Академический Документы
Профессиональный Документы
Культура Документы
Disclosure Statement
This third party publication is not prepared by BMO Capital Markets Corp., BMO Nesbitt Burns Inc., BMO Nesbitt Burns Ltee/ Ltd and BMO Capital Markets Limited. The information, opinions, estimates, projections and other materials contained herein are provided as of the date hereof and are subject to change without notice. Neither Bank of Montreal (BMO) nor its affiliates have independently verified or make any representation or warranty, express or implied, in respect thereof, take no responsibility for any errors and omissions which may be contained herein or accept any liability whatsoever for any loss arising from any use of or reliance on the information, opinions, estimates, projections and other materials contained herein whether relied upon by the recipient or user or any other third party (including, without limitation, any customer of the recipient or user). Information may be available to BMO and/or its affiliates that is not reflected herein. The information, opinions, estimates, projections and other materials contained herein are not to be construed as an offer to sell, a solicitation for or an offer to buy, any products or services referenced herein (including, without limitation, any commodities, securities or other financial instruments), nor shall such information, opinions, estimates, projections and other materials be considered as investment advice or as a recommendation to enter into any transaction. BMO Capital Markets is a trade name used by the BMO investment banking group, which includes Bank of Montreal globally; BMO Nesbitt Burns Inc. and BMO Nesbitt Burns Lte/Ltd. (members CIPF) in Canada; BMO Capital Markets Corp. (member SIPC) and Harris N.A. in the U.S.; and BMO Capital Markets Limited in the U.K. Unauthorized reproduction, distribution, transmission or publication without the prior written consent of BMO Capital Markets is strictly prohibited. TO U.K. RESIDENTS: In the UK this document is distributed by BMO Capital Markets Limited which is authorised and regulated by the Financial Services Authority. The contents hereof are intended solely for the use of, and may only be issued or passed on to, (I) persons who have professional experience in matters relating to investments falling within Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (the Order) or (II) high net worth entities falling within Article 49(2) (a) to (d) of the Order (all such persons together referred to as relevant persons). The contents hereof are not intended for the use of and may not be issued or passed on to, retail clients. - BMO (M-bar roundel symbol) Capital Markets is a trade-mark of Bank of Montreal, used under licence. Copyright Bank of Montreal 2009 BMO Capital Markets is the trade used by the investment banking groups of BMO Nesbitt Burns Inc, BMO Nesbitt Burns Ltee/Ltd, BMO Capital Markets Corp., BMO Capital Markets Limited, BMO Nesbitt Burns Securities Limited and the Bank of Montreal.
(1) BMO Capital Markets or its affiliates owns 1% or more of any class of common equity securities of the company (2) BMO Capital Markets makes a market in the security (3) BMO Capital Markets or its affiliates managed or co-managed a public offering of securities of the company in the past twelve months (4) BMO Capital Markets or its affiliates received compensation for investment banking services from the company in the past twelve months (5) BMO Capital Markets or its affiliates expects to receive or intends to seek compensation for investment banking services from the company in the next three months (6) BMO Capital Markets has an actual, material conflict of interest with the company
Coxe Advisors LLP. Author: Editor: 190 South LaSalle Street, 4th Floor Chicago, Illinois USA 60603
312-461-5365 604-929-8791
Basic Points is published exclusively for BMO Financial Group and distributed by BMO Capital Markets Equity Research for clients of BMO Capital Markets, BMO Nesbitt Burns, BMO Harris Private Banking and Harris Private Bank. BMO Capital Markets Equity Research Manager, Publishing: Desktop Publishing and Distribution Coordinator Monica Shin monica.shin@bmo.com Anna Goduco anna.goduco@bmo.com
July 2011
July 2011
We cannot play games or put off hard choices any longer.Our challenge is clear and inescapable: America cannot be great if we go broke. The contagion of debt that began in Greece and continues to sweep through Europe shows us that no economy will be immune. If the US does not put its house in order, the reckoning will be sure and the devastation severe.
July 2011
The Extended-Baseline Scenario generally assumes continuation of current law. The Alternative Fiscal Scenario Source: The Moment of Truth: Report of National Commission on Fiscal Responsibility and Reform, Dec. 2010 incorporates several changes to current law considered likely to happen, including the renewal of the 2001/2003 tax (CBO: income below $250,000 per year, continued Alternative Minimum Tax (AMT) patches, the continuation of the cuts onCongressional Budget Office) estate tax at 2009 levels, and continued Medicare Doc Fixes. The Alternative Fiscal Scenario also assumes discretionary spending grows with Gross Domestic Product (GDP) rather than to inflation over the next decade, that Alan does not increase forthright old former Senator from Wyoming, commented revenue Simpson, theas a percent of GDP after 2020, and that certain cost-reducing measures in the health reform legislation are unsuccessful in slowing cost growth after 2020.
at the release of their Report: Poised outside this chamber are the denizens of darkness those are the groups waiting out there in temples around the city, waiting to shred this baby to bits.
Our nation of on an unsustainable fiscal path. Spending is rising and revenues are falling short, He was, is course, absolutely correct. requiring the government to borrow huge sums each year to make up the difference. We face staggering deficits.document wasspending was nearlyPresident of Gross Domestic Product This dramatic In 2010, federal praised by the 24 percent with his customary (GDP), the value of all goods and services produced in the economy. Only during World War II eloquence in what larger part of the economy. Tax revenues the at 15 percent of GDP was federal spending aturned out to be a modern version ofstoodAntonian Funeral this year, the lowest level sincehis best togap between spending and revenue ofthe budget Oration, because he did 1950. The bury the Report within days its birth. deficit was just under nine percent of GDP.
His State of the Union Address and his own Budget dealt with such themes
Since the last time high-speed trains, but offered no proposals and no sacrifices as investing in our budget was balanced in 2001, the federal debt has increased dramatically, rising from 33 percent of GDP to 62 percent of GDP in 2010. The escalation was to avert the fiscal train wreck slew of fiscally irresponsible policies, along with a deep driven in large part by two wars and a the Bowles-Simpson report had described as economic downturn. We have arrived at the was as if the Mayor of New Orleans, on inevitable absent major reforms. It moment of truth, and neither political party is without blame.
being warned of a coming monster hurricane, had told his supporters to Economic recovery will improve the deficit situation in the short run becauseBlues to will rise gather in the SuperDome for a major jazz festival: Sing the revenues drive as people go back to work, and money spent on the social safety net will decline as fewer away are Blow! people the forced to rely on it. But even after the economy recovers, federal spending is
July 2011
In contrast, House Republicans issuedand passeda detailed road map showing the tough spending cuts that would be needed to prevent the national debt from exploding, and to protect Social Security and Medicare from imploding as the nation aged. The doleful document died in the Senate and the Republicans thereafter began to back away from demonstrations of fiscal responsibilitywith the loudest voices coming from newly-elected members and aging firebrands who were demanding that the Party refuse to authorize any increase in the National Debt Ceiling. Orwell, thou shouldst be living at this hour. Michelle Bachmann, a Tea Party favorite, is front runner in the Iowa Republican polls. She has been wowing her audiences with a pledge to vote against any increase in the debt ceiling. This is, of course, the equivalent of telling homeowners whose house prices have fallen to refuse to make any further mortgage payments. An old and wise friend with a distinguished career in Canadian finance, who is accustomed to measured understatement, sent us a one-line email last week: "Has the entire US political class gone mad?" Michelle Bachmann may actually be following a proven formula to move from political long-shot to front-runner: In the midst of this unfolding fiasco we witnessed a TV clip of a splendidly calm and well-reasoned speech by a US Senator explaining why he was going to vote against an increase in the debt ceiling. He talked in terms of households having to control their spending and debts, and said Washington should be doing the same. He had to cast this vote, he assured us, to protect the nation's future for coming generations. It was then-Senator Barack Obama, explaining his "Nay" vote on the debt ceiling increase proposed by George W. Bush. (As one might expect, the only network that has carried this stirring summons to Franklinesque restraint was Fox News. We recalled having heard Obama deliver it back then, and falsely concluded that such an unserious legislator backed enthusiastically by the Far Left in his party could never defeat the serious Hillary Clinton for the Presidential nomination. His speech and vote, which apparently had the desired effect in the Democratic Presidential Primary, have now been resurrected by a candidate from the Far Right in an attempt to produce another political miracle.)
July 2011
A crucial minority of House Republicans disdains such backsliding on thrift and restraint.
The Debate
Polls show that voters have been closely divided on whether the debt ceiling should be lifted, but are strongly opposed to cutbacks on Social Security and Medicare. They want to cut back on waste, corruption and foreign aid, but lack puritan fervor for cutbacks in "good and necessary" government programs on which so many of them rely. Democrats recognize this seeming contradiction for what it is: endorsement for raising the ceiling so the Social Security checks can be issued and the soldiers paid. A crucial minority of House Republicans disdains such backsliding on thrift and restraint. They want a national tourniquet on government spending and they're prepared to fight the next election for that cause, even if they face impalement on their own fiscal swords. 6 July 2011
THE COXE STRATEGY JOURNAL
The new (apocryphal) Republican restatement of Reaganism is that no taxes can ever be increased, which means the only course open is to close loopholes, slash dubious deductions and cut outdated expendituressuch as ethanol. (Yes, there actually is serious bipartisan discussion about addressing that most conspicuous form of waste, and some reform seems now inevitable. Ethanol will not, alas, get its fitting fatethe gas chamberbut it will be cut back. That surcease from stupidity would almost be worth a debt crisis.) The House Republicans also endorse a Balanced Budget Amendment to the Constitution. This is, alas, an exercise in gaseous emission and futility. Constitutional amendments are rare events, because the approval process is so daunting: Amendment requires a two-thirds supporting vote in both houses of Congress, and a yea vote from three-quarters of the states. The current Senate would certainly reject such an amendment, and the process of state-by-state ratification would take many years. The nation's debt crisis will not wait. Watching the TV addresses this week from the President and Speaker John Boehner, we saw again why Mr. Obama will likely win votes by blaming the Republicans if the debt ceiling isnt raised on time. He was doing what he does best: speaking. He had obviously decided that he was going to use his personal and Presidential power to undermine the Republicans in voters' eyesa great kick-off to the 2012 election. In forceful, unsmiling fashion, he denounced their opposition to a deal as being based in protection for the very rich. He presented himself as a reasonable moderate who has been trying for months to present proposals for a fair deal that will move the economy forward. He called on voters to phone Washington giving him support. (They didforcing switchboard shutdownsand polls showed that most viewers were convinced that Obama was reasonable and right, and the Republicans were mean-spirited and wrong. He won that instant popularity contest hands downand Speaker Boehner knew it.) Mr. Boehner was workmanlike, but he failed to charm the electorate. To win what had become the debate, he could have responded to the President's attack on him and his party by saying, Mr. President, you spent months demanding a 'clean' approval to raise the debt ceiling, insisting that no spending cuts be included. Now you say you have been presenting a wide range of cuts that many Democrats oppose. What budget proposals do you mean, Mr. President? The only numbers you've presented publicly were in your Budget, which was voted down 79 to zero in a Senate controlled by your own party. The Senate hasnt approved any budget in more than two years.
Ethanol will not, alas, get its fitting fatethe gas chamber...
July 2011
Baring all is an unsound strategy for married politicians tweeting young women, and for the leaders of a profligate nation that is borrowing 41 cents out of every dollar it spends.
July 2011
However, investors cannot assume that a last-minute Perils of Pauline outcome that snatches solvency from destruction means that Treasurys will thereupon retain their status as the Premier Global Risk-Free Standard. That outcome would mean that the Capital Asset Pricing Model would remain as the basic mechanism for appraising investment risk and reward. Perhaps not
...the agencies' distribution of Triple-A ratings during the real estate bubble was only marginally more restrained than Groupon's dissemination of its discount coupons.
July 2011
10
July 2011
Apart from default risk due to political miscalculation, there is also some riskhowever remotethat the holder of long-dated Treasurys may be forcedat some time in the futureto accept even longer-dated paper, or paper with lower yields than the investor has been earning. (This is in fact the scheme the Eurozone has imposed on banks holding Greek bonds, but critics point out that it resembles the scabrous deal Argentine inflicted on its creditors.)
Conclusion
Why accept an apparently subsidized yield for paper issued by an apparently dysfunctional government, backed by an increasingly dysfunctional economy? Investors can do betterand should. High-grade corporate bonds are the new normaland their yields are routinely used by corporate pension funds to discount their liabilities. Leading Public pension funds, on the other hand, use the lofty projected returns in their versions of the Capital Asset Pricing Return, and they continue to use 8% as their assumed rates of return, and for discounting their liabilities; they will likely be the next class of investors to spawn disasters and taxpayer bailouts.
Why accept an apparently subsidized yield for paper issued by an apparently dysfunctional government, backed by an increasingly dysfunctional economy?
July 2011
11
12
July 2011
the taxpayers. We need to try something else, but what is it?" We could offer no contrary arguments. A mother of three childrenone, a rebellious teenage boy, and two unemployed university graduate twenty-somethings told us, "I can't get my son to do his schoolwork. He says, 'What difference does it make? There are no jobs and there won't be any. I might as well have fun while I can'." [Youth unemployment is listed at 35% or 45%, depending on which statistic one believes.] The Spaniards' bitterness about their eurozone partners now extends to Germany, because of the sudden ban on their vegetable exports when an outbreak of a lethal strain of E. coli was blamed on the alleged low hygiene standards of Spanish gardeners. Financial losses for Spanish producers were enormous. It turned out that the culprit was sprouts from a German certified organic farm. As various American and British infectious disease experts had noted while the panic was spreading, the German authorities should have looked at sprout farms first, because sprouts are especially liable to be E.coli carriers. The Germans are compensating the Spanish, but the bitterness remains, because, Spaniards feel, the German response was rooted in Teutonic snobbishness about Spanish standards of cleanliness. We stayed at a hotel in Madrid located 100 meters from the public square used by the demonstrators against the government. The Spanish police managed the daily events superbly, checking all IDs, and showing an impressive display of weaponryrevolvers and nightsticks. The police were polite but firm, controlling all access to the square and ensuring that the demonstrations were peaceful. Spaniards aren't Greeks. But the nightly displays on European TV of anarchy and violence in Greece had a major impact on global investors' willingness to invest in debt issued by the other peaceful "peripherals"or in the equities and paper issued by European banks, wherever headquartered, which had large "peripheral" exposure. The European Bank Authority provoked laughter amid last autumn's eurogloom; when it conducted stress tests on 91 large banks, and pronounced them strong, only to have five collapse within weeks when Ireland went down. This year, we were told, things would be different as the eurocrats went back to their drawing boards and came up with new, tougher stress tests. Ninety
...nightly displays on European TV of anarchy and violence in Greece had a major impact on global investors' willingness to invest in debt issued by the other peaceful "peripherals"
July 2011
13
...a new flexible role to prevent contagion; (flexible is the Orwellian locution for craven abandonment of agreed-on principles.)
14
July 2011
The euro crisis is truly existential. As our readers know, we have long been euroskeptics because the euro is the first tradable currency to be backed by no government, no taxation system, no army and no navy; it is backed solely by a theory propounded by a prominent French eurocrat, Jacques Delors and other leftist elitists. When he outlined the proposal to the EU, Margaret Thatcher rejected it with her accustomed steeliness: "This is socialism by the back Delors." Like all the constitutions of France on which it was patterned, the euro pact has only rules for entrance. No exit. The European Central Bank is compelled by its rules to lend to banks against all sovereign europaper. Since the ECB has merely ten billion euros in equity, its financial condition risks becoming that of a large and impecunious Greek bank that is begging for a bailout. There is, of course, the International Monetary Fund, which became the euro's leading savior under the leadership of Dominique Strauss-Kahn. He had to vacate his chair under sensational circumstances; he was succeeded, as these things go in Europe, by another French elitist, the accomplished Christine Lagarde. It is now up to her and Jean-Claude Trichet to continue to coax and cajole the eurozone members into unanimous consent to what will be a never-ending series of aid packages, support packages and bailouts. The Germans are less and less happy with the plight of the peripherals, and are doubtless uncomfortable with France's control over the aid institutions. Karl-Otto Pohl, former head of the Bundesbank, and still a formidable figure on the Continent, recently told Spiegel that the euro is in trouble because the eurozone has been transformed into a transfer zone, with members sending aid to each otherin complete violation of the founding principles. Moreover, the European Central Bank is violating its constitution by making loans to member nations. He also noted that Greece should never have been admitted into the euro. We cite his views, because if you have a currency with no other backing than a theory and a set of rules, you have a serious problem when you violate those rules on majestic scale. The euro has lost its status as an elegant, eternal theory of financial stability, and is becoming just another bad European dream. It will existfor as long as it manages to existas the currency equivalent of the room in Hell in Jean-Paul Sartre's famous existential play, No Exit. A man and two women enter the room singly and, upon realizing where they are, try to establish some basis for communication. The man falls
...if you have a currency with no other backing than a theory and a set of rules, you have a serious problem when you violate those rules on majestic scale.
July 2011
15
...the likely future crises in Spain and Italy, are Sartresque: the euro is a locked room where countries are destined to torture each other in punishment of their sins.
Germany
What sin, you may ask, has Germany committed? It has been too good at what it does best. It is so efficient and successful that the eurozone has become, in effect, its privileged marketplace in which it profits by selling to partners, many of whom become more uncompetitive each year. In recent discussions with some knowledgeable observers, the following hypothesis emerged: When the Wall fell, Helmut Kohl made a strategic blunder: he agreed to swap good Deutschemarks even up for putrid ostmarks. Result: the reconstituted Deutscheland had a powerful, competitive West, and a weak, hopelessly uncompetitive East. Wages and benefit levels in East Germany were far too high to attract capital investment and launch the Marxist wasteland on the road to West German-style prosperity. (Prior to the Fall of the Wall, the sarcastic explanation of the Marxist Model was, "They pretend to pay us, and we pretend to work.") So the West Germans collectively sucked it up, and for a decade resisted wage increases and improvements in social programs for themselves, while pouring roughly $100 billion into the shambolic, socialist East. (As usual, the Western Left had it 100% wrong. J.K. Galbraith and other leading Western progressive economists pronounced East Germany a successful economy and society, right up to the Fall of the Wall, and top Western novelists like Gnter Grass published endless streams of fiction that described West Germany in hideous terms. Indeed, West Berlin prior to the Fall was a city that had more true Marxists-per-capita than East Berlinand they were being supportedin
16
July 2011
good socialist fashionalmost entirely from the output from the capitalists they reviled.) During that "lost German decade", Germany got virtually no financial help from its allies and EU "partners, yet Germany continued in its role as paymaster for the Euroelites and their spending schemes. Then the new millennium dawned, and all the europartners were locked into sharing the same currency. No longer could weaker economies rely on their ability to ease their competitive problems with devaluations. There was no exit door. As a wise client remarked recently, the euro may have accomplished for Germany what the Hapsburgs and Hitler could not: near-total economic dominance of the Continent. As Germanys trade surpluses with its europartners increased, its banks invested their depositors' savings in bonds issued by the other nations particularly the weakest of the weak sisterswhere a slight premium over bund yield was available. So they lenton easy termsthe money to their partners to help them to bankrupt themselves. That Deutscheland seems to be ber alles today would not have happened had West Germans not sacrificed for a decade to bail out their Eastern brethren. During those long years of sacrifice, the rest of Europe was enjoying the prosperity of the post-Cold War era and the technology boom. Wages rose faster than inflation. France cut the work-week from 40 hours to 35. Governments grew, and civil servants' pay and benefits grew even faster. Times were good. And those dull, dour Germans were still writing the checks that kept the EU afloat. None of the other countries' leaders seemed to notice that German wages weren't growing, but German competitiveness was. It didn't occur to them that they could be the new Philistineslaughing at Samson with his long hair and big muscles, not realizing that letting Samson loose when they were locked into a structure with no exits was a high-risk game. The euro is no longer just an elegant theory concocted by French intellectuals over glasses of premier grand cru wines (from vineyards subsidized through the 42% of the EU budget that went for agriculture). Because these intellectuals were socialists, the idea of the biggest member achieving sustained growth in industrial competitiveness within a single-currency environment was as unworthy of reflection or concern as recognizing that the Cold War had
...the euro may have accomplished for Germany what the Hapsburgs and Hitler could not: near-total economic dominance of the Continent.
July 2011
17
...those crisis meetings in which the Germans are asked to pony up more money... are as effective in restoring sound economic growth as plowing the North Sea.
18
July 2011
ISI reports another unhappy statistic about the vitality of the eurozone: the MSCI Eurozone Equity Index is at the same level as 13 years ago. (The S&P is up 11% in the same period, and the TSX is up 18%.) ISI estimates combined GDP performance this year from the weaklings as falling 1.8%, whereas the rest of the eurozone is predicted to grow 1.9%. (That happens to be within one-tenth of one percent of what Bill Gross has long proclaimed as the New Normal Rate of Economic Growth. Great call.) The 2008 economic crisis originated in the US financial system with the toxic mortgage products. The next economic crisisonce the Treasury default problem is resolved will originate in European banks stuffed with bad sovereign debts as more European economies weaken and the euro's core contradictions can no longer be denied. It may well spread to the US. Just as the collapse of those AAA-rated US mortgage products became a TransAtlantic horror story in 2007 because so many European banks had loaded up on malodorous mortgages issued by Wall Street, which, under Basel rules, required minimal capital allocations. (AAA is roughly at sovereign credit levels for Basel capital purposes.) This time, the backlash from an existential eurocrisis could become problematic for some big American money market funds that are heavily exposed to European bank paper. The Old World with the New Currency couldperhaps suddenlybecome a new kind of challenge to the stability of the US financial system. It is unlikely the euro will survive for long. However, the IMF, ECB and new Continental acronym rescue packages could, at least in theory, defer the climax of the existential crisis for years. What could accelerate the crisis is European democracy. The elites created the euro and will muster all the mechanisms possible to keep it afloat. But, as recent state elections in Germany and the Finnish election demonstrate, ordinary voters are becoming more furious as they watch Greek rioters on their TVsand more worried as they watch the contagion spreading to Spain and Italy.
Italy boasts (if that is the correct term) the third largest government debt market in the Western world.
July 2011
19
20
July 2011
July 2011
21
22
July 2011
...the sun went silentzero spotsfor the second longest period in two centuries in 2009.
Source: NOAA Space Weather Prediction Center, Boulder, Colorado. July 5, 2011.
What it shows: The new millennium began with a solar bang as monthly sunspot levels rose even above the frequently high scores of recent decades. (Each column is a year and each dot is the number of spots for a month.) Clients will recall that we began writing in 2007 about the possible end to the two-century pattern of enormously high sunspot activity after the [very cold] preceding centuries. Astronomers began to take serious notice that something big was unfolding when the sun went silentzero spotsfor the second longest period in two centuries in 2009. When the new sunspot cycle arrived, there was optimism that the sun would revert to its warm ways, and NASA and other agencies predicted that sunspot activity would climb swiftly back to the triple-digit range. Instead, spots only rose to a pitiful 25 during the first year, then seemed headed toward normal early this year before rolling over and falling anew. Those major reports that impressed even The Economist have been in agreement that a new era of minimalor even zerosunspot activity is upon us.
July 2011
23
In thisand perhaps only thiscase, they are heirs to the Enlightenment credo: "Man is the measure of all things."
24
July 2011
July 2011
25
The incentive system for politicians is skewed so as to punish candor about program costs and financial risks in favor of delivering goodies for voters.
26
July 2011
would benefit from the image of unshakable strength of Bunds and the bonds of other financially sound euromembers. The European Central Bank has routinely lent banks money against their holdings of bonds issued by any members. Pension funds have used European sovereign credits as risk-free assets in their calculations of their efficient frontiers for investing. After all, the politicians said, no European nation had defaulted in 40 years. That is no longer a defensible way to evaluate endogenous risk within institutional portfolios holding European sovereign credits other than Bunds and a few other seemingly bullet-proof bonds. A Treasury default or downgrade would threaten the entire process of efficient frontier calculations for American pension funds. Already, the evidence of the terrible deterioration in Washington's longer-term government liabilities has drawn response: one of the ratings services has indicated that a few leading corporate issuersincluding Procter & Gamblenow have higher ratings than Treasurys. This opens a Pandora's Box for institutional investorsand for pension fund consultants.... And a new, troubling level of risk has entered the pension fund world.
This opens a Pandora's Box for institutional investorsand for pension fund consultants....
July 2011
27
Recently, Glencore admitted that it had suggested to Putin that he should embargo wheat exportsin defiance of WTO rules.
14.00 13.00 12.00 11.00 10.00 9.00 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11
13.77
Jul-11
Weather across the major grain-producing states in the midsection of the US has been wild this yearfloods, tornadoes, droughts, and more recently, searing heat. In Eastern Europe and Russia, the weather has been very favorable. Proof that this should be a more reassuring year for global grain users: Vladimir Putin ended his embargo on wheat exports. (It will be recalled that it was his sudden imposition of an embargo on exports through the Black Sea that sent wheat prices soaring last fall. Recently, Glencore admitted that it had suggested to Putin that he should embargo wheat exportsin defiance of WTO rules. Glencore also disclosed it held significant wheat futures contracts at the time of its oh-so-helpful call.)
28
July 2011
Corn prices have been strong this year, but have fluctuated widely in response to US Department of Agriculture reports alternately expressing pessimism and optimism about this year's crops, andto almost everyones amazement conflicting reports about the size of corn carryovers. Those varying reports elicited an unusual denunciation from China, which complained that it failed to understand how carryover data could swing so wildly. At the moment, there is widespread agreement that this will be a near-record year for US corn production, and the world is breathing easier. We are pleased that the FAO's2 recently-proclaimed Global Food Challenge is unlikely to be upgraded to a new Global Food Crisis. Grain prices at these levels are enormously profitable for most farmers and the agriculture stocks have been firming. We remain very bullish on the outlook for agricultural stocks, (a stance we proclaimed in writing in the prospectus for the new Coxe Global Agribusiness Income Fund which was distributed this month and trades on the TSX, ticker symbol CAG.un. We express our gratitude to the many Canadians who supported the issue and hope that other investors will now consider it.)
July 2011
29
KBW US Bank Index (BKX) relative to the S&P 500 July 1, 2006 to July 28, 2011
110 100 90 80 70 60 50 40 30 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 41.76
KBW US Regional Bank ETF (KRE) relative to the S&P 500 July 1, 2006 to July 28, 2011
105 95 85 75 65 55 45 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 49.71
30
July 2011
It would be hard to write a better script for a recommendation to buy Gold than (1) the crisis in the eurozone, (2) a possible US Debt Ceiling default, (3) strong oil prices, (4) weak economic news in the US and Europe, and (5) pitiful performance of bank stocks in the US and Europe. However, those same factors are near-surefire guarantees to jolt politicians and political activists in Europe and the US to rush to the rescue. Result: gold's near-term price action is hostage to political events, and speculators could be scaling back on bullion and gold stocks in coming days. As the commentary in this issue reveals, we are skeptical that quick fixes during crises will challenge the basic arguments for strong portfolio representation in gold, and, for the gutsy, silver. Volatility will continue as the rescue packages unfold, but long-term investors in gold will surely use selloffs to build their exposure. In none of our previous endorsements of gold and gold shares in this publication did we include a failure to increase the debt ceiling. But that has been the Page One story for a month. As the five-year charts show, gold is gradually becoming recognized as a necessary investment for those with wealth to conserve who do not assume that the political classes in the US and Europe will display sustained statesmanship. The events of recent weeks were, in the sweep of history, mere spastic twitches toward common sense and sustained restraint. Golds move through $1,500 an ounce was driven by tremendous participation from Chinese buyers. According to the World Gold Council, Chinese bullion demand was up five-fold last year, and China has supplanted India as the worlds largest buyer. But some of these new enthusiasts are taking profits as Chinese stock markets continue to wiltaccording to the Financial Times. Although gold analysts will be watching these new world leaders closely, Chinese buying patterns will never be as important for gold and silver as they are for copper and iron ore. The move through $1,600 came after gold seemed to have lost momentum after breaking decisively through the Big Number of $1,500. Some analysts are warning that gold will need some proven outbreak of inflation to move up from these lofty levels. What inflation? these skeptics ask. When gold was steaming skyward in the 1970s, inflation was reaching double-digit levels across most of the OECD. Not this time.
The events of recent weeks were, in the sweep of history, mere spastic twitches toward common sense and sustained restraint.
July 2011
31
Gold is the exact inverse asset to bad mortgages and bad government bonds...
32
July 2011
118.18
We endorsed the International Energy Agency's call to release modest quantities of crude from Strategic Petroleum Reserves, because non-market fear factors were having undue influence on crude prices...
The Arab Spring Fear Factor is fading in oil pricing. Libyan Light Crude still flows, despite the fighting. Bahrain's problems have not spread across the causeway to Saudi Arabia. We endorsed the International Energy Agency's call to release modest quantities of crude from Strategic Petroleum Reserves, because non-market fear factors were having undue influence on crude prices at a time of softening economic activity across much of the world.
July 2011
33
...some people in the Obama Administration, and many of its most prominent friends and financial backers regard energy security as being based on green energy
34
July 2011
due to give its report on Keystone within a fortnight. The final decision rests with the President. What makes this final stage more problematic is that an old, small pipeline operated by Exxon Mobil recently leaked about 43,000 gallons of oil into the Yellowstone River. From the media coverage, this was the Exxon Valdes redux. Again, people recalled the supposed famous last words of the bibulous skipper of the Exxon Valdes: No, damn it! I said Tanqueray on the rocks! As the leader of the coalition battling the Keystone line exulted, This kills Keystone! Neer was a greenie happier with an oil spill. While this was going on, a court in Montana granted an envirogroups application to block the shipment of machinery across the state to an oil sands site in neighboring Alberta. We detail these doleful details because, for the first time since the oil sands came on stream, we realize that political risk may no just apply to oil producers in places such as Venezuela, Libya, the Democratic Republic of the Congo, and such other noted bastions of liberty and fair play. Well keep an eye on these unfolding events. For now, wed just like to suggest that the Tea Party might want to propose legislation that anybody who tries to block the import of reliable sources of oil overland into the United States will not be permitted to fly into or out of any US airport, and that such persons automobile license renewal fees be raised to $5,000 a year. As for that other hydrocarbon Much of the US is suffering from searing heat and air conditioners are operating at their maxima. Electricity plants using coal are, in general required to use natural gas for peak, heat-induced demands, so these should be the best of times for gas producers. Last winter was unusually cold, and that should certainly have been good for gas producers. The weather has been doing all it reasonably can to drive gas prices skyward. But all those shale drillers are doing the best they can to drive prices downward. US consumers, who have had little to cheer about, should be shouting ululations of joy about the sacrifices gas producersand their stockholdersare enduring to make homeowners happy.
...the Tea Party might want to propose legislation that anybody who tries to block the import of reliable sources of oil overland into the United States will not be permitted to fly into or out of any US airport...
July 2011
35
...we are suitably respectful of the persistence of paranoia among extreme environmentalists, and the persistence of rapacity among plaintiffs' lawyers.
How serious is the slowdown in China? We have been recommending an underweighting in the base metal stocks, partly because we didn't believe the consensus forecasts for good growth in the US economy, and we thought Europe would also disappoint, but mostly because China was obviously tightening because of (1) food and fuel inflation, and (2) a likely moderation in the furious rate of expansion of capex.
36
July 2011
Strikes at key copper mines and flooding problems for major Australian iron ore and coal mines have meant somewhat stronger metals prices than we expectedwhereas we were bullish on oil, gold, and agricultural prices on their fundamentals. But, as BCA Research documents, Chinese annualized money supply growth has gone from the plus 50% range back in 2009, when the Middle Kingdom was doing its best to restart the global economy, to negative 10%to restrain inflationary pressures. Similarly, Chinese auto sales growth on a year-overyear basis has plummeted from the 90% range to near-zero. There have been far too many housing startsand far too few completionsin the past year, which means the credit squeeze is beginning to hurt. Chinese stock prices have been basically flat for 18 monthsand the nation is suffering from food and fuel inflation. China and other leading emergent economies kept the global economy growing while the US and other OECD economies were struggling off the floor.
...Chinese auto sales growth on a yearover-year basis has plummeted from the 90% range to nearzero.
July 2011
37
Bond Durations
US Canada International Inflation Hedged Bonds Years 4.00 4.25 3.80 5.5 Change unch unch unch unch
38
July 2011
23 14 3 11
Bond Durations
US (Hedged) Canada: Market Index-Related Real-Return Bonds International Years 3.90 4.00 5.50 4.00 Change unch unch unch unch
July 2011
39
40
July 2011
4. Remain overweighted in global agricultural stocks, particularly the fertilizer and machinery companies. Farm incomes are outpacing economic growth in North America and in some South American countries. 5. Brazil has been the investors' favorite BRIC for several years. Apart from the economic overheating and the sky-high interest rates, its political situation has taken a turn for the worse since Lula retired. We think equity investors should resist the urge to take advantage of the Bovespa's pullback. Brazil has a long record of blowing its great advantages with political folly. History shouldn't repeat itself this time, but it might be prudent to wait and see. 6. Within the energy group, oil and coal remain favorable. BHP's purchase of a shale gas producer at a huge premium shows that long-term investors could be considering tip-toeing into leading natgas companies with long-duration reserves. 7. Base metal stocks are cheapparticularly the majors with long-duration reserves. They will probably get cheaper in the next 12 months. Continue to underweight the base metal stocks. 8. The falling dollar should continue to boost reported earnings for US multinational stocks. Although such earnings may be illusory and unrelated to corporate excellence, US investors can savor them at a time when domestic earnings gains will become harder to achieve. 9. Overweight Japan. Japanese stocks have completed their Triple Waterfall Crash, and are showing signs of a renaissance.
July 2011
41