Friday, May 14, 2010

Morning Note...

Futures are down ~100bps this morning as investors once again consider the broader implications of the IMF/ECB’s bailout and the implications for Europe, the euro, and the European Union.  U.S. futures are taking their cues from the EUR/USD action, which has faded to below $1.25, and from European markets, which are down roughly 2%.  There are all kinds of chatter about Germany shifting away from the euro currency (including a rumor that the German government has prepared a “Plan B” return to the deutschemark as early as this weekend!) and a Spanish paper is quoting French President Sarkozy as threatening to leave the euro during talks last weekend.  Further, DB chief Ackermann made cautious comments about Greece’s ability to meet its debt obligations.  As a result, the USD remains the beneficiary of a “flight-to-quality,” up 25bps against a basket of foreign currencies.  Gold continues to make new highs against all currencies, at ~$1250/oz.  In economic news, U.S. Advanced Retail Sales for April were double the expectation (+0.2%) to +0.4% but down from March’s revised +2.1%.  In corporate news, Mastercard and Visa are lower after the Senate approved an amendment effectively lowering debit-card fees, and NVDA and JWN are lower on earnings.  Industrial Production and Capacity Utilization are due at 9:15am.

Regarding the euro, the tug of war between the bulls and the bears has begun in earnest.  Just as a weak USD helped reflate risky assets in this country, bulls would argue that a weaker EUR will help exporters on a global scale (whose “cheaper” goods will be more competitive) and will mean less debt service to pay (as the currency devalues, you automatically owe “less”).  Of course the bears will argue that the EUR was an ill-fated social experiment from the beginning.  As investor Louis Bacon of Moore Capital said in April (I am paraphrasing here), “investors have long seen the EUR as a proxy for the very strong deutschemark…and they are just realizing that it’s become a proxy for the drachma instead.”  Further, according to Bloomberg:

Talk of a euro breakup is discussed as German-led northern Europe attempts to rectify mistakes made by the euro’s founders in the 1990s and squares off against the south over who will control the currency and the ECB, whether it will be used to prompt growth or curb inflation, and ultimately whether or not some countries “should be disbarred from the monetary union.” Former Federal Reserve Chairman Volker spoke in London yesterday and is quoted as saying, “You have the great problem of a potential disintegration of the euro . . . The essential element of discipline in economic policy and in fiscal policy that was hoped for [has] so far not been rewarded in some countries.”

The interesting action will be in the determination of where the EUR ultimately settles.  Will the EUR sink below its origin-levels (see trivia below)?  Will it drop to parity levels with the USD?  Or lower?  And what are the global repercussions of such?  Judging from recent action, in a unclear world, the only certainty – for the moment – seems to be gold.   Regarding gold and gold alternatives, I found this tongue-in-cheek note from BNY Convergex both amusing and interesting, especially the details on precious metal weight and private plane “portability.”  Somewhat reminds me of the Fall of 2008/Winter of 2009, when NPR ran a feature story on sales of firearms and safes hitting record highs worldwide:

Gold is clearly working as an investment, but perhaps not for the reasons we thought just a few months ago. The dynamics around the ongoing breakout, for example, seem to have more to do with Europe’s recent efforts to salvage the Euro than the ongoing profligacy of the U.S. government. There was a common wisdom that gold would rise as the dollar slackened. In fact, it has been the slow motion collapse of the Euro that has catalyzed gold’s move higher. No doubt other sources of demand, from domestic U.S. buyers to Chinese jewelry purchasers, have helped as well. But press reports of large scale European buying of physical gold correlate too well to the move in the past week to think any other of these more long-standing trends actually caused the breakout. Continental purchasers clearly see gold as a refuge from Euro devaluation.

There is a unique psychology to this “refugee buying” that dovetails with Europe’s experience of a major war every century for a millennium. Suffice it to say that anyone with first or second hand knowledge of what happened in Europe in between World Wars is not surprised by gold’s move higher this week. World War I left the continent in tatters and Germany was pressed into making crushing reparations to the Allies. Part of its efforts to pay those debts included printing currency at an astonishing rate, which led to hyperinflation and an economic collapse that spawned the rise of the National Socialists and Adolf Hitler as leader of the country.

Yes, to Americans that seems like ancient history, but the 1930s cast a long shadow over Europe, and especially across its largest economy, Germany. So since the EU announced its wide-ranging monetary stimulus plans to support the Euro, it is certainly understandable that Europeans have been incrementally hedging their bets with gold purchases. European countries have a strong tradition of minting gold coins and the Swiss also produce easy-to-store one ounce gold bars.

But the question that intrigues us is, “What other asset classes may see increases in demand from the current uncertainty over the value of the Euro?” We don’t think other currencies can be long-term beneficiaries, although the dollar has certainly gotten a tailwind in the last week. Individuals and institutions with concerns over the security of sovereign debt, currency exchange rates and even global taxation policies will more likely focus on portable real assets that carry few disclosure requirements and look for safe places to custody those assets.  So here are some ideas for the follow-on trade to gold:

Silver. Starting with the easiest call, silver is an obvious choice. It has been used in coinage for millennia so it has a similar psychological profile to gold as far as a historic store of value. It is not as portable as gold – $1 million in gold weighs about 57 pounds. The same amount in silver is 3,000 pounds, give or take. Still, if ounce-sized gold coins stay in relatively short supply, silver demand for investment purposes should stay strong as well.

Platinum. This metal has the right profile to be a new third choice for “store of value” metals investing. It is more expensive than gold, used in jewelry, and several countries – the U.S., Canada and China to name three – make bullion coins from the metal. It does have a wide range of industrial uses (as does silver, for that matter), so demand is not primarily driven by investment-oriented buyers. That is a risk to platinum prices if global economies see a “double dip,” but consider that our theoretical $1 million in cash translates into just 37 pounds of platinum. That’s pretty good portability. For the curious billionaire reading this note, your Gulfstream G5 will carry approximately $135 million of platinum (5,000 pounds), leaving space and weight for 2 copilots and 4-5 passengers.

Diamonds. For the ultimate in capital-preserving portability, diamonds have no equal. A super premium one-carat diamond currently trades for $25,000 – check out if you want to see the goods first hand. One pound of these gems would be worth $57 million, if you could even find that many. That one pound sack would contain over 2,000 one-carat stones. Of course, you could go bigger, and a two-carat flawless diamond would fetch $100,000. Diamond prices have begun to tick up in recent months, but are not yet back to inflation adjusted highs from the 1970s. We would note that the diamond market has historically been tightly controlled, first quasi-officially by De Beers and more recently by Russian producer Alrosa. This state-owned firm stockpiled gems during the financial crisis as demand collapsed but has returned to the market in the first quarter of 2010.

Tax haven real estate. With sovereign debt issuance rising in the U.S. and Europe, the next logical step will be to see taxes rise in both areas. That will make for a robust real estate market in countries like Monaco or territories like the Channel Islands. This is less of an issue for Americans – Uncle Sam follows you around the globe, no matter where you live, and asks for his fair share of income and capital gains. Most other countries, however, allow you to pay taxes in your country of domicile if you have legitimately set up house there. We do not have much data on the trends for real estate prices in the tax havens of the world as of yet. But suffice it to say that we suspect Monte Carlo real estate agents are going to have a very, very good year.

WSJ reports wireless carriers are shifting to prepaid segment in order to spur growth.  CITI ups PH.  KBWI cuts FAF.  JEFF ups POZN.  JPHQ ups APC.  UBSS ups CAE.  CITI cuts NFLX.  CSFB cuts BOH.  GSCO cuts EJ, WX.  SUSQ cuts MMSI. 

Asia lower overnight.  Europe down 2%.  USD +25bps.  Oil -1%.  Gold +140bps.

S&P 500 PreMarket 8:30am (last/% change prior close/volume): 
MASTERCARD INC-A       210.24  -9.5 %  161141
NVIDIA CORP                 13.75    -6.14%  537004
CA INC                          20.55    -6.08%  10900
DILLARDS INC-A             27.25    +5.95% 18900
GAMESTOP CORP-A        21.45    -5.42%  1643
COVENTRY HEALTH        20.76    -4.51%  386
CAPITAL ONE FINA         43.30    -3.58%  25676
DISCOVER FINANCI        14.26    -3.58%  12346
STARWOOD HOTELS      49.89    -3.35%  250
NORDSTROM INC           40.00    -3.12%  28513
AMERICAN EXPRESS       41.58    -2.87%  103196
FIFTH THIRD BANC         14.44    -2.43%  26134
BROADCOM CORP-A       32.25    -2.36%  7354
KING PHARMACEUT        9.05      -2.27%  813
FREDDIE MAC                1.35      -2.17%  23900
METLIFE INC                  42.14    -2.16%  2139
EL PASO CORP               11.90    -2.14%  2333
GANNETT CO                 16.09    -2.13%  1800
APPLIED MATERIAL         12.95    -2.12%  4900
MICRON TECH                8.95      -2.08%  42830
REGIONS FINANCIA        8.56      -2.06%  93383
YAHOO! INC                   16.47    +2.04% 136013

Today’s Trivia:  When the EUR debuted in 1999, at what level was it priced versus the USD?
Yesterday's Answer:  According to yesterday’s CNBC story, 65% of MCD’s orders are made from a car, i.e. from the drive-through. 

Best Quotes:  If there is one optimistic note to be sounded this morning about the beleaguered EUR it is that some of the nation’s in Europe actually do seem to be learning the truth about their precarious fiscal circumstances. Let’s applaud, then, Portugal and Spain this morning, but let’s do so quietly for what Portugal and Spain have done does not yet deserve resounding applause. Rather, quiet, modest applause shall suffice as their parliaments, with the clear support of the Prime Ministers of both nations… the wonderfully named Jose Socrates in the case of Portugal and Mr. Zapatero, the rather far-to-the-left-of centre Prime Minister of Spain… and the leader of the opposition party in Portugal’s Parliament, Mr. Pedro Passos Coelho, all agreed to raise their VATs, to raise income taxes, to increase the taxes on corporate profits and cut the salaries of many of the nation’s political leaders. These are “baby steps” in the right directions, at least when it comes to trying to bring some balance to their fiscal circumstances, and so we applaud them quietly. What bothers us, however, is that so little was done in the name of spending cuts and so much was done far too quickly in the way of tax increases. Would that they had endorsed huge spending cuts and had “matched” those cuts with tax cuts too… even if the tax cuts were very, very small. Those would be the policies that would allow us to applaud loudly; the stamp our feet, to whistle shrilly and to beat the drum in either nation’s case. That, however, is not going to happen… at least not in Europe.  --TGL

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