Eric Roseman's Eruptions: Stocks, Global Markets and Commodities BLOG

Where to Hold Physical Gold

At yesterday’s Total Wealth Symposium in Panama City, a delegate asked me what I thought about holding physical gold at a bank in the United Kingdom or Australia. It’s not the first time I’ve been asked this question – and my reply is always the same.

The Anglo-Saxon countries are not an ideal location for storing physical gold. That’s because gold storage is usually viewed as financial insurance and is tied to asset protection, privacy and safety.

The United States confiscated gold in the last century; the British imposed foreign exchange controls in the early 1970s and Australia and New Zealand aren’t exactly safe-havens since both have deep economic ties to the United States.

For gold storage, I prefer Switzerland and Austria. Both countries offer strict privacy and asset protection laws.

Switzerland has a long history of banking confidentiality while since 1955 the Austrian constitution ensures privacy to international investors. Bankers in both countries are jailed if they divulge information to third parties outside the banks’ auspices.

Switzerland and Austria can store either physical gold or will purchase gold certificates for your account. You’ll pay an annual storage fee for this service plus trustee and safe-keeping fees.

If I’m truly worried about protecting my wealth from the devastating effects of long-term inflation and the decline of fiat money, then gold is a natural. Holding most of your gold in a country with a strong tradition of protecting foreign investors is exactly where you want to store your gold. That means Switzerland and Austria.

Also, if you want to protect yourself from total financial Armageddon, gold coins (not numismatics) are portable, easily exchangeable and should be stored in a safe place at home, not overseas.

Gold offers piece of mind. I doubt we’ll see 1930s-type bread lines again any time soon. But in today’s environment, anything is possible. If you’re bullish on gold, consider holding your physical bullion, or most of it, in Switzerland or Austria.

Monday is Victoria Day in Canada. I’ll be back on Tuesday. Have a good weekend.

Buying Low Usually Pays Off for Patient Investors

Back in October 2006, my Commodity Trend Alert (CTA) plugged one of Russia’s largest oil companies amid a severe sell-off in Russian stocks. At the time, investors were growing increasing frustrated by Moscow’s interference with oil company profits. The Putin government was viewed as anti-shareholder friendly after nationalizing Rosneft and Yukos a few years earlier. Nobody wanted Russian oil and gas companies.

But upon researching this formidable company, I learned that its annual oil production was almost the same as Exxon-Mobil’s, yet the formers’ stock-market capitalization was about 85% less than the world’s largest oil concern. Something was definitely wrong with that picture.

That’s when I decided to start buying…

Including dividends, this large-cap behemoth has now gained a cumulative 35% following oil exploration tax incentives announced by the Russian government recently. Most of that gain has occurred over the last thirty days. Russia’s new government is now encouraging oil companies to explore as revelations among oil industry executives confirm the country is challenged by declining production as soaring costs pressure margins.

This year, as the majority of U.S. large-cap oil stocks struggle even with oil at $125 per barrel, this Russian giant has gained 27%. In fact, Russian oil and gas stocks rank as the top-performing energy companies in 2008 following two years of poor relative performance.

Contrarian investing is a difficult strategy. Going against the herd usually results in big profits – if you’re willing to buy when the consensus is bearish and prices are distressed. You also need patience. It’s an art that has been mastered over the years by legends like Jimmy Rogers who taught me in the early 1990s to buy when everyone else is selling and sell when everyone else is buying.

I’m now buying other bombed-out sectors, including solar energy, uranium, stock exchange operators and investment-grade corporate bonds.

Buy low, sell high. It pays – eventually.

The Global Stock Exchange Boom is Finally Affordable

One of the most profitable investment themes this decade has been the global stock exchange merger and acquisition story. From New York to Frankfurt, bourses have been aligning themselves with partners to boost product revenues and increase trading volume. It’s been a superb place to invest – until the party ended last fall amid subprime woes.

I’ve avoided the stock exchange merger story for the last few years because prices were just too high. Cross border bids became almost ludicrous on some deals while others stalled as parties tried to secure financing. This was a classic “bubble” with investors and institutions jumping at any price, driving multiples way above reasonable valuations. Then came subprime and global markets headed into the basement.

One of the highest profile cross border deals this decade is NYSE Euronext (NYX-NYSE). The NYSE merged with Paris based Euronext in 2006. It’s now one of the largest and most profitable stock market platforms in the world offering a prestigious exchange for listed companies and the highest trading volume liquidity.

But, I would not buy NYSE Euronext at this price, despite good earnings in Q1. Instead, look to bourses in Asia and Europe, which have posted sharp declines over the last nine months. Some of these stock exchange operators pay dividends in strong currencies in excess of 4% and trade about 25% to 50% below their all-time highs last summer.

The trend in cross border stock market mergers won’t end any time soon. This is one cash cow that should continue to easily attract financing amid a credit crunch. Many players are now attractively priced and I’m starting to accumulate positions. I’ll go into greater detail in upcoming TSI issues.

Time Changes Values in Panama City

I always enjoy returning to Panama. It’s a beautiful country, the people are kind and the weather is much better than in Canada!

When I started coming to Panama in 2000, real estate prices were among the most distressed south of the Rio Grande. The city’s skyline was littered with beautiful buildings, mostly high-rise condominiums that sold for a song compared to similar properties in Miami or Los Angeles. I surveyed more than a dozen condos in the early 2000s and now regret not speculating because prices have risen quite sharply over the last five years.

Panama was making a comeback. The airport was expanding, the canal was seeking its own expansion plans, following its reversion back to the Panamanians, and tourism was booming, as Americans were seeking more affordable primary residences or vacation homes following a real estate boom in the United States.

Panama City was dirt cheap in 2003…

But that’s not the case any more; following Donald Trump’s announcement in 2006 of a new 60 story hotel/condo resort complex, prices literally climbed 50% in Panama City within days. Developers immediately boosted prices.

Panama is still an affordable destination for a vacation home or a primary residence. Over 250 islands sit off the Panamanian coast – most also attractively priced. You can still find good deals. The best bargains, however, are long gone.

A good friend of mine purchased a prestigious high-rise condo unit in 2004 for $600,000. The unit has a spectacular view of the Pacific Ocean, high ceilings and first-class building materials, including marble in all three bathrooms. He’s now looking to sell that condo for $1.4 million dollars – a pretty steep increase. That’s an extreme example, but nevertheless indicative of how the top-end of the market is priced.

If I was looking to buy a house or condo today, I’d be looking very carefully at U.S. real estate, especially in Miami, Tampa, San Diego, Las Vegas and Phoenix. All five cities are much cheaper compared to only 36 months ago.

Aside from affordable real estate, Panama offers other benefits, including second citizenship and a much less taxing lifestyle. But it’s fair to say that after a housing bust since 2006, bargain hunters will now find very exciting deals across the United States – and prices are heading even lower over the next 12 months.

Five years ago, real estate for most couples or individuals was largely unavailable as smart speculators or prospective homeowners didn’t bite off more than they could chew. Prices were just too expensive.

A bear market or deflation in U.S. residential housing is still in progress. If you plan on staying in the United States and want to avoid the travails of moving and the language barriers, I suggest distressed property investing in America. The Europeans are all over New York City since 2007 amid a sky-high euro. Maybe it’s time Canadians and Americans do the same as prices get even cheaper. If you want a second home, it’s time to look at the distressed Sun Belt in the United States.

No California Dreaming for Vallejo

California probably best exemplifies the boom-bust cycle better than any other state. In May, the city council of Vallejo unanimously voted to file for bankruptcy, sparking a credit downgrade and unleashing fears of more municipal bankruptcies on the horizon.

California is infamous for harboring a few largely publicized municipal defaults or bankruptcies. In 2001, Desert Hot Springs went bust and, in 1994, Orange County sought protection from its creditors after making bad bets on derivatives.

Located near San Francisco, Vallejo’s bankruptcy is thus far an insolated affair. The city’s funding gap at a relatively small $16 million dollars is puny compared to California’s massive $20 billion dollar budget deficit.

More than any other state, California has been hit hard by the residential bear market in housing since 2006 as foreclosures hit record levels and state unemployment continues to rise. The bust has been particularly damaging to San Diego – home to one of the country’s biggest bull markets in property in the 2000s. Many other cities and municipalities are also hemorrhaging as state revenues decline and credit funding grows more expensive since last summer’s subprime implosion.

To date, Vallejo is a mere drop in the bucket. Its $16 million dollar funding gap pales compared to the tens of billions of dollars already lost in subprime foreclosures across the state. But if California’s housing woes continue to unravel, more municipalities will face higher funding costs and, possibly, credit downgrades by rating agencies.

For prospective real estate buyers, however, California Dreaming might become a reality. Real estate has finally become more affordable for many individuals as “cash is king” in mid-2008.

Prices across California continue to decline for residential housing as more owners walk away or default on their mortgages. The supply of new and existing homes stretches out as far as the eye can see; with interest rates heading lower to combat housing deflation in the United States, value investors can start combing the residual fallout for some quality properties in the Bay area and San Diego. The time to buy is approaching. Look for foreclosures to increase and the supply of homes to rise as the bear market deepens in 2008.

Big Fees, Poor Returns: Hedge Funds Fail to Hedge in 2008

Hedge fund managers probably have one of the most lucrative businesses on Wall Street and the City of London. Some might say hedge funds are even a con job.

Hedge funds first hit the investment scene in the United States way back in 1949 when Alfred Jones launched the first long/short equity fund. A typical hedge fund is long, or invested in stocks and other securities, and simultaneously short, or betting against overvalued securities. The premise is to deliver an absolute return in all markets while protecting investor capital, reducing risk and, hopefully, outpacing stock benchmarks.

Hedge funds generate massive fees. Investors fork over big bucks -- sometimes subjected to 12-month (or more) lock in periods and then hand over a 1% annual management fee and a sleek 15% performance or incentive fee on net new profits. What a deal! This pales in comparison to plain indexing or active mutual fund management, which don’t lock in investor capital and extract far less in annual expenses. They also rarely blow up like some hedge funds.

What Happened to Hedging?

To be fair, hedge funds as a group did protect investor capital in the last bear market from 2000 to 2002. But amid severe market dislocations in history, including events in August 1998 (Long Term Capital Management), 1994 (aggressive Fed rate hikes) and 1987 (October crash), most hedge funds lost a pile of dough. Provided there’s a series of established trends in their respective sphere of trading, hedge funds can make money; but when markets dive sharply, most hedge funds fall just as hard as everyone else.

In 2008, one of the toughest years for global investors since 2002, the average hedge fund is losing money and some categories are faring worse than the S&P 500 Index. Since 2007, a record number of hedge funds have either closed or collapsed as market volatility draws the final curtain on some of the more inexperienced and highly leveraged operators.

According to the Credit Suisse Tremont Hedge Fund Index, those amazing Wall Street and London trading wizards are down an average 2.1% this year through March 31; worse, of the 12 sub-indices comprising this database, only three are profitable. The best performing hedge fund sector this year is the short selling category – an obvious place to make money for any short only focused hedge fund. But others, including distressed debt, event-driven, convertible arbitrage and long/short equity, to name a few, are all suffering losses through March (latest data available).

So far in 2008, most hedge funds have failed the grade as investor flows tumble more than 50% compared to 12 months ago and redemptions surge. Many investors have also grown concerned about prime-broker counter-party risk, whereby investment banks like Bear Stearns conducted trading on behalf of large hedge funds.

Too Popular?

Hedge funds have grown from being marketed only to the super wealthy in the 1980s and 1990s, to mainstream investors through publicly listed companies and retail hedge funds offshore. Pension funds, endowments and even sovereign wealth funds (SWFs) are climbing aboard this decade as investors seek higher inflation-adjusted returns in a sluggish stock market environment.

Hedge funds grew so popular heading into the mid-2000s that several high profile managers went public. Fortress Investment Group (FIG-NYSE), no doubt one of the better hedge funds in the world, has seen its stock slammed since going public in 2007 following a dismal first quarter as leveraged loans soured.

Unfortunately, too many hedge funds fail to earn their stripes and don’t deserve their fat 15% incentive fees. Many managers disguise themselves as long/short products but, in reality, are glorified mutual funds that fail to properly hedge while levying huge fees.

Despite their ongoing travails, some hedge funds do belong in a large globally diversified portfolio. From a universe of more than 6,000 products, many are still worth your dollars. These managers have earned top performance accolades over the years, successfully protected investor capital and have a large portion of their own net wealth invested in their funds.

More than ever, investors must conduct careful due diligence with any hedge fund product. Make sure you understand that fund’s liquidity provisions, underlying leverage, lock-ups (if any) and the fund’s prime brokerage relationship. Also, a true blue hedge fund should be able to make money in most markets, including bear markets and crashes. Investors beware.

According to Soros, Stocks in Bear Market Rally

When George Soros speaks, I listen. The legendary hedge fund manager of the Quantum Fund is probably one of the best global investment thinkers in the business. Soros started the Quantum Fund in New York with another great investor, Jim Rogers, in the late 1960s. From 1969 until the late 1990s, Soros earned over 35% compounded per annum. That spectacular achievement is a rare commodity among hedge fund titans today, except Jim Simons of Renaissance Capital and a few other legends still actively trading.

In an interview this morning on Bloomberg television, Soros commented on the markets, subprime and housing. For the record, Soros remains bearish.

The United States has probably passed the “acute phase of the subprime crisis” at this point, according to Soros. Though he still expects volatility to persist over the next several months, he thinks most of the systemic danger has already passed regarding the banking system.

But on housing and the current stock market rally, the legendary hedge fund manager was not so optimistic.

Soros believes U.S. residential housing will “overshoot on the downside,” just as it did on the way up until prices peaked in mid-2005. The real estate market in the United States is still plummeting and shows no clear signs of a bottom. Trailing 12 month home prices have declined in excess of 12% through April, the worst slide since the 1930s. One in every 557 homes is now in foreclosure. According to Paper Economy, the last housing bear market lasted 97 months or 8 years from peak-to-trough.

On the markets and the economy, Soros claims investors are participating in a bear market rally. His reasoning lies behind bearish trends now unfolding in the real economy, which has yet to be fully discounted by the markets and corporate earnings. The real economy is being assaulted by surging gas prices, soaring food costs and rising unemployment.

Soros believes the severe shock suffered by the American financial system will ultimately spread to domestic consumption. If he’s right, stocks are heading much lower.

U.S. Bank Lending Tightens, Signals Worsening Credit Crunch

Credit stress is showing signs of abating in some areas of the market while increasingly deteriorating in others. It’s still a mixed bag as far as I’m concerned, with the most important segments of lending rapidly faltering. More than any other variable, bank lending signals whether liquidity is flowing to companies and individuals; if it isn’t, that’s a highly deflationary signal constricting economic growth.

High yield bond spreads, mortgage-backed debt and investment grade bonds have all seen their respective interest rate spreads decline versus Treasury bonds since mid-March. That’s a bullish sign for the markets. Also, the Dow Jones Transportation Average is just a few percentage points from an all-time high, stock market volatility has plunged and mutual fund investors are dumping money market funds and buying equity funds again.

Apart from the above, however, the bigger picture doesn’t look too pretty.

For consumers and businesses, bank credit continues to worsen in the United States. What’s alarming is the growing infection of tightening bank credit now encompassing the entire lending spectrum, as banks hoard their available cash reserves for the highest quality borrowers.

The Federal Reserve’s survey of banks’ senior loan officers found that the credit crunch is widening and now affecting a greater share of the economy. The proportion of domestic banks tightening their lending standards was at, or near, historical highs for virtually all loan categories, including credit cards and student loans.

In April, 44% of banks surveyed tightened their lending standards to consumers, up from 30% in January. For residential real estate loans, 70% of banks tightened standards compared to the prior three months – at exactly the wrong time. The mortgage market needs liquidity in order to create loan expansion in a distressed environment. More alarming, 60% of banks tightened their books on prime mortgages, up from just 15% 12 months earlier. And commercial real estate loans continue to feel the squeeze as 80% of banks tightened lending.

Some parts of the credit spectrum are improving and that’s good news. Unfortunately, the improvements lie mainly in the capital markets, which don’t affect the majority of real economy participants. The Fed’s April loan survey is a bleak picture. The real economy is deteriorating, not improving. This data confirms that consumers and businesses are struggling as credit becomes harder to secure – and that’s ultimately bearish for the market.

Protecting your Assets in a Volatile Financial World

As part of my discussions at the upcoming Total Wealth Symposium next week in Panama City, Panama, I’ll be delving into the world of financial risk management and how to protect your nest egg in the age of growing counter party and bank risk.

Let me express the following so that I’m totally clear right from the start: I’m not a perpetual pessimist nor am I projecting financial Armageddon. The world has survived countless financial shocks and panics since the advent of capitalism and, prior to that system, disruptions in the flow of trade due to wars. Life goes on. Trade continues. Long-term bears have never made money in the market. I’m a positive investor.

But we are living in uncertain economic times. Banks are losing hundreds of billions of dollars, real estate markets are crumbling across the most populous U.S. states and banks are reluctant to lend even to their prime customers.

In a recession, the threat to the financial system is greatest and is usually accompanied by either inflation, deflation or, in this case, both. This is the first time in the post-WW II period that inflation and deflation are coexisting side by side, threatening global financial markets as leverage continues to unwind. The Fed’s bailout of Bear Stearns in mid-March has halted the slide in asset values – but for how long?

Unfortunately, the modern version of capitalism has run afoul and now resembles a casino rather than a forum to exchange goods or financial securities.

The advent of securitization, or packaging and re-packaging all sorts of securities, including mortgage-backed synthetics, has clearly become a runaway freight train. Somewhere along the line, in an effort to boost profitability, Western banks went off the deep end, introducing a host of securities levered to housing and other risky assets. Worse, that process will take years to unwind as banks and regulators desperately try to match counter parties to these millions of outstanding trades. It isn’t pretty if you have been running a bank since last summer.

What’s important now is figuring out which banks, mutual funds, currencies and bonds might be vulnerable ahead of the next blowup.

For example, there’s a perfectly safe strategy to isolate your liquid assets away from your bank’s creditors both domestically and offshore in Europe. Also, did you know hedge funds also use prime brokers like Bear Stearns? Many of these prime brokers still hold infected or toxic assets. And, which currencies are most at risk as this credit unwinding continues to come undone over the next several years? Lastly, many corporate bonds have been awarded safe credit ratings by the credit agencies – the same people that assigned an AAA-rating to Ambac Financial!

Protecting your assets both in the United States and overseas has never been more important. Make sure you fully understand what you own and the risks associated with the respective custodians holding your assets.

Brazil the New Safe Haven in Emerging Markets

Last Thursday, S&P raised Brazilian debt to BBB-, one notch above junk bond status and its first investment grade rating in history. Incredibly, credit spreads for Brazilian sovereign debt are just 132 basis points above Treasury bonds on seven-year debt, or yielding just 5.07%. In the 1980s, Brazil couldn’t give its bonds away with inflation in the double-digits.

Brazil joins Mexico and Chile as Latin America’s third investment grade sovereign nation.

Here’s another mind-blowing number: since 2000, the BOVESPA stock index has skyrocketed over 1,600% in dollar terms and is actually up 15.7% this year, even as the majority of emerging and major markets remain in the red.

Brazil’s economic and fiscal achievements in the post-2000 period have been most impressive. The country now has a bulging trade surplus, budget surplus and the strongest currency in the Americas. In fact, it’s been one of the world’s best performing currencies since 2002, not far behind the euro.

Brazil has also dodged the subprime bullet. As subprime has gripped U.S. financial institutions since last July, Brazil’s banks have largely escaped the credit crisis. Securitization, a dirty word among global investors since the advent of the mortgage-backed securities blowup, is barely a fixture on Brazilian bank balance sheets.

Since April, when the U.S. dollar began to muster a bear market rally against most foreign currencies, the Brazilian real has actually gained 1%.

Is this a good time to buy Brazilian? Are Brazilian assets now in “bubble” territory?

I think the ship has long left the harbor. Credit spreads on Brazilian debt are too narrow, the currency is heavily overbought and the country is still mired by high public debt. Also, a surging currency over the last six years might start diluting some of the country’s export competitiveness.

As long as commodities remain in a secular bull market, however, Brazil’s economy will charge ahead. It’s an enormously rich nation. Brazil will be a great short sale candidate once raw materials hit a peak. Until then, it’s a freight train.