Friday, January 30, 2009

Right Forecast by Schiff, Wrong Plan?

Peter Schiff predicted a collapse of the U.S. financial system. The bust-up he didn't foresee was the one that made mincemeat of investors who took his advice in 2008.

Mr. Schiff's Darien, Conn., broker-dealer firm, Euro Pacific Capital Inc., advised its clients to bet that the dollar would weaken significantly and that foreign stocks would outpace their U.S. peers. Instead, the dollar advanced against most currencies, magnifying the losses from foreign stocks Mr. Schiff steered his investors into.

Investors open accounts at Euro Pacific to take advantage of Mr. Schiff's investment advice, which generally involves shunning investments in dollars. Individual returns can vary. Some investors may like gold-mining stocks, while others prefer energy-focused stocks.

Most had one thing in common last year: heavy losses. A number of investors said their Euro Pacific portfolios lost 50% or more in 2008, worse than the 38% drop in the Standard & Poor's 500-stock index last year. People familiar with the firm say that hardly any securities recommended by Euro Pacific brokers gained ground in 2008.

[Peter Schiff] Associated Press

Investment adviser and author Peter Schiff, still riding high on his prescient call on the collapse of the U.S. housing market, is the subject of more than 3,000 YouTube videos, including one called "Peter Schiff Was Right."

Such losses came as something of a surprise. Mr. Schiff's prescient call for the collapse of the U.S. housing market and the weakening of the financial system helped him gain fame as an economic guru and savvy investor who promised shelter from the financial storm.

In his 2007 book, "Crash Proof: How to Profit from the Coming Economic Collapse," he recommends that investors pile into gold, commodities and overseas stocks that spit out steady dividends.

When global markets were soaring, many Euro Pacific investors' accounts experienced strong performance. For several years, investors saw returns in excess of 20% a year as foreign stocks and commodities surged, according to people familiar with the firm.

In 2008, investors nervous about the state of the U.S. economy who were impressed by Mr. Schiff's track record poured money into Euro Pacific, nearly doubling the number of accounts to 16,000. But many did so at the worst time possible, much like investors who piled into Internet stocks as the dot-com bubble peaked.

Mr. Schiff, 45 years old, says the downturn in his strategy is a short-term setback. He argues that it is only a matter of time before the dollar collapses, pressured by massive government bailouts, triggering outsize returns for his investors.

"I think the dollar is going to get destroyed," he says. Investors with the staying power to wait out what he sees as a temporary phase of irrational confidence in the dollar will reap huge rewards, he argues.

Mr. Schiff is still riding high on his housing-market call. This week, he spoke at a global competitiveness conference in Riyadh, Saudi Arabia, alongside former heads of state, prime ministers and American gold-medal swimmer Michael Phelps. He is the subject of more than 3,000 YouTube videos, including one called "Peter Schiff Was Right."

His admirers even created Web sites supporting a possible run for the U.S. Senate in 2010. Mr. Schiff, who was economic adviser to independent presidential candidate Ron Paul in 2008, says he has no plans to run for the Senate but "anything's possible."

Critics say Mr. Schiff's strategy is much riskier and more aggressive than many investors realize. David Yeske, managing director of Yeske Buie, a Vienna, Va., money manager, says Mr. Schiff's investment strategy was a focused bet on a single outcome, rather than risk management for investors looking to protect assets from an economic collapse. "He's a speculator; he thinks he can see the future," says Mr. Yeske, former chairman of the Financial Planning Association. "That's not really risk control."

One of Mr. Schiff's biggest forecasts was that many overseas economies would "decouple" from the U.S., gaining strength even as the American economy struggled. Instead, overseas stock markets plunged as much or more than U.S. stocks in 2008 as the global economy skidded. Prices for commodities also tanked, torpedoing another favorite investment theme of Mr. Schiff's. After last year's losses, his firm has about $845 million in assets.

Early last year, Richard De Gennaro, a retired Harvard University librarian, put $100,000, about 15% of his assets, into a Euro Pacific account that included Canadian Oil Sands Trust, which focuses on crude-oil projects in Canada, and the India Capital Growth Fund, which holds investments in companies that do business in India.

Both investments took big hits in 2008, compounded by the fact that the Canadian dollar and the Indian rupee fell 18% and 19%, respectively, against the U.S. dollar. The 83-year-old retiree's account is now worth about $37,000, a 63% plunge. Mr. Schiff "goes around saying that he was right," says Mr. De Gennaro. "He was right about one thing and wrong about everything else."

Among investors who turned to Mr. Schiff's firm just as his strategy began to falter, Brian Kullberg, a design engineer in Portland, Ore., says he started to worry about the state of the U.S. economy in early 2008. He put $70,000 into a Euro Pacific account, hoping it would benefit as the U.S. economy and the dollar weakened. By late January 2009, his investment had shrunk to about $25,000.

"It's curious," says one longtime client of Mr. Schiff's who works in finance. "His thesis of how things are going to collapse and crumble and fall apart isn't effectively executed in [my] account." The account, which is largely invested in gold, mining and infrastructure stocks from Canada to Australia, was down roughly 35% last year, the client estimates. The Australian dollar weakened 19% against the U.S. dollar in 2008.

Mr. Schiff says one year's poor performance doesn't prove he was wrong. He has admitted in notes to clients that his investment thesis hasn't performed as expected, particularly with respect to the U.S. dollar. But he holds fast to his convictions and has been telling investors to scoop up a number of depressed stocks.

Some clients are inclined to agree. "The decoupling he talked about has not happened," says Barbara Hearst, a clothing entrepreneur who splits her time between Charleston, S.C., and Bridgehampton, N.Y., and has invested with Mr. Schiff since 2000. But "longer term or medium term, I don't discount what Peter says."

Thursday, January 29, 2009

10-Year Treasury Yield Reaches Key Juncture

Even with the Fed's reiteration that they were considering outright purchases of US Treasuries, the yield on the 10-Year has been climbing steadily higher from its lows in December. At 2.77%, the 10-Year is approaching yields that it traded at before the bottom dropped out in early December. How we trade in the next few days will go a long way in determining whether the current sell-off is simply profit taking after a massive rally, or the beginning of the end of the latest bubble in asset classes (stocks, real estate, commodities, etc...).

10 yr yield

S&P 500 Implied Sales Growth Update

Below is an updated graph of the historical average market implied sales growth for the S&P for the past 10 years. Even in 2002, the market did not forecast negative sales growth for the typical firm in the S&P 500. Today, the market is calling for these firms to deliver -3.7% annual sales growths over the next 5 years. This is an improvement from November’s expectations of -8.7%.

If you are interested in learning more about our view on the market implied expectations in the S&P 500, we previously discussed in more detail in our Then and Now Special Study

The Hedge Fund Size Effect

Do small hedge funds tend to prosper in their chosen niches while large ones outgrow their opportunity sets? In his January 2009 paper entitled "Does Size Matter in the Hedge Fund Industry?", Melvyn Teo examines the relationship between hedge fund size and future risk-adjusted (for seven factors) returns. Using monthly net-of-fee returns, assets managed and other characteristics for a large sample of live (3,177) and dead (4,240) hedge funds allocated to four styles over the period January 1994 through June 2008, he concludes that:

  • There is a negative, convex relationship between hedge fund size and future risk-adjusted returns (see the chart below). For example, an increase in
    assets from $10 million to $500 million implies a decrease in annual abnormal returns of about 1.23%.
  • A portfolio comprised of the smallest 40% of hedge funds outperforms a portfolio of the largest 40% hedge funds (both rebalanced annually) by a risk-adjusted 3.65% per year.
  • Limits on opportunity sets, not fund age or style or leverage, appear to drive the underperformance of large funds. These limits are most evident for funds managed by multiple principals who trade small, illiquid securities (e.g. emerging market securities), suggesting that price impact of trading and compromises in decision-making are decisive factors. The limits appear not to apply to funds of hedge funds.
  • While new investments flow disproportionately to small funds, they do not do so quickly enough to eliminate the hedge fund size effect.
  • Some hedge fund managers recognize opportunity set limits by adopting higher performance fees and sometimes closing their funds to new investments.

The following chart, taken from the paper, depicts the relationship between hedge fund monthly abnormal (risk-adjusted) returns and assets under management the prior month over the period January 1994 through June 2008. A best-fit quadratic polynomial shows the convexity of the effect (concentration among the smallest funds).

In summary, large hedge funds contend with significant diseconomies of scale, and consequently underperform comparable small hedge funds.

For related research, see Blog Synthesis: Mutual Funds and Hedge Funds.

Where the Financial Gurus Are Putting Their Own Money

In times of market strife, financial gurus often tell investors to think long-term and stay the course. Some of them even put their own money where their mouth is.

[Rob Arnott]

Rob Arnott

A sampling of high-profile industry veterans, academics and brokerage-firm chiefs reveals that many are hanging on to holdings battered by last year's market slide and busily hunting down new opportunities, particularly among bonds and beaten-down value stocks. Some are snapping up municipal bonds, inflation-indexed securities and steady-Eddie dividend-paying stocks.

And they're generally upbeat about the prospects for long-term retirement savers.

"I think this is a marvelous time to be investing," says Rob Arnott, the 54-year-old chairman of Research Affiliates LLC, an investment-management firm in Newport Beach, Calif. "There are more interesting opportunities out there now than any of today's investors have ever seen."

Financial stars are facing some of the same retirement-planning headaches as ordinary investors. Many suffered substantial losses last year in a market that crushed nearly everything. But unlike many small investors, they're patiently waiting and watching for bargains rather than making a mad dash for havens like cash or Treasury bonds or drastically revising their asset-allocation plans. And where possible, they're even stepping up their savings to put more cash to work in the market.

Certain parts of the bond market are priced for a scenario that's worse than the Great Depression. Rob Arnott, Research Affiliates

Great investing minds don't always think alike, of course. John Bogle, the 79-year-old founder of mutual-fund giant Vanguard Group, says he has only about 25% of his portfolio in stocks, for example, while David Dreman, the 72-year-old chairman and chief investment officer of Dreman Value Management LLC, says he has a roughly 70% stock allocation.

They do appear to have one thing in common, though: patience -- a trait many small investors lack. Last year, 401(k) participants shifted around 5.7% of their balances, compared with just over 3% in a typical year, according to consulting firm Hewitt Associates. Money flowed out of stock funds and into bond investments, money-market funds and stable-value products. And many fed-up and tapped-out investors have stopped contributing to retirement accounts altogether.

[Bogle, John]

John Bogle

But this is hardly the time to hunker down and take bets off the table, financial pros say. Don Phillips, managing director at investment research firm Morningstar Inc., says he invests his entire individual retirement account in the Clipper Fund, a large-cap stock fund that lost about 50% last year. Early this year, he made the maximum IRA contribution to that fund, just as he has for the last 20 years. "It's long-term money, and you have to look at it that way," he says.

Here's how some top investing experts are now allocating their own retirement savings and handling the heavy blows being dealt by a volatile market.


While many financial gurus say they're starting to spot some great opportunities in stocks, they believe the bargains in select corners of the bond market are even better. "Certain parts of the bond market are priced for a scenario that's worse than the Great Depression," Mr. Arnott says.

I earn my money and spend my money in dollars, and I don't need to take currency risk. John Bogle, Vanguard Group

One favored area is Treasury Inflation-Protected Securities, or TIPS, a type of Treasury bond whose principal is adjusted based on changes in the inflation rate. Ten-year Treasurys currently yield only about 0.9 percentage point more than 10-year TIPS, indicating that investors believe inflation will remain quite low in the coming years. Mr. Arnott says he boosted his TIPS allocation "in a very big way" in his personal taxable account toward the end of last year because he expects a substantial increase in inflation in the next three to five years.

Municipal bonds also look attractive to many longtime investors. Munis are typically exempt from federal and, in many cases, state and local income taxes. Many are now yielding substantially more than comparable Treasury bonds. In his taxable account, Mr. Bogle holds two muni-bond funds: Vanguard Limited-Term Tax-Exempt and Vanguard Intermediate-Term Tax-Exempt.

[Siegel, Jeremy]

Jeremy Siegel

Burton Malkiel, a 76-year-old economics professor at Princeton University and author of "A Random Walk Down Wall Street," says he boosted his allocation to highly rated tax-exempt bonds in his taxable account late last year, since yields available on some of these bonds were "unheard of."

Some market watchers believe that it's time to take on more risk in their bond portfolios. Even investment-grade corporate bonds offer high yields, and below-investment-grade junk bonds yield far more than that. Mr. Arnott boosted his allocation to investment-grade corporate bonds in his personal taxable account late last year because the market had reached "irrationally high yields," he says. And Jeremy Siegel, a professor of finance at the University of Pennsylvania's Wharton School and senior adviser to exchange-traded-fund management firm WisdomTree Investments, has recently raised his allocation for junk bonds.

"Stocks and high-yield bonds will move together as the crisis passes," rebounding from their depressed levels, the 63-year-old Mr. Siegel says.


Financial gurus are picking through the wreckage of last year's stock-market meltdown to find the best bargains.

Emerging-markets stocks have 'gotten cheap enough to really give value now.' Jeremy Siegel, the Wharton School

Some are looking for companies with strong market positions and juicy dividends. Muriel Siebert, founder and chairwoman of brokerage firm Muriel Siebert & Co., has recently been buying shares of companies like Pfizer Inc., Altria Group Inc., and General Electric Co. "I don't mind buying a stock on the bottom and waiting," says the 76-year-old Ms. Siebert. "But I do think when you get a market like this, you should be paid while you wait." Pfizer and Altria yield roughly 8%, while GE yields over 9%.

Some battered stocks in the energy sector also look like bargains, Mr. Dreman says. He likes oil and gas exploration and production companies like Anadarko Petroleum Corp., Apache Corp., and Devon Energy Corp. If we don't have a long world-wide recession -- a scenario that Mr. Dreman thinks oil prices currently reflect -- "we'll see much higher prices for oil again," he says.

Though foreign stocks were generally hit harder than U.S. shares last year, some gurus aren't rushing to invest overseas. Mr. Bogle, who says he has a very small allocation for international stocks, notes that investors poured money into foreign funds in recent years, chasing their strong returns, while yanking money out of lagging U.S. stock funds. "To me that's a red warning flag on a very tall flagpole on a very windy day," he says. "I also earn my money and spend my money in dollars, and I don't need to take currency risk."

[Muriel Siebert]

Muriel Siebert

Other experts say that emerging-markets stocks, which were hit especially hard last year, are starting to look tempting. If these shares take another dip, they could become "extremely interesting," Mr. Arnott says. Mr. Siegel keeps one-quarter to one-third of his foreign-stock allocation in emerging markets, and "they've gotten cheap enough to really give value now," he says. He has bought some more of these shares as they've declined in recent months.

Jim Rogers, a 66-year-old veteran commodities investor based in Singapore, is putting new money into Chinese shares. He's focusing on sectors of the economy that the Chinese are pushing to develop, such as agriculture, water, infrastructure and tourism.

Market gurus are also finding some bargains among alternative investments. Mr. Rogers is putting some new money into commodities, particularly agricultural commodities. "We're burning a lot of our food in fuel tanks right now," he says. And Mr. Siegel recently added some U.S. real estate investment trusts to his portfolio, which got "very cheap" after declining sharply last year, he says.

Staying the Course

Sticking to principles they've developed over decades in the market allows people who live and breathe investments to be relatively relaxed about their retirement portfolios.

I don't mind buying a stock on the bottom and waiting. But I do think when you get a market like this, you should be paid while you wait. Muriel Siebert, Muriel Siebert & Co.

Morningstar's Mr. Phillips, 46, has made it easier to stay the course. He has relinquished responsibility for allocating his 401(k) account, leaving those decisions in the hands of a managed-account program run by a unit of Morningstar. The program, which he started using in 2007, has "actually been very good for me," Mr. Phillips says. "They started putting me into things like TIPS and high-quality bond funds that I'd never had in the portfolio before."

And when they do suffer substantial losses, they tend not to panic. Mr. Phillips remains committed to his battered Clipper Fund, though it lagged the Standard & Poor's 500-stock index by about 13 percentage points last year. Ms. Siebert says she took a "very substantial loss" in Wachovia Corp. stock, which plummeted last year before the company was sold to Wells Fargo & Co., but she's hanging on to the Wells Fargo stock she received "until I see a reason not to."

She is, however, a bit sensitive when asked about her portfolio's overall performance last year. "Do you want to see a grown woman cry?" she asks.

Investment Outlook Bill Gross | February 2009

Beep! Beep!
The current financial and economic crisis is difficult to appreciate, not only for the drop in elevation, but because of the swiftness of the declines. It’s been a Wile E. Coyote 12 months – straight down like a dead weight. A year ago, global equity prices were nearly twice today’s levels and recession was only a whisper on the lips of the gloomiest of economists. Today, descriptions drawing parallels to the Great Depression make it obvious that a major shift in economic growth and its historic financial model, as well as policy prescriptions for its revival, are underway. Most of the world’s connected economies and its citizens are in shock, conscious but not fully aware of the seismic shifts that will unfold in future years.

PIMCO’s thesis for several years has held that the levered global economy long ago morphed from a banking-dominated regime to one that hid behind securitized lending and structures resembling a “shadow banking” system. SIVs, hedge funds, CDOs and increasingly levered mortgage and investment banks fueled asset appreciation in all investment markets, which in turn propelled real economic growth and employment to unsustainable levels. But, with U.S. housing prices as its trigger, the delevering process did a Wile E. Coyote and headed over the cliff in mid-year 2007, dragging down almost all asset prices except government bonds. The real economy followed shortly thereafter, not just in the U.S., but globally, proving that linkages work on the “down” as well as the upside. To PIMCO, the remedy for this deflationary delevering and mini-depression is simple and almost axiomatic: stop the decline in asset prices. If that can be done, the real economy will level out as well. When home prices stop going down, newly created households will be more willing to take a chance on ownership as opposed to renting. If stock prices consolidate, recently burned investors will be more willing to invest, as opposed to stuffing their 401(k) mattresses with Treasury bills. Business investment, jobs, and profits should follow quickly behind.

The simplicity of the solution, however, is not easily achieved once deflationary momentum takes hold. Animal spirits, once dampened, are hard to reignite; “fear of fear itself” dominates greed. Under such circumstances, the benevolent hand of government is required and Keynes is reincarnated in an attempt to plug the dike via fiscal spending and imaginative monetary policies that support asset prices. PIMCO has recently been contracted to assist in several publically announced programs which have helped in that effort: the CPFF, which has benefitted commercial paper yields, and the Federal Reserve’s purchase program for agency-backed mortgage loans, which has lowered 30-year mortgage rates to 4.5% and fostered the affordability of new and secondary housing prices. These two programs, in our opinion, have been the major policy successes to date – not because of our involvement – but because they have supported and increased asset prices whose decline has been the major deflationary thrust behind the real economy. Stop asset prices from going down and with a 12-month lag, unemployment will stop going up, and President Obama’s targeted three million new jobs will have a fighting chance of being achieved.

But stopping the decline of asset prices can be and has been attempted in numerous, seemingly uncoordinated ways. Recapitalization of the banks has been the major thrust, in the hopes that banks would extend credit which would reinvigorate asset pricing. Those who argue strongly for a recapitalization of the banking system, however, may be missing the distinction between the banking system as we once knew it, and the “shadow banking” system that superseded it. Jim Bianco, who heads up the research tank bearing his own name, brought the difference to mind in a recently produced piece entitled, “When Will The Banks Start Lending?” His conclusion was that banks already were – lending – but it was the “shadow system” (my words) that was holding up the parade. According to his analysis, shown in Chart 1, securitization has for several years exceeded bank loans as a percentage of private credit market debt. In contrast to recent headlines, however, banks have been picking up their lending, but it has been the “shadow banks” that have faltered. That makes sense. While banks may have tightened their lending standards, fresh capital from the TARP has made it possible to make new loans. The shadow banks, however – hedge funds, investment banks, and structured financial conduits – have been forced to delever as government funds have been directed to more visible institutional lenders. Granted, Goldman Sachs and Morgan Stanley have been TARP recipients, but only under the conditions of downsizing and degearing on their way to becoming regular banks, which have cut their holdings of assets significantly in percentage and actual dollar terms. It should not surprise, therefore, that with the exception of specifically directed government programs directed at commercial paper rates and 30-year mortgage yields, past policies have been unsuccessful. Banks have been recapitalized – yes – and banks have cautiously started to lend. But shadow banks are still delevering due to disappearing and unavailable fresh capital and, as they do, they continue to drag asset prices with them. PIMCO’s Ramin Toloui has produced Chart 2 which correlates the contraction in household debt to the decline of the securitization market. He estimates that there is a one trillion dollar hole that needs to be filled by policymakers in this area alone.

Stressing the importance of the shadow banks is not the same thing as suggesting that they should be next in line for government largesse and bailouts. Lord knows, the Obama Administration is not going to bail out hedge funds, CDOs, private equity firms (Cerberus?), or Donald Trump. There are levered risk takers that will be, and should be, allowed to fail. But in permitting failure, policymakers must still be cognizant of the need to support asset prices – hopefully by inducing confidence and trust in private investors, as pointed out by Robert Shiller in a recent Wall Street Journal op-ed, but if need be by the financing or purchase of assets themselves. It’s not so much that the stock market needs to go back to 10,000. That would be nice for millions of 401(k)s that have been cut in half over the past 12 months, but it is not likely. Rather, asset prices securitizing commercial real estate and credit card receivables, as well as plain old-fashioned municipal bonds, must stop going down if the real economy has any chance to revive by 2010.

Example: CMBS or commercial real estate mortgage-backed securities are now priced to yield over 12% vs. 5% in recent years. As real estate financing comes due and rolls over in the next few years, it is imperative these yields return to mid-single digits if shopping centers, retail malls, and office buildings are to remain viable. How best to bring those yields down is debatable: another CPFF-like structure with self-insurance and contributed fees as its equity backstop? A generous portion of remaining TARP billions providing a reserve cushion for Federal Reserve funding? A good bank, bad (aggregator) bank structure? All three are being debated by policymakers and we should have clarity within a week’s time. But one thing is certain: an economic recovery is dependent upon commercial real estate prices stabilizing and most retail stores staying open for business in the months and years ahead.

Similarly, municipal yields are now trading at nearly twice their Treasury counterparts, implying that municipal bonds are trading at 80 cents on the dollar instead of 113 cents like the average Treasury. To enable states and cities to return to normal functioning, those bonds must return to par. Modern day capitalism depends on the successful refinancing and issuance of securities at a price and yield level not significantly divorced from past experience. That is the same thing as saying that current yields must come close to matching the economy’s embedded cost of debt if default is to be avoided. Not only municipalities, but the efficient operation of hospitals, nursing homes and even universities depend on the leveling and returning of municipal bond prices to higher levels. Similar arguments can be made for corporate bonds as well.

PIMCO’s advice to policymakers is as follows: you can’t bail out everyone, yet economic recovery is not possible unless certain critical asset sectors are not only reliquefied, but rejuvenated in price. The prior Administration’s focus on the banks has been critical but unidimensional. The shadow banking system with its leverage and financial innovation, powered a near 25-year global economic expansion, but it is the delevering of those hidden quasi-banks that is now threatening its petrification. Policymakers should not focus entirely on one-off bailouts of large real estate developers, municipalities, or even credit card issuers like they have with Citi, BofA, and AIG. Rather, they should recognize that supporting critical asset prices such as municipal bonds, CMBS, and even investment grade corporate bonds is a necessary step towards eventual economic revival. Capitalism at its philosophical and practical center depends on credit, and while new loans can be and are being advanced via the banking system, it’s a much more difficult task to force shadow banks to lend. That lending depends on securitization which in turn depends on stable and eventually higher asset prices than currently exist. The original focus of the TARP was on asset prices, but the prior Administration quickly lost its way or perhaps its nerve. Like his Road Runner nemesis, Wile E. Coyote must now extend some infrequently used figurative wings to avoid the deflationary precipice below. Support asset prices. Beep Beep!

William H. Gross
Managing Director

Wednesday, January 28, 2009

Greenlight Founder Takes Grandfather’s Advice on Gold

By Stewart Bailey and Saijel Kishan

Jan. 28 (Bloomberg) -- Greenlight Capital Inc. founder David Einhorn is finally taking his grandfather’s advice. The $5.1 billion hedge fund is buying gold for the first time amid the threat of inflation from increased government spending.

Since Einhorn was 10 years old, his grandfather has warned him that investing in bullion and gold-mining stocks was the only “sensible” thing to do given the threat of inflation and the risks of so-called fiat currencies, New York-based Greenlight said in a Jan. 20 letter to clients. The firm had never before considered buying bullion or mining-company shares.

“To everyone’s dismay, we believe some of Grandpa Ben’s predictions are playing out,” Greenlight said in the letter, a copy of which was obtained by Bloomberg News. “The size of the Fed’s balance sheet is exploding, and the currency is being debased.”

Greenlight is turning to the centuries-old currency to mitigate the effects of the economic collapse and government efforts to end it. Bullion gained for the eighth straight year in 2008 as governments in Europe and the U.S. rescued banks from collapse.

Greenlight said in the letter that in addition to buying gold, it has added call options on gold and the Market Vectors Gold Miners exchange-traded fund to its other investments. Call options are the right to buy a security or commodity at a set price, within a set period of time. The owner of the call profits when the security rises above the set price.

Gold & Silver Index

The 16-company Philadelphia Stock Exchange Gold & Silver Index gained 90 percent in the three months through yesterday while the Standard & Poor’s 500 Index fell 0.4 percent. Gold rose 21 percent in that period. Gold futures for April delivery fell $11.30, or 1.3 percent, to $888.20 an ounce today on the New York Mercantile Exchange’s Comex division.

Steven Lehman, who manages Federated Investors Inc.’s $1.3 billion Federated Market Opportunity Fund, beat the S&P 500 by 30 percentage points last year. The fund, which outperformed 99 percent of its competitors in that period, also has bet on the precious metal and counts Toronto-based Yamana Gold Inc. and Goldcorp Inc. among its top holdings.

‘Too Many Mistakes’

Greenlight, which Einhorn, 40, started in 1996, has returned an annual average of 20.8 percent from its Greenlight Capital LP fund. The firm said it made “too many mistakes” last year, when it lost 23 percent from its main fund, its first annual loss. Mary Beth Grover, a Greenlight spokeswoman, declined to comment.

The Federal Reserve’s policy of taking unorthodox steps to boost the supply of credit is essentially “printing money,” Greenlight said. The government’s “aggressive” fiscal policy also signals all efforts will be made to stem the effects of the current economic problems, the fund said.

Hedge funds are private, largely unregulated pools of capital whose managers can buy or sell any assets, bet on falling as well as rising asset prices and participate substantially in profits from money invested.

To contact the reporters on this story: Stewart Bailey in New York at; Saijel Kishan in New York at

Last Updated: January 28, 2009 16:21 EST

Harvard, Dartmouth Losses May Widen on Private Equity

Jan. 27 (Bloomberg) -- North American college endowments lost an average of 22.5 percent on investments from July to November and the declines probably will get bigger after returns on private equity and real estate are calculated.

The funds shed $94.5 billion in asset value in the five months ended Nov. 30, according to a study released today by Commonfund and the National Association of College and University Business Officers. The loss, the biggest in 35 years, compares with a 29 percent decline in the same period by the Standard & Poor’s 500 Index, including reinvested dividends.

Harvard University, whose $28.8 billion endowment is the biggest in higher education, and Ivy League rival Dartmouth College have yet to disclose the value of alternative investments such as buyout funds and property, which take longer to price because they aren’t traded on exchanges. These assets probably dragged down returns further, meaning less income for schools that are already cutting budgets.

“It’s as bad as it gets,” John Griswold, executive director of the Commonfund Institute, said in an interview. The Wilton, Connecticut-based center is affiliated with Commonfund, a manager of more than $25 billion, and seeks to improve investment returns by nonprofit organizations.

Endowment income is a primary source of revenue for colleges and universities, along with tuition, public financing and gifts. Schools use investment earnings to help pay for salaries, scholarships and capital improvements like new buildings.

The Commonfund-Nacubo study findings were based on market value estimates by investment professionals at 435 schools with a combined $420 billion at the start of the fiscal year in July.

Endowment Scrutiny

In fiscal year 2008, funds lost an average of 3 percent, their third decline in eight years, according to the separate study conducted by Nacubo, and TIAA-CREF, which surveyed 796 colleges and universities in the U.S. and Canada.

The losses so far this year surpass those in 1974, the worst year for endowments, according to Commonfund and Brett Hammond, chief investment strategist for New York-based TIAA-CREF Asset Management, which worked on a separate survey with the Washington-based business officers association. Losses may climb to as much as 40 percent by June if the public and private markets don’t recover, Griswold said.

Endowments have drawn criticism from Senator Charles Grassley, the Iowa Republican who has raised issues of tax fairness in relation to Harvard’s fund and those of other large schools. Grassley said yesterday schools shouldn’t use their portfolio losses “as an excuse” to increase tuition or halt student aid and instead should spend more.

‘It’s Pouring’

“If an endowment is a rainy day fund, it’s pouring,” he said in a statement.

Harvard is freezing salaries at the Kennedy School of Government and the Faculty of Arts and Sciences to offset endowment losses, while the Stanford Graduate School of Business fired 49 staff members, about 12 percent of its non-faculty workforce. Brandeis University, in Waltham, Massachusetts, plans to close its Rose Art Museum and sell its more than 6,000 artworks to offset endowment losses, Dennis Nealon, a university spokesman, said today. Those works were appraised at about $350 million in 2007 by the school.

“You can cut expenses, borrow money and increase liquidity in your endowment fund,” said Verne Sedlacek, chief executive officer of Commonfund. “There’s not a lot of other options.”

More Alternative Assets

The percentage of endowment assets in alternative investments rose in the fiscal year ended in June as stock prices fell and colleges and universities shifted cash to support operations, Commonfund said. Endowments had an average of 46 percent of assets in alternative categories as of June 30, the study shows.

At endowments managing more than $1 billion, the allocation increased to 52 percent from 47 percent, according to the study. Those with between $500 million and $1 billion in assets had the biggest increase, moving to 42 percent from 35 percent.

Harvard, in Cambridge, Massachusetts, said its endowment fell 22 percent from July to October and is planning for a 30 percent decline, since its estimate didn’t fully reflect the value of its private equity and real estate.

The university put $1.5 billion of buyout stakes on the market last year. Most of the holdings went unsold because the offers were too low, three people familiar with the matter said last week.

Dartmouth, in Hanover, New Hampshire, lost 18 percent in the second half of 2008. Diana Pearson, a spokeswoman for Dartmouth, the smallest school in the Ivy League, said the college is studying how to value those assets.

Liquidity Paramount

The University of Virginia, which had $3.8 billion in assets as of Nov. 30, lost 25 percent in the first five months of the fiscal year, according to the Web site of its investment management firm.

The Charlottesville school’s private-equity holdings lost 38 percent, resources fell 32 percent and private real estate dropped 27 percent. The school valued those investments at “fair market value,” the site said.

“Liquidity is the biggest priority for endowments,” said Scott Malpass, chief investment officer at the University of Notre Dame, in South Bend, Indiana. “Things are changing so fast in the economy and in the market that one needs to remain vigilant and nimble and be opportunistic in making commitments.”

In the next two years, Notre Dame will focus on buying securities that protect its endowment from inflation and “enhancing our liquidity position to take advantage of select distressed opportunities in all asset classes,” Malpass said.

Malpass declined to say how much the endowment, which had $7 billion on June 30, had lost since then.

To contact the reporter on this story: Gillian Wee in New York at

Last Updated: January 27, 2009 15:44 EST

Tuesday, January 27, 2009

The Baby Doomers

This morning's release of Consumer Confidence for January was the lowest on record (going back to 1967). In order to get a better read on the true state of the consumer, however, it often helps to look at the sub-categories within the report. For example, the age of the person being questioned can play a large role in how he or she feels about things. The charts below show the historical levels of Consumer Confidence broken out by age group. While confidence levels are at historical lows for each age group, people under the age of 35 (43.6) are considerably less downbeat than those over the age of 55 (34.7). While from time to time we have all put on the rose-colored glasses and reminisced about the "good old days," at the rate things are going, "Baby Boomers" run the risk of being labeled "Baby Doomers."

Consumer Confidence 012709

Kass: Is This the End of Warren Buffett?

Doug Kass

01/27/09 - 10:59 AM EST
This blog post originally appeared on RealMoney Silver on Jan. 27 at 7:49 a.m. EST.

"All good things must come to an end, but all bad things can continue forever."

-- Unknown

Last week, I suggested that Warren Buffett's star was crashing back to earth.

Barron's Senior Editor Andrew Bary penned a similar piece over the weekend.

Stock Rating
Jim Cramer:
Human After All

Armed with some additional information, I have made tentative conclusions regarding the intrinsic value of Berkshire Hathaway's (BRK.A Quote - Cramer on BRK.A - Stock Picks) common shares.

At year-end 2007, Berkshire's investment portfolio had a cost of $39.2 billion and a market value of $75 billion. Since the end of third quarter 2008, the value of Berkshire's investment portfolio has experienced a pronounced drop.

Berkshire's six investments listed below have fallen by over $16 billion in value; this is more than just a bump in the road:

1. Wells Fargo (WFC Quote - Cramer on WFC - Stock Picks) closed at $37.53 on Sept. 30, 2008. Last week, it closed at $15.87. Berkshire owns 290 million shares, a drop of $6.3 billion dollars.

2. American Express (AXP Quote - Cramer on AXP - Stock Picks) closed at $35.43 on Sept. 30, 2008. Last week, it closed at $16.00. Berkshire owns 151 million shares, a drop of $2.9 billion dollars.

3. Coca-Cola (KO Quote - Cramer on KO - Stock Picks) closed at $52.88 on Sept. 30, 2008. Last week, it closed at $42.20. Berkshire owns 200 million shares, a drop of $2.1 billion dollars.

4. Burlington Northern Santa Fe (BNI Quote - Cramer on BNI - Stock Picks) closed at $92.43 on Sept. 30, 2008. Last week, it closed at $63.32. Berkshire owns 63 million shares, a drop of $1.8 billion dollars.

5. ConocoPhillips (COP Quote - Cramer on COP - Stock Picks) closed at $73.25 on Sept. 30, 2008. Last week, it closed at $48.10. Berkshire owns 60 million shares, a drop of $1.5 billion dollars.

6. U.S. Bancorp (USB Quote - Cramer on USB - Stock Picks) closed at $36.02 on Sept. 30, 2008. On Jan. 20, 2008, it closed at $15.34. Buffett owned 73 million shares, a drop of $1.5 billion dollars.

Note: These losses do not include the recent purchase of General Electric (GE Quote - Cramer on GE - Stock Picks) and Goldman Sachs (GS Quote - Cramer on GS - Stock Picks) preferreds and Berkshire's large and so far unprofitable foray into shorting puts on the major stock indices.

If one triangulates Buffett's comments in his annual reports during the late 1990s, he seems to view Berkshire's intrinsic value as the sum of its investments per share plus approximately 12 times pretax profits, excluding all income from investments.

Given many of my concerns expressed initially in March 2008, I am increasingly coming to the conclusion that the above calculation of intrinsic value is too liberal. Considering the high cost of Berkshire's investment style drift into derivatives (massive short put positions), Buffett's refusal to sell and his apparent lack of recognition that investment moats no longer exist in some of his largest investments (especially in banking), I now feel that Berkshire's valuation will steadily suffer, despite the long-term allegiance of its investors who are geared toward evaluating the company over decades, not years. Indeed Berkshire, in the fullness of time, might suffer the same fate of many other listed closed-end equity mutual funds; its shares could trade at a discount to its investment value per share -- plus some multiple to pretax profits.

I have worshiped at the altar of Warren Buffett since the late 1970s -- ever since an investor and acquaintance, Conrad Taft, introduced me to his investment methodology and style at Berkshire Hathaway. Indeed my writings over the last seven years have often been punctuated with Buffett-isms. I have repeatedly objected to, scoffed at and refuted criticisms of Buffett's strategy on this site and elsewhere. That said, the rationale behind avoiding/shorting Berkshire Hathaway's common stock must be segregated from my respect/worship of the greatest investment icon of the last half century.

-- Doug Kass, March 10, 2008

As I wrote almost a year ago, Warren Buffett is justifiably revered by investors around the world, and I consider myself one of those who have worshiped at his investing altar over the past three decades. Nevertheless, from my perch, Buffett's salad days seem to be over; the only question that remains is the timing and to what degree investors will abandon the Oracle of Omaha.

Reflecting some of the above concerns and since late September 2008, Berkshire's shares have fallen from $145,000 a share to $85,000 a share. There is no apparent end to the decline in sight.

All good things, it seems, in markets and life, must come to an end.

Will CDS spreads tumble in February?

Fortis certainly thinks so.

The bank’s analysis, which is based on Didier Sornette’s research into bubbles (think US housing and oil circa 2008), holds that recent increases in CDS spreads in both US and European markets have reached unsustainable levels and are due for a correction - sharpish.

Per the report, by Peter Cauwels, Ken Bastiaensen and Amjed Younis:
Based on our findings, it is likely that the peak for the 4 major indices will be reached between the 2nd and the 12th of February, and as a result they will fall. This is particularly significant since these indices are closely watched as a “fear gauge” for Financial Markets, alongside the VIX Index, Libor-OIS spread and the spread between German bond yields versus other Euro Area government yields.

Their conclusion is based, in part, on the application of the mathematical model of Sornette’s general theory of crashes, which they backtested using the performance of the US dollar weighted average as a data series:

On December 5th, the toolset detected a bubble-like behavior and reported December 10th as most likely crash

Starting on December 9th, the DXY began a consecutive drop of more than 8% until December 17th. This drawdown13 was the largest since the start of the daily DXY index in 197114 and can thus statistically be considered a crash.

In addition to this forward test, a wide range of historical crashes15 have been analysed and the results used for calibration.

The formula, which according to Fortis represents a so-called “log periodic power law” (LPPL) and is given by:

p(t) ≈ A + B(tc - t)-β + C(tc - t)-β cos(ω log(tc - t) +ϕ )

Fortis believes four of the major CDS indices - the iTraxx Crossover and Main, and the CDX High Yield and Investment Grade - which all recently hit record highs, show a ‘bubble-like formation in spreads’, per the graphs below:

Fortis chart of the bubble in the iTraxx MainFortis chart of the bubble in the CDX IG

As for just what a bubble in CDS means:
… in the case of CDS, the spread can be viewed as the cost of buying protection against default and the bubble can be interpreted as a rush to buy protection at ever spiralling prices.

The fundamental picture does add weight to the thesis that the cost of protection could be overvalued. Viewing the implied probabilities as the breakeven levels when buying protection can be useful when assessing the value of CDS protection. For example, the iTraxx Crossover index is a 5Y contract that implies a projected default rate of 60% over the coming 5 years for the constituent companies 16.

The implied probability of default embedded in the spreads is higher than the realised default rate during the worst point in the Great Depression, and is higher than the 15.1% global default rate for speculative grade names projected by Moody’s for 200917. For European speculative grade issuers this is expected to rise to 18.3%. However this figure is not directly applicable to the iTraxx Crossover since the index also includes low investment grade names which normally have a lower default rate.

A correction would therefore portend the return of risk appetite and improved investor confidence.

Mark your calendars, then.

Chart of the Day: The CDS-Bond Basis


Many thanks to JP Morgan, which sent me the data for the above chart, which shows the CDS-bond basis for BBB-rated debt. In English, that means it's the number you get when you take the CDS spread on BBB-rated credits (that's the lowest investment-grade rating), and subtract the yield on those credits' bonds.

The lower this number goes, the higher the arbitrage opportunity: you can buy a bond, hedge it with a CDS, and pocket the profits.

It's not a perfect hedge, since there are counterparty risks involved, but they're normally dealt with through margining requirements. Was the plunge in the CDS basis between September and December the result of a huge increase in counterparty risk? It's possible: it'll be very interesting to see what happens to the basis if and when these credits migrate to a CDS exchange with minimal counterparty risk.

It's also far from clear whether the above chart is what was responsible for a large part of Merrill Lynch's $15 billion in fourth-quarter losses. But remember that historically the basis has been positive, which means that Merrill's traders might well have seen a juicy profit opportunity when the basis turned negative in 2008. After all, what were the chances it would get much worse?

Credit Default Risk Down But Still High

Below we highlight a chart of an index that measures the default risk of investment grade credit in the US. Throughout the credit crisis, default risk has risen sharply, although it has ticked lower since peaking in December. Any decline in default risk is a good sign, but it needs to fall much more before anyone can make the claim that things are "settling down." As shown, the index has still not broken below the bottom of its uptrend line that formed back in April 2008.


Checkup on Volatility

We've been highlighting the record volatility that we've seen in this market for some time now, and below is a chart showing where things currently stand. On December 9th, volatility peaked when the S&P 500 saw its 50-day average absolute daily percent change hit a whopping 4.02%. Things have definitely settled down quite a bit since then, making the current environment seem downright boring. Over the last 50 days, the average daily move for the S&P 500 has been +/-2.52%. But even though things seem quiet now, 2.52% is still in the top 2% of volatility periods since 1927. While volatility has declined in relative terms versus the fourth quarter, we're still in "crazy" territory on an absolute basis.


CFA Institute Guide to Fraud Prevention

The CFA Institute (of which several members of Castle Hall's team are members) has recently published ten "tips" on avoiding fraud (available here.)

The list is fairly obvious, but worth repeating:

1) Understand the investment strategy

2) Match investment strategy to reported performance

3) Watch for e-mail solicitations and internet fraud

4) Be wary of "sure things", quick returns and special access

5) Understand what, if any, regulatory oversight exists (As an aside, we are not convinced by the Institute's comment that investors should be "careful of offshore investments". Given the conspicuous failure of multiple layers of the US regulatory regime in the Madoff affair, investors outside the US could very well be saying that investors should be "careful of US investments".)

6) Assess the operational risk and infrastructure.

This is, of course, a point with which we do agree. The CFA Institute comments that: "any investment management operation should have an infrastructure for trading and administration. Ask to see them, and inquire about the firm's processes and controls. It is important that a firm have separate, independent operations for asset management, trading, and custody to provide checks and balances against fraud."

7) Ask about independent audits and who performs them.

In case of interest, our most recent comments on some of the issues raised by current hedge fund audits can be found here.

8) Assess the personnel

9) Perform a background check

10) Limit your exposure.

All sensible stuff.

Depression *alert*

Well, it’s finally happened - a mainstream investment bank calling not just a recession, but a depression. How depressing.

In a note entitled “Some inconvenient truths”, Merrill Lynch’s North American economist David Rosenberg elucidates (emphasis ours):

It shouldn’t come as any big surprise that with such a provocative title, we would be saddled with questions as to how an economic depression is even defined. Of course, most portfolio managers still don’t know that a recession is not defined as back-to-back quarters of negative real GDP prints (which we had neither in 2002 nor 2008) but instead the timing of the peaks in real sales activity, employment, industrial production and organic personal income growth.

As for depressions, there is no official definition, except to say that they have existed in the past. There were no fewer than four in the nineteenth century, one in the twentieth century, and we are very likely enduring another one today. Though this current one is muted by the fact that most countries have an elaborate social safety net (deposit insurance, unemployment benefits, welfare, and socialized health care).

Depressions are basically long recessions - they can last anywhere from three to seven years, while historically cyclical recessions last 18 months - and tend to follow years of leveraged prosperity of Gatsby-like proportions. Considering that in this most recent leveraged cycle from 2002-07, we reached a point where a record 40% of corporate profits were derived from financial activities, where household debt relative to income and assets surged to unprecedented levels and the personal savings rate briefly went negative at the height of the housing bubble, it is safe to say the down-cycle we are currently experiencing did indeed follow a classic elongated period of leveraged prosperity. It is now reverting to the mean.

And with regards to reverting to the mean, Rosenberg provides some rather scary numbers:

  • $6 trillion - The amount of private sector debt that needs to be eliminated (Based on ML data that total private sector credit market debt relative to national income is still near a record-high of 140 per cent vs a long-run norm of 80 per cent).
  • $1 trillion - The amount of excess capacity in the US economy.
  • $13 trillion - the cumulative loss of household net worth at the end of 2008.
  • 70% - The US’s share of global consumer spending/GDP, which Rosenberg predicts will now revert to its long-run average of 64 per cent.
And the scariest bit of all:As Morgan Freeman (Red) put it so eloquently in The Shawshank Redemption, “that’s all it takes, really, pressure, and time.” Time is certainly going to be a big part of the solution, and history tells us that deleveraging cycles last years. While the pendulum is obviously on the downswing, the forecasting community is obsessed with locating the bottom. In our view the appropriate focus is to assess just how far the pendulum will swing in the opposite direction, because a mean-reversion process actually breaks through the mean.The full note available in the Long Room (H/T teapack).

2009 Country Stock Market Performance -- Things Already Aren't Pretty

Of the 84 country equity indices that we track, 19 are up so far this year, which is at least better than we could say for 2008. As shown, China is currently the second best performing country so far this year, with a gain of 9.33%. Another BRIC country that is currently in the black for 2009 is Brazil, with a gain of 2.49%. But 19 countries in the black means that 65 countries are already in the red, and some are bleeding pretty badly. Seventeen countries are down more than 10%, including G-7 countries Germany and Japan. Canada is the best performing G-7 country so far in 2009 with a decline of 3.50%. Puerto Rico has seen the biggest loss -- falling by 34%.


Monday, January 26, 2009

For Some, Sound of Profit Is 'Timber!' While Other Investments Wither, Forest Land's Value Keeps Growing

WINCHENDON, Mass. -- Money still grows on trees.

Timberland, which a few years ago became a popular investment among institutions and wealthy folks, has held up amid market massacres for most other assets lately.

[Timber Sprouts Growth]

Through Sept. 30, the value of timberland rose 5%. When the National Council of Real Estate Investment Fiduciaries reports 2008's final quarter this week, this number is unlikely to move much. That marks a slower pace of growth, yet it is growth nonetheless. In 2007, timber appreciation was a towering 15%.

How can positive returns exist in these dark days of shrunken prices for everything ranging from real estate to commodities to stocks? Oil, after a summer price spike, was down 54% in 2008, while corn lost 11% and copper 54%. (Gold, as a refuge commodity, rose 6%.) Prices for lumber, a key forest product, have fallen by 34% over the past year as housing construction has ebbed.

The answer to this riddle is that timberland is the ultimate long-term investment, with relatively little bought and sold each year -- and demand still respectable for what does change hands. "As long as the sun shines, the trees will grow," says Jeremy Grantham, chairman of Boston money manager GMO and a long-time fan of timber investing. "Timber will never be an orphan."

Timber often is likened to high-grade bonds, meant to be held for 10 years or more. The average annual timberland appreciation for the past decade is 4.1% versus minus 3.8% for the Standard & Poor's-500 stock index. The timberland appreciation figure, which encompasses both the land and the trees, is based on sales and appraisals. After 10 or 15 years, investors cash out when the land is sold.

On top of the appreciation, timber generates regular income. Trees are constantly chopped down and sold for everything from boards to paper mulch, albeit in smaller volumes these days. Cash returns from this "harvesting," as it's called, are now 1.5% of the property value, down from 3% in 2007 and about 5% annually the three years before that.

[Timber Sprouts Growth] Jason Grow for The Wall Street Journal

Forester Dag Rutherford, a senior vice-president at Bank of America's U.S. Trust, knows timber is a long-term investment. 'No quick pay-offs here.'

Nobody creates investor dividends quite so dramatically as a woodsman. Standing amid 70-foot pines that thrust into the cool New England air, Dag Rutherford, a rangy veteran forester, gives the go-ahead to start the day's cutting. "These trees took decades to grow," says Mr. Rutherford, a senior vice-president at Bank of America's U.S. Trust wealth-management unit, which runs this tract for a rich family. "People still need wood."

This day's tree toppling, in the deep woods about 100 miles from Boston, should bring up to $8,000 worth of lumber. The operation is masterfully efficient, capable of felling around 80 trees in two hours. Time was, a lumberjack with a chain saw would take a day to do that.

For this job, though, Mr. Rutherford has hired a giant machine that resembles something out of the movie "Transformers." Run by one man in a cabin atop a tractor-like chassis, this $1 million harvester machine has a huge claw that grabs a trunk and swiftly severs it with an embedded saw. The tree falls noisily to earth with a bird-frightening crash. Then the tree is fed through the claw, which snips off branches and slices the trunk into 16-foot logs.

The 6-foot-4 Mr. Rutherford, born in Canada, spent his youth working on family timberlands in his ancestral Norway and has forestry in his blood. Both sides of his family tree have loggers. As he tromps through the Massachusetts boondocks, he sees a sapling. "This will be a mighty oak in 75 years," he says. "No quick pay-offs here."

Back in the late 1990s, when investors were obsessed with tech stocks, timberland seemed stodgy and fetched around $700 to $800 an acre, according to the Conservation Fund, a big timberland buyer. Then came the past decade's housing boom, and big investors got interested. Wood-products giants like Weyerhaeuser Co. cashed in by divesting vast forested tracts to a welter of private partnerships, university endowments, real-estate investment trusts and other financial buyers.

Prices have since risen to the $1,500 to $3,000 range, depending on the quality of the wood.

One allure of timber is that it isn't closely correlated with other asset classes. That's because it is highly flexible. Other organic commodities like corn or pork have to come to market in season, or they will rot.

"Trees keep growing 4% per year, no matter what happens to inflation, interest rates or market trends," says Dennis Moon, head of U.S. Trust's group overseeing timberland, as well as farm and mineral investments. "You don't have to cut them down this year if that doesn't make sense."

On the downside is that, as the ultimate long-term investment, timber is very illiquid. Looking to park your kid's college tuition someplace for eight years? Forget wood. Plus, timber's cost of entry is dauntingly high. The best returns, adjusted for risk, come from large, multimillion-dollar partnerships called timber-investment management organizations, or TIMOs, sponsored by the likes of GMO and U.S. Trust. But these require a minimum $250,000 investment, and often many times that.

TIMOs' overhead can be onerous, too: They may charge from 3% to 5% per year in assets for property management, taxes and insurance.

A cheaper way of investing in timber is via several real-estate investment trusts. Most prominent is Plum Creek Timber Co., the largest private land holder in the U.S. Investors can get in for around $32 per share. Over the past 52 weeks, its price has fallen 26%, better than the S&P 500's 37% drop. Indeed, Plum Creek's showing is better than the S&P paper and forest product index, which has slid 50%. The index is focused on board-making companies like Weyerhaeuser, whose fortunes are more closely tied to the housing industry, rather than the slow-growing majesty of a maple.

Top investor calls for Wall St 'moderation'


The financial crisis has exposed greed, predatory behaviour and conflicts of interest in Wall Street banks and investment firms, one of the top investors in the US has said.

David Swensen, the chief investment officer of Yale University's endowment - who has achieved near-legendary fame as an investor, said he hoped some "moderation of compensation" on Wall Street would be a result of the crisis.

"Even if the returns they generated were real, they were paid too much, and in the context of the absolutely disastrous performance of these institutions their pay was obscene," he said.

In the 10 years to June 2008, Yale's endowment returned an average of 16.3 per cent a year after fees. That is almost three times the return of the average college endowment.

In the 25 years since he took the helm, Mr Swensen turned the traditional endowment model, which had 80 per cent of the money in US stocks and bonds, on its head, putting most of the money into private equity, hedge funds, non-US securities and property.

Despite allocating money to 100 managers, he is highly critical of the money management industry.

Mr Swensen recently revised his book - Pioneering Portfolio Management - that outlines his philosophy and packed it with recent examples of venality.

Fortress, Goldman Sachs, Microsoft, Morgan Stanley and large buy-out funds are among those which he criticises for self-interested actions at the expense of their investors.

"Look at investment banks and how they price swap transactions. Instead of being symmetric and using the same discount rate when selling and buying, they will say that on the cash flows you owe us, we're going to use a low discount rate, and on the cash flows we owe you, we're going to use a high discount rate. It's stunning that anyone could say something like that with a straight face," said Mr Swensen.

"This bad, predatory behaviour - unilaterally changing marks, asking for more collateral, etc - it seems the financial crisis stripped off this veneer and caused them all to behave in more venal ways," said Mr Swensen.

"The overwhelming number of investors fail because the fees charged by the investment management industry are egregious relative to the amount of value that is added. It is really quite stunning," he said.

Mr Swensen said nobody at all should use hedge funds of funds, which take investor money and, for an additional fee, allocate it to a range of hedge funds.

"You can't make sensible investment decisions with fund of funds or consultants. Madoff is just a great example of the dangers of making an investment and not understanding where the money is going."

He said the $17bn Yale endowment was shifting as much available money as possible into distressed debt.

Peter Schiff was Wrong

There are numerous YouTube videos, articles, and references to Peter Schiff being "right" rapidly circulating the globe. While Schiff was indeed correct about the US imploding, most of the praise heaped on Schiff is simply unwarranted, and I can prove it.

First, let's start with a look at the claim being made. Peter Schiff concludes many of his articles, books, etc. with the following statement.

Mr. Schiff is one of the few non-biased investment advisors (not committed solely to the short side of the market) to have correctly called the current bear market before it began and to have positioned his clients accordingly.
Highlight in red is mine.

I would like to see some proof of that statement. Specifically I would like to see the average returns posted by EuroPacific clients for 2008.

I have talked with many who claim they have invested with Schiff and are down anywhere from 40% to 70% in 2008. There are many other such claims on the internet. They are entirely believable for the simple reason Schiff's investment thesis was flat out wrong.

I have an actual portfolio statement from one of Schiff's clients at the end to discuss, for now let's discuss the main points of Schiff's thesis.

Schiff's Overall Thesis

  • US Equity Markets Will Crash.
  • US Dollar Will Go To Zero (Hyperinflation).
  • Decoupling (The rest of the world would be immune to a US slowdown.
  • Buy foreign equities and commodities and hold them with no exit strategy.

Schiff was correct about point number 1 above. The US equity markets crashed. That was a very good call. Unfortunately, his investment thesis centered on shorting the dollar in a hyperinflation bet, and buying foreign equities rather than shorting US equities.

Furthermore, Schiff made no allowances for being wrong and had no exit strategy whatsoever.

What happened in 2008 was that foreign equities sold off much harder than US equities, and a strengthening US dollar compounded the situation.

In other words, Schiff failed where it matters most: Peter Schiff did not protect his client's assets. Let's take a look how, and more importantly why, starting with charts of various foreign indices.

click on any chart in this post for a sharper image

$SSEC Shanghai Stock Exchange Weekly

$NIKK Tokyo Nikkei Weekly Chart

$TSX - Canada TSX Weekly Chart

$AORD Australia ASX Weekly Chart

$SPX S&P 500 Weekly

2008 Equities Bloodbath

2008 was a global equities bloodbath. Clearly there was no decoupling. The Shanghai index (China), Nikkei (Japan), TSX (Canada), AORD (Australia), and virtually every world equity index collapsed along with the S&P 500, the DOW, and Nasdaq in the US.

Many, if indeed not most, foreign equity markets did worse than the US indices. The Shanghai index fell from 6124 to 1665, a whopping 72.8% decline top to bottom.

Let's investigate why this happened, starting with the decoupling thesis itself.

Global Decoupling Thesis

Please consider this excerpt from the Little Book of Bull Moves in Bear Markets, page 41:

"I'm rather fond of the word decoupling, in fact, because it fits two of my favorite analogies. The first is that America is no longer the engine of economic growth but the caboose. [The second] When China divorces us, the Chinese will keep 100% of their property and their factories, use their products themselves, and enjoy a dramatically improved lifestyle."

I mentioned decoupling many times previously but declared it officially dead on January 22, 2008 in Global Decoupling Myth Shattered In Equity Selloff. There are some interesting charts on currencies in that post as well.

Here is a snip from Tail Wags Dog Theory Blows Up written November 1, 2008.
Tail Wags Dog Theory Blows Up

At every peak there are always ridiculous predictions. In the dotcom bust, it was all about the "gorilla game", the "new economy" and "click counts". When the Shanghai Stock Index rose from 998 to 6124 in about two years, we heard the same sort of thing about growth in China. Instead of click counts, the theory in vogue was called decoupling. China was supposed to be the 800 lb gorilla with insatiable demand for commodities and perpetual growth for the next decade.

That decoupling theory was based on the belief that the US no longer mattered, that China demand was self-sustaining, that China could grow forever with no problems, etc. Such beliefs eventually became a religion.

The tail does not wag the dog no matter how many people think otherwise.
Let's explore decoupling by looking at manufacturing, employment, and capital flows.

Global Manufacturing Contracts

Please consider US Manufacturing Orders at 60 Year Low, China Contracts 5th Straight Month.

  • China’s manufacturing contracted for a fifth month.
  • European Manufacturing Contracts At Fastest Pace On Record.
  • Russian Manufacturing PMI Shrank the Most on Record.
  • U.S. Manufacturing Shrinks as Orders Hit 60-Year Low.

That's not decoupling, that's a worldwide recession.

Millions of Chinese Struggle to Find Jobs

In the wake of a global slowdown, Chinese export shrink, civil unrest is a worry, and unemployment is rising as noted in Xinhua says there will be more unemployment and social revolts in 2009.
State council adviser Chen Quansheng, warns that unemployment is much more serious than portrayed by the official statistics. According to Chen, so far at least 670,000 small industries have been closed, leaving 6.7 million people unemployed, but this number refers only to registered workers. But there are millions of people working in the underground economy, coming from the countryside, who are being fired and are forced to return to their villages without any unemployment benefits.

The academy of social sciences is also warning about the worrisome number of firings. In 2009, the government will have to create work for at least 33 million people, including migrants, young people seeking their first jobs, and new graduates.
The odds of China finding work for 33 million workers without printing vast amounts of money are slim.

Hot Money Outflows Exacerbate Chinese Problems

Inquiring minds are reading Monetary conditions might exacerbate the Chinese adjustment by Prof. Michael Pettis.

Synopsis: Chinese monetary policy has locked the country into a dangerously pro-cyclical trap. Hot money flowed into China and pushed the economy into overheating. Those inflows have reversed sharply, perhaps by as much as $100bn last quarter, equivalent to around 8% of Q4 GDP. These outflows are causing a credit contraction and an even sharper economic slowdown at exactly the worst possible moment.

One Tail Cannot Wag Six Dogs

Those hot money inflows were all part of the global credit boom that is now unwinding. Much of China's boom centered on exports. Now that the US consumer has thrown in the towel, a key question arises:

Can China expand enough to make up for the contraction in US and European demand given that the two economies are more than six times the size of China?

The answer to that last question is an emphatic no. One tail cannot wag six dogs.

Here is another way to look at it. The US is the world's largest economy. Housing had already weakened but commercial real estate had not. US retail stores and malls were being built at an unsustainable blowoff pace and those stores were crammed with goods coming from China and Japan.

The decoupling theory was that loss of the US consumer would not matter to the commodity producers like Canada and Australia or the manufacturers like China and Japan. How could any economist have thought that? Many did. Schiff was one of them.

Peter Schiff on 2009-2010 USA Hyperinflation

Here is a partial transcript of a Schiff Audio On US Hyperinflation
The whole idea is to get out of the US Dollar. It is on the verge of collapse. The people who don't get out of the US dollar are going to be completely broke and that is obvious. Look at what Ben Bernanke did. Interest rates are zero. Money is free.

Bernanke is going to run up printing presses as fast as he can. This is pure inflation Latin American style. This is hyperinflation; this is Zimbabwe; this is the identical monetary policy of the Weimar Republic.

I am just as convinced that people who have their money in US dollars are going to be just as broke as people who have their money with Madoff.

I do not know how much time you have. With the dollar dropping 5% a week at this point, could it snap back? But what if it keeps falling? What if it's down 5% next week? And 5% the week after that? And then what if it drops 10%? and another 10%? At some point a year from now the dollar could be dropping 5% a day.

The inflation rate in Zimbabwe is over 100 million percent a year.
Hyperinflation or Hyperventilation?

Schiff asks "But what if it keeps falling? What if it's down 5% next week? And 5% the week after that? And then what if it drops 10%? ...."

That was quite some rant, enough to scare many who listened. Schiff is indeed very charismatic.

He never bothers to ask, "What if it doesn't?" The answer was not so pretty for his clients. The simple fact of the matter is Schiff was wrong where it mattered.

Schiff has been ranting about hyperinflation for years. The dollar is substantially higher now than it was at the start of 2005. His explanation for the recent rally is there is no "real demand" for dollars, it's just deleveraging.

I agree that deleveraging is indeed happening.

But why is deleveraging happening? The answer is everyone herded into anti-dollar plays based on decoupling and hyperinflation theories that did not pan out. Those trades are now being forcibly unwound. The bulk of the carnage is likely over but the losses have been immense.

Unlike Schiff, I called for this US dollar rally.
On November 9th, I went neutral on the dollar as the US dollar index came close to hitting my target.

In 2001-2002 the US$ index peaked at 121. Since then there was a massive flight out of US dollars into anything else. That flight continued into 2008 even though the fundamentals were changing.

The fundamentals of China and the commodity producers were simply not very good once the US consumer threw in the towel.

Schiff simply did not see this coming.

US the Next Zimbabwe?

Schiff continually compares the US to Zimbabwe. Such comparisons are silly. Please consider Zimbabwe to launch 100 trillion dollar note.
Zimbabwe's central bank will issue a 100 trillion Zimbabwe dollar banknote, worth about $33 (22 pounds) on the black market, to try to ease desperate cash shortages, state-run media said Friday.

Prices are doubling every day and food and fuel are in short supply. A cholera epidemic has killed more than 2,000 people and a deadlock between President Robert Mugabe and the opposition over power sharing has dampened hopes of ending the crisis.

Hyperinflation has forced the central bank to keep issuing new banknotes which quickly become almost worthless. There is an official exchange rate, but most Zimbabweans resort to the informal market for currency transactions.
Does that sound like anything that is happening or is going to happen in the US? I think not.

However, let's assume for a moment that hyperinflation is going to happen. Where then could one get the most bangs for their buck to take advantage? The answer to that question is in real estate, where one can buy on 5% down. Nowhere else can one easily get such leverage.

Note that there has never been hyperinflation in history where real property declined in value. Therefore, if Schiff really believes in hyperinflation, he ought to be suggesting that his clients buy houses.

However, Schiff thinks housing prices will continue to crash. So do I. And if they do, you can kiss hyperinflation theories goodbye.

EuroPacific Thoughts on the Financial Crisis

I do not expect every advisor at every company to think alike, but I did find these Thoughts on the Financial Crisis by Andre Sharon, Consulting Research Analyst for Euro Pacific Capital rather interesting.
What Now?
Only three possible outcomes:

1. We inflate to the level of the debt, i.e. we "fulfill" debt obligations, but in mini-dollars
2. We take the hit, cleanse the system of excesses and move on. Result: deflation, bankruptcies, high unemployment, etc...
3. We disinflate veeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeery slowly, like Japan. Won't happen: the American psyche won't take 16-odd years of no growth. Different cultural mindset: you can't prick a balloon slowly here.

My guess: combination of 1 and 2. I would hope for a bias towards 2. Terrible for many, but healthier for the system long-term. Schumpeter's concept of creative destruction trumps Keynes, in my book. That's life, and progress, with all its faults and flaws.
My pick is a combination of 2 and 3 (2 is not by choice but rather by force) for reasons explained in Brink of Debt Disaster.

But what I find interesting is that a Europacific advisor believes that Keyensian economics can be trumped (I do as well, Japan proved it), but also that Andre Sharon at least in part is calling for "Result: deflation, bankruptcies, high unemployment, etc..."

I would advise Schiff to toss his hyperinflation theories out the window and listen more to his research analyst. However, Schiff cannot and will not change because he has two books calling for hyperinflation.

On the other hand, I can change. I called for deflation and it is here right now. I do not have to wait for it. The only debate is how long it lasts.

At the appropriate time, I expect to transition my stance towards a stagnant slow growth period in which there will be inflation but not by a lot. In such a scenario, the US would hop in and out of recessions for up to a decade, much like Japan.

Time will tell whose model is correct. I reserve the right to change my model. It's too late for Schiff to change his. The damage has already been done.

Closer Look At Currency Fundamentals

The US economy is clearly in shambles. However, when the US dollar index crashed to 70 the dollar was priced as if the US alone was in trouble. That was hardly the case. Europe, China, Australia, Canada, the UK, are in shambles as well.

On August 8 2008, Trichet Put the Spotlight on the Euro, Dollar by saying economic growth in Europe would be "particularly weak". That was a clear signal all was not well in the Eurozone. Most, including Schiff ignored the signal.

Although the US had a massive housing bubble, so did Spain, Ireland, and other parts of Europe. Also note that European banks invested in US mortgage debt.

Finally, European banks invested heavily in Latin America and the Baltic states. The US did not make those mistakes.

The credit crunch now threatens the sacrosanct

On January 19 2008, New Europe reported The credit crunch now threatens the sacrosanct.
Last October, the ECB signed a currency swap agreement with the Swiss National Bank. The obvious purpose was to support the solvency of the Swiss Franc. The reason why the franc needed support was that the country’s banks had undertaken huge obligations in foreign currencies, which exceed the Swiss national income, probably by many times. Who knows how many? Last week this agreement was renewed and extended in volume.

The case is similar with Iceland. That tiny country was one of the richest and most reliable in the world, a kind of small Switzerland. But Iceland’s banks were found at the beginning of credit crisis to have huge obligations in foreign currency. When the banks started to go insolvent the government of Iceland stepped in and nationalised them.

In the case of Switzerland - along with the ECB - came the American central bank, the Fed, to support the solvency of the franc with foreign swap agreements. Who on earth wants the Swiss banks to fail? In short, nothing has been settled in the credit crunch crisis and the entire world continues to support those who created the problems in the first place.
Think the Swiss Franc is a safe haven? I don't.

So what about the Euro? Here are a few headlines to ponder.

Germany Faces Worst Post-War Economic Decline


Germany is facing its biggest economic downturn since the Second World War with Chancellor Angela Merkel's government saying Wednesday it expects Europe's largest economy to contract by 2.25 per cent this year.Germany's Economics Minister Michael Glos and Finance Minister Peer Steinbrueck released the latest data on Wednesday, revising their prior 2009 forecast down sharply from last October's prediction of 0.2 percent growth.Since then, German exports have declined precipitously and are expected to be down 8.9 percent for the year.

Berlin Sees No Limits to Economic Intervention


As part of her efforts to combat the economic crisis, German Chancellor Angela Merkel is increasing the state's influence in the market, buying holdings in banks and bailing out individual industries and companies.Is Germany turning into a planned economy? Only a few weeks ago, Chancellor Angela Merkel spoke out against "arbitrary, unfocussed economic stimulus programs" and large-scale government intervention in the real economy.

Trichet Vision Unravels as Italy, Spain Debt Shunned

On January 16, 2009 Bloomberg reported Trichet Vision Unravels as Italy, Spain Debt Shunned
European Central Bank President Jean-Claude Trichet’s vision of economies converging behind the shield of a shared currency may be unraveling.

The gap between the interest rates Spain, Italy, Greece and Portugal must pay investors to borrow for 10 years and the rate charged to Germany has ballooned to the widest since before they joined the euro. The difference may grow further as Europe’s worst recession since World War II hurts budgets and credit ratings across the region.

Diverging bond yields hurt Trichet’s argument that the ECB’s inflation-fighting mandate ushered in an era of stability for nations that once suffered rampant price growth.

They also make it tougher for the ECB, which cut its key rate to a record yesterday, to set one benchmark for all 16 euro nations. That may delay recovery as governments try to fund stimulus plans.
Monetary union has left half of Europe trapped in depression

Ambrose Evans-Pritchard at The Telegraph is writing Monetary union has left half of Europe trapped in depression.
Events are moving fast in Europe. The worst riots since the fall of Communism have swept the Baltics and the south Balkans. An incipient crisis is taking shape in the Club Med bond markets. S&P has cut Greek debt to near junk. Spanish, Portuguese, and Irish bonds are on negative watch.

Dublin has nationalised Anglo Irish Bank with its half-built folly on North Wall Quay and €73bn (£65bn) of liabilities, moving a step nearer the line where markets probe the solvency of the Irish state.

A great ring of EU states stretching from Eastern Europe down across Mare Nostrum to the Celtic fringe are either in a 1930s depression already or soon will be. Greece's social fabric is unravelling before the pain begins, which bodes ill.

Each is a victim of ill-judged economic policies foisted upon them by elites in thrall to Europe's monetary project – either in EMU or preparing to join – and each is trapped.

In Lithuania, riot police fired rubber-bullets on a trade union march. Dogs chased stragglers into the Vilnia river. A demonstration outside Bulgaria's parliament in Sofia turned violent on Wednesday.

Latvia's property group Balsts says Riga flat prices have fallen 56pc since mid-2007. The economy contracted 18pc annualised over the last six months. Leaked documents reveal – despite a blizzard of lies by EU and Latvian officials – that the International Monetary Fund called for devaluation as part of a €7.5bn joint rescue for Latvia. This was blocked by Brussels – purportedly because mortgage debt in euros and Swiss francs precluded that option.

Spain lost a million jobs in 2008. Madrid is bracing for 16pc unemployment by year's end.

Private economists fear 25pc before it is over. Spain's wage inflation has priced the workforce out of Europe's markets. EMU logic is wage deflation for year after year. With Spain's high debt levels, this is impossible.

Italy's treasury awaits each bond auction with dread, wondering if can offload €200bn of debt this year. Spreads reached a fresh post-EMU high of 149 last week. The debt compound noose is tightening around Rome's throat. Italian journalists have begun to talk of Europe's "Tequila Crisis" – a new twist.
On page 157 of Little Book of Bull Moves in Bear Markets, Peter Schiff writes "The Euro could possibly replace the United States dollar as the world's reserve currency."

I suggest a breakup of the Eurozone has a greater chance than that. While I agree that US dollar hegemony will end eventually, ideas that the Euro will replace the US dollar as the world's reserve currency are farfetched.

Looking far ahead, there may not be any one reserve currency per se. Ideally we will return to a gold standard but at the moment that does not seem particularly likely either.

So what about Australia? Can it decouple?

Australia is one of Peter Schiff's favorite countries for investing. Please consider Aussies hit by 50yr record wealth decline.
CommSec equities economist Savanth Sebastian says that is the worst fall in records dating back to 1960.

"It's no doubt that it will have a big impact on consumer spending going forward adding further downward pressure after we saw those job losses in terms of full-time employment," he said.

"So it suggests that for the Reserve Bank and for the government further stimulus will need to be on the agenda."
That additional "stimulus" is the same thing Schiff rails about in the US every time he speaks. The whole world is stimulating now.

Australia Won't Hesitate To Stimulate

Australia Treasurer Wayne Swan says Australia’s government won’t hesitate to stimulate the economy further should the need arise amid the global recession.
“We will not hesitate to take whatever further action is necessary to support growth and jobs,” Swan, 54, said in speech notes received via e-mail. “Major financial institutions, some of which have withstood world wars and the Great Depression, have either collapsed or been bailed out.”
Australian Dollar Monthly Chart

The Australian dollar is one of Schiff's favorites. "While other countries are creating inflation, Australia's central bank is raising interest rates to keep inflation in check." page 161

Australia May Cut Interest Rate Below 2%

Former Reserve Bank Governor Fraser suggests Australia May Cut Interest Rate Below 2%.
Fraser, Reserve Bank of Australia chief during the nation’s last recession in 1991, said policy makers may reduce the overnight cash rate target to less than 2 percent from 4.25 percent now. The bank’s board gathers for the first time this year on Feb. 3.

“This recession will be deeper and longer than the last recession in 1991,” Fraser said in a phone interview today from his home near Canberra. “The Reserve Bank could go below 2 percent; they will go as low as they need to and a further stimulus from the government will be required.”
Australia started reducing rates at the fastest rate ever in 2008, culminating with a surprise cut of 100 basis points in December. More rate cuts are coming.

One of the biggest drivers for currencies is relative differentials in interest rates, as well as expectations of future increases in interest rates differentials. The Fed is not cutting any more so future rates cuts in Australia may increase the unwinding of various carry trades (borrowing in dollars or Yen, and investing in Australian dollars or Euros).

Peter Schiff did not see or simply ignored the ramifications of the unwinding of various carry trades. All gains in the Australian dollar have been wiped out since 2003.

US$ Trading Range Theory

China, the UK, the Eurozone, Canada, Australia, and Japan are all slashing interest rates. And every country above is printing like mad. Finally, European banks are in dire straits because of bad loans to the Baltic states and Latin America on top of bad investments in US mortgage backed securities.

Schiff simply ignores those problems, or worse yet is not even aware of them.

Given the severe stress everywhere, and given the race to zero interest rates by all, the odds favor a wide trading range rather than a collapse of the dollar. Hyperinflation is simply not in the cards, at least for the US. Ironically, China or Russia is at far greater risk.

What About Commodities?

The following is from a chapter in his book called "Hot Stuff" on page 105.

Schiff writes: "What I want you to take away from this chapter is the knowledge that there is extraordinary excitement in commodities, which are in the early stages of a historic secular bull market." ...

$CRB Commodities Monthly Index

"There is extraordinary excitement in commodities."

Indeed there was. However, the time to invest in anything is not when there is extraordinary excitement but rather when there is no excitement at all.

When there is no excitement, the likelihood of investing safely for a long period increases. The above chart shows what happens when you invest for the long haul during periods of high excitement.

The Little Book of Bull Moves in Bear Markets nailed the exact cyclical peak in the commodities boom. Ironically, the subtitle to his book is "How to Keep Your Portfolio Up When the Market Is Down".

Peter Schiff was wrong about deflation.

There is no debate (at least there should not be a debate) that the US is in deflation. The conditions in the US are exactly what one would expect to see in deflation. The score is a perfect 15 out of 15. Please see Humpty Dumpty On Inflation for details.

I believe I know Schiff's rebuttal. He will talk about soaring money supply. Yes, money supply is indeed soaring, but destruction of bank balance sheets is happening faster. He will counter that it is money that matters, not credit.

History proves otherwise, but I willing to debate on the basis of money supply alone.

Base Money Percentage Change From A Year Ago

Using monetary expansion alone, one would conclude there was massive inflation during the great depression, starting in 1931!

Any definition that suggests that there was inflation in 1931 is silly. Some might counter, as one person recently did "It's not silly. When gold was confiscated by FDR and then revalued 70% higher in dollar terms, was this not inflation?"

My reply is "During the Great Depression, the purchasing power of the dollar went up vs. everything but gold. If the purchasing power of gold vs. the dollar is the sole judge of the inflation-deflation debate, then deflation ruled from 1980 to 2000, a ridiculous proposition."

It is important to pick definitions of inflation carefully. A definition based on money supply and credit successfully predicted interest rate trends, stock prices, the price of gold, housing, and numerous other things.

A definition of inflation based on the CPI failed miserably in predicting interest rates.

A definition based solely on an increase in money supply failed miserably in predicting interest rates, the recent strengthening of the US dollar, gold's decline from 850 to to 250 between 1980 and 2000, and numerous other things.

Soaring money supply simply is not proof "Big Inflation Is Coming" just as it was not proof that "Big Inflation" was coming in 1931. There cannot possibly be any other logical conclusion when confronted with the data.

Is Peter Schiff Early?

Some will claim that Schiff is simply "early". However, from the perspective of the Little Book of Bull Moves In Bear Markets, Schiff was 5 years too late.

To be fair, he was talking about commodities and foreign equities long before that, but as is often the case, such books come out at a time of "Peak Excitement". Schiff's book was the ultimate contrarian indicator.

Let's Return to Schiff's Investment Thesis.

Schiff's Investment Thesis

  • US Dollar Will Go To Zero (Hyperinflation).
  • Decoupling (The rest of the world would be immune to a US slowdown.
  • Buy foreign equities and commodities and hold them with no exit strategy.

12 Ways Schiff Was Wrong in 2008

  • Wrong about hyperinflation
  • Wrong about the dollar
  • Wrong about commodities except for gold
  • Wrong about foreign currencies except for the Yen
  • Wrong about foreign equities
  • Wrong in timing
  • Wrong in risk management
  • Wrong in buy and hold thesis
  • Wrong on decoupling
  • Wrong on China
  • Wrong on US treasuries
  • Wrong on interest rates, both foreign and domestic

That's a lot of things to be wrong about, especially given all the "Peter Schiff Was Right" videos floating around everywhere. The one thing he was right about was the collapse of US equities and no part of his investment strategy sought to make a gain from that prediction.

Peter Schiff concludes many of his articles, books, etc. with the claim he saw this coming and "positioned his clients accordingly".

Fortune Magazine bought into it the hype

Peter Schiff: Oh, he saw it coming

'Dr. Doom' became a star by predicting last year's market meltdown. And now his 2009 forecast is even scarier.

Schiff did not invest for doom; he invested for a bull market that did not exist. He was wrong where it mattered most, protecting client assets. For this amazing feat, people think of him as a star.

An Actual Schiff Portfolio

click on chart for sharper image

The above statement is from a person who claims to have additional portfolios invested with Schiff over the past 2 years. In total (not just this portfolio), my contact says he invested $70,000 and is now down to $27,000. That is a loss of 61%.

I have talked with another person who claims to be down 72%, and many others who claim 40% or more.

Schiff's entire invest thesis seems to boil down to "Buy and hold foreign stocks, foreign currencies, and commodities, come hell or high water, and hold on to them." Hell has arrived for those following Peter Schiff's philosophy.

Perhaps I have stumbled on the worst of Schiff's portfolios. There is one way to find out.

I challenge Schiff to post the average returns for his clients on a year-by-year basis, just as Sitka Pacific does. That is the only way to see just how right (or wrong) his investment thesis is.

Sitka Pacific vs. Europacific Philosophies

Rather than take a rigid position as to what the market "should do", Sitka Pacific Capital Management tries to position itself for what the market is doing. At times we may like a particular stock group, commodity, or currency, and at other times not.

We do not think this is a good time for buy and hold strategies for either foreign or domestic stocks or currencies. Moreover, we certainly do not think it was prudent to put 100% on foreign stocks and currencies, with virtually no exit strategy if wrong.

We do feel a long-term position in gold on a percentage of assets is a reasonable proposition.

Schiff's slogan is "Because There's A Bull Market Somewhere. TM" but for a year he failed to find one with the exception of physical gold. Ironically, one of his most hated asset classes (US treasuries), had one of their best years in history.

Sitka Pacific Strategies

The two key strategies at Sitka Pacific are called Hedged Growth (a long-short, primarily domestic strategy), and Absolute Return (a global strategy that can invest in domestic stocks, foreign stocks, gold, and currencies, hedged at times with inverse index ETFs).

Absolute Return may at times bear some resemble to Schiff's strategy but we are not dogmatic about it. If we do not like market action in stocks and commodities, we are on the sidelines and heavy in cash or treasuries.

Absolute Return had a 34% position in long dated treasury ETFs in 2008, now well less than half that after cashing out.

Chart of Hedged Growth Since Inception

click on chart for sharper image

Note the .17 correlation to the S&P 500 in Hedged Growth.

Correlations run from -1 (perfect inverse, think inverse ETF) to +1 (think buying every stock in the S&P). Zero is no correlation. A correlation of .17 is very low. What it means is the strategy is not dependent on market direction. Many hedge funds make that claim, but the average hedge fund got lost well over 20% in 2008.

Hedged Growth achieves its performance by picking a basket of stocks long and a basket of stocks short. Market direction, inflation-deflation debates, interest rates, etc., simply are not a concern for this strategy. The idea is to pick a winning basket of good stocks vs. poor stocks on a relative basis.

The most we ever put on a short position is 1.7%, and we only take a position in liquid issues. We never add to short positions. This is for risk management purposes.

Absolute Return Since Inception

click on chart for sharper image

The chart shows a monthly correlation to the S&P at .36. That is a low number, which is a good thing.

The chart also shows we had a significant drawdown between June and October. That drawdown was based primarily on an expectation that gold and gold miners would diverge from the market on a seasonal trend. That seasonal pattern did not happen. We are not going to get everything correct, but no one else will either. We made much of that drawdown back in late November and December while hedged growth was flat.

One additional thing I would like point out is that none of our strategies was net short in 2008. Our most cautious stance is market neutral. Thus, we were neutral to long the whole year, and our two key strategies finished solidly in the green even though the S&P finished down 38.5%.

90+% of Sitka Pacific accounts are either Hedged Growth or Absolute Return.

To lay everything out in the open, we also offer Commodities Focus (a portfolio of commodity related stocks and ETFs). Commodities Focus does not hedge and will tend to track a blend of energy stocks and mining stocks. It was down 34.5% on the year. Only 2% of our clients are in this strategy, approximately ½% by total asset value.

Commodities Focus is best suited for those who want anti-dollar plays for a hedge or for those with a very long time horizon as opposed to boomers headed into retirement with their nest egg.

We also offer Dividend Growth for IRA clients who cannot short. Dividend Growth is similar to Hedged Growth, except it may or may not hedge. When it does hedge, it uses inverse ETFs as opposed to shorts. Dividend Growth was down 4.6% for the year, a good achievement compared to the S&P 500 which was down 38.5%.

Gains Needed To Get Even

10% - 11%
50% - 100%
70% - 233%

If you are down 10% you need to gain 11% to get back to where you were, at 50% down you need a 100% gain to get back to even, and at 70% down you need a 233% gain to get even. This is why risk management and capital preservation is paramount.

Boomers significantly down hoping to get back to even may find it will take a decade or more. Those close to, or already in retirement, simply do not have a decade to make up for losses. That is the problem with buy and hold strategies.

Buy and hold was wrong nearly everywhere, but especially for those in or approaching retirement.

Client Letters

We post our client letters online, on a 2 month delayed basis. The letters come out sooner if you subscribe. Subscription is free. Interested parties may Register For Sitka Pacific Monthly Newsletters. Subscribe at the bottom of the linked-to page.

In the wake of various scandals, a certain question invariably comes up.

How Sitka Pacific differs from Madoff, hedge funds, and mutual funds.
  • We are not a hedge fund.
  • We offer managed accounts.
  • The accounts are in investors names.
  • Statements are from a brokerage house not us.
  • We cannot manipulate earnings because we do not produce the statements.
  • We have no access to investor funds.
  • If someone sends us a check made out to us, we send it back. As a strict rule, we never handle client money.
  • We have no exit penalties and no exit restrictions.
  • Someone can close their account for any reason at any time and can even do it without telling us. If you do not like how we are trading your account, you can close it.
  • We do not use leverage.
  • We often have high cash positions.
  • Clients can see every trade we make. This is unlike hedge funds where you typically cannot see anything, or mutual funds where all you see is a snapshot at the end of the month.
  • We have trading rights to accounts; all other aspects of the account belong to the client.
  • Your account is not commingled with any other account.
We are the very opposite of hedge funds or mutual funds.

High Risk, High Reward Strategies

Placing everything one has on anti-dollar bets is a type of high risk, high reward strategy. There is little room for error, especially if there are no risk management controls, which Schiff does not seem to have. "The whole idea is to get out of the US Dollar. It is on the verge of collapse. The people who don't get out of the US dollar are going to be completely broke and that is obvious. ...people who have their money in US dollars are going to be just as broke as people who have their money with Madoff."

Such arguments can easily be construed as "fear tactics". Listen to the previously mentioned Schiff Audio On US Hyperinflation and make your own determination. While it is certainly prudent to have some diversification, it is not prudent, in my opinion, to bet the farm on a complete hyperinflationary collapse of the US dollar that did not occur and in my estimation won't, at least for a long time.

Undiversified, unhedged portfolios may succeed spectacularly. They also risk catastrophic loss. Many who rolled the dice on Schiff's philosophy came up snake eyes: a catastrophic loss that depending on the exact portfolio, may take a decade or longer to recover.

Where To In 2009?

The question as to where the market is headed comes up all the time. The truth is, no one really knows. However, we see no real value here. Fundamentally stocks are not cheap. Earnings are sinking, unemployment is rising, and this was the biggest debt bubble in history. Logic dictates the biggest bubble should be followed by the biggest crash.

To pick a range for a bottom something like 450-600 on the S&P 500 would seem about right. If so, that is quite a drop from here, and one would certainly want to be hedged if that happens.

However, if the market starts to behave like there is some value now, we will change our tune.

We strongly doubt the dollar will crash, but we will take notice if it breaks out of its trading range. We do like gold here but that can change. Commodities may have bottomed. We doubt stocks have. Foreign stocks may outperform but remember they were clobbered more in 2008.

We are not permabears or permabulls, nor do we daytrade. We review and reposition our strategies monthly, but if something noticeable happens mid-month, we try to react to it.

Unlike Schiff, we attempt to position our clients for what the market is actually doing, not what we think it ought to be doing. The distinction is paramount, especially when such thinking just might be wrong.


I am informed by Peter Schiff that the statements in the hyperinflation video were from a Fox TV interview in December 2007 regarding his forecasts for 2008. The YouTube Video itself was not created until late in 2008. I incorrectly attributed the wrong timeline to his statements and removed a chart depicting the time of the call. The dollar was not rising at the time of his statements. Apologies are offered to Peter Schiff for this error.

Mike "Mish" Shedlock

Lunch is for wimps

Lunch is for wimps
It's not a question of enough, pal. It's a zero sum game, somebody wins, somebody loses. Money itself isn't lost or made, it's simply transferred from one perception to another.