|
In September two significant events happened that
will mark the month as the most financially significant in US history by far
1. Fannie Mae and Freddie Mac were nationalized;
this was no surprise as I predicted in November 2007: http://www.goldmau.com/marketupdatenov23.php
If left to their own
devices by the government, Fannie and Freddie are doomed. At this juncture,
the Fed has no choice but to redeem any and all mortgages at near face value
directly, through GSEs, or offshore vehicles.
2. Lehman Brothers went under. While I have said all
major US banks (including Citibank, and JPMorgan), brokerages (including
Goldman Sachs), and big finance companies (AIG, GE, GM, etc) are insolvent, I
didn't expect that Lehman would be allowed to go under.
Paulson clearly didn't understand Lehman's
involvement. Lehman is a leveraged brokerage shop that was the counterparty
to trades sized in the $hundreds of billions, including interest rate swaps,
commodity futures, corporate bonds, international equities and real estate
loans, currency swaps, and private equities. The counterparty risk created
fear and triggered domino selling. Banks refused to lend to one another
fearing the other end to be infested with Lehman's positions. Insiders claim
that it could take over a decade to fully unwind Lehman's positions.
What's more, Lehman was one of the largest prime
brokers to international hedge funds. Lehman's bankruptcy immediately caused
wholesale panic within the hedge fund industry as funds tried to
close/transfer/pull their money out of their Lehman custodian. Today over $60
billion is still locked up in Lehman's London brokerage unit. Given the
leveraging nature of hedge funds, the effect on global equity markets was
catastrophic as trillions of dollars were wiped off global equity markets.
Global equity and commodity correction
With $hundreds of billions-worth of positions that
need to be closed fast, we witnessed the most dramatic equity downturn
outside of 1930 and 1987.
Russian markets went down 70% and Nikkei, the world's second-largest equity
index, is down 30% since September 1.
Given that consumer spending accounts for 50 - 70%
of GDP across various countries, the equity downturn caused spending pullback
and thus global recession talk abounds.
I believe this sudden downturn had more to do with Lehman's derivative
positions and hedge funds having locked up than it did with fundamentals.
For example, demand for Oil and Copper had never
slacked yet Oil and Copper prices were cut by half in 4 months. Inventory
levels remained near historic lows and there was no projected slowdown in
commodity demand from China, the world's largest consumer.
In the financial arena, Chinese, Asian, Middle
Eastern, and Latin American banks had minimal exposure to US subprime debt or
to the collapse of US banks. The debt level of the Asian consumer, the key
driver to the next phase of global growth, remains low.
Junior
sector and resource funds
The S&P TSX Ventures Index, a proxy to the
junior resource sector, is down 70% to 900, from a high of 3,000 in 2008.
In September and October, 2 prominent resource funds
closed: Ospraie and RAB. Both combined controlled over $3 billion in the
resource junior sector. They literally owned 10-20% of the market and
positions had to be sold. We saw classic margin-call selling. Prices of
stocks were down 10% on consecutive days with small breaks in between and no
rebounds. Many companies soon traded 10%, then 20%, then up to 50% below
their bank cash balances. The situation clearly became irrational. Premier gold
and silver producers were down 50-70% in 2 months.
Where to go from here
As of October 20, the junior market looks to have
stabilized and I am convinced the correction for quality companies will not
last long (i.e. 6 months, less than one year for sure). This is much like the
Nasdaq in 2001. Bad companies will go under, while good companies will
survive and flourish.
With central banks recently pledging over $2
trillion to solve the crisis, a $750 billion bailout, more consumer stimulus,
a federal deficit set to blow over $1 trillion, a continued US trade
imbalance, a gigantic $10 trillion foreign reserve that is mostly yet to be
diversified, and the central banks' inability to raise rates to combat
inflationary pressure, I am more bullish on gold and gold equities than ever.
Severe shortages of gold and silver at the retail level across the globe
validate my belief that the supply of precious metals is dwindling fast at
current prices. Reports from top Swiss vaults state they have "topped
up" their metal storage space with no more capacity to spare.
There is talk of a deflationary depression, but my
view strongly differs. Firstly, the money supply is exploding so prices will
trend up after a brief scare. Secondly, on a global scale, the modernization
of Asia and the Middle East is far from over with US $4 trillion at their
disposal.
Regardless of the long term picture on gold, when
things are selling at 50 cents on the dollar as some stocks are, a brief
rebound should see a recovery back to at least cash value. Whenever there is
a crisis there is an opportunity.
John Lee, CFA
Goldmau.com
John Lee is a portfolio manager at Mau Capital
Management. He is a CFA charter holder and has degrees in Economics and
Engineering from Rice University. He previously studied under Mr. James Turk,
a renowned authority on the gold market, and is specialized in investing in
junior gold and resource companies. Mr. Lee's articles are frequently cited
at major resource websites and a esteemed speaker at several major resource
conferences.
Please visit www.GoldMau
for instant market alerts and stock updates.
| 
