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Germany and the Euro Bailout Fund

Germany and the Euro Bailout Fund

Europe’s Banking Swoon Gets Temporary Band-Aid

Last week, five important central banks offered one-time funding lines to large commercial banks.  Why? Access to capital from money markets was drying up and liquid first aid was needed. The commercial banks were having a hard time borrowing dollars needed to repay loans in U.S. currency made by U.S. money market funds that decided not to renew the loans.

Hitherto, U.S. money market funds had been huge lenders to large European banks. Now, bad news about Europe’s sovereign debt situation is scaring U.S. money market institutions away, even though the Europeans have offered significantly higher interest rates. The greater fear is trumping higher returns.  Greece and Italy have been stalling on implementing needed reforms, and the French banks hold a great deal of the suspect sovereign debt.   

So five central banks stepped up on behalf of the challenged commercial bank community.  The rescuers — the European Central Bank, the Bank of England, the Swiss National Bank, the Bank of Japan, and the U.S. Federal Reserve – are providing three-months’ worth of dollar loans.  To read what the Financial Times has to say about Europe’s funding follies, click this link.

http://www.ft.com/intl/cms/s/0/7fb63b78-e053-11e0-ba12-00144feabdc0.html#axzz1YgwZkqTT

 
What Lurks Inside A Major European Bank?

Many pundits believe there is yet another reason for the coordinated action of the five central banks; to help an ailing French bank in particular.  Societe Generale, the giant French bank, may be the largest contractual participant in over-the-counter (OTC) derivatives in the world.  The opaqueness of this market is a problem.  No one really knows if Societe Generale has the capital to hedge its exposure to these risky positions. 

What is known is that many hedge funds who have contracted for over the counter derivatives with Societe Generale wish to get out of the contracts. The hedge funds will have to take a discount to liquidate before the time is up on the contracts but some are willing to do that. To the extent that Societe Generale agrees to close out these contracts, it is unknown how much risk they will retain and how much they will make or lose on the contracts and the discounts.

In summary investors fear is that there is a lack of capital at many European banks due to their commitment to the sovereign debt of Greece and other stressed countries. Compounding the problem is the lack of detailed information about OTC derivative positions. Lack of information creates further fears.

Over the past five years, we have written a great deal about the risks that OTC derivatives pose.  To review our writing, go to our archives at www.guildinvestment.com and search for the word ‘derivatives’. 


Germany and the Euro Bailout Fund

German Chancellor Angela Merkel’s Christian Democratic Union party has been losing seats in the German parliament with increasing regularity. It has been assumed by us and others that German voters are growing weary of bailing out their less thrifty European neighbors that have become referred to as the PIIGS (Portugal, Italy, Ireland, Greece, and Spain).  On the surface, this development would seem bad for the prospects of more German assistance to the bailout funds.  However, it is turning out that the winners of some of the seats are not the center-right anti-European Free Democratic Party (FDP), but the more pro-European labor group, the Social Democratic Party (SPD).

To quote global macro trader Yra Harris’ thoughtful  blog Notes From The Underground , “I caution that the rise in the SPD may mean that Merkel moves to form a coalition with the pro-Euro labor group and the Europhobic FDP is losing its standing in Germany.  The movement is paving the way for Frau Merkel to get the legislation necessary to enhance the EFSF that she has promised others in the EU…Isn’t it ironic that the more Merkel loses the more probable the bailouts.”  

EFSF is the acronym for the European Financial Stability Facility.  We agree about the irony.  We also believe that Germany’s endorsement of the bailout fund would be a very positive outcome for stock markets around the globe.

Events in the coming days are sure to set off spasms of volatility in the world’s equity, currency, commodity, and bond markets. The U.S. Federal Reserve and IMF G-20 meetings take place this week. Then there’s the German parliament vote on the EFSF September 29th .  If the EFSF is passed as Yra Harris suggests, we also expect to see some kind of expanded QE from Europe.  For this and other reasons we are getting more bullish on the U.S. stock market and on the markets for some emerging countries, as well as for gold, volatility notwithstanding.

Gold Mining Stocks Are Cheap…And word is getting out

The weekend edition of the Wall Street Journal carried an article about how investors are becoming aware of the fact that the rise in the price of gold has not been reflected in gold shares. No surprise here. It’s been our belief for a while that gold shares are too cheap and have even more upside than gold at this juncture.

Last week we wrote that we plan to take profits at $1,880 / Ounce on 20 percent of our long gold position that we have had since gold sold at $325 per ounce nine years ago. The strategy is simple: to sell enough to recoup our entire cost basis in gold, and ride on the “the house’s money.”  As we explained, it is not that we are bearish on gold. We think it can move decisively higher over time. 

At the same time, we’ve grown increasingly bullish on gold mining shares. Our exuberance stems from the strong belief that gold mining shares could rise 20 percent or more without any increase in gold prices, but as gold goes higher from here the mining shares could move up even higher as well.

Historically, many big gold mining companies have done stupid things.  Many sold forward gold futures to fund their operations, thereby capping their revenues.  Then, they experienced big increases in mining costs so even with higher gold prices their profits were not able to see any substantial growth.  Some small companies unwisely financed their growth with gold loans collateralized by their future mined ounces.  This behavior has been a prescription for disaster, and many gold mining stock investors were wiped out. ETFs took market share instead. 

To be fair, not all mining companies have acted unwisely in the past.  Some companies adroitly avoided selling gold forward and then having to buy it back at higher prices. The quality companies that deserve to be owned have also avoided the big debt that eventually forces management to sell shares at low prices and excessively dilute the ownership of existing shareholders.

To analyze gold mining companies properly, smart investors need to look for the following clues:

  • operators with large current gold reserves not yet recognized by the markets,
  • operators with big potential reserves and with drilling results and geologic reports outlining newly discovered reserves.

Just as with an oil company, a gold company tends to fare well if it combines the discovery of new reserves with the ability to find a partner, buyer, or if internally it has the ability to mine and exploit reserves at a reasonable cost per ounce.  So investors should look companies with the ability to mine cheaply, or to sell the company to those who can mine cheaply.

Central Bank Gold Buying

For the first time since 1985, Europe’s central banks have now become net gold buyers.  This is a change as for several years earlier this century, the European central banks had been net sellers of gold.  Other central banks have jumped on the gold bandwagon. Very large purchases have been made by central banks in Mexico, Russia, South Korea, and Thailand in addition to large purchases by the long term buyers in China, India, and elsewhere.

Finally, according to Bloomberg News, Austria has recently limited the purchases of gold by citizens to 15,000 euros per transaction.  Austrian authorities say the reason is to prevent money laundering. Such restrictions in any country will increase demand for gold mining stocks.

Gold trading by traders often follows the trend following method. The strong trend has brought money into gold for the last 2 months is now being withdrawn by traders. The fundamentals remain strong. The current decline is just traders taking profits and a few new holders panicking. This is why we say use rallies to take profits and buy on dips.

 

Guild Global Market Commentary Widely Quoted 

We are pleased to report that hundreds of printed and electronic editions of newspapers and magazines throughout the world are picking up Guild Investment Management’s opinions.  Additionally, hundreds of investment professionals and their customers follow and quote this letter to their clients, readers, and listeners. Monty Guild and Tony Danaher are frequently quoted in the media and private research worldwide.

 

Tracking the Real Rising Cost of Living 

Many readers have inquired about our Guild Basic Needs IndexTM, a simple at-a-glance cost-of-living feature designed to track changes in the price of basic necessities in the U.S.  We created the index because the existing yardsticks used by the government, such as the Consumer Price Index (CPI) just represent spending patterns, and do not reflect the rising cost of living in America. 

 

By comparison, the Guild Basic Needs IndexTM concentrates on four fixed categories of primary and essential living needs.  They are food, clothing, and shelter, and energy (which is essential for basic heating, electricity, cooking, and transportation).

The categories and their values within the Guild Basic Needs IndexTM are fixed, unlike the government indices. There is no tampering — no seasonal adjusting, smoothing, or replacing of components.   


Mea Culpa

We were wrong to be recommending long positions on the U.S. market and the Indian market. We are withdrawing recommendation on these and are putting a sell in our remaining currency positions as the U.S. dollar is in a rally phase which could last for a few more weeks or months.

Our Humble Thanks

We thank you for reading our newsletter and look forward to hearing from you. To request information about Guild Investment Management services and offerings please call (310) 826-8600 or email us at guild@guildinvestment.com.

  Date

Date

Appreciation/Depreciation

Investment Recommended

Closed

in U.S. Dollars

Commodity Market Recommendations      
Gold 6/25/2002

Open

+448.9%

Corn 4/20/2011

8/3/201

-6.3%

Oil 2/11/2009

8/3/2011

+157.1%

Corn 12/31/2008

3/3/2011

+81.0%

Soybeans 12/31/2008

3/3/2011

+44.1%

Wheat 12/31/2008 

3/3/2011 

+35.0% 

Currency
Recommendations
     
Long      
Canadian Dollar 9/13/2010

Closed

+2.2%

Long      
Chinese Yuan 9/13/2010

Closed

+5.8%

Long      
Swiss Franc 9/13/2010

Closed

+12.1%

Long      
Brazilian Real 9/13/2010

9/1/2011

+6.4%

Long      
Singapore Dollar 9/13/2010

8/3/2011

+10.9%

Long      
Australian Dollar 9/13/2010

6/29/2011

+14.1%

Long      
Thai Baht 9/13/2010

6/22/2011

+6.5%

Short      
Japanese Yen 4/6/2011

7/27/2011

-9.7%

Short      
Japanese Yen 9/14/2010

10/20/2010

-3.3%

Equity Market
Recommendations
     
U.S. 9/14/2011

Closed

-2.3%

India 4/6/2011

Closed

-21.6%

Malaysia 6/29/2011

8/3/2011

+0.1%

U.S. 6/29/2011

8/3/2011

-4.6%

Japan 2/15/2011

8/3/2011

-9.5%

Australia 2/15/2011

6/22/2011

-0.9%

Canada 3/24/2011

6/22/2011

-7.1%

Colombia 9/13/2010

6/22/2011

+2.6%

Malaysia 4/6/2011

6/22/2011

+0.8%

Canada 12/16/2010

3/11/2011

+7.9%

U.S. 9/9/2010

3/11/2011

+18.1%

South Korea 1/6/2011

3/3/2011

-2.9%

Colombia 9/13/2010

2/2/2011

+3.9%

China 9/13/2010

1/27/2011

+5.0%

India 9/13/2010

1/6/2011

+7.9%

Chile 9/13/2010

12/16/2010

+8.9%

Indonesia 9/13/2010

12/16/2010

+9.5%

Malaysia 9/13/2010

12/16/2010

+1.3%

Peru 9/13/2010

12/16/2010

+32.2%

Singapore 9/13/2010

12/16/2010

+4.8%

Thailand 9/13/2010

12/16/2010

+11.9%

       
Bond Market
Recommendations
     
       
 30 YR Long Term      
U.S. Treasury Bond  

8/27/2010

10/20/2010

0.0%