The Goldwatcher

Energy consumption forecast to increase by 57% by 2030. What will it cost?

If current laws and policies remain unchanged The Energy Information Administration International Energy Outlook 2007 forecasts world energy use will grow  by 57% from 2004 to 2030. Growth in non OECD countries will almost double and in OECD countries demand growth will be almost a quarter. This must surely be like a leading indicator of future demand for commodities generally.  It is also in tune with the advice on commodities from  Harvard’s Doctor Mohamed El-Erian and Pimco’s Bill Gross mentioned in the last two Goldwatcher postings

Oil Prices round $65 with  Brent crude for July having traded as high as  $71.20 in London reflect supply and demand realities.  Expect price shocks when markets react to the revelation that Mr. Ahmadinejad  is poised  to use a nuclear weapon threat within a few years and the reality of a US fleet already poised in waters near Iran.  Conflict with Iran could result in the closure of the Strait of Hormuz through which, according to the Energy Information Administration, tankers ship about 17 million barrels of crude a day.

 El-Erian on derivatives

CNBC’s three ‘master class’ interviews with Dr Mohamed El-Erian last week probed his opinions on major investing themes. Asked if he agreed with Warren Buffett that derivatives were ‘weapons of financial mass destruction’  he identified two sides to derivatives and made these points:

1: Warren Buffett’s risk alert applies when derivatives are used to lower barriers to entry for financial markets. Lower barriers can encourageo participation in financial markets like mortgages by people who should not be there. Sub prime and other exotic mortgages are essentially derivatives of mortgages. Problems in these markets now are an example of what can go wrong;

2:Generally derivatives are a ‘ tremendous tool’ for risk management that stabilize the system by sharing risk between many participants and enabling competent investors to do smarter things; and

3: For Goldwatchers the key point made was that derivatives will fuel a crisis.in a financial market if everyone wants out at the same time

As expected, Warren Buffett’s remarks must always be taken seriously. And we think so must gold as a hedge against inflation and insurance against financial market crises -  or even meltdown..

El Erian on inflation, interest rates and investing in commodities:

Two tailwinds supported low inflation for many years. Increased productivity in the US (the productivity shock) and lower manufacturing costs worldwide following access to vast new labour pools in low cost countries. Both were one time developments that have run their cousre.  Inflation is already creeping up. El-Erian advises increasing exposure to commodities. His approach to gold is that it is with commodities as he doesn’t have sufficient expert knowledge to single it out. He also expects interest rates to rise globally within the next few years. The Harvard Magazine has reported on the 16.7% annual  growth already achieved for their endowment on his watch and his investing strategies

CNBC’s ‘master class’ with  El-Erian and Pimco’s secular forum:

CNBC’s Michelle Caruso Cabrera’s interviews with Mohamed A. El-Erian last week are as good as financial and business TV get. A protégé of Pimco’s Bill Gross El-Erian’s analysis is in tune with Gross’s commentary reported in the Goldwatcher May 15 posting. Other investing themes discussed in the interviews include the emergence of a Middle class in India & China.

 The modest cost of a subscription for  CNBC programmes interviews and archives comes with a 7 day free trial.

Fears of deflation and a contrarian opportunity to invest in gold in 2001: 

According to transcripts released May 15^th in Washington and reported in Bloomberg Federal Reserve officials, including the Chairman at the time Alan Greenspan,  were concerned about deflation by November 2001. That was about a year and a half before they disclosed to the public that interest rate policy was responding to ‘an unwelcome’ fall in inflation.’

A renowned contrarian researcher and investor servicing institutional clients, Kiril Sokoloff, was concerned about deflation long before then. In March 2001 he published a report: BUY GOLD…BEFORE CENTRAL BANKS ARE FORCED INTO A MAJOR REFLATION. Noting the already tight supply demand dynamics for gold and expecting monetary reflation to fend off deflation he advised both gold and gold shares. The article is still accessible on Sokoloff’s 13D.com web site. (Click the sample reports tab on the home page then scroll down to the last report.) It’ must be one of the best contrarian calls made this century. The opportunity was almost risk free at the time. The rewards were phenomenal. And the report demystified the opportunity.

Pimco and an opportunity to invest in commodities in 2007: 

Pimco’s Bill Gross has today posted generally positive conclusions following Pimco’s annual secular forum.  Of special interest to Goldwatchers is the recommendation that :

‘ clients and other readers’ continue to diversify their asset mix with a growing percentage of commodities.’

And an article in today’s Wall Street Journal also reveals that Greenspan is now advising Pimco. Are any clues forthcoming on the question raised in the last parapraph of my May 3rd posting: ’Will a new global and financial architecture reduce the chances of  Uncle Sam being left with ’a crown on his head and not much else to show?’  We need to read more on Pimco’s secular forum before even suggesting any answers but the bond king is certainly less anxious than he was a few years ago.

# Note : A correction to this post dated 12th May has been posted and additional comment added on 15th May. 

The so called warnings to hedge funds: 

This morning I read a headline Bernanke warns Hedge Fund Billionaires on the Fox News website. According to the writer ‘in an unusual warning, the central bank waved a red flag about the growing risks in the $1.4 trillion hedge fund industry. …………the ink was barely dry on the Fed’s hedge fund warning when UBS, the biggest money manager in the world, announced that it was forced to shutter its hedge fund at a cost of more than $300 million, due to staggering losses in the sub-prime mortgage market.’

The so called warning was in remarks made yesterday at a conference on hedge funds and risk organized by the Federal Reserve Bank of Atlanta and reported on by the Chicago Sun-Times .  Referring to the collapse of Long-Term Capital Management, the hedge fund that received a $3.6 billion private bailout in 1998, Bernanke said  ’Authorities should and will try to ensure that the lapses in risk management of 1998 do not happen again’   

Last month in a speech at the New York University Law School Financial Regulation and the Invisible Hand.Bernanke addressed hedge fund regulation at some length. Here are a few points from the speech: ‘The growing market share of hedge funds has raised concerns about possible systemic risk…… the collapse of a hedge fund might come with little warning….many hedge funds are either highly leveraged or hold positions in derivatives or other assets that make their net asset positions very sensitive to changes in asset prices…..leverage also increases the risks to the broader financial system….. The failure of a highly leveraged fund ….could involve ….. heavy losses on counterparties.(that) could lead to further defaults or threaten systemically important institutions. …… market discipline can fail, as is illustrated by the hedge fund Long-Term Capital Management (LTCM), which was at the center of an episode of severe financial stress in 1998′   Its probably my fault but, after reading and re-reading Bernanke’s speech, am not sure what he is saying.

Please, Dr Bernanke, no Greenspeak

Please, Dr Bernanke, don’t start using your predecessor Alan Greenspan’s Greenspeak language. He was opaque, long winded and he used to quip ‘if you think you know what I meant you didn’t understand what I was saying.’ Markets and investors need you to say what you mean and mean what you say. Let’s cut to the chase. Is Warren Buffet right that leverage and excessive use of derivatives have made your efforts to regulate credit irrelevant? 

As a blogger on gold I am of course also being too long winded. The message is simple. When you read about a super danger  from the world’s most respected investor and risks of systemic failure from the world’s most important central banker it’s time to think about the best protection for even unlikely worst case scenarios. Gold.

Correction : 12th May 2007:

Dr. Bernanke’s speech on Financial Regulation that I found long winded and had difficulty getting to grips with  was not comment addressed to the investing community. It was addressed to students at the New York Uniersity Law School.  In this context my critical remarks were inappropriate.  Further US Treasury Secretary Paulson is chairing a White House working group addressing hedge fund issues, systemic risk and investor protection.  Bernanke is a member of that group.

Bernanke is also the keynote speaker (viia satelite) at the Federal Reserve Bank of Atlanta’s conference:‘Credit Derivatives : Where’s the risk?’ on Tuesday May 15th. There is no reference on the Bank’s website of preliminary comments from him. From the agenda it does not appear that the question whether hedge funds and the use of leverage and derivatives have impaired the Federal Reserve’s power to control credit is up for discussion..  

15th May :

Dr. Bernanke’s speech Regulation and Financial Innovation focused on managing risk with credit derivatives. . There was no comment on monetary policy, economics or the issue raised by Warren Buffet that excessive use of derivatives had made central banker’s  efforts to control consumer  credit irrelevant..

The Oracle of Omaha’s ’super danger’ warning on derivatives:

While contrarian investors buy gold when it is cheap and out of favour most investors miss contrarian opportunities and think of buying gold as crisis insurance when they expect ‘unpleasant things’ will happen.  America’s second richest man Warren Buffett, the often contrarian investor known as both the Sage and Oracle of Omaha is warning again of a financial derivatives crisis. A Bloomberg article recounts how his contrarian bets led to an increase in the value of his shares by 3,600 % since 1987. Though at times he uses them to advantage Buffett has already branded financial derivatives weapons of financial mass destruction. Now he is warning they are potentially a ’super danger’ that make the Federal Reserve’s efforts to regulate the use of credit to purchase securities ‘irrelevant a joke and an anachronism.’ He warns  ‘there will be some very unpleasant things that happen in the financial markets’ acknowledging ‘we may not know exactly where the danger begins and at what point it becomes a super danger.’

Contrarian investing icon Marc Faber’s views on the dollar and gold:

In a Forbes article published in 1999 contrarian investing icon Dr. Marc Faber went as far as telling America’s richest man Bill Gates why he should sell his Microsoft shares. At the time Microsoft shares were frothing and Bill Gates could have bought gold at about $320 with the proceeds!

In current Marc Faber commentary he sees a contrarian play buying ’the US dollar against the Euro. ‘Sentiment about the dollar’ he finds ‘is very negative and the dollar is oversold near term. This is not to say that (his)  long term negative view about the dollar  has changed but a near term bounce is probable.’  He continues to recommend the gradual accumulation of precious metals as the only asset class for which he has ‘a high degree of confidence from a long term perspective’ and ’would not hesitate to increase the exposure should precious metals correct by 10% or more.’ 

Marc Faber’s headline remarks are all widely published by the media and often  move markets.Serious investors can be informed through an annual subscription to his Doom Gloom Boom report  that costs only a nominal $200. With it comes analysis that fleshes out his investing ideas and themes with timely revisions.

Cover story hype leaves financial magazines ‘covered in shame.’

A study on cover stories as contrarian indicators published recently in The Financial Analysts Journal found:   ‘positive stories generally indicate the end of superior performance and negative news generally indicates the end of poor performance.‘   An Economist Article ‘Covered in Shame’  endorses the case for a contrarian response to journalistic hype.

# 11th May 2007 : Note on Marc Faber added to Realistic Expectations page

The bond king reveals all:

William H. Gross, ‘Bill Gross’ the bond king, founder and managing Director of Pimco, with some $700 billion in assets under management, contributes amongst the best research money can buy.Free.

Following Pimco’s  annual secular conference in 2005 he published a report on its findings titled  The strange tale of the bare bottom king  illustrated with a cartoon of the king,  looking suspiciously like the bond king himself in the guise of the famous Coppertone girl - shocked as a terrier puppy rips off her pants and reveals her bare bottom. This is how the report closes:

‘As to happy endings in the global economy and financial markets? Well some assets – high quality bonds, and certain commodities in limited supply among them – may continue to do well; other risk-oriented holdings can be pumped only a little bit further. And then? Well, given appropriate steps from government policy makers that attempt to rebalance our decidedly imbalanced global economy, we can still continue to prosper, but as with most fairy tales, the wicked witch lurks. For now we at PIMCO will be content to acknowledge our reigning King’s clothes, the poor quality of the stitchery, and the partial exposure of his bare-bottom displayed on our front cover. Stay tuned in future years. This may yet turn into a reality show that resembles not the Coppertone Girl but Uncle Sam with a crown on his head and not much else to show for his/our years of profligate consumption based upon Bretton Woods II and the leveraging of near costless finance.’ Bill Gross’s report on the 2006 secular conference is titled ‘Mission Impossible.‘

Insight on  the global and financial architecture in the years ahead will be vital for gold prospects

A post now on Pimco’s website from Managing Director Paul McCulley  gives the details of the agenda for this year’s forum: # An expert on global economic and financial trends will discuss the impact of globalization on the world’s supply chain; # A noted author and expert on political and military affairs in the Middle East will discuss the state of geopolitical and military play in the region; # a world-renowned economist will discuss the evolution of the global economic and financial architecture in the years ahead; and # an authority on China’s economy and monetary policy will discuss the country’s growth momentum and the long-term challenges China faces.

Pimco analysis and research on fixed income investing is focused by and large on  the same macroeconomic factors that affect gold. There are always dots to fill in with macroeconomic analysis. Relating fixed income based analysis to currencies, commodities and precious metals calls for a few more connections between the dots. Reviewing analysis from previous years increases the chances of making the right connections!

Of particular interest in the 2007 secular review will be commentary on whether a new global and financial architecture will reduce the chances of  Uncle Sam being left with ’a crown on his head and not much else to show.’

Marking the unhappy fourth anniversary of a botched landing with a Presidential veto: