Investment Strategy Newsletter

During the 1980s, banks in Japan lent crazy amounts of money against real estate. Of course, they couldn’t get it back. To save the lunatics, interest rates were kept at basically zero for the next 20 years.

During the early years of the new millennium, US banks lent crazy amounts of money against real estate that people couldn’t afford in the first place. Of course, they couldn’t get it back. Interest rates dropped to zero to save the dumb (or criminal) bankers.

During the last forty years, European banks lent crazy amounts of money to their governments to help them getting reelected. Of course, they can not get it back. Interest rates have dropped to naught to save the lenders.

It goes to show that banking’s rule number one “Lend out money only to those who can pay it back from their cash flow” has been violated practically everywhere (some dumbo banks not only lent to bankrupts, but did it in foreign currencies, just to show that ignorance obviously has no limits).  The culprits in all cases, deranged imbeciles masquerading as bankers, have not been punished, but instead rescued and rewarded.

It’s now an extended, grinding process to let technically broke banks recover again. It’s also confusing: folks have been taught for generations that saving has merit. Now they are being told to go to hell. They’re not needed when central banks unleash avalanches of money. A trillion here, a trillion there, happy times are back again. The ECB alone has given half a trillion in 3-year money at just 1% to its banks. A similar amount is being readied for release in a few weeks time.

What about inflation? As we have said here before, there is no imminent danger of it. The newly printed money is not yet being injected into the real economy. It’s sloshing around in the tubular interbank system, channelled back to the ECB and farted into the casino which the markets have become. It is thus pushing up some asset prices, stocks and, to a lesser degree, commodities.

We could deplore this state of affairs here, but our mission doesn’t include saving the world; we’re just trying to help with investment decisions. Therefore: since all the money is flowing towards the banks, stick to them. January was very good for banking shares, and this could continue for a few more weeks. No important bank is allowed to go bust, and the margins are ok: get money at 1% or less and lend it out anywhere between 4 and 24% (credit card and overdraft charges, in case you wonder). There are hardly any geniuses in banking (except at Goldman, of course) but luckily, with this kind of support, you don’t need to be a genius to make it.

Enough of this! Let’s instead look at mobile communications and such. The clear winners so far are of course Apple, Samsung, Amazon as well as Qualcomm and Arm Holdings. Unfortunately their prices are (too?) high, but whenever there’s a 10% pullback, one should consider to buy some. The previous leader in this field, Nokia, has been left for dead, but it just came out with its new Windows series, the Lumia 710 and Lumis 800. The reviews and market reception so far have been good. If Nokia succeeds, the stock, now trading near its all time low of 4 € (5 $ for the ADR), could be a stunner (Disclosure: I’m long NOK). Hardware providers, which build the infrastructure for the net, have pulled back considerably. Look at companies like Juniper, Riverbed Technology, Alcatel Lucent, Ericsson, Cisco and even Siemens for possible entry points. Storage is a universe onto itself (the Cloud!). EMC Corp. is a prime name in this field.

Finally: the euro will not go away soon. It’s been a relative success, even though some profligate countries couldn’t handle it, initially. Even if Greece and Portugal drop out, the rest of Europe will keep it.

The world needs an alternative to the dollar, not least because the USA is misusing it as a political nuclear weapon. Whenever Washington threatens to cut somebody off, like just now anybody who deals with Iranian banks, all must cave in and follow Washington’s dictate, like a herd of “sheepletons”. Europe and the ascending superpower China can stop that, but only if they have a credible, strong reserve currency.

After a disappointing and difficult 2011, we found some joy in the first trading days of 2012. Hopefully, it will last. I want to share my thoughts for the immediate future with you here:

The most important support for the market is the scaffolding of extremely low interest rates which is not going to be removed soon. Secondly, companies are doing generally well; they are cashed up and prepared to navigate through potentially difficult terrain.

China will not implode as expected by many pundits. The US economy will continue to grow moderately, usually a good condition for the stock market. The euro will not turn into confetti, banks in Europe will not collapse and any state or other body too big to fail will not do so. The opinion leaders in Europe and especially its successful businesspeople are fiercly backing the euro. That matters more than the guided opinions of large parts of the population which remain angry and confused.

I expect continuing tensions in the Middle East, perhaps a war between Israel and the US vs. Iran. The same interests which promoted the phony war in Iraq are aligned to do it again. Eisenhower’s “military-industrial complex” needs a new war to justify and guarantee its trillion dollar allocation. If it happens, the dollar and gold will go up, along shares of Lockheed Martin, General Dynamics etc. The rest of the market will wobble, but eventually recover. Oil will explode, at least for a few days or weeks.

I’m not as optimistic about gold as I have been over the last few years. Even if base money increases due to “money printing”, it’s only about a tenth of overall money supply and won’t matter much in the short to medium term (just look at Japan, if you doubt that). More importantly, banks are deleveraging and cutting balance sheets, states are switching to austerity mode and consumers are tight. The velocity of money, the speed it’s moving through the system, is low.

Take all that and inflation is not the imminent danger. Down the road, in 3-5 years, that might change. If there’s little danger from inflation and even the euro disaster of the second half of last year didn’t push gold up markedly, why expect a bull market now? I keep my gold but I won’t buy more – for the time being.

Finally, I stick with energy stocks (often recommended here) and add a few bucks into speculative counters such as banks, which have been totally bombed out.

Folks are upset when they hear that banks are being rescued while ordinary guys are discarded without hesitation.

The anger is justified, but it can’t be helped. You see, the big banks all over the world are like segments of a giant roller coaster. If only one of those segments collapses, the whole coaster would become off limits, especially when nobody knows which part of the ride would fall off. One could improve safety by changing the design of the machine, but that takes time, especially when it has to continue running during the upgrade.

Central banks of the world are also connected at the hip and are the responsible guardians of the system, the roller coaster. They cannot allow the track to become unsafe, they have to stand behind the whole juggernaut. And because that is as it is, I expect no big bank to fail.

That makes for an interesting trading proposition:

Every other day some bad news or rumors are spreading, and the market tanks, most of all the financials.

Time to buy.

Unsurprisingly, the sky is not falling, central banks are easing, bank shares are rallying.

Time to sell.

This strategy is of course not suitable for everyone. One needs strong nerves, because the exact timing of tops and bottoms is impossible. There will be (temporary) losses, some entries and exits will happen too early. But, considering that bank shares have already been beaten down a lot, it could be worthwhile. It’s hard speculation, but nearly everything in life is, too. Whom we marry, what job we choose, if/when/where we build a home – we’ll only know years later, whether it was the right decision or not.

Even gold, the seemingly safest way to navigate the present circumstances is an essential gamble. We are, willingly or not, forced to choose, or gamble, and doing nothing is also a choice.

Finally, here is a famous statement of the US Fed boss, Ben Bernanke; he said “The U.S. government has a technology, called a printing press (or today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at no cost.” Congressman Ron Paul accused him of being engaged in a full time money counterfeiting operation. Be it as it may, money will definitely be created to save the banks (and governments).

It’s known that insurance companies pay out less than they take in. The beasts have to be maintained after all, and that costs.

The arrangement would perhaps be acceptable if the guys behind the marble columns were superior guardians of our money. Risk assessment is their daily bread, and investment management their calling. It turns out, however, that the insurance folks were trusting believers in long-running Ponzi schemes. They’ve placed large portions of their assets in government bonds which will never be paid. At least not in the same money which went into them.

It is unclear why experienced actuaries, statistics and maths wizards, ever assumed that states, which couldn’t balance their budgets for decades, were somehow good debtors. It must have been an extreme example of swarm intelligence gone bad. Now one insurer after another admits to losing hundreds of millions, or even billions, of dough. Bad luck for their clients and shareholders.

What happened in the insurance realm is nothing new in banking. Boom and bust are familiar cycles. The same mistakes which killed banks since they existed are being made again and again. Insane leverage, term and currency mismatches are the eternal poison pills for aggressive bankers. Astonishing gaps in risk control are the icing on the cake.

Our conclusion from this state of affairs has to be to either to avoid both sectors completely, or try extremely short-term speculative dips into them. The volatility is tempting, like a surfers’ paradise, with waves like giant barrels and plunging breakers.

We repeat our long-standing recommendation for solid blue chip stocks with good dividend yields. The precious metals position stays, too. Periodic profit taking after short surges is not a bad idea.

The Euro was the political price which the French President Mitterand demanded for Germany’s reunification 21 years ago. The two main actors, Mitterand and Kohl, agreed on a common currency without understanding the basics of it, let alone the disasters it would entail. Now we have landed in a holy mess and if we don’t find and accept the only feasible way out of it the Euro is doomed. Time is of the essence. Incompetent politicians have already wasted two years and we are moving ever more closely to a steep cliff and a hard fall.

The only way out of the terrible situation we find ourselves in is the monetization of a large part of European debt by the ECB. All of Europe is technically bankrupt because it is unable to meaningfully reduce its debt without placing the whole continent into a severe depression. Now, in order to deflect the two main arguments against monetization, moral hazard and inflation, here is our solution:

Instead of just forgiving a large part of Greece’s debt and later on also Portugal’s, Italy’s, Spain’s etc. we just forgive half of the debt of each and every Euro country. Nobody has to pay the debt of other countries, all benefit equally from debt forgiveness. Technically that will work through the purchase of about 3 trillion Euros of government-issued debt by the ECB. Immediate consequences of the announcement of such action should be: a gigantic rally in the debt, equity and commodity markets, a drop in long-term interest rates, especially for the weaker countries and a decline of the Euro exchange rate. The latter would definitely be welcome by European exporters.

In order to eliminate moral hazard all parties have to agree to follow a strict debt regime with severe and automatic sanctions in case of delinquency ( exclusion from the Euro zone ). This must be agreed before any monetization can take place.

As to the danger of inflation: While banks are shrinking balance sheets and consumers stay tight with their money there is no danger of inflation. Witness Japan and the USA which have printed tons of money without igniting inflation. Of course the danger of future inflation is real and the ECB shall be ready to act if that becomes necessary.

Our guess is that the above solution or variation of it will be chosen, but only after everything else has been tried and has failed.

That means the turmoil will continue for the time being. During such time the volatility is extreme, oscillating between hope and despair. It’s a potentially good time for traders as we see movements of 20% or more within a few weeks. It’s also very dangerous for inexperienced or overconfident folks. A quantity of them will be crushed and this itself will contribute to the chaos which only few can navigate successfully.

Life is relatively easy – when you are in possession of a limitless credit card. At least it seemed like one. Our welfare state was built on it. But suddenly a whistle has been blown, credit is being withdrawn, and the wheels are coming off our shiny car.

Economists were always laughing when some simpletons compared governments to households and said: you can’t run persistent deficits. Yes it’s true, nations can increase taxes or crank up the printing press, but those actions have consequences. And they are not pretty. There’s simply too much debt around nowadays, and there are only three choices before us:

• 1) Austerity and hard deflation.
• 2) Default.
• 3) Inflation.

Looking at these choices, and also at various decisions being made by our politicians and central bankers, it seems obvious we’re headed towards choice number 3. Debts will be wiped out on one side of the balance sheet, assets and savings on the other. Before and while that happens, we’ll have to spend some time in austere purgatory, just to make sure that the misery is really thorough. ‘

As if that were not enough, our governments are introducing new taxes – while real incomes are stagnating or even dropping. And the common currency of over 300 million people in Europe is in danger of collapse.

Yes, the house is on fire and the exits are not clearly marked.

We at XAM Capital Ltd. have managed wealth successfully for over a decade, and we are well equipped to steer through the coming storms. Many people will lose a lot of money in this turmoil. A few will be able to sail through, preserve and even add something to their wealth. In these uncertain times, trust becomes a rare and precious commodity. Trust to be in safe hands, and in a safe haven.

At XAM Capital Ltd., we are offering a safe haven to some old and a few new friends. As anybody can see from our results over the last decade, we have done well, always emphasizing low risk and high liquidity – while avoiding various bubbles.

Due to our philosophy and the nature of our setup we can only accept a very limited number of new assignments. Should you wish to explore possibilities,  please contact us directly.

Do we have a situation here? And if so, can anything be done about it? In Italy, Cavaliere Cagliostro Berlusconi answers in the negative: Nothing much can be done, it’s a shitty country after all, which makes him sick. Lowering the bar a bit more, he gives his assessment of Dear Angela: an unmountable horseass. There’s some entertainment value in this opera buffa. Other than that, nothing much. To have money is better than having no money, and since we are now entering the age of less money, it’s going to be less pleasant; perhaps a lot less.

The emperor has no clothes, the treasuries are empty, the entitlements are hollow.

Mountains of debt have to be dealt with. The choices before us are all hard. It’s clear: somebody has to pay. But is it the taxpayers, the banks, the shareholders, the bondholders, the rich or, perhaps, us?

When chaos breaks out, gold shines. But beware of desperate governments, like F.D. Roosevelt’s, which confiscated all privately held gold in 1933 and threatened anybody who kept his gold with a 10-year prison term. Conclusion: Bullion and coins are safer than certificates, as long as they are kept in a safe place, far away from our government grifters.

How safe are the banks? Today we read that Siemens has withdrawn all cash it had deposited with French banks. That is remarkable.

Many banks are dependent on emergency cash windows at the ECB. The ECB itself depends on swap arrangements with the Fed to supply European banks with needed dollars. The most likely scenario is an extended period of muddling through with emergency meetings, last minute rescues and an insane up and down in the markets.

A few will make money, wealth preservation is the priority, but many must lose.

We, at XAM Capital Ltd., are privileged to reside in Asia, and are trying our best to keep assets in relative safety.

We are drifting through white water rapids, towards a waterfall. We don’t know its height yet, and neither the dangers that are lurking at its bottom. We always knew that dangerous currents lie ahead, and we have written many times about them, in this space. We’ve advocated gold for years. Now’s the time the ship is coming in.

There’s been a divide between bad debt, owed by the southern European countries, and good debt, issued by the likes of Germany and the US. This is clearly shown by the interest rate differential between the two. In our opinion, the so-called good debtors are as – or nearly as bad – as the presently punished, “bad” ones. Most countries in the western hemisphere plus Japan have spent year after year, decade after decade piling up debts. None of it will ever be paid back. Whoever lends money for 5, 10 or even 30 years to a bankrupt government at ridiculously low interest rates, is a fool. Nearly every insurance company and pension fund belongs in that category.

Now, as previously “safe” government debt has been found to be toxic, most banks are facing insolvency. Panic is the worst possible outcome. We don’t think it will come to that. The Federal Reserve in the US and the European Central Bank are in business to prevent such disasters. Pushed to the wall, they will run their printing presses day and night. Unlimited lines of credit can be extended to banks, and government bonds can be bought up at the flick of a button. The monetization of debt is likely, in our opinion. The manure will be spread around through fine nozzles in an Herculean effort to clean the Augean stables.

That means inflation is upon us. That’s nothing new. Most people already experience inflation at least twice as high as officially reported. We’ve mentioned the statisticians’ tricks a few times before. We expect gold to do well, still; however, the more parabolic its curve becomes, the more speculative it will be. There will be setbacks, trading opportunities for alert investors. Because of the steep falls in equity markets, we feel that good investment opportunities will evolve soon.

There’s an old saying “Don’t try to catch a falling knife”, and there is some truth in it. Nevertheless, reward will only come to the bold (and prudent) man; that means to push the ‘buy’ button at certain times. Look at the overall strength of a company, its dividend yield, the desirability of its products as a guideline.

As said above, there is no panic – yet. If it ever occurs, all short-term bets are off (except gold, of course). But a river usually runs through a quiet stretch after passing mighty falls.

Once upon a time, there was a simple solution to the problem of a country losing its competitiveness. When pressures became unbearable, the central bank devalued the currency by an appropriate percentage, and exports got a rejuvenating kick. But then the euro was introduced: a beautiful construct, a concept which, like so many beautiful concepts (communism for example), doesn’t work very well when applied in real life.

Look at Greece: It is burdened with a bloated, largely incompetent public sector, its private industry fell behind and didn’t pay its dues, it lived beyond its means and suddenly the sh*t hit the fan. An urgently needed devaluation is impossible. The EU solution for this critically wounded patient is life support through continuous blood transfers. And while blood is being transferred into the right arm, it is drained from the left. This is not a promising way for a cure. If Greece were the only wounded body, it would be relatively easy, even if a lot of blood had gone to waste already. But this is not so. Euroland resembles a forest with quite a lot of wounded deer inside. Wolves are circling around it, and vultures cruising above it. They won’t go away. It’s clear to me that we’ll have to live with periodic assaults on this or that country and subsequent crises as an ongoing feature.

But because of these crises and the general lackluster economic situation, we can expect continuing low interest rates, more money printing and a growing tolerance of inflation. In fact, inflation will be the only cure if we want to avoid major civil unrest and catastrophic collapses.

Starting from this base scenario, we can expect ongoing volatility which is great for sharp, nimble traders but frustrating for the average investor. My suggestion would be to pick a list of good quality stocks, mostly dividend paying I’d say, and then use dips of 10% or so to buy them and upswings of a similar magnitude to sell again. One could keep a core of blue chips and then add or deduct from the stash whenever those predetermined swings occur. In case the whole thing goes bad, one could at least receive dividends during long waiting times.

Holding on to some hard assets including gold is probably not a bad idea. Whenever gold corrects noticeably, one should add some and when it runs up nicely, throw some overboard, just like with stocks.

All the major currencies look ugly and can only gain against whichever looks most ugly during a particular period. A beauty contest in reverse and, again, an open invitation to trade a bit.

The last few days were pretty good in most markets and I’d expect the good times to roll for perhaps a few weeks longer (the biggest fires have been temporarily subdued), but the wolves have not gone away; they’re just resting for a while.

This will not end well. It was a project of the “Elites” who thought they knew better than the unwashed masses of citizens. The same people who pushed it without thinking it through are now running around with dire warnings about the disaster that will befall Europe if their grand idea collapses. It reminds me of an architect who designs a building without the help of a structural engineer, a rickety construct which might be mistaken for a genial strike of Santiago Calatrava, daringly cantilevered but beautiful to look at. But the Euro architects were no Calatravas, just guys whose training consisted of sitting it out in backrooms while most folks tried to get and perform real jobs.

Why are we still listening to these failed bean bags?

The Euro was introduced based on lies, deception and incompetence. Its major underpinning, the Maastricht treaty, was broken and abandoned a millisecond after it was signed. Everybody thought it’s party time with unlimited money at ridiculously low interest rates. There was no mechanism to discipline profligate countries. Just naked hope that all will go well. The present mess is the unsurprising outcome of half-baked thinking by a generation of politicians who are meanwhile retired on huge pensions and weighed down by more awards, gongs and distinctions than Colonel Gaddafi.

The Euro as such is not the cause of our trouble. It is a medium of exchange, measurement and wealth storage as good as any other currency, even gold. The problem occurs only when, for unfathomable reasons, it is suddenly declared that nobody who uses this currency can go bankrupt. Oh, if we would have had that system in my home country, Austria!  I sure would have dined out in style while cruising around in a Porsche.

This unexplainable fixation on the illusory solidity of any country which happens to use the Euro is a phenomenon which should not only be studied by economists but also by clinical psychiatrists and even pathologists. Meanwhile, to uphold the fiction that all is well, the European Central Bank is forced to buy all the junk bonds of countries which nobody else in their right mind wants to touch. This is printing money without sufficient collateral and undermines the currency.

What will happen next?

The politicians will try to evade reality as long as they can, because failure is not an option for them. After all, it’s not their money they are burning. Instead of tearing down the faulty towers, they will add support columns here and there, inject concrete into the ground and try to cover everything in colorful wrappings. This could go on for a while longer till folks in one or more countries start to rebel seriously and eject their government. For us, as investors, thinking about the long-term safety of our retirement funds, it means that sovereign bonds are definitely out. Cash is good only for the short term, until some feasible investment opportunity crops up. Equity in a diversified group of multinational companies is a serious option. Gold, of course, is too.

Real estate holdings should be qualified by the likely desire of governments to raise taxes on them. After all, property is hard to hide and easy to tax. While it is still possible, one should open offshore accounts in places like Singapore. Financial repression might reappear again, meaning that desperate states could restrict the free movement of capital (this was the norm during much of the 20th century) in order to force their citizens to buy local bonds at artificially low interest rates.

Get going as long as this is still an option.