Savvy Investor

There are countless examples were a minority of savvy investors and hard-nosed business people actually prospered handsomely during sharp economic downturns, wars and financial corrections. 

During my journey I have actually had the fortune or misfortune of meeting such people. For example, the stubby limbed, ruddy faced multi-millionaire Australian business man who monopolized the retail local meat market. Hanging on his office wall I noticed a vintage photo of a young man standing on what appeared to be a soapbox and handing out small parcels wrapped in newspaper sheets. The man was surrounded by crowds young and old, but there was one thing that the people in the crowds had in common; their clothes all seemed too baggy and a size or two too large. “That's my father standing on the soapbox”, said the ruddy faced Australian proudly and then he proceeded to tell the story. “During the great depression, like most people my parents were struggling for the bare necessities, including putting food on the table. Never having enough money to buy meat, he would buy offal instead, (the internal organs of a butchered animal). ” “He then realized that if the hungry masses couldn't afford meat, then offal would make an affordable substitute.” It was a winner and the business grew from there onwards to being the most successful meat retailer in the country. That's just one inspirational example of someone flipping adversity on its head and making a success out of it. 

Then there is another example of a shoulder length haired angelic faced man who amassed more than one million USD during the 1960s Vietnam War selling, this is slightly unpleasant, nevertheless a true story, body bags to the US Government! Softly spoken, the man said, “Did you know that I was an active protester against the Vietnam war..... I just saw a legitimate need for my product and supplied it....” He admitted to giving some of his profits to injured servicemen charities. 

Maybe a less palatable and inspiration story, however, it is an example of how some people turn adversary around. Given a miserable situation these people remain optimistic enough to spot opportunities that others are completely oblivious to. 

During the last century's great depression two Wall Street investors Alfred Lee Loomis and his partner and brother-in-law Landon Thorne managed to amass a fortune after the stock market crash of 1929. The two had been leading financiers for the new electric power industry in the 1920s. Loomis was also a scientist, and he became a major supporter of some of the century's greatest scientific minds at his Tuxedo Park home. By early 1929, the two partners had liquidated all their stock holdings and put the gains into long-term Treasury bonds and cash. The reaction by their peers, so many of them forced out of business, seemed more like envy than admiration since "in the midst of so much despair, with the economic situation deteriorating day after day, Loomis and Thorne continued to profit handsomely," writes Jennet Conant, author of the Loomis Biography Tuxedo Park: A Wall Street tycoon and the Secret Palace that changed the Course of World War ll.

So during the last great depression bonds performed well. We know there is an inverse relationship between interest rates and bond prices. Moreover during economic down cycles interest rates are kept deliberately low by central banks with the aim of stimulating investment and the economy. So interest rates were low during the depression and bond prices also soared. High bond prices also pulled bond yields sharply lower during the last depression. For instance, the prime corporate bond yield average went from 4.59% in September 1929 to 3.99% in May of 1931. By June of 1938 the average corporate bond yield fell to a new low of 2.94%. Bonds returned 6.04% during the 1930s securities or bills returned 3.39% over the same time period. You might be right in believing that there are some striking similarities with the way interest rates, bond prices, gilts, treasuries and yields are performing now to that during the great depression. 

The obvious risk of investing in debt is that the debtor might default and that regretfully also happened during the great depression. The history books identified a number of cash-strapped corporations and municipal governments defaulted on their debts during the great depression.

Perhaps if the economy takes a turn for the worst and investors see central banks shy away from interest rate hikes, the gilt and treasuries might still continue its rally. Why? Simply because it’s a safe-haven play. Bearing in mind UK and US sovereign debt score top credit ratings and are formidable nuclear military powers the likely hood of them being invaded by a foreign power is so remote it’s probably not worth considering as a risk. So if investors flock into gilts and treasuries the trend of a gilt/treasury rally will probably continue with a corresponding fall in yields.

Owning your own property without a mortgage or managing rental properties is considered sound during a depression or recession. A place to live is a necessity, irrespective of what economic cycle we are in. With banks hesitant to rent during a sharp economic downturn there's usually a pool of good renters. Although real estate is less of a liquid asset, particularly so during a recession/depression it’s harder to liquidate, nevertheless history shows in the long-term it has been a good asset. Obviously, location is important with tenants paying more if it’s near good schools.

Precious metals such as gold, is another recession, depression proof asset which also performs well in times of geopolitical tensions. However, buying into an already inflated asset has its risks, If you can pick this precious metal up at the support levels, even better. Silver, seems to be neglected at current prices USD19.5 spot troy ounces and might represent value if things go pear shaped. However, silver is a smaller market and can be more volatile than gold.

Keep aside three to six months of living expenses in cash if something unfortunate happens, such as a job loss or unexpected expense might help you keep a cool head to invest wisely and try and spot opportunities were others don't.

Gold! Should You Have It In Your Portfolio?

 Having reached highs of $1923 in 2011 Gold has been drifting down ever since.  As gold is regarded as a safe haven investment and we continue to live in a very uncertain world why has it drifted off?

Gold is used to diversify risk in portfolios.  It produces no income but global investors will head for safe havens such as the US Dollar and gold when there is significant uncertainty to make investors nervous. It earns no interest but investors will buy it for stability when the value of other assets is falling or is not adequately compensating for risk.  So in a crisis or when inflation is undermining the value of investments portfolio managers will buy gold as a hedge.  This puts pressure on the price, and the ensuing increase in value of the investment, at least partly, offsets the losses elsewhere in the portfolio.

It has a major role in the thinking and financial planning of all global financial authorities so that in 1999 the Washington Agreement On Gold between Europe, The United States, Japan, Australia, Bank for International Settlements and the IMF agreed to limit gold sales to 500 tonnes per annum for 10 years. That has been extended beyond 2009 for a further five years to sales of no more than 400 tonnes.  During that first period the Bank of England and Swiss National Bank were keen sellers something they may have regretted during the financial crisis when gold rose rapidly in value. 75% of all the gold produced has been mined since 1910.  It is, generally, stored as gold ingots with one ingot weighing 400 troy ounces which is about 12.4 kilograms.

Gold has many uses in electronics, dentistry, medicine, radiation shielding and, of course, jewellery.  It is a highly malleable metal and extremely ductile so that one ounce of gold can be stretched into a gold thread 8 kilometres long.  It can even be used as embroidery thread. An ounce of gold can also be beaten into a sheet that is 300 square feet large and can be made so thin that it is transparent. It is odourless and tasteless, is non-toxic and can be digested as metal flakes in food or drink without ill effects.

The purity of gold is measured in karats and pure gold is 24 karats.  It is, however, very soft and can wear away very easily so in less pure forms it may contain a variety of other metals such as silver, copper and platinum in order to make it cheaper or tougher or to meet other criteria. Very few chemicals can attack gold so that it can be buried for many years without deteriorating.

Gold was first used as money in 643 BC.  The first time it was valued was by Emperor Augustus in ancient Rome when the price of a pound of gold was set as being worth 45 coins.

The price of gold is determined twice each day on the London bullion exchange by five members of the London Gold Market Fixing Ltd via a telephone conference facility.  Originally this took place in the offices of N M Rothschild & Sons just once a day at 10.30am, however in 1968 a second time of 3pm was established in order to coincide with trading in the US. The price is set in US dollars, Sterling and the Euro.

The first modern day gold price was set in 1919 at a price of US$19.39 per ounce or four pounds 18 shillings and 9 pence per troy ounce.

In 1933 the President of America at that time, Franklin D Roosevelt ordered US citizens to hand their gold over to the government for $20.67 per ounce and the price was promptly raised to $35.00 per ounce.

During the 2nd world war the fixing of the gold price was suspended in 1939 and not resumed until 1954. In 1946 The Bretton Woods System was enacted whereby the 44 countries that joined were joining a system of fixed exchange rates that allowed the participating countries to sell their gold to the United States Treasury for $35 per ounce. The purpose of the agreement was to speed up post war reconstruction and to bring order to international finance.  As part of the agreement the IMF was formed as was the bank for international reconstruction and development. The agreement was ended on 15th August 1971 when President Nixon ceased trading of gold at a fixed price. This stopped the era of exchange rates being fixed but the other institutions remain and have an important role in global finance.

There is still plenty of gold in the ground to be mined but its status as a store of value plus its other relatively unique properties and attractions as a thing of beauty mean that the price of gold is more determined by the level of demand that there is for it.

Industrial demand is fairly stable and alternatives can be found for some of its uses. India represents the market most watched to judge the potential for demand for jewellery and for retail demand generally. Diwali is the time in the Indian calendar when wealth is celebrated.  This falls between October and November. Gold is a store of value in India and is a symbol of wealth and status especially among the rural population where practical considerations of portability and security help to explain the huge demand there in spite of the rise in the price of the metal.

Demand for gold from investors, however, is probably the main influence on the price as it is a recognised form of investment diversification.  Hedge funds and portfolio managers use it for this purpose and the introduction of Exchange traded funds (ETFs) some of which require the physical commodity to be held and which is highly accessible to the retail investor has led to the potential for massive increase in demand at a time of financial crisis.

Demand for gold rose sharply following the collapse of Lehman Bank and was a symbol of the low levels of confidence in the market over the years until 2011 when the price peaked.  Slowly confidence has returned and the price of gold has fallen. Incidents such as the Russian annexation of Crimea and the uprising in Iraq will have temporary but low level influence on the price provided the incidents do not escalate out of control. Many investors see gold as an essential part of their portfolio as a counter balance to other assets in a highly volatile and uncertain world.

Modi Wins - will India Prosper?

It’s no surprise that when the world’s largest democracy, India with a population of 1.2 billion people and economy valued at 4.962 trillion dollars, based on 2013 GDP figures, goes to the polls the world’s media sits up and pays close attention.   

Whilst the outcome of the recent national elections in Indian was fairly predictable, based on local polls, which pointed to a land slide victory for the former tea merchant, Narendra Modi's Bharatiya Janata Party (BJP), nevertheless, the election would be a momentous occasion for the emerging economy, India. No other political party other than the Congress party had ruled the country for 18 of the 67 years, since its independence from Britain. The elections were a "genuinely revolutionary moment … a democratic asteroid," according to author and academic Sunil Khilnani, as reported in the Times of India.

Indeed, Modi's politically right leaning BJP party now controls around 340 of the 543 elected seats in parliament at the cost of the centre-left who had their representation squashed to just 40 seats, a historic low.  With voter turnout at around 66.38 percent, up 3 percent in the 1984-85 elections, according to Hindustan Times, it becomes apparent that Modi BJP leading party has conceded power with a healthy legitimacy of its people. Moreover, the Indians have given their thumbs up to a pro business party and they appear to have shunned the political left.

Meanwhile, the herd instinct of the financial market has driven the Indian stock market to record highs and the local currency, the rupee has rallied since Modi’s election win.

Therefore, with all this in mind, a politically friendly business climate and buoyant Indian financial markets, a question worth pondering over is whether all this might be a catalyst for greater capital inflows to India. 

Modi undoubtedly is keen on attracting inward investment to India, bearing in mind that capital investment accounts for nearly 35 percent to India's economy, which incidentally barely grew in the previous fiscal year that ended in March due to funding issues, thereby putting a spanner in the works of many infrastructure projects.

There are some pressing issues for Modi to deal with as soon as he puts his feet under the premier’s desk. For example, on the economic front India’s credit rating has been downgraded to a "BBB-minus", by the credit rating agency Standard & Poor, which has a negative outlook on its sovereign debt.  The market is now anxiously waiting to see if Modi can prevent a further downgrade by the credit rating agency to junk status. The pivotal point will be in July when the new government will need to convince investors that it is serious about getting its budget deficit under control

But getting the deficit down to its target of 4.6 percent of gross domestic product (GDP) is by no means an easy feat.  The previous administration, riddled with corruption scandals, has not left the state coffers in a healthy state. Moreover, the Indian economy is neither looking virile and relatively reliant on public funding. Public spending in the Indian economy accounts for 11 percent of GDP. So a cut in government spending could be a further dampener on the Indian economy as a sizable number of the electorates’ livelihoods are dependent, either directly or indirectly, on it.  Austerity is not going to be an easy sell for the Modi, despite the leader’s landslide victory.

Also improving the state’s coffers from increased tax revenues is unlikely to materialize in a relatively fragile economy.

Moreover, India’s Reserve Bank is keen on tackling the inflation rate, which currently stands at 8.6 percent. Their inflation target is 7 per cent by January 2016.  The implication here could be further interest rate hikes; already it has jacked up interest rates three times since last September.  But higher interest rates could be a double blow for India’s businesses by increasing the cost of financing and servicing existing debt, but also it would appreciate

 the rupee and make exports more expensive.

Then there are all these bad loans racked up, 100 billion USD to be precise, which are mainly associated with public infrastructure projects.  This currently represents 10 percent of all loans and it is estimated to reach 14 percent of loans by March 2015, according to Fitch Ratings.

The trade deficit is another issue the new government may need to get to grips with.  Indian has set a target of a 2 percent trade deficient of its GDP. Gold imports have contributed to a greater than desired trade deficit. The previous administration responded by slapping tariffs, duties onto gold, which then fuelled a black market in the precious metal.  Modi has promised to abolish these duties on gold. While this may be good news for gold buyers, this could also exert downward pressure on the value of the rupee, which would not be favorable to investors.  

Another potential black swan for investors could be the ongoing religious feud between the Hindu majority and the Muslim minority.  Modi, a Hindu, may not be perceived by the alienated and in some cases discriminated Muslim population, representing 14 percent to be sympathetic towards Muslim issues.  Many Indian Muslim distrust Modi, who has been allegedly linked with a police assassination squad, which targeted Muslims. If the Muslim minority population continues to feel alienated, they could be radicalized resulting in more attacks against western interests.

There are some clear distinctions between China and India’s economy. For one, China has a large trade surplus, whilst the later has a deficit. China’s GDP grow rate, albeit decelerating in growth, at 7.7 GDP in 2013. India’s GDP growth rate has been estimated at 4.7 percent. China’s population is ageing, India’s is relative young and maybe looking into the future confident and energized by their new leader, while China’s people continue to be repressed by the regime, cohurst into accepting inhumane working conditions. The protests continue in China-how long can the authorities repress a nation of 1.3 billion people. 

Darren Winters

The Ukraine Crisis part2

The Ukrainian crisis continues to remain vivid on investors’ radar as fatalities on both sides regretfully increase. “We are as close to civil war as you can get,” declared Russian Foreign Minister Sergei Lavrov, early this week and in the same breath he urged both sides to find a peaceful solution.

But with both the US and Russia pointing the blame at each other for stirring up the conflict between the Ukrainian government supporters and pro Russian activists there appears to be no respite in sight to this ongoing crisis.  The USA is pushing its EU allies for greater sanctions against Russia but with the EU’s economy having emerged recently from a severe recession and in a fragile state there is no real appetite for this. Europe’s powerhouse, Germany is not keen on any meaningful sanctions, as it is heavily reliant on Russian oil and gas.       

                                                                                       

Meanwhile, the British are calling for a diplomatic solution to the crisis, bearing in mind that at the centre of Russian oligarch wealth lays British tax havens and multimillion pound London properties. So the British too don’t want to slay the goose that lays the golden egg, certainly not in this fragile economic environment.

Russian leader Putin has probably worked out that he is dealing with the weakest western elite in a generation and he might just be testing how far he can push the redline.  First it was Georgia, then Crimea and still no clear redline from the West so Russia may just keep pushing on for more territory.

Moreover, it is not only Russian expansionism that’s ruffling the USA feathers. Since 2007 Russia has been working on a plan, an Independent Ruble system, a financial system based on Russian resources, its own economy and backed by its own gold reserves.   In other words, a Russian economy independent from the US dollar and the whims of speculators.      “Russia, at its present stage of development, should not be dependent on foreign currencies; its internal resources will make its own economy invulnerable to political wheeler dealers,” said a Russian central bank official.

But Putin may be just too ambitious for Russia, a threat to US supremacy and the powers to be in Washington may think it’s time to topple him. So the economic assault on Russia has begun.

Already capital outflows, money leaving Russia has amounted to approximately $50bn since the start of 2014, this full year figure could be as high as $130bn, according to a Goldman Sachs report.  This net capital outflows in the first quarter alone was more than during the whole of 2013, according to a recent report from Alfa Bank.

On the foreign exchange market the repatriation of foreign capital from Russia represents investors selling Rubles and buying either dollar or euro assets, depending on where they reinvest their funds.                                                                      Additionally, in a climate of geopolitical uncertainty the Russian public is also flocking to what they perceive to be safe haven currencies. For example, the demand for USD rose 48% in March compared with the prior month, while interest in buying euros rose 50%.

The resulting outcome of capital outflows from Russia has been the inevitable depreciation of the ruble, due to the fact that there have not been inflow of capital entering Russia equal to, or greater than the amount leaving Russia.  So the negative net inflow of capital has caused the ruble to topple in value against a basket of currencies. The ruble has already depreciated 6.5 per cent against the US dollar this year

Russia’s economy is heavily reliant on the exports of it natural resources namely its oil and gas, which are priced in rubles. Moreover, about 50 percent of the Russian population is sucking on the state’s teat, employed either as civil servants, teachers, public health care worker, pensioners and people on benefits, all of whom rely totally on the state’s income.  A devaluation in the ruble means less income earned to pay for its large public sector.  A crash in the value of the ruble would see Putin’s budget explode. Perhaps Putin’s great danger is that he may have been budgeting for oil at over 150 USD a barrel at a higher ruble exchange rate to finance public spending   

Furthermore, the private sector is relatively underinvested and internationally uncompetitive. The Russian economy is not in a buoyant state. In 2013, Russia’s economic growth slowed to 1.3 percent, its weakest pace since Putin came to power in 2000.

Russia’s Central Bank would not want to raise interest rates in an attempt to support the ruble because this would choke private business investment by making borrowing costs more expensive, which would not be desirable.

Instead, in a desperate attempt to support the currency the Russian Central Bank decided to sell a record $11.3 billion in foreign currency to buy rubles. But it yet remains to be seen if this policy, in the long run, will be enough to halt the tide in the falling ruble. Will the Central Bank throw in the kitchen sink by selling off their gold reserves to support the ruble?  

If so this could result in downward pressure on gold prices.  

As if a depreciating ruble was not enough to worry the Central Bank, the collapse in demand for Russian debt, bonds has result in falling Russian bond prices on the secondary market and simultaneously pushed up bond yields. Secondary market bond volumes have fallen on the Moscow exchange by 43 percent.

Losses are raking up on funds heavily exposed to Russian assets. Moscow-based Prosperity Capital Management which has $3.3 billion in assets under management fund has fallen 16.2% this year.

As one hedge fund manager put it, “It's a very fast world now," said Nicolas Rousselet, head of hedge funds at Swiss-based investment firm Unigestion.  Funds have a position for "one hour, and you take it off."

Darren Winters