the boxing bouts and bicycle races and maybe skiing mattered besides—but you felt in him such a clean, clear strength. I know his legend caught up with him and all the beard and "Papas" and posing and drinking and publicity became part of the legend and the later man—I don't know how much he himself became the persona the legend created. But I've always felt there was the real human being, unphoney, unpublicized, caring like hell. |
