Risks, Hedges and Opportunities

James Grant, editor of Grant’s Interest Rate Observer, composed on December 5, 2009 in the Wall Street Journal the Requiem for the US dollar. A very good article but I disagree. He admits that there is no greater success story in the long history of money than the greenback. It has no intrinsic value for it is collateralized by nothing than the trust that it can be used to buy goods, services and investments at will for as long as there is another confident person prepared to accept the exchange.

The same can be said for gold, and any other currencies. Yet, he mourns, like many gold bugs, the classical gold standard. John Maynard Keynes called gold a barbarous relic of a currency whose price, not value, is determined by the relative supply and demand to any given currency. This is not much different than for the US dollar. Demand is determined by buyers and new supply by miners in the case of gold and by the central bank in the case of the dollar. There is no way that gold will ever replace the US dollar or a basket of currencies for its balancing effect is too drastic on economic activity and too theoretical to practically replace the global foreign exchange market that trades more than $3 trillion a day.

Moreover, half of the $900 billion’s worth of us dollars in circulation is in the possession of foreigners and approximately 65% of all international foreign exchange reserves is comprise of US dollars. For practical purposes, one should be more concern with what is the dollar correlates with. It seems to me that the price of the dollar depends on the narrative of the time.

At the tail ends, dollar price increases with risk aversion and decreases with risk appetite. Under normal circumstances, the dollar fluctuates over the medium term with anticipated and actual monetary stance of the Fed and, over the long term, with changes in world order and trends in the balance of payment. In order to capture significant shifts in currency valuation, it is better not to measure the rate of exchange in terms of gold for it can be misleading. As a matter of fact, just about anything can be subject to price changes in US dollar terms (stocks, real estate, bonds, and commodities). A better measure is the spot price of the US dollar index that is constructed in a fashion to aggregate the value of a basket of currencies weighted by their respective importance in export trade.

In the period leading up to March 2009, the US dollar index shot up to 90.0 reflecting the abrupt stop of the "carry trade" where speculators unwounded their pairs, the sudden sale of risky assets by investors in favour of the "safe haven" of US dollar denominated T-Bills and the loading of US dollar notes by banks and governments for reserves. At that time global economic activity, from industrial production to foreign trade, was literally falling apart. As a result of a large, broad and fast response by the USA and China, a catastrophe was averted. Sure enough, the market sentiment slowly but steadily improved and the dollar index decreased from 90.0 in March to 74.0 in early December.

Private investors borrowed near-zero cost dollars in abundance to buy risky assets and alarmed speculators contented that the US dollar was about to lose its reserve currency status. The latter did not happen for several reasons. Firstly, the role of the dollar, as the world’s reserve currency is not likely to lessen for a long time. There are no alternatives for there are no other currency that offers size, liquidity, military power, political independence and legal stability.

While I recognize that its dominance may be challenged, it is more likely to be shared with other currencies in time. The international financial crisis is proof enough that the world has outgrown the old Powers of G-8. World gatherings have been eclipsed by G-20 making the European Union geopolitically irrelevant. World affairs must include South Africa, Mexico, Indonesia and even Iran, if anything of multinational importance needs to be discuss or done.

What is particularly important is the geopolitical shift to the EAST. China and India are making their presence felt. For 500 years, the boundaries of global power were drawn by the Atlantic. Today they are defined by the Pacific and that is where the USA is concentrating its diplomatic effort. The talk is about a G-2. The USA and China are the essential guarantor of global financial security.

In reality beyond the G-2 things are not that rosy. China and the USA do not face the same major structural problems of other big industrial economies. One has only to think about the demographic problem of old Europe, Japan and Russia, the sovereign debt fears of Spain, Portugal, Ireland, Greece and several OPEC countries are in a tax trap unable to raise revenue to pay their committed outlays. The USA has a positive fertility rate, a steady inflow of immigrants, enjoys institutional independence and a mutual deal agreement with China. This later deal explains why the brunt of the Yuan’s peg to the US dollar was bourn by other currencies. Several investment banks have estimated that the EURO is overvalued by as much as 20% to 25% and GOLD is only the new Tupperware party_a social gathering that is invading America’s living room to buy and sell Gold.

Secondly, it should be noted that past recession was not caused by too much inventory but by too much cheap credit. Americans are in the process of de-leveraging and it’s nowhere near completion and tons of debt is being retired on all sides. In this connection, personal income is saved, bank profits are purchasing government bonds and business profits are retained. This behaviour is reorienting the US economy towards a better internal and external balances where, with the exception of the government, Americans’ finance is based less on consumption and borrowings but more on savings and productivity.

The results have been dramatic, the personal savings rate is up to 4.0%, the money centre banks have paid back what they owed to government and businesses are reaping the profitable benefit of cost cutting. The result is that the current account deficit is now less than 3% of GDP compared to to 6.2% in 2006. One more push, and we could see its elimination and, in turn, a fixing of the global imbalances that are at the root of today’s economic crisis.

Since December 3, 2009, the US dollar index rose to 78.0 and the greenback is up more than 5% against the Euro and 2.5% against the Yen. It looks as if a rally is gaining momentum. Investors appear to be recalibrating their outlook. Leading economic indicators accompanied by improvement in the labour markets are suggesting that the US may turn out stronger growth than either Japan and Europe. Moreover, the Fed has given several hints as to the timetable for the removing of extraordinary monetary stimulus, closing down of most liquidity facilities and normalizing of interest rates.

A change in the discount rate is now imminent because banks’ capital and reserve ratios are appropriate to start liberalize banking lending practices. It is very possible that the tail ends like risk aversion and risk appetite may play a lesser role in the near term. The foreign exchange market may forget the rock-solid relationship of the past two years that dictated dollar performance (risk aversion and risk taking). The new narrative may have to do more with relative value and under a more classic macroeconomic response linking the dollar with normalized monetary policy and treasury yields.

Hubert Marleau, CIO, Palos management Inc


Risks, Hedges and Opportunities

Bull markets need two ingredients – these are a plausible narrative and an abundance of cheap money.

The ‘narrative’ or story is that the banking crisis has given cause to doubt the growth prospects of the OECD countries. These same countries have pushed a huge supply of low cost monies into the global financial system. The combination has driven the Gold, Bond and Emerging Equity markets well above their equilibrium price. The narrative part of the equation is compelling because the difference in the state of government finances and the trend in foreign exchange reserves are huge between emerging and developed countries. However, there are a number of good reasons to believe that central banks in the Western Hemisphere are about to exit their easy monetary stances.

1) Business conditions may be sluggishly in some quarters, but they have generally improved in a sustainable fashion since the end of last winter. Confidence in the economy is steadily improving. The Federal Reserve Board forecast is calling a change of 3.0%, 4.0% and 4.2% in real GDP for 2010, 2011 and 2012 respectively with an inflation pace of 1.0% to 2.0%. In this connection, the Fed will be forced to normalize the target rate to appropriately reflect rising inflation and growth rates.

2) Banking conditions have swiftly recovered from the gravest financial crisis since the Great Depression. By paying back government rescue funds with private capital, confidence in the financial system is rising nicely. Citigroup and Wells Fargo stand alone as the only two giant banks with TARP money. The Bank of America is about to shed the government stigma by year end. In this connection, the Fed will be less compelled to keep the government yield curve steep in an effort to restore banking profitability for liquidity and capital ratios are now good enough to keep them out of trouble.

3) In the diplomatic corridors of G-2, there may be a deal in the making. It is not in the mutual interest of either US or China to allow protectionism, capital controls and competitive devaluation to spread. It could very well be that rate hikes in the US would be matched with corresponding revaluations of the Yuan.

4) The markets are, in effect, daring the Fed to raise interest rates. Stability is still regarded as "an anchor for policy makers". Otherwise increased risk awareness of investors will mount and impose discipline on the Government. That is one thing that the Fed does not want to loose control over. Rate increases typically come after the unemployment rate peaks. This might be based on Friday’s job report. The futures markets are putting a 68% chance that the federal funds rate will be raised to 0.50% by June and more than a 90% probability that it will hit 1.00% by next December.

5) There is a lot of political and investor pressure on the Fed to change direction and be more forward-looking in its actions to protect credibility, keep inflation expectations low, oversee directly the soundness of the banking system and stop the "carry-trade" from transferring precious domestic capital to emerging equity and commodity markets. The Fed may deem it necessary to act in manner to show independence from and resolve to Congress.

6) As we move closer to increased regulations in order to protect the financial system from the excess vagrancy of monetary policies and banking practices, it will become less important to hold interest rates low to mop-up bursting bubbles permitting small and frequent rate increases to tame the markets.

Acknowledging that monetary policy works with a lag on the economy but how quickly markets can respond to it, the Fed has already started to use reverse re-purchase agreements to drain some of the $1 trillion in excess reserves of the banking system and may soon start to normalize the level of short term interest rates. Since inflation is relatively low, even baby steps toward normalcy could cause a surge in demand for US dollars causing changes in capital flows. As a matter of fact, the sooner the Fed backs-off its near-zero rate policy, the more capital will be allocated on the basis of relative value and less with complete disregard to valuation constraints. It seems to us, that both the narrative and the abundance of cheap money are in a process of change.

Even though the repurchase market, where securities are used as collateral for loans by investment banks, shows that the North American equity markets are not in a bubble state, it would be unrealistic to assume that the Fed can exit without some effect on asset prices. We took a few chips off the table in Gold, Emerging and Home markets for good profits and entered into a small short position in the TSX for downside ‘insurance’ protection.

Hubert Marleau ,Chief Investment Officer, Palos Management Inc.



Three commentators discuss the same phenomenon:

OVER THE PAST DECADE, stock and bond prices have generally moved in opposite directions, meaning that share prices and bond yields have moved together, both higher and lower.(…)

This important relationship held true this year until June, when bond yields peaked. One month later, as yields moved lower, stocks began their current leg up.(…)

Given their relationship at major turning points over the years, something is not quite right. And when it comes to trusting bonds or stocks for the correct "opinion," history would suggest that it’s usually better to go with bonds.(…)

One part of the bond market caught my eye this week. The yield on two-year Treasury notes fell nearly 40% to an unreal low of 0.67% and is just a hair from its generational low of one year ago.

[Getting Tech chart]

This is important for two reasons. The first is that one year ago, the financial markets were nearly frozen and investors looked for the safest places possible to park their money. Treasury securities with short maturities were the only assets that were holding their value and demand to own them pushed prices up and yields way down.

The second reason is that the yield on the two-year note joined three-month bills in approaching zero again. Longer dated Treasury yields, from five years to 30 years, are not even close to reaching respective 2008 lows and that suggests that some money is moving towards an extreme safety position again.(…)

Full Barron’s article

And David Rosenberg

The U.S. 10-year Treasury note yield gapped above the 50-day moving average yesterday. In the past six months we have been in a most unusual backdrop: bond prices up, equity prices up, oil prices up and gold prices up. Looking back at the historical record, this is what you call a 1-in-15 event. In other words, not normal, and something has to give.

In the past, it has been Mr. Bond, shaken and stirred, that has been the arbiter of realigning the asset mix. (…)

The odd man out here is clearly the bond, but if yields head back up to 4% (about 50% of the rally in the 10-year note has just been retraced in this recent spasm in yield), expect a countertrend rally in the U.S. dollar over the near-term and a giveback in all these risky assets that all of sudden become 90% correlated with the greenback.

As for the vast amount of supply we mentioned above, well, the U.S. Treasury is going to auction — get this — $105 billion in Treasury bills and notes next week. Talk about choking on the wishbone. This fiscal largesse may come at a pretty big cost and aside from a countertrend rally in the U.S. dollar (as Mr. Trichet is pushing for) a further yield spasm in the Treasury market at a time when the economy is still struggling (ISM services back below 50 — that is not good) could well be enough to upset the equity market apple cart; just as investors are closing their books as the year draws to a close. Buying some protection, especially now that it is cheap, may not be a bad idea.

Tony Boeckh adds

The last nine months have been a remarkable period in that equities, gold and corporate bonds have all appreciated by double digits. This has only occurred on two other occasions in the last 50 years. Typically, equities perform best during periods of low and stable inflation, like the current environment. Gold (and other commodities) performs best during inflationary periods and when the dollar is weak, while government bonds tend to outperform during periods of deflation and risk aversion. The current, unusual dynamic where almost everything has gone up together cannot last forever.(…)

The current environment diverges from the typical cycle in that easy policy is not translating into domestic consumer or business credit expansion.


China Unlikely to Buy Gold

From Scotia Capital’s excellent Na Liu:

? Every once and a while, the gold bulls become excited about the potential of China’s diversification of its foreign exchange reserve into gold. Back in November 2008, the talk was that China had “announced” that it would like to diversify its foreign exchange (FX) reserve into gold by buying 4,000 tonnes of gold. That was proven to be fake news, though it did move the market for a few sessions.

? One year later, gold bulls are finding more excitement. A few days ago,
China Youth Daily quoted Ji Xiaonan, who chairs the supervisory board for
big state-owned companies under the State Council’s state assets
commission, as saying that a team of experts from Beijing and Shanghai had set up a task force last year to look at the issue of gold reserves. “We
suggested that China’s gold reserves should reach 6,000 tonnes in the next three to five years and perhaps 10,000 tonnes in eight to ten years,” the paper quoted him as saying.

? Although we do acknowledge that Ji Xiaonan is a high-ranking official in China, and therefore his words have more credibility than the rumours of one year ago, we would still observe that it is the central bank, not the State Assets Commission, that determines China’s gold holdings in its foreign exchange reserve. And the central bank officials do not seem to
be impressed by gold. The recent sales from the IMF to the Indian central bank were a good example: the People’s Bank of China (PBOC) did not compete with India to buy gold, although PBOC was tipped to be the top candidate on the purchasers’ list for the 400 tonnes of gold offered by the IMF.

? Yesterday, Hu Xiaolian, a vice-governor of PBOC, weighed in by calling the current gold price a “bubble.” “We must keep in mind the long-term effects when considering what to use as our reserves,” Hu told reporters in Taipei, when asked if China had plans to increase its gold holdings in its foreign exchange reserves. “We must watch out for bubbles forming on certain assets, and be careful in those areas.”

? In our opinion, the comments from Hu are a lot more credible than those from Ji, as PBOC has the authority to determine China’s gold holdings. And as we have long argued, the judgment of PBOC is reasonable. To us, although China does need to diversify its FX
reserve, a purchase of 4,000 or 5,000 tonnes of gold is too big to implement, but too small for China to diversify.

? It is almost impossible to buy a few thousand tonnes of gold in the spot market. Just to draw a comparison, the global annual gold demand is about 4,000 tonnes and the gold annual mine output is about 2,500 tonnes.

? Some may argue that China can buy the gold through inter-central bank swaps. However, even for this channel, 4,000 tonnes is still too large an amount. For the time being, the United States holds the largest amount of gold in reserve, at 8,134 tonnes, followed by the German central bank, which holds 3,408 tonnes. Therefore, among the world’s central banks, only the U.S. Fed could do a 4,000-tonne swap in one deal with China, but this is highly unlikely, unless the Fed needs money in a desperate way (and if the Fed is indeed desperate, it can always print money).

? We calculate that 6,000 tonnes of gold is about 192.9 million ounces; at a gold price of US$1,200/ounce, it is worth some US$231 billion. Given the size of China’s FX reserve, which is now over US$2.27 trillion, the proposed diversification is only slightly over 10%. In other words, even if China buys 5,000 tonnes of gold to top up its existing reserve holding
of 1,054 tonnes to just over 6,000 tonnes, it would not serve the purpose of diversification very well.


Risks, Hedges and Opportunities

The cost of money is so low that no matter what view an investor may have, there is enough money around to be right over the short term.

Players that are deploying a defensive investment strategy either by buying deflation related trades like bonds or inflation related trades like gold are winning. I argued, last week, that gold is due for a 20% price reduction. By the same token, treasury yields are subject to a similar upward correction.

As of November 27, 2009 ten year US treasuries were yielding 3.25%. A decomposition of this rate reveals that the US economy is not likely to increase much more than 1.25% per year on the long term with an inflationary factor of 2.00%. As an historical rule, US treasury yields have for most part averaged 80% of the growth of nominal GDP. It’s interesting to note that nominal GDP should decrease 1.55% in 2009 and increase by as much as 4.00% and 4.25% respectively in 2010 and 2011. Accordingly, actual treasury yields are bang on with fundamental, equilibrium and fair value.

However, investors are receiving absolutely no compensation for any fiscal risks. The Treasury market is priced for perfection believing that the ‘sweet spot’ created by the quantitative and near zero monetary policies of the central bank plus the collapse of credit demand by the private sector and benign inflation will last for a long time. Like gold, there is a huge disconnect here.

Forward-looking bond participants are not considering the possibility that strong headwinds of large debt burden, huge deficit financing and un-relented currency depreciation could bring about responsive money management and/or earlier rate hike by the FRB. Investors cannot hope on huge household savings, albeit much better than it has been for years, to bail out the government.

Based on the recent performance of leading indicators, a 5.00% increase in nominal GDP is not out of the question. A circumstance that would certainly stop QE, raise bank credit demand and increase target rates a few notches forcing yields on ten year treasury notes toward 4.25%. Defensive plays like the purchase of treasuries are good insurances against deflation, but current premiums are expansive for they are not automatically "risk free’. The FED may not believe that an exit strategy is yet warranted. Nevertheless, investors should have one because it may come sooner than expected and it would then be too late to smartly react.

We will always hold bonds for insurance in all of our funds but a lot less than we used to own. Keep a close watch on the weekly ECRI Leading index. It increased to 128.8 for the week ended November 20 for an annualized growth rate of 24.1%. A significant improvement since the bottoming out of last March. The Great Recession ended in late July.

Hubert Marleau, Chief Investment Officer, Palos Management Inc.



The Fed’s Misguided Monetary Policy
The monetary policy being pursued by the Federal Reserve, which
is aiming at boosting asset prices, actually leads to more economic and financial volatility. I’d also like to mention that the easy monetary policies of the Fed also lead to colossal debt growth.

image You can print money and you can increase your debt and you can put everything on the balance sheet of the government, but it is unlikely to help the typical household in the United States. It may help Wall Street and it may help some asset markets, but not the standard of living. Otherwise, if money printing would make countries rich Zimbabwe would be the richest country at the present time.

Even under a gold standard, where money and credit is relatively tightly controlled, you can get bubbles in one sector of the economy or another. In this case, everything went up — equity prices, real estate prices, commodity prices — and not just in the U.S., but everywhere in the world. During this period of time, the only thing that went down was the U.S. dollar.

In my opinion, the government in the U.S. will continue to print money, with all the negative consequences that go along with it. And so, I think that looking forward, investors have to be very clear that if the dollar is very weak, there is a chance that equity prices around the world could rally quite substantially.

It’s not so evident that the dollar will totally implode against the euro and other paper currencies because the other central bankers are also money printers. But it is my opinion that it will continue to implode against commodities. Some more than others, but commodities where there are shortages will perform okay. And, in particular, when interest rates are at zero, then obviously gold, silver, platinum and palladium become currency of choice.

I don’t see why someone would hold dollars and not hold some physical gold. There’s no cost associated with holding the gold, compared to dollars that have no return. I think that, gradually more and more people will come to the realization that they have to own some resources, some commodities and some mining companies and obviously some physical precious metal.

How Did Economists Miss the Problem?
There was recently an article by Paul Krugman in the New York Times titled “How Did Economists Get It So Wrong?” Well, first of all, I think the title should have been “How Did I Get It So Wrong?”

I’d also like to point out that not every economist got it so wrong. The economists at the Federal Reserve and the economists at the Treasury and the economists at universities got it so wrong. But private economists have been warning about this excessive debt growth for quite some time, and were very concerned about it.

The real problem of the housing market was not that home prices went down, but rather the excessive leverage of homeowners. Partly encouraged by artificially low interest rates and partly encouraged verbally by the Federal Reserve, homeowners borrowed more and more against their homes. That’s why I find the Fed essentially mistaken in its belief that the problems were not foreseeable.

Total New Borrowings by Households and Non-Financial Business % PGDP

PGDP = Implicit Price Deflator for GDP
Source: Bridgewater Associates, Goldman Sachs

The chart above shows total new borrowings by households and non-financial businesses. Credit growth accelerated to a peak annual rate of 18 percent at the end of 2006. It slowed down following the rate cut in September 2007, then accelerated once again a little bit. Then in 2008, it totally collapsed. And, of course, for an economy that is driven by credit, such as the U.S., a total credit growth collapse is a disaster.

The private sector is now de-leveraging. Households and businesses are behaving rationally – they are saving more, they are paying down their debts. That’s a rational action to take in a recession such as we have. At the same time, the government has come in and built up – the U.S. Treasury as a percent of the economy has expanded very rapidly. The fiscal benefits this year will probably be around $2 trillion.

The problem with all this is, in my opinion, is that the government’s role can’t really come down significantly because the moment you reduced your fiscal deficit, you would again have a negative impact on the economy. So I think that as far as the eye can see, we will have artificially low interest rates, near zero percent, because unemployment in the U.S. is not going to go away overnight. And at the same time, the deficit will stay very high and that will lead, in my opinion, sometime down the road to more inflation, which will then necessitate more money-printing, in order to keep short-term rates artificially low.

Bright Future for Resources
I think that gold is a desirable asset, but for my taste there was a little bit too much euphoria just recently, when gold went over $1,000. And so what we could get is kind of a correction in gold, and then a little bit of a rebound in dollars.

The exploration companies were decimated in 2008 and they have recovered, but in my opinion, they still offer very good value. What has to be clearly understood is that exploration companies don’t really have a cash flow, and they have to discover something to make it work. Many exploration companies will not survive and others will be taken over by the majors. There will be a lot of volatility in the sector, but it’s an exciting sector.

I feel that the demand for resources overall is actually well-supported, and there’s another factor that’s important to understand. The bull market in commodities that began in essentially 2001 and lasted to 2008 was, in my opinion, too short to really trigger a supply response. Once the market collapsed in 2008, a lot of projects were canceled and a lot of exploration companies didn’t get the money they needed to carry on with their exploration work.

In the case of oil, the peak for new discoveries came in the 1950s and 1960s. Since then new oil reserves continue to be found but in smaller and smaller quantities, and also at higher and higher costs in areas that are inhospitable or very deep at sea.

When I look at the oil demand pattern of China and India and then I look at the supply pattern, I think that oil prices will have a rising trend. And here, leaving out the money-printing function of Mr. Bernanke, the more money you print, the more oil and other commodities go up.

Growing Clout of Emerging Markets
I have to say that, probably in our whole lifetime, we will never again have this kind of synchronized boom that we experienced in the period 2005 to 2007. It is most unusual economically that the whole world was in boom condition, and in the future, I would rather expect that some countries will do well and others will do less well.

For 200 years it was the
rich countries of the West that essentially became richer and richer, and for the first 150 of those 200 years, what are now called “emerging economies” were colonies and thereafter they had regimes that were not particularly desirable. But now these countries have been unleashed. In the past, the rich countries of the West financed economic development in poor, emerging countries. But now the foreign exchange reserves are in emerging economies.

I mention this because sometimes people still think that emerging economies are poor, or that the emerging economies depend very much on the West. That is no longer the case. They are a very, very powerful economic bloc, and they will become a very, very powerful political bloc as well, and a military bloc. And that is something that will create a lot of tension in the world

The strong economic development in Asia has obviously slowed down because we have a recession and exports collapsed. But Asia is not going to stop buying commodities. The Chinese have very little natural gas, they have little crude oil, they have very little iron/ore and copper. They may buy less in any given year, but there is not going to be a situation where they won’t buy anything at all.

Chinese steel production went from 10 percent of the world’s total in 1990 to more than 40 percent now. For aluminum, production in China went from 10 percent of the world’s total in the year 2000 to now more than 30 percent. That isn’t going to go away because a lot of this production is actually not for export, but rather for domestic consumption.

The per-capita consumption of oil and other resources in China and India is still extremely low compared to say more advanced economies, such as Japan, South Korea and, of course, the energy-wasting United States. That is shown on the chart below. I would argue that actually oil demand in China will have trend-line growth of between 6 percent and 9 percent annually for the next 10 to 20 years, and in India, trend line growth, in my opinion, will be between 5 percent and 7 percent annually.


Rise of the Asian Consumer
In China and in the whole of Asia and the emerging world, we still have a lot of poverty and we have a lot of people who can’t afford to live a very free life. In other words, they can’t afford to travel and they can’t afford to make many choices in their lives.

But at the same time, in both India and China, you have the emergence of a hardworking urban class — these are people who work for companies in clerical positions and also in management positions and they do relatively well. So if you have 1.3 billion people, all you need is essentially 200 million people that live a reasonable lifestyle and you have a huge market.

Over time, starting from a low level, these countries move up the scale in terms of standard of living. Their GDP per capita improves and the middle class expands. Now is everything perfect? No. And is the stimulus package in China working? Probably not very well. It leads to a lot of speculation and further reallocation of resources, bubbles in property and so on.

But I take the view that, if you look at the next 10 to 20 years, I don’t see how the lifestyle of the average person in Western Europe and in the U.S. will improve meaningfully. I just don’t see it. On the other hand, if I look at a country like Vietnam, it has GDP per capita annually of $800, which may go to $3,000 over the next 15 to 20 years. The same idea holds for China and India.

You will have in India a middle class of maybe 200 million or 300 million people. They will not all buy Mercedes Benz cars, but they will buy a Nano for $2,500. And that will require resources and it will eventually also be an incentive for people to work very hard.

When a family moves from the bicycle to the motorcycle, it’s an improvement in their standard of living. But then when you move to the car and you drive your children in a car to school, it’s a huge increase in your standard of living, and also in your social class. In the Western world, I think that they will be at war and they will have civil unrest and their standard of living will not be as good.

From US Global Investors


Paulson Bets BofA Will Double by End of 2011, Likes Gold

Paulson & Co., the hedge fund firm run by billionaire John Paulson, told investors Bank of America Corp.’s stock will almost double in the next two years as writedowns ease.(…)

PAULSON“Banks will have passed the current writedown cycle and have visibility for growth in 2012,” the letter said. Bank of America dropped to $2.53 in February amid concern that the U.S. might seize banks that ran short on capital. While the bank “has risen from when we purchased the stock, we believe considerable upside remains,” the letter said.

(…) The Charlotte, North Carolina-based bank represents Paulson’s biggest holding among financial companies, the letter said. Earlier this month, he disclosed a stake in Citigroup Inc.(…)

The hedge-fund firm bought its stake in Citigroup during the third quarter, acquiring 300 million shares valued at $1.4 billion as of Sept. 30, according to the filing. The hedge fund sold its entire investment in Goldman Sachs Group Inc. and trimmed its holding in JPMorgan Chase & Co.

Paulson earned an estimated $2.5 billion last year, according to Institutional Investor’s Alpha Magazine. His Credit Opportunities Fund soared almost sixfold in 2007 on bets that subprime mortgages would plummet.

Last year, his largest fund, the Advantage Plus Fund, returned 37 percent, compared with a loss of 19 percent for hedge funds on average.

Full Bloomberg article

Paulson is also launching a hedge fund dedicated to buying up shares of gold miners and other bullion-related investments, according to investors.

Mr. Paulson told his investors he personally would invest between $200 million and $250 million in the new fund (…)

Mr. Paulson at Tuesday’s investor meeting countered that the bull run was only beginning for gold.

He noted that central banks around the globe have gone from sellers of gold to buyers, and that the global supply of gold is constrained.

While harmful inflation isn’t on the horizon, he said, Mr. Paulson argued that there is a risk of a burst of inflation down the road. That’s because in the past there’s been a lag between a surge in money supply and higher inflation. Gold often does well when inflation rises.

Mr. Paulson told investors that the Federal Reserve will prove reluctant to raise interest rates, given the weakness in the economy, which also could pave the way for higher inflation, at least at some point, another reason for his growing conviction about gold.(…)

Full WSJ article

Other posts on Paulson & Co:


Gold Price Won’t Drop Below $1,000 an Ounce Again, Faber Says

Gold won’t fall below $1,000 an ounce again after rising 27 percent this year to a record as central banks print money to help fund budget deficits, said Marc Faber, publisher of the Gloom, Boom & Doom report.

(… )News last week of bullion purchases by the Indian and Sri Lankan governments raised speculation that other countries would follow suit.

“We will not see less than the $1,000 level again,” Faber said at a conference today in London. “Central banks are all the same. They are printers. Gold is maybe cheaper today than in 2001, given the interest rates. You have to own physical gold.”

China will keep buying resources including gold, he said.

“Its demand for commodities will go up and up and up,” he added. “Emerging economies will grow at the fastest pace.”

In contrast, Western countries will be lucky to avoid economic contraction, while the Federal Reserve will maintain interest rates near zero percent, he said.

Full Bloomberg article