WHERE TO INVEST IN 2009  part I
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WHERE TO INVEST IN 2009 part I

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Central Bankers are in a race against time to convince the world it is safe to invest and spend. They are working to ensure important financial institutions do not fail and can resume lending to cash ...

Central Bankers are in a race against time to convince the world it is safe to invest and spend. They are working to ensure important financial institutions do not fail and can resume lending to cash starved companies. Money is being thrown at economies to generate confidence and fight deflation in the first truly global overburdening debt crisis that no one has seen before. Central bankers are currently winning the battle of hearts and minds as we have seen forward inflation expectations pick up citing the much vaunted “green shoots” of recovery, despite remaining in a deflationary environment. However, you cannot spend on borrowing forever as you have to earn to pay off your debt.

Henry Morganthau Jr. (FDR’s US Treasury Secretary) said in 1939 of the failed fiscal stimulus packages during the Great Depression that “never in the history of the world has there been a situation so bad that the government can’t make it worse.”

Indebted central bankers have embarked on a high risk “Voodoo Economics” strategy of borrowing more to solve a debt crisis.

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    WHERE TO INVEST IN 2009  part I WHERE TO INVEST IN 2009 part I Document Transcript

    • LONGER TERM THEMES A GUIDE FOR ASSET APPRECIATION Sound Advice 15th May 2009 VOODOO ECONOMICS PART I James Vinall – Senior Investment Officer Premise This is a guide to the emerging themes EquityBell is pursuing. This report does not attempt to define the exact timing for entry into or exit from an investment, but explores the basis for considering proactive longer term asset switching. Dominant Theme Central Bankers are in a race against time to convince the world it is safe to invest and spend. They are working to ensure important financial institutions do not fail and can resume lending to cash starved companies. Money is being thrown at economies to generate confidence and fight deflation in the first truly global overburdening debt crisis, something that has not been seen before. Central bankers are currently winning the battle of hearts and minds as we have seen forward inflation expectations pick up citing the much vaunted “green shoots” of recovery, despite remaining in a deflationary environment. However, you cannot spend on borrowing forever as you have to earn to pay off your debt. Henry Morganthau Jr. (FDR’s US Treasury Secretary) said in 1939 of the failed fiscal stimulus packages during the Great Depression that “never in the history of the world has there been a situation so bad that the government can’t make it worse.” John Morton Blum - “From the Morgenthau Diaries” Indebted central bankers have embarked on a high risk “Voodoo Economics” strategy of borrowing more to solve a debt crisis. THIS IS A MARKETING COMMUNICATION Intended for information only and should not be construed as an invitation or offer to buy or sell any investment vehicle or instrument. This note has not been prepared in accordance with legal requirements designed to promote the independence of investment research; and is not subject to any prohibition on dealing ahead of the dissemination of this marketing note. EquityBell Securities will provide extra detail on data or graphs used in this note upon requested.
    • LONGER TERM THEMES A GUIDE FOR ASSET APPRECIATION Sound Advice 15th May 2009 Currencies Major currency pairs have been difficult to trade as no one is sure which economy is more compromised than their peers at any moment in time. The UK government is printing money from quantitative easing to buy government “Gilt” bonds. Their stated intention of quantitative easing was to provide liquidity to the commercial sector and banks to create inflation. However, the Bank of England (BoE) has confirmed that less than 1% of the £44.5 billion it has printed so far has gone to buy company loans and bonds, but instead has mainly bought Gilts where it plans to issue £240 billion this year. One government department printing money for another government department is likely to have a negative effect on the currency. The US Federal Reserve Bank (Fed) is following the BoE’s lead by using quantitative easing printed money to buy US Treasury bonds, which will also not help the US$. As cash strapped companies are borrowing from the bond markets, longer term rates in GBP and US$ are set to rise in a steep yield curve. The actions of the US and UK are likely to raise questions on money backed by paper (fiat) money causing a flight into gold and other tangible commodities. While the BoE has forced the UK banks to come clean and reveal their balance sheets, the IMF reckons that US banks and particularly European banks have not properly addressed their credit crunch related losses. The ECB has taken a different route by easing credit to corporations instead of printing money via quantitative easing to provide capital to governments. However this leaves Euro-zone governments to raise the money they desperately need by their own devices, which should raise longer term rates in a steeper yield curve, possibly keeping the Euro stronger against the US$ and Sterling. However, Spain and Ireland have both used cheap rates from joining the Euro to leverage borrowing on property over the past decade. Construction and leveraged property speculation has been the main economic activity and deleveraging their debt “house of cards” is going to be painful. Peripheral Europe (Ireland, Portugal, Spain, Italy, Greece and the ex-Soviet Eastern bloc) have yet to fully grasp the nettle of deleveraging their vast property debt nightmare. The Japanese government conducted significant quantitative easing programs over a decade ago and currently owe US$159k for every worker in the country which will take generations to pay back as average net earnings are US$35k pa. Japan’s financial system collapsed in late 1989 from overburdening debt and has unsuccessfully tried many techniques to stimulate their economy over the last 19 years to defeat deflation. The Bank of Japan (BOJ) continues to issue JGB government bonds, but they have little room to borrow more as their depressed credit ratings are under close scrutiny. At the same time the BOJ is buying back their own JGB’s (without quantitative easing) as way of pushing investors into higher risk assets to provide liquidity. Without printing money and little ability to borrow more, the Yen will likely stay ahead of declines in US$ and Sterling. The Fed, BoE and ECB are likely to keep short rates close to zero for the foreseeable future, while demand for money by governments and industry is likely to push up longer term rates in a steeper yield curve. As Japan has little scope to raise long term rates, the Yen carry trade could re-emerge as investors borrow cheaply and convert the proceeds into other currencies to use abroad, suppressing any Yen advance.
    • LONGER TERM THEMES A GUIDE FOR ASSET APPRECIATION Sound Advice 15th May 2009 The Fed, BoE and ECB are all highly aware that running a zero interest rate policy for an extended period like Japan has, actually suppresses normal economic activity as banks have no incentive to lend money among themselves. The BoE actually praised higher rates at the longer term as a sign of economic strength. As we have already said, it is extraordinarily difficult to trade the US$, Sterling, Euro and Yen currency pairs as no one is sure which economy is more compromised than their peers at any moment in time. As the world’s overburdening debt is deleveraged, faith in fiat money and central bank fiscal management is being questioned, it may be easier to find clarity of direction within asset backed economies. As we have said before, China has acted like a department store credit card, where they lend you money to buy their goods. The problems start when the store has lent you more money than you can pay back and you stop buying their goods. China is very concerned about weakening the US dollar as they are said to hold 10% of all US public debt and is taking early steps to move away from their reliance on the US dollar. They are buying fewer longer dated US Treasury Notes and have been arranging trade facilities by swapping the Renminbi directly into other currencies. They have also banned individuals from selling Gold abroad and the government is accumulating reserves from their distressed population who are concerned about job security and having to support ageing parents and grandparents in absence of the US consumer. China has been accumulating vast amount of copper and soybeans that they are storing as a strategic investment asset more than for actual use. This may be creating the impression that the rise in copper prices is an indicator of increasing industrial activity. It appears most likely that they are using commodities like copper and soybeans for the first time as a hedge against the US$ like most other governments buy gold. This is all part of a long term plan to make the Renminbi fully convertible and become a global reserve currency. China’s actions as the Western world’s largest creditor point to a continual long term appreciation of the Renminbi and depreciation of the US$ and GBP particularly. China seems to be taking some unorthodox routes to mitigate their vast US$ risk as they fully understand the level of US debt and the Fed’s inability to meet their obligations without significantly depreciating the currency. Although we conclude that the US$ and Sterling will most likely be weaker than the Yen and then the Euro, commodity currencies appear to have the greatest chance of appreciation. Global crude oil inventories are at record highs, so the price is reverting to supply / demand after months of accumulation. The main crude oil asset backed currencies are the Norwegian Krone and Russian Ruble. Both are likely to advance against the US$, but this will probably be more US$ weakness than crude oil strength. Precious metals, base metals and agricultural products are the main commodities being accumulated as a tangible asset hedge against a fall in the US$. The Australian Dollar and Canadian Dollar, as the main precious and base metal asset backed currencies are set for the most significant long term gains as prices rise and the US$ falls. Commodities China is not the only country with significant US$ reserves that they would like to hedge. As concerns over US government debt grows, commodities as a real asset are likely to be accumulated. China already has a Renminbi / Peso swap agreement with Argentina to pay for two thirds of their soybean exports, bypassing the US$.
    • LONGER TERM THEMES A GUIDE FOR ASSET APPRECIATION Sound Advice 15th May 2009 This trend is likely to escalate and has significant implications for the US$ as the world’s reserve currency. As expectations of inflation gather pace, gold and other commodities (agricultural and base metals) are likely to continue to increase, especially as the US$ declines. But, commodity price increases may be driven up more by investment in a tangible asset rather than demand by end users. Oil is a case in point, where global crude inventories are at record levels and storage is at a significant premium. Source: Saxo Bank On the right is a chart of the June 2009 crude futures contract showing the advance from the mid-March peak of $55.50 to the current $57.90 is a rise of 4.3% On the right is a chart of the December 2009 crude futures contract. The advance from the mid March peak of $62.08 a barrel to the current 62.28 is rise of 0.3% With crude inventories at record levels, spot buyers previously had nowhere to store purchases. This storage shortage has now extended to the back month contracts and the contango (back month futures much higher than front month) is contracting back to normal levels. Therefore the current front month crude price hikes probably have more to do with a weaker dollar and lack of storage than increased demand from a pick-up in industrial activity. The massive accumulation of crude across the world shows how oil is being bought as a strategic asset and US$ hedge and now all storage facilities are full, the price now reflects supply / demand. As an indication of demand destruction the International Energy Agency (IEA) said yesterday that World oil demand will fall by 2.56 million barrels per day (bpd) in 2009, the sharpest annual decline since 1981. Crude oil prices are unlikely to make significant gains from here in the near future. As we said earlier, the Chinese have been buying copper and soybeans as a US$ hedge as they are not actually using the copper for export manufacturing and inventories are growing as fast as imports. China has been very smart in aggressively buying soybeans (although they are perishable they can be stored for many years) as wet weather in the US is delaying planting and prices are creeping up. However, China does not wish to upset normal commodity market activity and do not want to flag their undeclared policy of buying assets to exit the US$.
    • LONGER TERM THEMES A GUIDE FOR ASSET APPRECIATION Sound Advice 15th May 2009 The markets don’t seem to have picked up that the Chinese are accumulating many different commodities as a strategic hedge against the US$. The Chinese also would like to avoid creating inflation for as long as possible to avoid being blamed for collapsing the US$. The Chinese are leading the way for the rest of the world to accumulate hard assets as a hedge against a falling US$ and failing trust in financial institutions. We conclude that global commodity prices (not including energy) are likely to increase over the coming years, particularly those that can be stored easily for long periods. We will cover Fixed Income and Equities in Part II next week EquityBell Securities Dowgate Hill House, 14-16 Dowgate Hill, London EC4R 2SU Tel: +44 (0) 20 3189 2108 www.equitybell.com Risk Warning Notice: Equity Bell Securities is a trading name of Equity Bell Limited (registered office: Talbot House, 8 – 9 Talbot Court, London EC3V 0BP. Registered in England and Wales No. 6725781) is an Appointed Representative of London Islamic Investment Bank Limited, which is authorized and regulated by the Financial Services Authority. Whilst every attempt is made to ensure the accuracy of the information provided, no responsibility can be accepted for any inaccuracy. The information provided cannot be relied upon as constituting a recommendation, nor construed as any offer to sell, or any solicitation of any offer to buy investments. No liability is accepted for any loss whether direct or indirect, incidental or consequential, arising out of any of the information being untrue and / or inaccurate, except caused by the wilful default or gross negligence of EquityBell Securities, its employees, or which arises under the Financial Services and Markets Act 2000.