Article originally submitted to subscribers on 22nd December 2006...
Is it Merger Mania out there or what?
The quantity and value of M&A deals is truly staggering.
Amongst the more prominent buyouts this year:
Bank of New York's $16.5bn takeover of Mellon Financial Corp;
And the unforgettable - Google's USD$8bn acquisition of YouTube.
Europe also saw it's fair share of M&A activity, the most prominent being the £10bn takeover of BAA by Spanish construction company Ferrovial.
Where is all the money coming from?
How long can it go on?
Is there an M&A Bubble?
I'll let you in on a little secret.
In the world of Asset Management the deals, the big money flow, the exciting speculative activity always happens near the top of the market.
Have you ever wondered why there is no merger mania going on in the Junior
Gold Sector? Or how about in the Small Cap stock sector?
I'll tell you why because the speculative fever just isn't there as it is in the Big Caps.
There are fundamental reasons - there always are. For example, Large Caps are normally multinationals and multinationals have export earnings which shield against a falling Dollar - a popular investment theme.
The Army of Private Equity is funded by cheap debt, and it's the large institutions that have access to cheap debt in sufficient quantities. Hence it takes Big deals to impact the bottom line of a Goldman or a Citigroup.
But the overlying truth is that the gambling fever is in the large cap arena. The psychology is right and the rewards are Big!
So how long can it all go on?
Here are 2 charts which have me very worried about the sustainability of the current merger boom. Both are long term charts and both have a significant impact on merger rocket fuel - DEBT.
Chart 1 - 10Yr yields (monthly) encountering stiff resistance
The 10yr rate is a pivotal rate because it's the bedrock rate for Mortgages.
Aside from all the risks that rising mortgage rates pose to the economy and they are significant. There is an incentive for Corporations, Banks, and Private Equity to borrow at 10 years rates, rather than borrowing at short-term rates, courtesy of an inverted yield curve.
Based on the above chart, the rate of borrowing and the debt itself may shortly be under severe stress. 10Yr notes are encountering fierce resistance in the way of converging trend lines (blue lines).
Chart 2 - Japanese Yen (monthly) hitting long term resistance
The famous Yen carry trade is the borrowing of money in Japan at bargain basement interest rates and reinvesting it in anything that will provide a positive yield spread.
Since the interest rate is so low, even a doubling of Domestic Japanese Interest Rates would not rock this boat. But what would put severe pressure on this mountain is a stronger Yen. [A stronger Yen will erode no-Yen denominated returns]. And the above monthly chart shows that the Yens fall against the Dollar may be halted at STIFF resistance.
The assumption that Merger Mania takes hold at a market top is completely supported by a VERY overbought Dow and the Cost of Debt hitting extreme lows.
Effect on Gold:
There are 2 possible scenarios at this time:
- The current mania continues and becomes more frantic. The Yen continues to weaken and the 10Yr note breaks below major resistance adding debt fuel to the fire. Gold will continue to float up with all other asset classes on the ocean of liquidity.
- The Yen and 10Yr Yields reverse higher placing severe stress on debt and all assets supported by debt. A liquidation cycle follows accompanied by anything from mild to severe panic. A stampede to safety ensues with Gold being a MAJOR beneficiary.
Gold will be a winner regardless of the outcome!
Happy Holidays to all Readers. Rest Up, 2007 is going to be a Doozy.
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