Investments for 2012

Investors are worried. On one had inflation theatens to reduce the value of the money holdings and on the other hand, they may lose money if they invest. Stocks can be volatile and has not plumbed to the depths of the past financial crisis of 2008 OF WHICH THE WORLD HAS NOT RESOLVED. Banks in US continues to pay obscene bonuses , Companies are robbed dry by their CEO and senior executives who speculate with companies's money to get huge bonus. Tom Cook who replace Steve Jobs at Apple  is said to receive an annual compensation package in excess of US$300 million.

Banks sells investment products with layers of hidden fees and commissions. They are ruthless in their pursuit of profitability. So what to invest in? Bonds may decline in value once interest rates spikes up. The recent high interests paid by the Italian Government shows that interest can shoot to over 7%. Imagine you had a year ago bought Italian sovereign bonds with a coupon rate of 3.5%.  The increase in coupon rate would cause your bond to drop in value substantially.

Properties in Singapore are now in suspended animation where the direction up or down is not clear. If we cannot invest in stocks, hedge funds, private equities , bonds or properties what can we invest in?  We can invest in shares of companies with good long term prospects. This means we must be prepared to ride the down cycle and hold on to these assets. Think of yourself as not holding stocks but hard assets. Assets can be physical or intangible as in intellectual properties.

What does the world need in the longer term  whether there is a financial crisis or not? The world population is increasing and the increasing middle class in China, India and Indonesia will eat more meat , fish and consume more milk. I would invest in companies that have links , the more direct the better, to food production. If I had the funds, I would start a private equity fund investing in companies that are into producing more food with less inputs. There are agricultural commodities funds but one needs to look beyond the name to see what they actually invest in. Many commodities funds don't invest in hard assets but in options which fluctuate with the prices. Avoid these.

Market Vector Agricultural ETF invests in large companies related to agribusiness. It has holdings in Potash Corporation, the world 's largest manfacturer of fertilisers, Mosanto which is well known for its genetically modified seeds  and claims that it can increase yields dramatically, Deere & Company which makes large farm machines and Wilmar, one of the largest palm oil plantation companies in the world. Its expense ratio is 0.56% and if you hold for four years, your holding costs is less than 3% .  In four years, the world will have recovered from the debt problems and with the increasing wealth of China and India, agribusiness would be the next big HIT.

Rather than buy gold we can invest in Market Vectors Gold Miners ETF.  It has a low expense ratio of 0.53% and invests in gold mining companies such as  Barrick Gold Corporation, Newmont Mining Corporation and Goldcorp  Inc. As paper currencies devalue, gold mining companies will appreciate due to their assets in gold. Now that gold has dropped  to US$1,640, off its high of US$1,800,  this could be a good time to invest inn gold mining companies.

I am not promoting Market Vectors ETFs and don't even know how we can buy them since they are a US based company .I am just using them as an example of low expense ratio ETFs that invest in companies with solid long term assets such as agribusiness and gold. You can look for other similiar ETFs to invest in as I am sure they Market Vectors are not the only one with ETFs in oil , gold and agribusiness.

The final recommendation is Market Vectors Oil Service ETF. This ETF invests in companies that service the oil industry such as Halliburton, Schlumberger and  Baker Hughes. If you think oil is getting scarce and if you believe that oil production has peaked and there is a need to look for new oil fields in areas that are hard to drill, oil service companies will be a good bet.

These three recomendations are not instant hits but safe bets that in two to three years time, may give you more than 10% annualised yield!  These are "hard core" companies that will not go broke, or be over-leveraged because of speculative investments. They have good residual value regardless of the market outlook. The three sectors are in food ( we need to eat) and energy ( we need to keep our homes warm or cool and our cars running!). They are the basic necessities the world needs. Gold is a hedge to protect against rapid inflation or devaluation of paper currencies.

Geopolitics and Regional Currencies

The new weapon is currency, This is the new WMD that could have vast impact on a globalized world. The Cold War has not ended but has morphed into a war fought with money, energy and commodities. Indeed a top general from Europe forecasted that Third World War will be fought over water. Wars, whether hot or cold, are about countries trying to protect themselves and gain advantages over other countries. That is why we have trade pacts and G7, G20, ASEAN and all manner of meetings between heads of states. Each country tries to position itself to gain by forming blocs of all kinds.

Five major players are in this competition . USA, Europe,BRICS, pro-USA Middle East, anti-USA bloc. Each party is in the competition for survival. USA and Europe faces large and growing unemployment and massive debts. BRICS wants to protects its reserves especially US Treasury Holdings and want to improve living standards of its people . Oil rich Middle East has declining oil outputs and may fall back on its reserves to sustain its lifestyle. Anti-USA ENTITIES want nothing more than the collapse of USA or a toothless USA.

In simple terms, it is a battle between the haves and have-nots. The have-nots are countries with massive debts and need to continue to borrow .Like drug addicts, they cannot face the withdrawal pains of not having easy either by borrowing or printing. The haves are those with large reserves , lots of which Is in US dollars which faces steady devaluation. Both parties are locked in a fatal embrace and this year will see a more rapid unlocking of this embrace.

The most obvious unlocking is to stop using US dollar in international trade. Countries have SWAP agreements which enable them to trade using a regional currency. Four regional currencies may appear, the Russian ruble, the Chinese Yuan, Euro and the SDRs of the IMF. Japan is too fearful of the USA , it's political leaders too weak and fragmented to be a regional currency.
Russia will try to persuade Ukraine, Central Asia and Eastern Europe to use the ruble. China will corner Africa and Latin America and even Middle East to use the yuan or the SDRS. Euro will continue to be used by its member states. There already exists various SWAP agreements to allow trade between different currencies without the US dollar.

What this means is that trillions of US dollars will go back to America causing high inflation.It is like a man who eat excessively but his friends get fat , not him. The more he gorge himself, the fatter his friends became. He enjoys all the pleasures of eating and his friends suffer from its effects. Imagine that one day, all the fat accumulated ny his friends suddenly returns to this glutton. Imagine the impact on the glutton even is 20 percent of all fat accumulated on his behalf by his friends is returned to him! That glutton has a name.Hebis called America and his friends are called Japan, China, Russia and Brazil.

Most of these arrangements will be done in secret or with little publicity. We don't get to read it or even understand its importance as the world media covers US presidential elections , Euro debt crisis and the Arab Spring. But momentum is slowing building and like the bamboo, regional currencies suddenly become the talk of the town. It won't be a global catastrophe except for those with US dollars, but there will be confusion by idiots who cannot envision a world where US dollar is no longer the world's reserve currency.

It is good for the world even for America. Take the glutton example. Isn't it better for each country to face the effects of own monetary policies rather than defer the bad effects by temporarily transferring it to others? Not being the world reserve currency will impose fiscal discipline on American politicians who seem to think that it can print and borrow money ad infinitum.

Investors who understand the above stands heads over shoulders above those who blindly follow trends and fashion based on the assumption that US dollar wil be strong as always.

2012 The End of Paper Money

World war 3 has begun but few people recognized it because it is a war not fought with guns and bombs but with currency manipulations. In a world with a shrinking wealth pie, Government scrambled to keep their economies competitive. Sadly, rather than look at long term solutions, most Government goes order the quick fix , which is to devalue their currency. A country exports more when it makes products that are desired by the rest of the world. China produces low cost goods at rock bottom prices by having low wages, ignoring pollution and seizing peasant lands for peanuts . Germany produces expensive quality goods likes its BMW cars through design and manufacturing discipline. But a country with high wages and not enough quality goods and services will end up earning less. This is not bad as lower earnings will result is lower wages and eventually the country will be competitive again.

The problem is the citizens cannot take the pain of earning less . To make up for the deficit in export earnings , the Government spends more. Everyone is happy as the gravy train continues to roll. The problem is that Governments borrow or print money out of the air to sustain the increased expenditure without raising taxes. Raising taxes would mean the people have less to send which is what the Government wants to avoid! But for the time being it is party time until Government either can no longer print money or borrow .

They cannot borrow because lenders are too nervous and believe the borrower would not be able to pay them back. This is amazing as we are not referring to an individual or company but a Government. This lack of trust means lenders are willing to lend only at high interest rates but high interest rates mean the Government would be even less likely to repay debts. This leaves the second option of printing money. Unless the currency is used outside the country, the printed money would return to the country causing inflation . Inflation is when too much money chase after too few assets.

Inflation is political dynamite where there is a large section of the population who are poor. Food prices goes up and the poor starts to protest as they find they can afford less and less food. When a country is awash with money, the rich can borrow more to invest in stocks and properties. The rise in stock and properties benefit the rich while the poor earns the same but has to pay more for food. From China to Africa, political instability is one of the side effects of inflation especially when it is not matched by rising wages at the lower end.

Even in America, the Occupy Wallstreet movement is a protest by the average America against rising cost of living. The US Government wants China to revalue the yuan upwards but this will ake imports more expensive. When before there is a choice of the more expensive locally made product or the cheaper imported product, there is no choice for the Americans since most of the consumer products they want are imported. A rising yuan will increase the cost of imported goods which means inflation will be higher. The American will have to pay more for his clothes, shoes, computers and TVs. They will be unhappy and will express their unhappiness at the coming Presidential elections.

There is no short term solutions and in democratic countries where elections are held every four years , no politician wants to commit suicide by adopting painful long term solutions. So the money printing and the debasement of fiat currencies on a global basis continues until one or more countries get knocked out. Greece for example cannot continue its party since it cannot borrow excessively anymore. America may find that quantitative easinf increases the cost of living and becomes politically untenable. I think the world will continue to debase paper currencies as this is the only option left for Governments.

Fiat Money

Wikipedia defines fiat money as money declared by governments to be legal tender and are issued without any backing of state assets. All national currencies today like the US dollar, Euro and Singapore dollar are fiat money. Many people still believes government cannot print money and must have equivalent amount of gold to back up the money it issues. On Augst 15, 1971 the US government under President Richard Nixon terminated the convertability of dollar into gold. The Bretton Woods systems officially ended and the US dollar became a fiat currency backed by nothing except the promise of the Federal Government!

Fiat money is paper money with no intrinsic value. It is not backed by gold or silver only by faith in the issuing authority. Government issues bonds which are accepted by banks as if it were a genuine tangible asset or an actual deposit. The holder of a Government bond believes he has a claim on a real asset when in fact there are more claims outstanding than real assets! Fiat money offers an easy short term solutions to Governments who spend more than they receive in taxes. Just print the money by issuing Government bonds.

The US Government has this year to issue $2.35 trillion as Treasuries bonds. China and Japan used to buy huge amounts of these bonds but of late they have reduced their purchases and the amount of Treasury bonds has increased by more than what these two and other countries can buy. The Federal Reserve has stepped in to buy these Treasuries! On 4 Nov 2010, the Federal Reserve has said it will buy an additional US$600 billion of Treasuries. Where did the Federal Reserve gets the money or assets to buy these Treasuries? Amazingly it is conjured out of thin air as Congress has given the Feds the power to create money out of nothing. This has created huge amounts of money and in order to maintain exchange rates equilibrium, other countries has also created fiat money to offset this huge increase from the US. The world is flooded with money which is one reason why assets are increasing in price from commodities like gold, silver, oil to properties.

This exploding US National Debt has serious ramifications on the world's economic stability and asset prices. Investments is not limited to a particular share or even how a country is run but globalisation means we have to understand how much fiat money Governments in USA, Europe, Japan and China are creating. Fiat money will eventually lead to massive inflation which devalues money and increases the cost of assets relative to paper currencies.

What to make of sovereign debts

I was told that developed countries in 2009 issued US$12 trillion worth of bonds. It is hard to imagine what this $12 trillion means. Sometimes numbers are so large that they become meaningless because we simply cannot grasp what they mean. At US$1,100 per ounce, one trillion USD buys 25,000 tons of gold. Well 12 trillion buys 300,000 tons of gold! But this comparison is meaningless as most of us do not deal in gold except for a few petty grams of gold trinkets here and there. Let us put this 300,000 tons in perspective. The annual gold production from mines is about 2,400 tons . Developed countries have issued money worth 125 years supply of gold in just one year!

The value of gold can be seen from this simple example. Gold supply is 2400 tons per year but money supply in just 2009 is equal to 300,000 tons or 125 times the annual gold output from all mines. If paper currencies from developed countries multiplies 125 times faster than gold , what do you think will be the value of gold relative to paper currencies?

Interestingly this time the debt is not issued by developing countries but by developed countries with matured economies and presumably run by matured finance ministers. This incredible amount of debt will mean either the countries have to increase taxes, reduce spending or simply print more money. The last alternative seems to be politically the most attractive. When countries issue fiat money in large quantities, inflation will rear its ugly head.

Here is what I believe will happen . Asian currencies or those countries will less debt will have their exchange rates increased relative to those countries with huge debts. Some may think Asian Governments will keep their exchange rate low in order to remain competitive but to do so will be to invite inflation into their own countries. The only way to retain an exchange rate is to follow your neighbours. If the print money, you simply have to follow suit. There will be a period of confusion , of fear but eventually everyone will settle on USA dollar being on par with a Singapore dollar and one Sterling pound is below one Singapore dollar. It is basically a simple arithmetic equation. The more money one prints, the lower the value of that money!

China will at last increase the exchange rate of the yuan vis a vis the US dollar when she realises that she will remain competitive even though the yuan appreciates 50% or even 100%! Manufacturers in USA and Europe are ten to twenty times less cost effective than a China manufacturer and so even a 100% increase in the yuan vis a vis the US dollar will not affect China's competitiveness. If all Asian and BRIC countries currencies appreciates in tandem, China's competitiveness will not be affected.

What will happen is that consumers in Asia and BRIC countries will feel "rich' and this will trigger a consumer boom for Western products. What happens is an exchange of goods by different sets of consumers. Low and middle class Americans and Europeans will buy cheap goods from China while affluent Chinese will buy luxury goods from the West. There will be more tourists from Asia visiting Europe and USA and hence a more equitable world economy will ensue.

Now it is like a person having a severe tummyache. He needs to vormit out the poison in order to feel better. Asia must be brave and accept a higher exchange rate for future stability and not be fearful that higher exchange rates will make their exports uncompetitive. Get the poison of low echange rates out of the way. My wife bought a rechargeable torchlight from China for S$2.00. There is absolutely no way any one in Europe or USA can make that torchlight for S$4.00 or even S$10.00. So let us not worry about high exchange rate and allow our currencies to appreciate and enjoy life! We can have cheaper US steaks and French wine so let's be sensible and do what needs to be done

Is gold a better investment than property?

In 1970, the price of gold is US$34.94 per ounce. Today it is around US$1120 per ounce. This is a 32 times increase since 1970. Imagine you had bought a house in Henry Park , a good district 10 area in Singapore for S$70,000 . Today it is selling for S$1.2 million . You think it is a fantastic investment seeing the price goes up from $70,000 to $1.2 million. In 1970, one US dollar buys $3.06 Singapore dollars. Gold price of US$34.94 is therefore S$107. Today the US dollar is 1.40 and one ounce of gold cost S$1,568.

$70,000 divide by $107 gives 2,222 ounces of gold and this is the amount of gold we get in 1970 for S$70,000. Today S$1.2 million divide by $1,568 gives us 2,987 ounces of gold. This is a miserable 34.4% increase after almost 40 years! That is very poor 0.74% per annum increase over a period of 40 years. Thus while in Singapore dollars, we see a decent 7.36% increase per annum , when we look at the price in terms of gold, we see a miserly 0.74% annual increase. THIS MEANS THAT THE SINGAPORE DOLLAR HAS DEVALUED SIGNIFICANTLY OVER THE PAST 40 YEARS!

Singaporeans who are estatic about their properties and the gains they make should recalculate their value in terms of gold. Gold it seems is a very good long term investment. If we use to buy gold with the $70,000 in 1970, we will have 2,222 ounces. Selling the gold at S$1,568 per ounce will get us S$3,484,096. If instead of buying the terrace house at Henry Park, and had he invested in gold, he would reap earn a huge S$3,414,096 in capital gains. Of course during the period the house could be rented but still the rent would not cover the difference of S$2,284,096.

If gold touches US$2,000 per ounce, or S$2,800, then S$1,200,000 will buy even less gold or a mere 428 ounce. If we sell the house for S$1.2 millon, it means we will in fact be taking a hefty 80% hair cut from our investment in terms of gold. There is a psychological factor here. Few people had invested in gold but most adults would have at some point in their life ad bought or considered buying properties. Today that same house in Henry Park that sells for S$1.2m cannot possibly be sold for S$3.4 million. If we ask S$3.4 million for a 2,000 sq ft terrace house, we will be laughed as mad or totally unrealistic in our expectations. There is less resistance to buying gold at US$2000 per ounce as compared to buying that house for $3.4 million.

Gold mania is far more possible than property mania. Foreign investors cannot buy landed property while there is no restriction for anyone buying gold! Therefore as an investor now perhaps is a good time to invest in gold.

Fundamentals will prevail

The market has rallied and people are optimistic about the greenshoots. But what about the blackshoots which are the opposite to the greenshoots? GM has filed for bankruptcy and the new GM will mean closure of some factories and the loss of thousands of jobs. In any other time, such news would have a negative impact on the US Stock market. But it seems some kind of immunity to bad news have set in and the fact that the US Government has stepped in to "rescue" GM is now treated as good news.

GM is like a sick old man and pumping full of vitamins (money) is not going to revitalise the company. Thousands of managers, supervisors and those who made GM the way it was, remains with the company.Will they change their way of working, will they be suddenly more cost conscious, more creative and more efficient? Possible but very unlikely. They need a boss like Jack Welch , or someone even tougher than Jack to shake up the management and replace the management layer with fresh blood. The fact that no private investors are willing to jump in and take over shows that they know one cannot revitalise a sick old man. With the US Government, union and bondholders being major shareholders, I can imagine how impossible it would be for the board to operate!

With GM , AIG. Fannie Mae and Freddie Mac, the US Government has ended up as owners of large corporate entities. Running a company is like a Viking ship. You need strong and forceful leadership to ensure everyone pulls in the same direction. The US Government cannot provide this kind of leadership and the end result will be a slow decline to lower productivity and even higher losses. Government owned companies in the past has never performed so why should it be different this time around? Britain used to nationalised its major industries and have learned to let them go. The best thing is the hardest to do. Let them all fail and let the marketplace adjusts itself. Failure is not necessarily bad. It opens up opportunities for smaller firms to move into the space vacated by these sick giants. Smaller and more efficient firms will gain market share and in turn create more employment.

The impact of GM closure of factories will have greater impact especially when the number of jobless is already high. The focus seems to be on minimising the impact of negative events such as managing the bankruptcies of GM and Chrysler. There is too much of an eagerness to return to the good old days of double digits return on all sorts of investments. There is a need to reduce consumption, to increase and encourage savings. Interest rates should be high to encourage more savings so that these savings and not money created out of thin air by the US Goernment can be used to reinvest in businesses. If a person lost his savings in a bad investment, he should start to save again to rebuild his nest egg rather than continue spending.

The approach should be bottoms up. Take care of the consumers and businesses will take care of iself. Now it seems the mantra is take care of businesses and it will take care of consumers! The consumer must comes first. He must learn to save more and spend less. Saving more will rebuild capital that America so desperately needed. To keep interest rate low is to punish the consumer. Any business that solely relies on low interest to survive and compete is not a healthy business. It should be able to make money from its equity capital and not from loans from banks. A company with an equity capital of $100 million and makes $10 million profit is earning 10% on its equity. If it borrows $100 million and makes $10 million, its return on capital is hlaved to 5%.
The policy of keeping interest rates low to help businesses is flawed. Higher interest will encourage more savings and some of these savings may end up as equity investments which means companies need not even pay interest since it is equity capital. Without savings, consumer have no money to invest in shares and companies have to revert to the more expensive alternative of borrowing.

The huge amount of debt incurred by US Government and the huge amount of printed money it created will come to haunt it in the years to come. Future generations of Americans will find they have to pay more taxes and suffer a lower standard of living. America will no longer be the consumer capital of the world. It will behave like the son of a rich man who has gone bankrupt. There will be years of denial and Americans will continue to hope and believe that its former glory days can be restored.

America has one trump card up its sleeve. It can spend less on its military. Under President GW Bush the 2009 defence budget is US$515 billion. This is ten times higher than Russia's defence budget. America can trim its defence budget to $200 billion and still spend many times more than any other country. It can save trillions over the next decade if it is willing to pare down its military spending. When Obama starts to reduce the number of trrops stationed overseas, troops not only from Iraq but Germany (56,200 soldiers) ,Japan (33,122 soldiers) and Korea(26,339) soldiers, we will know that they are cutting the defence budget out of sheer necessity. All empires end because they did not have the financial resources to maintain their massive armies. The fall of the Roman Empire is because it could not maintain its soldiers to defend itself. This reduction in military spending will give America the space to recover economically. To maintain its huge military bases overseas is like a bankrupt rich man who insists on keeping its mansions in ten countries.

The fundamental of economics is that money cannot be created out of thin air without long term consequences. Sure there may be no short term consequences but in time, the consequences will be felt. To maintain a huge defence budget in the face of its current huge budget deficit is not to face reality . We will watch and see if the Obama's administration has the courage to face reality or prefers to believe in Hollywood's kind of miracles.