According to the Federal
Reserve statistical release dated 12/31/2009, securities held by the Federal
Reserve increased by $1,350 billion during the 2009 calendar year. This
increase consisted of $300.6 billion of US Treasury securities, $139.6 billion
of Federal agency (Fannie Mae, Freddie Mac, etc.) debt and $909.6 billion of
mortgage-backed securities. The purchase of these securities was offset by
large reductions in other items on the Federal Reserve balance sheet: term
auction credit, other loans, commercial paper and central bank liquidity swaps –
categories which expanded during the financial crisis of 2008.
The level of debt in the US
economy has reached untenable levels. Rob Arnott, Chairman of Research
Affiliates, recently wrote that “at all levels, federal, state, local and GSEs,
the total public debt is now at 141% of GDP. That puts the United States in
some elite company – only Japan, Lebanon, and Zimbabwe are higher.” When you
add household debt (highest in the world at 99% of GDP) and corporate debt
(highest in the world at 317% of GDP), the total debt is 557% of GDP. If you
add the federal government’s unfunded portion of entitlement programs, the total
reaches 840% of GDP. If the projected federal and state government deficits for
the next several years are anywhere close to accurate, the US debt/GDP ratio
will go even higher.
According to Oppenheimer
Capital’s mid-December 2009 estimate, the US Treasury expects to sell $1.91
trillion of debt (net of maturities) for the calendar year 2010, compared to
$1.56 trillion for 2009 and $0.37 trillion for 2008. The trillion dollar
question for 2010 is who will be the big buyers of US Treasury debt? The
Federal Reserve could sell a portion of its large portfolio of mortgage-backed
securities (MBS) to provide a source of funds to purchase US Treasury debt but
investor appetite for MBS is poor and it would increase long-term interest
rates. If the Fed purchases large amounts of US Treasury debt without selling
other assets, there will be another major expansion of the Fed balance sheet,
which will raise concerns about the value of the currency. One way or another,
the US Treasury’s massive issuance of debt is likely to be problematic for the
financial markets in 2010.
Balestra Capital has
maintained a negative stance on the financial markets with the exception of
precious metals and high-grade bonds. The firm issued a November bulletin in
which they provided their assessment and criticism of Federal Reserve and
government policy:
We are no longer in a golden age. We are in
trouble. The correction of economic and social distortions that have built up
over the past twenty years is underway. It is creating serious ongoing economic
and social problems, and despite the reassurances of central bankers and
investment pundits, there is no easy way to deal with it. The Fed’s standard
remedy for treating recessions by lowering interest rates and boosting liquidity
has been seriously abused since 1982. The normal clearing function of
recessions was aborted by an over-reactive monetary intervention in every case,
while fiscal irresponsibility at all levels of government mounted unimpeded, and
regulators were curtailed, reviled or fired. These policies are not a template
for remediation. As we wrote in a recent Balestra Bulletin: for policymakers to
expect the most over-borrowed and over-spent consumers in the world to borrow
and spend more in order to carry us out of this recession is foolishness.
The economic policies of the
US Government and the Federal Reserve Bank show a remarkable lack of
imagination. Their only prescription for improving the economy seems to be
larger fiscal deficits and lending to the banking industry and other favored
groups at near-zero interest rates. US policy makers have ignored the warnings
and protests of financial commentators and foreign governments.
Several foreign governments
have openly declared their dissatisfaction with the US dollar as a reserve
currency and declared their intention to replace the US dollar as the world’s
primary reserve currency. Given a reduced US trade deficit which reduces demand
for US Treasury securities by trading partners and the huge amount of US
Treasury debt to be financed, 2010 may be the year when the US dollar loses its
currency reserve status. Damon Vickers, Chief Investment Officer at Nine Points
Capital Partners, summed up his thoughts about the currency markets in November
as follows: “We (in the US) don’t have resources….Countries that have resources
– the Brazils, the Canadas, Australia – their currencies are doing well….They
export real things. The United States exports promises and pretty paper.” And
foreigners who have been accumulating those promises and pretty paper have
become wary.
As we begin the year, I
expect to maintain a diversified portfolio consisting of precious metal ETFs,
foreign government bonds, and foreign stocks. I expect to remain underweighted
in US stocks and bonds for the foreseeable future. Cash levels will most likely
remain high for moderate risk portfolios until interest rates move higher.
Additions
Pembina Pipeline Income Fund
(PMBIF) transports crude oil and natural gas liquids produced in Western Canada,
owns and operates oil sands pipelines, and has a growing presence in midstream
and gas services. At the time of purchase, PMBIF had a dividend yield of 10%.
The Fund’s management believes that it should be able to maintain its
distribution level after conversion to a corporation.
Enerplus Resources Fund (ERF)
is a Canadian investment trust that owns crude oil and natural gas properties in
Western Canada and the United States. ERF has a current dividend yield of 9.0%.
Chemtrade Logistics Inc. (CGIFF)
is one of the world’s largest suppliers of sulphuric acid, liquid sulphur
dioxide and sodium hydrosulphite, and a leading processor of spent acid.
Chemtrade is also a regional supplier of sulphur, sodium chlorate, phosphorous
pentasulphide, and zinc oxide. Major sources of demand for their products are
the fertilizer and paper industries. Chemtrade sells for 7.3X 2009 estimated
earnings and has a current dividend yield of 10.9%.
The UltraShort 20+ Year
Treasury ProShares (TBT) was purchased as a hedge against higher interest
rates. The exchange-traded fund seeks daily investment results which correspond
to twice the inverse of the daily performance of the Barclays Capital 20+ Year
U.S. Treasury index.
Bonds of the European Bank
of Reconstruction and Development (9.50% due 11/6/2013) were purchased at a
price slightly above par. The bonds are denominated in the Brazilian real and
have a credit rating of AAA.
Artis Real Estate Investment
Trust (ARESF) is a Canadian REIT which has most of its properties in Alberta and
Manitoba. Property types include office, industrial and retail. The overall
occupancy and committed rate is 97.3%. ARESF sells for about 7X 2009 estimated
funds from operations and has a current dividend yield of 9.6%.
Deletions
Advantage Energy Income Fund
(AAV) was sold for all moderate risk accounts and positions were reduced for
tactical allocation accounts. AAV discontinued distributions to shareholders
early in 2009 in order to increase capital expenditures and develop properties
at a faster pace. Proceeds will be used to purchase other equities that have a
higher dividend yield.
The Western Assets Emerging
Markets Fund (ESD) was sold as a precaution. If there is a decline in the
financial markets accompanied by deleveraging, ESD is likely to decline in price
and sell at a larger discount to net asset value. Most of the fund’s bond
holdings are denominated in US dollars.
CurrencyShares Swiss Franc
Trust (FXF) was sold. FXF does not currently pay an income dividend to
shareholders. Proceeds will be used to purchase other foreign securities that
can generate more income.
American Strategic Income
Portfolio Inc. (ASP) was sold. The discount to net asset value has recently
declined to less than 10% of net asset value. As commercial real estate
properties have experienced more problems in the U.S., the potential for loan
defaults has increased.
The Canada Government bond
(5.25% due 6/1/2012) was sold at a yield-to-maturity of 1.75%. Portfolios now
hold several Canadian stocks due to their high dividend yields and the
allocation to Canadian stocks is likely to increase in the future. Proceeds
from the sale of the bond will be used to achieve more geographic
diversification.
Updates
All account positions now
have the maximum allocation authorized by the investment guidelines for
commodity related funds - 10% for moderate risk accounts and 20% for tactical
allocation accounts. Accounts hold a combination of three ETFs that hold
precious metals in vaults: SPDR Gold Shares (GLD), ETFS Gold Trust (SGOL), and
iShares Silver Trust (SLV). SGOL replaced a portion of the GLD position during
the fourth quarter in order to have more than one custodian/vault location for
gold. The custodian for GLD is HSBC Bank USA and its vault is located in
London. The custodian for SGOL is JP Morgan Chase Bank and its vault is located
in Zurich, Switzerland.
If you have any questions
regarding your accounts, please contact me.
Sincerely,
Robert G. Kahl
CFA, CPA, MBA
Sabino
Investment Management, L.L.C.