By Paul Azeff and Kory Bobrow
"It's a complete tempest in a teapot." - Jamie Dimon, CEO of JP Morgan on April 13th, discussing large derivatives trades that became known as the "London Whale" trade.
"In hindsight, the new strategy was flawed, complex, poorly reviewed, poorly executed and poorly monitored." - Jamie Dimon, on May 10th, after disclosing that the losses on the "London Whale" trades exceeded $2 billion in less than six weeks.
"I think gold is a great thing to sew into your garments if you're a Jewish family in Vienna in 1939, but I think civilized people don't buy gold. They invest in productive businesses." - Charlie Munger, Vice-Chairman of Berkshire Hathaway
"Whoever controls the volume of money in our country is absolute master of all industry and commerce…and when you realize that the entire system is very easily controlled, one way or another, by few powerful men at the top, you will not have to be told how periods of inflation and depression originate." - US President James Garfield, 2 weeks before his assassination.
"The future's uncertain, and the end is always near." - Jim Morrison, Roadhouse Blues
Well, here we are again. It's getting a little tiring spending so much time talking about a Mediterranean country with a GDP roughly the equivalent to the State of Washington's, but Greece is yet again in turmoil, and now threatens - as we had predicted several times over the last couple of years - to bring down the entire eurozone. At last count, more than 10 European leaders who supported the austerity and bailout measures have been replaced, most recently in Greece and France. In France, once half of the "Merkozy" duet working hard to keep the eurozone together, voters replaced Sarko with a socialist leader who had run on a platform that espoused, among other things, increasing the tax rate to 75% on earnings of over 1 million euros.
But it's still tiny Greece that is at the epicentre of the troubles, and there, elections have seen the interim leader thrown out, and big wins for once-marginal parties that espouse an end to austerity, and in some cases, an outright dissolution of the eurozone. In fact, as of the time of this piece's writing, Greece's efforts to form a coalition government have failed, and now the only option left is another election. One of the parties, Syriza, which the Financial Times describes as "…a coalition of a dozen far-left factions…" has publicly stated that it will not agree to help form a coalition unless the other coalition members agree to renege on the bailout agreement that was signed just a couple of short months ago, which might not be of any concern, if it weren't for the fact that Syriza came in second in the polls, and will inevitably form part of the next government, unless the results from the re-election are materially different! It's gotten so bad in Greece, that even the London bookmakers, known worldwide as ready to make bets on pretty much anything under the sun, have stopped taking bets on Greece exiting the eurozone by year end, after having slashed the odds repeatedly.
Not surprisingly, Germany's Angela Merkel was quick to point out that the deal reached with Greece was not up for renegotiation. Germany would be rather embarrassed if all the money it had thrown at the Greek problem went up in smoke, but this is precisely what Syriza has in mind. Historically, isolating the German chancellor hasn't worked out too well for anyone…. And does anyone really think that if Greece manages to renege on the debts, other countries, like Portugal say, or heaven forbid, Italy or Spain, wouldn't want to see their burden eased as well?
Turning to Spain, which is a much larger economy, and hence a much larger problem than Greece, the situation is precarious at best. More than 50% of Spain's youth are unemployed, causing many to worry about the potential for unrest. Spain's economy officially "double-dipped" into recession (and it isn't alone; the UK also double-dipped!). Spanish banks' loans represent over 170% of GDP, and the amount they borrowed from the European Central Bank jumped from 169 billion euros in February to a staggering 316 billion euros in April! In the month of March alone, Spanish citizens pulled out 65 billion euros of deposits from Spanish banks. And here's the kicker: Spain is supposed to contribute over 95 billion euros to bail out… Greece!
In this environment, how long before capital controls are openly debated in the parliaments of Europe? If you have money in a European bank today, you may want to take Hugh Hendry's (Eclectica Asset Management) now famous advice: "I would recommend you panic!" It sure seems that Greek citizens have taken his advice to heart: published reports suggest Greeks pulled more than 700 million euros from their bank accounts on May 15, alone.
Let's turn our view Stateside, not because there isn't more to say about Europe, but we see no need to flog a dead horse. Feel free to call us if you want additional depressing news about Europe, OK?
Against the dismal backdrop of Europe, it's certainly lucky that the U.S. economy has turned the corner. It has turned the corner, hasn't it? If the only thing you looked at were some of the economic indicators that came out early in the first quarter of this year, you could be forgiven for thinking that it had. Our view is that the early economic numbers were positively impacted by unusually warm weather experienced throughout much of the continental U.S. during the first couple of months of 2012. Regardless of the reason for some of the better-than-expected data, things have changed course significantly in the second quarter.
As David Rosenberg points out in a recent piece, more than two-thirds of the economic data are now coming in below expectations. Consumer confidence fell for the 2nd month in a row to 69.5 (the average number during recessions is 78, so what are we in now?). March durable goods posted a 4.2% decline, the largest drop since January 2009! Oh, and the previous month was revised lower by almost 10%. April ADP employment numbers came in at 119,000 versus an estimate of 170,000. The Philly Fed May Business Index just came out, and it was expected to rise 8.5%, but instead came in at a decline of 5.8%! And so on, you get the picture…. We maintain that there will be more money printing announced shortly. Stay tuned.
You don't have to take our word for how bad the U.S. economy is, just have a look at the Treasury market. Sure, the Fed has purchased over 60% of all bonds issued last year, but we think that the low yields we are seeing today go far beyond that. The 10-year Treasury at under 1.75% and the 30-year at under 2.85% sound decidedly unattractive. Corporate spreads have widened out, so if you are looking for yield, there are better places to put your money today.
Sadly, things are even worse in Japan. Our last piece was all about our reasons for thinking Japanese yields are headed higher, so we won't belabor the point, but in case anyone was wondering whether things have gotten any better, take a look at this chart, courtesy of Zerohedge, showing Sovereign debt as a percentage of government revenue:
Nope. Not getting better.
So with all this doom and gloom, what do we like, you may ask? We're buying what the IMF is buying: gold! Yes, the IMF was selling gold to emerging countries' central banks quite recently, but now it is buying, and the reason, as QBAMCO pointed out recently: "…there is a need to increase the Fund's reserves in order to help mitigate…elevated credit risks." We couldn't agree more. The only difference is that we believe that gold producers are even more attractive than gold bullion at current prices. Have a look at the charts below. Gold has officially dropped 20% from its high, but the junior miners have been decimated, and even the relatively safe senior producers, like Barrick Gold (ABX), are off significantly. In fact, the last time Barrick traded at these prices, gold was more than $600 cheaper! At these prices, Barrick yields far more than money market rates, and roughly 10% more than the S&P 500 (SPY), and Barrick's dividend has been increasing, with a 33% increase announced just last quarter. From 2001 to 2011, their earnings went up tenfold. The company has indicated that it expects to increase production from 7 to 9 million Oz over the next 2 years. So here is a company that trades at less than 8x trailing earnings, the earnings are increasing, the dividends are increasing, and the stock has… gone down significantly. 'Nuff said.
We want to be perfectly clear on this: we believe the gold stocks represent value unlike anything we've seen since the 2009 market lows. Several of the juniors are now trading well below cash value, one we're familiar with is trading at just two-thirds of the value of its net cash position.
We can't let Charlie Munger's comments about gold go unchallenged, so, presented below, is our full response, readers can determine for themselves what "civilized people" should do:
As an aside, we don't think it was the Jewish people in Vienna in 1939 who were uncivilized….
Similar opportunities exist in the energy space. To give just one example, Pengrowth hasn't traded at these price levels since the bottom of the market in early 2009, and now yields over 11%!
The opportunities we see in energy and gold serve to highlight some of the reasons why we believe Canada is the "one-eyed king" on the world stage. Even in the sectors that we don't like, such as the banks (if Jamie Dimon doesn't know what his balance sheet looks like, how can anyone else hope to), Canada stands out as a strong relative player. A recent report by the Canadian Centre for Policy Alternatives claimed that several of the Canadian banks required substantial government support back in 2008. In the chart below, you can see that they claim CIBC required the greatest amount of support relative to its market capitalization.
It's only fair to point out that this report was controversial, and some of its facts and figures have been disputed. In any case, even if their numbers are spot-on, what it serves to highlight to us is that even in the midst of the worst crisis since the Great Depression, Canada's Federal Government had enough resources at its disposal to dispatch aid to any "needy" Canadian bank. An important difference between 2008 and today is that Canada's Conservative Government now enjoys a strong majority in Parliament, as well as a majority in the Upper House. This means that if it decided that aid needed to be dispatched again today, it would be extremely difficult for the opposition parties to counter its moves. There are few other countries around the world where this is the case today.
Canada's economic numbers have also generally been much better than those of our neighbour to the south. Our employment picture is getting stronger,and we aren't printing money. Canada has also never confiscated its citizen's gold, as the USA did in 1933. Our tax regime is getting more competitive, simply because taxes are rising globally. As the chart below shows, our debt-to-GDP is in very reasonable territory, especially in comparison with the U.S., Japan or southern Europe.
Canada has little political dissent, other than Quebec students who are upset that they are required to pay roughly 16% of the cost of their post-secondary education. We have no NINJA-mortgages. No non-recourse mortgages. No upcoming Federal elections. No nasty disagreements with the IMF. No money printing. No massive youth unemployment problem. What we do have on top of great hockey teams, maple syrup, and beer is a stable and growing economy, vast natural resources, a strong currency and a business-friendly government. And that's the bottom line.