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Articles for the second week of 2009

Some articles and information you may find useful... links at the top with comments further below...

  • Summary of the current US government bond predicament (The Economist): Excellent article by The Economist's Buttonwood on the current situation in US government bonds. Summarizes the situation while presenting the bullish and bearish case for low bond yields. (Highly recommended reading) [further comment below]
  • Will emerging markets make it through this crisis? (The Economist): A run-down, with admittedly some oversimplification, of various emerging markets and the likelihood of them performing well while the developed world slumps. Keep in mind that economists, and certainly the magazine, is often wrong. But the key benefit for macro investors is to get a sense of the situation and form their own opinion. [further comment below]
  • Risk aversion is developed during younger days (The Economist): Sort of a fun article talking about some research which shows that investor risk aversion is formed throughout their life experience, with those growing up during the Depression have different risk sensitivity to those that grew up in later periods.
  • The decline of newspapers (New Yorker): Nothing new... provides some thoughts on the situation. Unfortunately, the author is correct in saying that we will likely end up with lower quality media but one that is free. Right now, the free internet sources source from the costly, high quality, newspapers who are suffering.
  • The loss of trust (New Yorker): The big problem in the markets is not collapsing real estate prices, although that doesn't help matters. Rather it's the loss of trust. I don't think trust will return quickly and that's one reason, among others, why I'm not bullish on the markets yet.
  • Start pondering your M&A deals (Old School Value): A list of pending M&A deals. I think we won't see the wide spreads of 2008 but my feeling is that the probability of deals closing is likely to be higher this year. We won't see the serious financing problems of yesteryear since no one is going to loan money with lax terms. This means that takeover prices will be reasonable and only serious bidders (i.e. strategic buyers) will likely be doing much buying.
  • Will gold advance this year? (Financial Post; article by Bloomberg); Gold stocks outperforming gold? (The Globe & Mail): A copule of generic articles on gold that contains analyst estimates and provides the reasons for being bullish on gold. Consensus is for another rise this year, which would take the streak to 8 years of positive returns (I have to check the numbers but gold might the best performing major asset in the last 10 years.) I'm seriously thinking of shorting gold and am doing some research and coming up with some theories. [further comment below]
  • Satyam board dismissed by the government (Bloomberg): Quite ironic for a company whose name comes from the word 'truth' to be the biggest fraud in India. I just want to highlight a subtle point from this news article. [further comment below]

Click through for my opinion on some of these stories...

The Bond Dilemma

(Illustration by S. Kambayashi, The Economist)

When commentators say that some assets look cheap, they tend to use low government-bond yields as their benchmark. Corporate-bond yields are not that high in historical terms. It is the spread they offer relative to government bonds that is extraordinary. And at 3.3%, the dividend yield on the American stockmarket hardly seems mouthwatering, but it is higher than the long-term Treasury-bond yield for the first time since the 1950s.

All this is occurring when Western governments are conducting an immense economic experiment, with vast fiscal stimuli accompanied by monetary expansion. In the medium term, a sharp rise in inflation is a distinct possibility. Government bonds may be offering “return-free risk”, in the neat phrase of Jim Grant, a veteran newsletter publisher.

One warning sign is that real bond yields (as measured by the inflation-linked market) have risen. Some believe this move has been driven by expectations of low inflation (or deflation) in coming years. But it may also suggest investors think the long-term fiscal position of many governments is not sustainable.


But what if Japan provides the template? Many people thought Japanese bonds were overpriced when yields fell to 1-2% in the late 1990s. They have stayed around that level for the past decade, despite a vast amount of issuance (at $8.7 trillion, according to Bloomberg, the Japanese government-bond market is the biggest in the world). Even the expected $2 trillion of American issuance this year will leave its debt well below Japan’s.

The crucial difference, however, is that Japan has been running current-account surpluses, not deficits. The Japanese owe the money to themselves whereas the Americans are in debt to foreigners. Such investors could lose twice over: yields could rise and the dollar could depreciate.

For the moment, the balance is maintained by what Nick Carn of Odey, a hedge-fund group, calls “mutually assured destruction”. If overseas investors seek to sell their bonds, they will not only ruin the American economy but the value of their existing portfolios as well.

I remember thinking that the inflation vs deflation battle would be resolved quickly but it doesn't seem like it will be. The outcome here will have a massive impact on investment performance. As long as the bond market keeps signalling a deflation threat, I will be leaning in that direction.

Bullish On Gold--Not Me, the Media That is

The Financial Post article presents the reasons for being bullish on gold, while The Globe & Mail article speculates on the possibility of gold stocks outperforming gold.

Financial Post

The metal will average US$910 an ounce in 2009, 4.3% more than last year, according to the median forecast of 20 analysts, traders and investors surveyed by Bloomberg. Silver and platinum, which averaged at least 12% more in 2008, will decline this year, the survey showed.


Average gold prices have risen for seven consecutive years, the longest winning streak since at least 1949. While the return of 5.8% through 2008 was the smallest since 2004 in dollar terms, gold rose 11% in euros and 44% in British pounds, data on Bloomberg show.

I suspect that the longest streak since 1949 is going to come to an end. The question is how much it will fall. If it only falls 5% this year, it is not a worthwhile short.

The Globe & Mail

However, as ugly as the past decade has been, some observers believe that the relative performances of gold and gold producers move in cycles, and a switch could occur. Gold outperformed gold stocks in the second half of the 1990s. Gold underperformed gold stocks from about 2000 until 2003 – and the two were duking it out until the disastrous performance by gold stocks last year.

There is some evidence to suggest that gold stocks could start to shine. John Hussman, of Hussman Funds, compares the price of gold with the Philadelphia gold and silver index to come up with a ratio. Right now, that ratio is more than 7, which is exceptionally high by historic standards.

According to Mr. Hussman, when the ratio is above 5, gold stocks follow with average annualized gains of almost 90 per cent. When the ratio is above 5 and the U.S. economy is weak (as determined by manufacturing activity, or the purchasing managers index, which is in the ditch these days), gold stocks have risen at an average annualized rate of more than 125 per cent.

Hussman's results may be based on a few data points so one shouldn't blindly jump into that trade. However, I do think that gold stocks are more likely to outperform bullion but timing and size of the return is diffcult to ascertain.

I'm trying to build a bearish case for gold. It's still too early to say whether I will do anything but my thinking is that I will consider shorting gold in April or May if it trades around $1000 to $1500, and if high inflation still seems unlikely to me. Shorting gold would be very contrarian IMO. Is it likely for a major asset like gold to increase for the 8th year in a row? If there is high inflation, sure, that's possible but inflation has been quite low in the last decade. So, was gold just catching up to inflation in the 90's or is the market pricing in some rosy outlook for gold (i.e. very high inflation)?

Indian Government Dismisses Satyam Board of Directors

I'm just a newbie and not familiar with Indian laws but, from the Satyam case, you can see how there seems to be a huge, subtle, risk for shareholders in emerging markets like India. And I'm not even talking about the fraud. So what is it?

C.B. Bhave, chairman of the Securities & Exchange Board of India, met Corporate Affairs Minister Prem Chand Gupta in New Delhi following the arrest of the brothers late yesterday. The government sacked the board members of the company, India’s fourth-largest software exporter, for failing to deliver and said a reconstituted one would meet in seven days.

Well, notice how the Indian government supposedly dismissed the board of directors of Satyam. I suspect many in India or even in America or Canada would view this government action favourably. After all, we have our share of overpaid incompetent directors in America, Canada, and elsewhere who are still presiding over companies like Citigroup, AIG, Yahoo!, and GM, even though the company was run into the ground under their watch (admittedly you are seeing some of the not-yet-disgraced directors starting to resign with Robert Rubin of Citigroup being the latest.) Replacing the board en masse would stabilize the company and provide short-term benefits. Given how the company is probably worth zero, even some Satyam shareholders may like such a drastic action. Yet, I believe that the Indian action is a terrible thing for shareholders and is definitely deterimental in the long run.

Shareholders are the ones that elect the board and have control over it. The company is owned by the shareholders!!! Yet we have a situation where the government swoops in and takes control of the company from shareholders. It shows how little power shareholders have in India.

Having said all that, if the Indian government injects capital in exchange for equity (similar to what is happening to banks in America and Europe) into Satyam, I would change my mind. In that case, the government becomes a shareholder and you are effectively nationalizing the company (if government ends up owning more than 50%.) Also note that, for the government to become an owner, it has to get an equity stake, not simply loan money to them. So far, no signs of that in the Satyam case. As it stands, this is a terrible sign of shareholder rights in India.

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