If I may quote myself from a few weeks ago regarding my junk bond plays (NCV and ILH): "I'll bail out if I see one of the two monsters winning - another deflationary collapse, or serious inflation".
Well, I think that the Dow hitting its lowest close since May 1997, and the very real likelihood of sovereign default in Eastern Europe, qualifies as a renewed deflationary collapse. So, regretfully, I have dumped my junk bond holdings - NCV at $3.98/£2.74 (a 32% sterling loss) and ILH at 30.5p (a lesser loss of about 5%).
Obviously, I got this call spectacularly wrong, but such is the nature of a hedged portfolio, which is what the CCI portfolio tries to be.
Europe's financial system is sunk Ambrose Evans-Pritchard, The Telegraph, 15/02/09
My last post examined the likely next phase of the Credit Crunch - the implosion of the Eastern European economies, and the resulting collapse of the European banking system. I also reviewed the CCI portfolio under such circumstances: broadly, while I expect gold bullion (and possibly gold miners), government bonds, dollars and yen to do well, it is likely that my holdings of Singapore equities and junk bonds will suffer. Interestingly, yesterday's trading seems to have borne these predictions out, although it would be wrong to read too much into a single day's results.
I also think it is time to get aggressive - how can I profit directly from a European crash? Looking at Proshares' portfolio of short ETF's, there isn't one that directly targets emerging Europe, or the European financial sector, but there are a couple of interest, offering inverse positions on either:
- the MSCI Emerging Markets Index (unfortunately, while it includes Russia, Hungary, Poland, and the Czech Republic, this index has a 70% weighting towards China, Korea, Brazil, Taiwan, South Africa, and India)
- the MSCI EAFE Index (this index has a 39% weighting towards France, Germany, Switzerland, Spain, Italy and the Netherlands, and another 45% towards Japan and the U.K.)
While neither of these indices are perfect, I am more inclined to go with the inverse EAFE, as it is closer to my target area (and I am also not optimistic about Japanese or British equities).
In each case, Proshares offers both an inverse and a leveraged inverse ETF. Given the known problems of leveraged ETF's (high volatility hitting long-term returns), I'm going for the unleveraged Proshares Short MSCI EAFE ETF (EFZ.NYSE). I bought a big chunk of these yesterday, at $100.64 (about £70.74).
Bank Austria and its Italian owner Unicredit face a "monetary Stalingrad" in the East
You simply must read this terrific article in yesterday's Telegraph by Ambrose Evans-Pritchard, detailing what is surely the next phase in the global Credit Crunch.
Everyone (especially Gordon Brown) knows that the current crisis started in America, caused by irresponsible mortgage lending to "an unemployed black man in a vest". See here for a concise explanation:
However, subprime mortgages were not the only insane lending boom of recent years - there was also a stupendous boom in East European borrowing, by the former Soviet bloc countries. As Evans-Pritchard's article notes, the total borrowed is in the region of $1.7 trillion, of which some $400 billion will have to be repaid (or rolled over) this year. And, most of it is owed to West European banks. Can you see what's coming?
Evans-Pritchard makes a simple and compelling case that "Europe's financial system is sunk". There are great quotes, such as the Latvian central bank governor's description of his economy - "clinically dead". Of course, to anyone with any knowledge of financial history, this will seem terribly familiar: the Wall Street Crash of 1929 may have been the initial shock, but the true pre-cursor of global depression was the systemic bank crisis that began in Austria in 1931.
Oh, and you know the bit above about how Bank Austria and its Italian owner Unicredit now face a "monetary Stalingrad"? You do know that Creditanstalt, the Austrian bank whose bankruptcy in May 1931 sparked the global systemic collapse, was nationalised after World War II, then sold to Bank Austria and is now part of Unicredit! Plus ça change, plus c'est la même chose.
Evans-Pritchard's bottom line is this:
If one spark jumps across the eurozone line, we will have a global systemic crisis within days.
So, are we ready?
Well, the main point of the CCI portfolio is to be ready for further such events. Time for a quick review:
iShares MSCI Singapore Index Fund (EWS.NYSE) Obviously, this would not do well under such conditions, but neither would it be fatally affected - Singapore banks have avoided East Europe.
Lyxor Gold Bullion Securities (GBS.LSE) If gold bullion won't do well under a global systemic crisis, then what will?
Market Vectors Gold Miners ETF (GDX.NYSE) May or may not be hit, depending on whether mining shares are lifted by rising gold or punished by the more deflation. The 2008 experience suggests the latter.
Centamin Egypt (CEY.LSE) As above.
iShares Government Germany 10.5+ (EXX6.DE) "Berlin is not going to rescue Ireland, Spain, Greece ... Portugal ... Italy ... or ... Austria". I'm very glad I switched from IBGL to EXX6. Long-dated German government bonds are likely to prove as safe a haven as you will get.
M&G International Sovereign Bond Fund More broadly, let the experts at M&G continue to find the best-value government bonds.
CurrencyShares Japanese Yen Trust (FXY.NYSE) Again, this is one crisis that Japan has no direct exposure to.
Junk Bond Funds (ILH & NCV) No dodging the bullet here, these would be slaughtered by a further collapse in global credit. Remember diversification, though - there is no certainty of the European collapse happening, "things can only get better" (maybe).
Lots of cash in USD (no GBP any more) Can't go wrong much here.
I've just dumped my TBT holdings, as the inverse ETF (TLT) exhibited a positive 3/13 dma cross yesterday. I got out at $47.39 (about £32.93), a sterling profit of about 4%, which is hardly worth the effort.
Sometimes, you can be right about the overall trend, but just not able to make reasonable profits from it. Still, this is a trade to keep on my watch-list.
"Drawing his own conclusion" - the fate of non-core euro sovereign debt?
The iShares Euro Government Bond 15-30 ETF (IBGL.LSE) was added to the CCI portfolio last September, and has been a solid perfomer since, up some 14% on the average purchase price of £116.96 (along with a nice divi).
I believe that the rationale for my purchase of IBGL remains strong, viz.:
- deflation is more likely in the euro zone than anywhere else; - the ECB will remain "behind the curve" of interest rate reductions and money-printing; - the euro will be a relatively strong currency; - long-dated government bonds will be very attractive assets.
IBGL, which represents a bundle of long-dated bonds issued by all euro-zone governments, is a simple way to play this trend.
However, the reality is that all euro-zone debt is NOT created equal, and I am increasingly worried about the PIGS - Portugal, Italy (or Ireland), Greece and Spain.
Back when the euro was launched (and, having been intimately involved in the project on behalf of a major European bank, I remember it well), there was a lot of discussion regarding "convergence" - how the different markets for European financial instruments would converge in terms of risk rating, now that all were priced in a single currency. This was, of course, one of the aims of the project - to help EU capital markets aquire the same depth and liquidity as those in the US. And, for a while, it did indeed seem to be the case that euro-zone sovereign debt prices were converging - that a German government bond of a given maturity was being regarded as the same thing as an Italian government bond of similar maturity.
Which is, of course, nonsense, when you consider it. Bonds issued by the First Appalachian Savings and Loan are denominated in the same currency (US dollars) as those issued by, say, Warren Buffet's Berkshire Hathaway, yet no one would suggest that they should be rated similarly for default risk. Just because Italy has joined the euro does not make it as good a credit risk as Germany.
And, as I have noted before, it is highly likely that the Credit Crunch will, at some point, force at least some of the PIGS to abandon the euro, as they reach for their traditional response to economic crisis - just print more money! Then, they can simply repudiate existing euro debts by announcing that, in future, they will be repaid in "new lira", at an arbitratily fixed exchange rate (which will bear no relation whatsoever to the prevailing market rate).
It's commonplace to read (eg, here) that such a scenario would mean "the end of the euro", but actually I very much doubt that. The core of the euro - in truth, the core of the whole EU project - is the alliance between France and Germany. All else is peripheral, and I very much doubt that either of those two states will ever be forced into such action.
For Germany, of course, where the lessons of the Weimar experience are still very clear, such a move would be anathema. It is also unlikely to be necessary, given the relative strength of the German economy.
So, the point I am coming to, in practical terms, is that IBGL is far from ideal. Long-dated euro government debt is, I think, I great investment for deflationary times, but it should, ideally, be the right government debt, rather than a bucket like IBGL. Ideally, it should be German government debt ... why buy a FIAT when you can have a Mercedes?
Well, on investigation, you CAN buy a Mercedes, relatively easily, if your broker can trade European shares. Barclays iShares also offer German-only euro government bond ETF's, traded (naturally) on the Deutsche Borse. The long-dated one (which I think offers best upside potential) is the iShares eb.rexx Government Germany 10.5+ (DE), ticker symbol EXX6. To find out about it, you have to navigate to the iShares German site.
So, I have today dumped IBGL at £132.42 and bought a similar value amount of EXX6, at € 127.54 (about £111.13).
Right, I have pondered long enough, and have decided to take the plunge. As I explained in my last post, an investment in junk bonds (and convertibles) is really a play on a relatively benign outcome, for at least the next few months. That is, we don't need to see a roaring new bull market, just a gradual return of confidence. Once investors accept that these issuers are not going to go bust, they'll snap up anything with a 20% yield.
Of course, I could be wrong, but that's why the CCI portfolio holds all those government bonds, gold bullion and cash. One must diversify!
For further diversification, I've bought not one but two closed end funds / investment trusts (delete depending on which side of the Atlantic you are). From the US, I have bought a fair-sized chunk of the Nicholas-Applegate Convertible and Income Fund (NCV.NYSE), at $5.85/£4.04. As Marc Faber mentioned on Barrons Roundtable:
The junk-bond market and convertible securities could rally substantially, as corporate bonds have done. The Federal Reserve's move to buy up assets will lead others, including Bill Gross at Pimco, to front-run the government and buy the same assets.
At $5.86, I estimate the yield on NCV to be around 18.5%, assuming that dividends are maintained at 9 cents per month.
From Blighty, I've bought a fair-sized chunk of the Invesco Leveraged High Yield Fund Limited (ILH.LSE), at 32p.
This one should yield 23% based on last year's 7.5p distribution, or at least 15% going forward (management have pledged to pay out a 5p divi if at all possible).
My exit strategy for both these plays is when the yield falls to more normal levels. Alternately, I'll bail out if I see one of the two monsters winning - another deflationary collapse, or serious inflation.
Well, it IS a possibility. I've used the picture above to refer to the two monsters which threaten our future - the ongoing battle between inflation and deflation (with deflation emerging as the clear winner since last September). But, governments throughout most of the world have been doing their best to reflate, the latest and most significant being Obama's $819B stimulus currently working its way though Congress.
While some details may be changed, there is no realistic prospect of the new President's "big idea" NOT going ahead. And, however much I tend towards pessimism on this blog, I must admit to the possibility of it working, at least to a limited extent. Consider the current state of the Credit Crunch Investor Portfolio:
Ultrashort Lehman 20+ Year Treasury (TBT.AMEX) A play on rising inflation forcing higher T-Bond yields.
iShares MSCI Singapore Index Fund (EWS.NYSE) A play on an end to deflation and return to economic growth (mild inflation).
Lyxor Gold Bullion Securities (GBS.LSE) A play on rising inflation and a loss of faith in other financial instruments.
Market Vectors Gold Miners ETF (GDX.NYSE) A play on rising inflation causing the gold price to increase faster than mining costs.
Centamin Egypt (CEY.LSE) A play on rising inflation causing rising gold demand, forcing gold producers to buy new projects.
iShares Euro Government Bond 15-30 (IBGL.LSE) A play on continued deflation forcing down ECB short-term interest rates.
M&G International Sovereign Bond Fund A play on continued deflation increasing the value of government debt (and on sterling weakness).
CurrencyShares Japanese Yen Trust (FXY.NYSE) A play on continued deflation causing the real value of cash to rise (and the BoY being reluctant to print money).
Lots of cash in GBP and USD A play on continued deflation causing the real value of cash to rise.
Broadly,then, I have four investments that will do well under inflationary conditions, four (including cash) that will do well under deflation, and only one (EWS) that will do well if "things" (i.e., the global economy) actually get better, without sparking high inflation.
Now, don't get me wrong, I'm still bearish. I do think that this is the big one, a second Great Depression which will only be "cured" by massive debt liquidation and very high inflation rates. But, at least for the next few months, I am warming to the idea of a bit of a bounce. Are there assets out there which could prove profitable if the world economy just "does ok" (or, at least, doesn't get much worse) for a few months?
A great bit of reading is published yearly by Barrons Magazine - their January Roundtable of investment experts, pitching their ideas for the year ahead. Of course, if you're a tightwad like me, you won't want to shell out for the mag itself, but luckily the articles (it's in three parts) have been republished on the web. Check out the following links:
Part 2 - Bill Gross, Felix Zulauf, Archie MacAllaster and Abby Cohen
Part 3 - Scott Black, Marc Faber, Mario Gabelli and Oscar Schafer
Now, there's lots of good ideas there, but one theme that jumped out at me was the spread between US Treasuries and corporate debt, especially sub-investment grade corporate debt (or, to put it more plainly, junk bonds). Bill Gross, the Pimco bond expert, points out that (at the time of the session) the Pimco High Income Fund was yielding some 23%, yet only 40% of its holdings were actually high-yield (i.e., 60% investment grade). Marc Faber discusses the Nicholas-Applegate Convertible and Income Fund, which also has a yield in the 20% range.
I am intrigued. A 20% yield is something quite exceptional, when interest rates are heading for zero world-wide. Obviously, it signals that the market thinks such dividends are unsustainable, or that they are necessary to compensate to the risk of high inflation. But, suppose the market is wrong? Suppose that things actually get a little better ... for a while at least. There must be a mass of income-hungry investors who would like a crack at these yields. Further investigation required!
I bought the Swiss franc currency ETF (FXF) back in December as a diversification away from US dollars. Lately, however, I have become concerned about the exposure of the big Swiss banks, and the extent of the Swiss National Bank's (SNB) bailouts. See this Guardian article for details.
However, I was really shocked to read this article on "quantitative easing" (aka "currency debasement"), based on a report by Credit Suisse. In particular, this quote:
The SNB has indicated its willingness to use QE and has explicitly mentioned FX intervention as a means to achieve its objectives.
So much for traditional Swiss conservatism! While Credit Suisse still infer that the Swiss franc is likely to hold up better than the US dollar, or (especially) the pound, it is reason enough for me to dump FXF, which I have done today at $87.35/£60.73 (in sterling terms, virtually a flat performance on purchase, but obviously a dollar loss).
Rather than leave the cash in US dollars, however (of which I have a considerable pile), I've decided to go for the other major currency - the Japanese Yen. To quote Credit Suisse again:
[Japanese] QE’s implementation was unsuccessful earlier in the decade and the BoJ is very reluctant to allow rates to return to zero. Following the Fed’s lead, it is now starting to try to improve domestic credit mechanisms, but remains hampered by residual weaknesses in the domestic financial system and appears unwilling at this point to seek to resolve them aggressively.
I don't view this as a high-return play, but have bought a big chunk of the CurrencyShares Japanese Yen Trust (FXY) at $112.44/£78.17.
P.S. Just to give you a warm feeling about our nation's future, I'll leave you with another quote from Credit Suisse:
The pound has weakened sharply in anticipation of QE ... GBP is vulnerable to QE because attempting to underpin a leveraged national balance sheet through sovereign debt expansion is inherently unstable given the threat of domestic capital flight ... while the US is still master of its own destiny, in the UK, QE is insufficient to fix the problem.
As predicted, I dumped my short position in US Real Estate (SRS) yesterday, getting out at $61.42/£43.25. Thanks to the anything-but-sterling effect, a small profit of about 3% - I can live with failed trades like that.
The [Davos] World Economic Forum has ended with a call to rebuild the global economic system ... However, most discussions described the problems, not solutions ... Nobody in Davos tried to refute the prediction that the global economy is heading into a deep and long recession. BBC News, 01/02/2009
If financial sector problems are not remedied or further shocks add to current stresses, there is a significant probability of more negative deflationary outcomes, with a deeper and more prolonged recession The IMF, quoted by Reuters, 28/01/09
Gordon Brown has reportedly said that the government must use simpler language about the credit crunch, because banking and financial-policy jargon just confuses everyone. Well, I can sum it up quite easily: we're bust, and we're going to print money to make ourselves feel richer. Dr Eamonn Butler, 30/01/09
Well, that's enough light relief. How has the Credit Crunch Investor portfolio performed over the past month?
Short-term Speculations:
Ultrashort Lehman 20+ Year Treasury (TBT.AMEX) Initially bought on 6th January at $42.33/£28.42, then whipsawed out on 20th January at $41.24/£29.61. Note that, despite this being a failed trade, it actually realised a sterling profit of some 4%! Another example of my "anything-but-sterling" investment theme (much related to, I suspect, Guido Fawkes' "Anyone but Gordon" tag).
However, I bought into TBT again the 22nd, at $43.25/£31.47. It now stands at $47.80/£32.89, so is going in the right direction, if not exactly coining it in. If you look at the chart of TBT's inverse ETF, the iShares 20+ T-Bond (TLT), you'll see that the dma's suggest continued decline. However, the 14-day RSI is now at 30.9, which is approaching oversold territory, so this trade may not last much longer.
I do agree with the likes of Marc Faber that this could be THE big trade of 2009, but the problem is there is no way of knowing for sure exactly when. And, with a leveraged ETF like TBT, knowing "when" is essential - look at when I tried this in November 2008, when the fundies were just as compelling. If I'd hung onto my TBT, purchased at $62.70, I'd now be down about 24% in dollar terms. In the absence of knowing "when", I'm left to follow my technical rules, which should at least get me in and out of the big moves.
Ultrashort DJ US Real Estate (SRS.AMEX) Bought on 12/01/09 at $62.04/£41.72, and a definite failure - a positive 3/13 dma cross on IYR occured on Friday, so I'll be dumping SRS on Monday. The price today is $59.32/£40.81, so it looks like being a sterling loss in the region of 2% (helped, once more, by the anything-but-sterling effect). I can live with that.
Long-term positions:
iShares Euro Government Bond 15-30 (IBGL.LSE) Bought 13/09/08 and again 23/09/08 at average price £116.96; price now £135.41, sterling profit about 16%. Actually, this is a big decline on the start-of-January valuation of £153.25 - a decline of about 12%. Nonetheless, I remain happy to hold, as I think that real deflation is more likely in the euro-zone than anywhere else, and the ECB hasn't reduced short-term rates to zero yet.
M&G International Sovereign Bond Fund Bought on 24/10/08 at 60.61p; price today 77p, profit 27%. Note that this is virtually the same as the start-of-January valuation (78p); the benefits of diversification, even when it comes to something as boring as government bonds. Keep holding, both for possibility of more deflation ahead, and as an anything-but-sterling play.
CurrencyShares Swiss Franc Trust (FXF.NYSE) Bought on 19/12/08 at $90.24/£60.53; price now $86.19/£59.30; sterling loss 2%. Now, this is a big one-month reversal, as FXF was at $92.35/£63.47 at the start of January (so, down near 7% this month). Such is the nature of short-term currency fluctuations; all fiat currencies are fundamentally worthless, but some are more worthless than others, and I suspect (believe?) that the Swiss Franc is likely to prove more enduring than (certainly) sterling and (very possibly) the US dollar and the euro. At any event, FXF is (for me) simply a diversification tool for holding cash in an non-USD or GBP form.
iShares MSCI Singapore Index Fund (EWS.NYSE) Bought at $7.66/£4.59 on 21/10/08; price now $6.45/£4.44; sterling loss about 3%. Again, note that this is a big one-month reversal, from a start-of-January valuation of of $7.25/£4.98, so losing about 11%. Still a HOLD for me, as my intention is to soak up the divi's until the global economy (on which the Singapore stock market is something of a leveraged bet) eventually recovers. And, when it does, I suspect the epicentre of that recovery will be in the east.
Lyxor Gold Bullion Securities (GBS.LSE) Bought 18/09/08 at $81.38/£44.35; price now $90.50/£62.26; sterling profit 40%. In the past month, it's been a move from $86.31/£59.32, so a January advance of about 5%. Now, that's a bit more like it! Have you worked out why I love gold so much? In fact, I'm going to get myself a lady covered in gold paint ... must remember to leave the base of her spine clear, though, unlike that poor Miss Masterton.
Market Vectors Gold Miners ETF (GDX.NYSE) Added to the portfolio on 08/01/09 at $31.52/£20.71; price today $34.23/£23.55; sterling profit about 14%. A gold mining ETF is essentailly like gold, but with leverage. Hence, GBS up 5% this month; GDX up 14%. Plenty of upside yet; this baby has barely gotten started.
Centamin Egypt (CEY.LSE) My favourite gold junior, added to the portfolio on 13/01/09 at 39p, price today 41.75p; profit about 7%. CEY is moving in the right direction, although noticably weaker than the GDX producers' ETF. To my mind, this means CEY is relatively cheaper than before; assuming it all works out, one of those GDX producers will end up having to buy CEY a long way north of 41.75p. CEY issued its quarterly report on 30th January, indicating that "Commissioning and gold production remains on track for Q2 2009". It is also interesting to note that CEY was able to raise C$60M in finance during January, to advance the Sukari mine, so indicating that, credit crunch aside, money can be raised for projects such as this. Hold on for a double within 12 months.
Dumping the junk
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