Preserving Wealth during the Global Banking Crisis

By: Gary Dorsch | Wed, Jan 21, 2009
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"Accepting losses is the single most important investment device to insure safety of capital. It is also the action that most people know the least about, and are least likely to execute. The most important single thing I learned is that accepting losses promptly is the first key to success. It's a great mistake to think that what goes down must come back-up," warned Gerald Loeb, the Dean of Wall Street, in his epic book "The Battle for Investment Survival," last copyrighted in 1965.

"In all cases, where actual losses are involved, I'm inclined to say that when a new investment has shrunk by 10%, it's time to stop, look, and listen. I think it usually ought to be sold-out, and the loss taken. I'm almost inclined to say, dogmatically, sell it out before trying again," Loeb advised his readers, concerning wagers in the stock market that turn sour, due to unexpected and unforeseen events.

A once-in-a-century financial crisis has brought some of the world's largest banks to the brink of insolvency, and quasi-nationalization, choking-off credit to wide swaths of the private sector, and threatening to throw the world economy into its deepest and longest recession since the "Great Depression" of the 1930's. Global stock markets have been mauled by the fallout from the "credit crunch," losing roughly $32-trillion of market value from peak levels reached in October 2007.

According to Mr Loeb, "Successful investing is a battle for financial survival. Investing is fundamentally, an effort to obtain a rental from others, for the temporary use of one's capital. One should attempt to conserve the purchasing power of money, through the purchase or retention of fixed interest and principal obligations, including cash and a government promise to pay, only during cycles of deflation, and various forms of equity holdings, only in cycles of inflation."

During this once-in-a century financial crisis, the strategy of owning high-grade bonds and gold, proved to be "safe-havens" for preserving wealth. With the US stock market suffering its worst year since the 1930's, the Lehman Treasury bond index posted a gain of 14.6%, its best performance since 1995. Ten-year US-Treasury yields started the year at 4.03% and closed at 2.20%, after trading near 4.11% as recently as October. Gold ended +5% higher in US-dollar terms last year, and gained 30% against the Aussie dollar, 35% vs the British pound, and 10% vs the Euro.

Shell-shocked investors in the US-stock market were badly burned last year, and are now sitting on a record $3.85-trillion in money market funds. However, the Federal Reserve has driven the fed funds rate into a target range of zero to 0.25%, and has vowed to keep interest rates pegged near zero for a long period of time, probably through 2009 and beyond. Taxable yields on money funds have tumbled to a pitiful 0.40%, after annual operating expenses are deducted.

The idle cash parked in US-money market funds is nearly equal in size to China's FX reserves and the SWF's of Kuwait and Saudi Arabia combined. Would holders of US-money market funds agree to buy long-dated Treasuries, in order to finance the deficit at historically low interest rates? Or should investors turn to high-grade corporate bonds, for companies with strong balance sheets, little debt coming due over the next few-years, and yielding 400-basis points or more than Treasuries.

Barclay's High-Grade Corporate Bond Index, (US-symbol: LQD), has recouped most of its losses from the post-Lehman bankruptcy shakeout, including its $5.60 annual dividend payments. Still, buying corporate bonds is not without risk, especially if the Dow Jones Industrials tumble below the November low of 7,500, ushering in a "Great Depression," and increasing the odds of company defaults. Also, corporate notes might sink under the weight of $2-trillion of fresh Treasury debt this year.

The plunge in the US Treasury's 10-year yield to 2% was preceded by a stunning collapse of commodity markets, especially for base metals and energy. In the span of just six-months, the Dow Jones Index of 19-exchange traded commodities, swung from a annualized +40% gain in July, to a stunning -41% loss in December. Volatile swings in the commodity markets are often seen as leading indicators for producer prices, and ultimately, the consumer price index.

The US-Consumer Price Index (CPI) fell 0.7% in December, the third-straight monthly decline, capping a year in which prices advanced only 0.1%, the weakest 12-month reading since December 1954. Gasoline fell 17.2% and accounted for almost 90% of the decrease in headline CPI. If commodity markets can't recover in a meaningful way in the months ahead, the CPI and producer prices (PPI) would begin to show outright signals of deflation seeping into the broad economy.

If a long period of deflation and depression lies ahead, then a best case scenario one might expect is an "L" shaped economic recovery, after stock markets finally reach the elusive bottom. The lethal "credit crunch," engineered by the top-tier US-banks, has led to the massive destruction of 2.6-million US-jobs, which in turn, is fueling a downward spiral, where unemployment depresses consumer spending, retail sales, and business investment, which in turn, lead to further layoffs. As long as this vicious cycle remains unbroken, high-grade bonds would remain a safe-haven.

On Dec 18th, Dallas Fed chief Richard Fisher said the US-central bank would take whatever steps necessary to avoid a depression. "We stand ready to grow our balance sheet even more should conditions warrant. At the current time, the biggest concern is deflation and the Fed can worry about inflation later. We have to do everything we can to lift the economy up and prevent deflation from taking hold."

On Jan 15th, Chicago Fed chief Charles Evans said, "With the United States is in the midst of a serious recession, it could be useful to purchase significant quantities of longer-term securities such as agency debt, agency mortgage-backed securities and Treasury securities," he said. Thus, the Federal Reserve is expected to be the buyer of last resort for the upcoming supply of US-Treasury debt, by running its electronic printing press at billions of dollars per hour.

There might be no alternative to fixing America's greatest financial crisis since the "Great Depression" of the 1930's, than to ask the Fed to monetize the upcoming supply of Treasury debt. The biggest risk for today's buyer of Treasury-notes is that the Fed might be successful in reviving inflation, but alert traders can gauge trends in the commodities markets, for the first signals of such a development. The gold market is more focused on the upcoming tidal wave of paper currency that central banks will churn out in the months ahead. Even the Swiss National Bank is vowing to devalue the Swiss franc against the Euro, with a massive money printing operation.

Big Buyers of US Treasuries Sidelined for 2009

Still, risks remain for buying the Treasury's debt at historically low interest rates. The two biggest foreign buyers of US Treasuries over the past 15-months have been the Arab oil kingdoms, ($245-billion), and China, ($233-billion). But with dwindling external surpluses, and big economic troubles at home, the Arab oil kingdoms and China's government could be absent from this year's Treasury auctions.

"The Arab world has lost a total of $2.5-trillion in the past four-months, as a result of the global financial crisis," admitted Kuwaiti Foreign Minister Sheikh Mohammad al-Sabah on Jan 19th. Declines on foreign stock markets accounted for $600-billion of the losses, while Arab investors were also hurt by sharp declines in oil revenues, declining value of property investments, and other repercussions of the global downturn. Ignoring Loeb's empirical rule of limiting one's losses to 10%, when they inevitably arise, due to unforeseen events, was an expensive education.

In the second half of 2008, the OPEC oil reference price plummeted 75% from a record high of $140 /barrel in July, to as low as $34.50 /barrel in December. Persian Gulf property prices also crashed as the credit crisis engulfed the financial markets. Consequently, investor sentiment turned negative and the efforts of Arab Gulf kingdoms to stimulate their economies and boost investor confidence failed. The UAE stock markets absorbed the biggest blow, shedding 72.4%, Saudi Arabia's TASI lost 56.5%, and Kuwait's lost 38%, during the past year.

In the second half of 2008, the OPEC oil reference price plummeted 75% from a record high of $140 /barrel in July, to as low as $34.50 /barrel in December. Persian Gulf property prices also crashed as the credit crisis engulfed the financial markets. Consequently, investor sentiment turned negative and the efforts of Arab Gulf kingdoms to stimulate their economies and boost investor confidence failed. The UAE stock markets absorbed the biggest blow, shedding 72.4%, Saudi Arabia's TASI lost 56.5%, and Kuwait's lost 38%, during the past year.

In a desperate attempt to stop the slide in oil prices, Saudi Arabia removed 1.7-million barrels per day (bpd) of oil from the world market in the second-half of last year, to 8-million bpd, and Saudi oil chief Ali al-Naimi said on January 13th, the kingdom will cut an extra 300,000 bpd of supply in February. But the combination of declining oil prices and production cutbacks is expected to trim OPEC's oil export revenue to $440-billion this year, down sharply from the $962-billion in 2008, when the OPEC cartel raked-in from oil exports, according to the EIA.

China's trade surplus climbed 13% to a record $295-billion last year. But Beijing will spend 4-trillion yuan or ($586 billion) of its surplus cash on domestic stimulus projects this year, to cushion its economy from a hard landing. China's exports, the key engine of growth for its economy, have plunged from a +22% growth rate a year ago to -2.8% in December. One-third of the 45,000 factories in the major export cities of Dongguan, Shenzhen and Guangzhou have shut-down, idling millions of workers, and forcing Beijing to spend more money to create new jobs.

Crackdown on Banks Required for Economic Recovery

The US-economy has little chance of a sustained recovery unless President Barack Obama's financial squad, will crack-down on the corrupt management of the elite US-banking cartel that has brought this great calamity upon millions of innocent American and foreign workers. Former Treasury chief Henry Paulson handed out $200-billion of taxpayer money to the elite US-banks, with no strings attached, and no stipulations to increase lending to the private sector.

Banks have also raised $115-billion by selling FDIC-guaranteed bonds since Nov 26th, enabling them to rollover their debts coming due at super-low rates, while leaving the rest of corporate America high and dry, and worried about defaulting on their bonds, in the event of an economic depression. In order to preserve precious cash, companies have resorted to slashing capital spending and their payrolls.

Obama will have a "strong message for the bankers," adviser David Axelrod said Jan 19th. "We want to see credit flowing again. We don't want them to sit on any money that they get from taxpayers," he warned. Obama's approach is in sharp contrast to that of former Treasury chief Paulson, who argued on Jan 12th, "The banks need to lend. They can't hoard capital. But I do not believe it is proper or right for politicians or the government to tell banks whom to loan to and how to lend," highlighting Paulson's collusion with the Wall Street banking cartel.

In the first significant reform of the TARP program, Obama is ordering the Treasury Dept to limit bank-executives' compensation and dividend payments by institutions that get "exceptional assistance" from the financial rescue fund, said Larry Summers, White House chief economist on Jan 13th. "Until taxpayer money is paid back, ban dividend payments beyond de-minimis amounts, and put limits on stock buybacks and the acquisition of already financially strong companies."

Fears that TARP recipients would be forced limit their common stock payouts to 1-penny per share rattled a jittery banking sector. The common stock dividends, if fully paid by US-banks at previous levels, would channel $25-billion to shareholders this year. Taxpayers have been told the bail-out money is necessary to rebuild bank capital, yet a significant portion of the money ended-up with the directors of the top elite banks - the beneficiaries of $250 million in common stock dividends.

Fears that Citigroup would be forced to slash its dividend payments sent its preferred series-P share plunging from $18 at the start of the year, to $6.60 today, to yield 30.7-percent. Over time, the US-government could exercise more day-to-day control over the US banking system, which desperately needs more capital. Estimates of future losses from bad-loans range from $700 billion to $2 trillion.

Sterling Plunges deeper into a Black Hole, lifting Gold

As part of a second rescue package, designed to prevent the UK-economy from spiraling into depression, PM Gordon Brown has created a special fund for the Bank of England to buy high quality corporate bonds and other assets directly from banks, starting on Feb 2nd, to combat deflation and unblock frozen credit markets. The UK-government will also insure banks against default on toxic loans in exchange for legally binding commitments to lend to British businesses and home buyers.

Brown and UK Treasurer Alistair Darling have refused to specify where the money will come from to pay for the latest banking bailout scheme, but it's expected to dig Britain deeper into debt, adding-up to an extra £350 billion. Prior to the second rescue package for UK-banks, gilt issuance was expected at 146.4-billion pounds ($222-billion) this year. But now, there is no ceiling on government borrowing. Most importantly, the BoE has been authorized by the Treasury to begin monetizing the debt, or printing money in order to buy the new supply of gilts.

Sterling plunged deeper into a black hole on the foreign exchange markets this week, as traders anticipate the arrival of "Quantitative Easing" in England, more BoE rate-cuts, possibly to near zero-percent, and an explosive surge in the UK's M4 money supply, which is already expanding at a +16.4% annualized clip. The BoE has slashed it base rate by 350-basis points since October to a record low of 1.50%, pulling out all the stops to stop the slide in the UK-housing and stock markets.

Fresh concerns about the stability of the UK's financial system pushed sterling to an eight-year low of US$1.3750, an all-time low of 124-yen and towards parity with the Euro. Roughly £484-billion off the value was wiped-off of Britain's top-100 companies in 2008, and UK home prices fell an average 18.9%, reducing the average home value to £159,896, adding greater momentum towards a depression.

Yet the BoE's rapid-fire rate cuts, designed to stabilize markets, have back-fired on the central bank, by crushing the value of the British ounce to 124-yen, which in turn, fueled the unwinding of "yen-carry" trades, and the dumping of UK-listed shares, by Japanese and hedge-fund speculators. There is a real danger that the devaluation in sterling becomes a full-blown crisis and a headache for gilt holders, as "Printing Press" headlines make for uncomfortable reading.

The big-4 British banks have a combined loan book of more than £6 trillion, more than four times Britain's annual GDP of £1.3 trillion, and a collapse of this sector, would deal a punishing blow to the broader economy. Combined with a sharp slide in global commodities, a view of a deflationary depression in Great Britain has emerged. The speculator's first instinct was to jump into British gilts, guaranteed by the BoE's printing press, as a "safe-haven" from the global meltdown storm.

Mirroring the sharp slide in base metals, crude oil, and grain markets, yields on the UK's 10-year gilt plummeted from as high as 5.20% in July to a record low of 3-percent in December. Yet counter-intuitively, one is surprised to learn, that the best performing asset in the UK, during times of a deflationary depression was the ultimate hard currency, - Gold, a hedge against inflation, and safe-haven in times of turmoil. London gold appreciated 35% to a record 600-pounds /oz, as the British-ounce lost its purchasing power against the Euro, Japanese-yen, and US-dollar, and while UK-banking shares were bludgeoned amidst fears of nationalization. If the BoE is successful at some point, under the QE framework in reviving inflation in the UK-economy, British gilts would lose purchasing power to the yellow metal.

Trying to increase wealth, while navigating through the stormy seas of a treacherous banking crisis, is a most daunting challenge. Short sellers profited handsomely in this bear market, if they held steadfast during the vicious short squeezes engineered by the "Plunge Protection Team" along the way. The British government has provided a viable blue-print for other governments to follow to thaw-out the credit crunch, which must include, at its core, the printing of trillions in paper currencies, in order to monetize the vast amount of government debt offerings in the year ahead.

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Gary Dorsch

Author: Gary Dorsch

Gary Dorsch

Gary Dorsch

Mr Dorsch worked on the trading floor of the Chicago Mercantile Exchange for nine years as the chief Financial Futures Analyst for three clearing firms, Oppenheimer Rouse Futures Inc, GH Miller and Company, and a commodity fund at the LNS Financial Group.

As a transactional broker for Charles Schwab's Global Investment Services department, Mr Dorsch handled thousands of customer trades in 45 stock exchanges around the world, including Australia, Canada, Japan, Hong Kong, the Euro zone, London, Toronto, South Africa, Mexico, and New Zealand, and Canadian oil trusts, ADR's and Exchange Traded Funds.

He wrote a weekly newsletter from 2000 thru September 2005 called, "Foreign Currency Trends" for Charles Schwab's Global Investment department, featuring inter-market technical analysis, to understand the dynamic inter-relationships between the foreign exchange, global bond and stock markets, and key industrial commodities.

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