Crescat

Fears over the “fiscal cliff” present an opportunity to position for and capitalize on Crescat’s macroeconomic investment themes that will play out over the next several years.

The Global Debt-to-GDP Bubble is being resolved, not with deflationary debt deleveraging, but with nominal economic growth from good old fashioned Keynesian fiscal and monetary stimulus, i.e., deficit spending and money printing, as well as from competitive market driven forces.

In the U.S., the Fed’s QE4 and interest rate suppression policies will provide more than enough monetary stimulus to offset any impending fiscal restraint to drive ongoing nominal GDP expansion. Even with the inefficiencies of government intervention in the markets and the economy, the invisible hand of self-motivated economic participants will continue to drive innovation and real economic growth. We see this growth today with respect to Crescat’s macro themes: New Oil and Gas Resources, Digital Evolution, Nanoscale, and the U.S. Housing and Banking Recovery.

There is a battle going on between deflationary and inflationary forces in the economy. There is a deflationary cognitive bias in the U.S. capital markets today that manifests as a high equity risk premium, or risk aversion to equities as compared to cash and bonds.  This risk aversion is in no small part driven by the aftershock and debt overhang that remain after two 50% stock market declines and a housing bust in the first decade of the millennium. Deflationary concerns are being heightened once again by the threat of increased taxes and reduced growth in government spending as a result of a political stalemate over the budget. What these deflationary concerns have in common is a weak outlook for economic growth.

However, there are also deflationary forces at work today that are positive for the economic growth outlook. These result from competition and innovation, particularly with respect to Crescat’s New Oil and Gas Resources and Digital Evolution themes.

On the inflationary side, there is one pre-dominant force at work, the extraordinary monetary stimulus being provided by the Federal Reserve and other global central banks, as represented by Crescat’s ongoing Global Fiat Currency Debasement theme. Central banks have proven more than capable of creating enough liquidity to avert the deflationary debt deleveraging spiral.

The good news is that for the intermediate term, we believe we are at a point in the economic cycle where the deflationary and inflationary forces are counterbalancing each other effectively enough to allow market participants to get on with the business of lifting the economy out of The Great Recession.  As a result, we see continued earnings growth, ongoing low interest rates, higher P/E multiples for stocks (a declining equity risk premium), improving unemployment, and sooner or later a constructive compromise over tax hikes and spending moderation in Washington. These conditions can hold for as long as inflation expectations can be reasonably held in check relative to true inflation, a condition that could remain for a time even under ultimately rising interest rates.

It is a Raging Bull Thesis for Crescat’s investment strategies over the next several years. Crescat employs a dynamic and reflexive investment process based on Top Down Macroeconomic Themes, Bottom-Up Data Driven Analysis, and Pro-Active Investment Execution to capitalize on and hedge against global imbalances in the markets.

The biggest risk to the Raging Bull Thesis for stocks and the economy is if market participants adjust their inflation expectations upward too rapidly. Stimulative monetary policy can only be effective when true inflation is higher than perceived inflation. For the time being, that definitively remains the case.  

Crescat’s composite performance reports through November in compliance with Global Investment Performance Standards (GIPS®) are now available:

Crescat Large Cap

The Crescat Large Cap Composite was up 1.3% net of fees in November 2012 bringing its year-to-date performance up to 9.8% net of fees. Since inception in January 1999 through November 2012, the Composite is up 300.2% net of fees compared to a 48.6% for the S&P 500.

See Crescat’s latest Macroeconomic Research Letter that lays out the Resolution of the Global Debt-to-GDP Bubble and Raging Bull Investment Thesis.

Please contact us at info@crescat.net if you would like to get more information on Crescat’s investment strategies or to see a complete firm presentation. 

Happy Holidays!

Sincerely,
Kevin C. Smith, CFA
Managing Partner, Chief Investment Officer

Posted: December 17, 2012 by Kevin S. (Digital Evolution, Global Debt-To-GDP Resolution, Global Fiat Currency Crisis, Nanoscale, New Energy Resources, Raging Bull Thesis, U.S. Housing Recovery)
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Crescat Macro Letter 2012 1203: “We are encouraged at the prospects in the intermediate term for real economic growth with only moderate inflation, a macro environment that could definitively lift the economy out of The Great Recession. The conglomeration of Crescat macroeconomic themes, including New Oil and Gas Resources, Nanoscale, Digital Evolution, U.S. Housing Recovery, and Global Fiat Currency Debasement leads to an intermediate term Raging Bull Thesis for U.S. stocks…

The ‘fiscal cliff’ is perhaps the most advertised pending recession in U.S. history, but it appears to us to be a bear trap for investors. The fiscal cliff is a straw man set up by policy makers to be knocked down with ongoing deficit spending, interest rates suppression, monetization of debt, and the surreptitious inflation tax. It is a bipartisan economic deal that is already done and in full swing…”

Posted: December 3, 2012 by Kevin S. (Aussie Housing Bubble, China Real Estate Bubble, Digital Evolution, Global Debt-To-GDP Resolution, Nanoscale, New Energy Resources, Raging Bull Thesis, U.S. Housing Recovery)
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In June, one of the largest UK and global banks, Barclays PLC, admitted to manipulating LIBOR interest rates in a settlement with the US Justice Department. The LIBOR scandal is significant because according to the Bank for International Settlements, there are $708 trillion in off balance sheet notional value of derivatives in the global banking system, 900% of world GDP. The vast majority of these derivatives are interest rate swaps tied to LIBOR. Barclays’ admission of interest rate rigging implicates other major banks and is blood in the water for attorneys representing many parties.

Interest rate manipulation by the Fed and the rest of the world’s central banks is perfectly legal of course. It is standard operating procedure in support of otherwise insolvent large member banks and governments around the world. Interest rate manipulation is not legal at the bank level however, unless authorized by central banks. The problem is that it has been going on for so long that it has allowed fiat currency, debt, and derivative bubbles to grow to unsustainable historic proportions. With the proliferation of LIBOR lawsuits, the sea might be changing toward some sort of unwind.

The shocking notional value of off balance sheet derivatives reported by the BIS to date may prove best as an estimate of the amount of money printing in today’s dollars that will be needed to bail out the global financial system, its sovereigns, and its starving populations from the consequences of these bubbles.

Current investment themes and positioning (subject to change):

Global Fiat Currency Crisis. Long precious metals and related miners and royalty trusts. Short fiat currencies including the euro, yen, and Australian dollar.

China Infrastructure Bubble. China government led investment in fixed assets has been overdone. Short Chinese equities, short iron ore industrial commodity producers, short copper. Short Australia, Brazil.

New Energy Resources. Production of tight oil and gas from new technologies is booming. Long oil and gas pipeline and utility infrastructure in U.S. Short select integrated and E&Ps.

Debt bubble.  Have backed away from outright shorts of interest rate securities due to interest rate manipulation. Looking opportunistically at re-entry on true unwind. Still have serious scars, LIBOR puts in one fund.

U.S. Nominal GDP Expansion. Favors owning great companies with great products and services in a broad variety of important industries that will survive and even thrive in an inflationary period whether through interest rate suppression, competitive currency devaluation, or outright money printing. Own stocks in agricultural chemicals, pharmaceuticals, industrials, food, credit cards, technology, telecommunications.

Posted: July 17, 2012 by Kevin S. (China Real Estate Bubble, Fixed Income Bubble, Global Fiat Currency Crisis, New Energy Resources, U.S. Nominal GDP Expansion)
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• Global Fiat Currency Debasement: With historically high and unsustainable global debt to GDP levels across the world, we believe central banks will continue their attempts to forestall sovereign debt and banking crises, stimulate the economy, and fight deflation by engineering negative real interest rates, monetizing debts, and working in cahoots with sovereigns to understate true and rising inflation. In the end, it equates to continued global fiat currency debasement relative to precious metals as we have been right in foretelling for years. We believe there is still much to play out in favor of hard money as the debt to GDP imbalances have yet to be resolved. The Fed recently extended its exceptionally low interest rate forecast through 2014, and the ECB continues to explore monetary measures to address the Eurozone debt crisis while other central banks follow suit. These developments have been positive for precious metals so far in 2012 after a pullback in late 2011.
• China Infrastructure Bubble: The China growth juggernaut has been driven in no small part by a world record high and unsustainable trend of internal infrastructure and real estate investment relative to GDP. It has resulted in vast excess capacity and what we believe is a looming credit crisis. We believe that the asset bubble will cause a hiccup and possibly worse in China’s growth trajectory, affecting Chinese banks, industrial commodities, and stocks of industrial commodity producers. This theme performed well in 2011 although not so far in 2012.
• New Energy Resources: The deployment of directional drilling and hydro-fracturing technologies to extract shale gas and oil in North America has created a material and sustainable boost to energy supplies. It foretells a similar trend throughout the world and is one of the countervailing but positive macroeconomic forces in world today. It has mixed implications though for the various participants in the oil and gas sector. Oil prices are likely to follow the gas price experience, as new shale oil resources come on stream and as low natural gas prices stimulates greater oil sands extraction from Canada. Oil prices are historically and unsustainably high on a BTU equivalent basis relative to natural gas. We are short the heating oil/natural gas spread and long stocks of companies that benefit from the expansion of North American oil and gas supplies (oil and gas pipelines) and distribution (natural gas utilities). We are also short a handful of upstream oil and gas producers that are highly overvalued based on the initial response to the shale boom but stand to be hurt by generally declining oil and gas prices that they are collectively creating. 
• Global Sovereign Debt Bubble: Governments across the world have assumed more social responsibilities than they can afford. We ultimately expect sovereign interest rates to rise materially, but we have been too early or in the wrong place at the wrong time on this theme. We are forced to acknowledge that central banks still wield too much power and influence to control interest rates, although opportunities certainly have arisen already for getting short bonds, particularly in Europe.  We have reduced exposure to this theme until we can assess that the bond vigilantes have taken control again, such as in the late 1970s and early 1980s when there was a loss of confidence in the Fed’s ability to control inflation.
• Competitive Innovation: U.S. manufacturing is beginning to benefit from rising wage rates in emerging economies. At the same time, cloud computing, nanotechnology, and biotechnology pose opportunities that we can exploit through long positions in various high growth as well as niche cyclical companies across the technology, healthcare, and industrial sectors.
• Consumer Squeeze:  The biggest lag in inflation remains in housing and consumer incomes while central bank stimulus measures have been flowing through much more quickly to goods and services prices, particularly food and healthcare.  With the consumer debt hangover from the housing bubble still lingering, this trend favors both the high and low end consumer retailers and consumer staples over middle market consumer retailers and consumer cyclicals.

Posted: February 1, 2012 by Kevin S. (China Real Estate Bubble, Competitive Innovation, Consumer Squeeze, Fixed Income Bubble, Global Fiat Currency Crisis, New Energy Resources)
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Per Shadow Government Statistics:

“Continuing $5 Trillion GAAP-Based Federal Deficit Remains Unsustainable, Uncontainable and Unstable.  Against a headline, official quasi-cash-basis and gimmicked reporting of a $1.3 trillion federal budget deficit in 2011, GAAP-based accounting (using generally accepted accounting principles) indicates that the actual 2011 deficit ran somewhat in excess of $5 trillion for the year.  The largest difference between these estimates is that the GAAP-based number includes the widening shortfall of unfunded liabilities for social insurance programs, such as Social Security and Medicare.”

The GAAP gap is alarming.

Posted: January 5, 2012 by Kevin S. (Fixed Income Bubble, Global Fiat Currency Crisis)
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There is a good article just published in CFA Magazine entitled China: Unhedged Risk in Your Portfolio?  Joel Hirsh, CFA, reinforces many of the points we made about China in our latest Macroeconomic Update.  Some highlights:

• “Chinese government agency estimates suggest China has accumulated bad loans to local governments totaling more than 15 percent of GDP.”
• “Chinese central government statements, rating agency reports, as well as third-party analysis suggest China’s banking system is in a highly precarious position, with a reasonable probability of being insolvent.”
•  ”Fixed investment (such as construction spending funded by a bank loan) represents 60 percent of annual GDP. This level of investmentfueled growth has never been successfully sustained.”
•  ”The most effective way to hedge the threat of a Chinese slowdown is through the external link to China’s economy—imported commodities.”

With China’s predicament, short positions in commodities like copper, iron ore, and metallurgical coal and their miners provide a good hedge for long positions in gold and silver and related miners.  The latter are key to protecting against global money printing and debt devaluation.  There is potential for alpha generation on both sides.

See full article here: http://viewer.zmags.com/publication/761a93ac?page=12#/761a93ac/12

Posted: November 3, 2011 by Kevin S. (China Real Estate Bubble, Global Fiat Currency Crisis)
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Please check out Crescat’s latest macroeconomic research letter.  We discuss the implications of record high global debt levels, China’s unsustainable fixed asset investment binge, the European debt crisis, declinging real household income in the U.S., understated CPI, gargantuan off balance sheet derivatives.  Central banks have been behind an upward spiraling series of bubbles, busts, and bailouts.   The biggest busts and bailouts are likely still ahead of us, possibly the end game for fiat money itself.  Long and short opportunities abound.  Hard money, scarce resources, and equities of competitive and innovative companies offer ways to protect and grow capital amidst central bank money printing and debt devaluation.  Cash and government bonds are not the safe havens they appear – neither is China the export driven growth juggernaut it appears.

Posted: October 24, 2011 by Kevin S. (China Real Estate Bubble, Competitive Innovation, Consumer Squeeze, Fixed Income Bubble, Global Fiat Currency Crisis)
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Here is a thoughtful analysis by Chris Martenson, rebutting the argument that commodity prices are poised to fall. We agree with his contention that gold is increasingly viewed as a safe haven currency alternative to fiat currencies US$, Euro, etc. We see continued volatility but strong upside for precious metals and other commodities, and we agree with Martenson’s rebuttal of deflation. However, we think the picture is not so rosy in the short run for commodities tied to China’s unsustainably high infrastructure growth.

Click here for Martenson link.

Dan

Posted: September 19, 2011 by Crescat (Commodity Supercycle, Global Fiat Currency Crisis)
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We have oft voiced our view that the growing U.S. debt position is unsustainable, including significant debt on the books ($13T) and unfunded liabilities ($56T and counting). Respected investment commentator Richard Russell espoused on the issue in his Friday commentary. We post some pertinent quotes from Russell’s newsletter below. He also describes his view of investment implications, which is aligned in many important ways with ours. Best regards,

Dan Hoskins

Partner

Crescat Capital LLC

“The US has a national debt of $13 trillion (that’s trillion, not billion). There’s no way in God’s name that the US can ever pay off that debt. Actually, if the US does nothing the interest on the debt will eat up the nation. Worse, aside from the national debt the US has over $50 trillion in unfunded liabilities.”

“To put it frankly, the US is facing a debt future that can not be solved by cutting back on expenses and raising taxes. Even if the US taxed away all the income and profits of individuals and all corporate profits, the government would still not be able pay off its debts.”

“In my opinion, the US MUST default on its debt. There are two ways to default. One is simply to renege on the debt. I don’t think the US would ever do that. If the US did that, nobody would ever deal with the US again. The other way to default on the debt is to inflate it away. I’m absolutely convinced that this is the path that the US will take. If the US inflates enough, then over time (many years) the devalued dollar will tend of reduce the power of the debts.”

“I guess optimists continue to believe that Treasuries are temporary save-haven items and that they are going to move higher. But if the bonds rally by say 5% and you lose 8% in the dollar, what good are the bonds? Some experts believe that deflation will drive interest rates well below zero. Ah, that’s why the smart guys are buying Treasuries. I knew there was a reason. But I’ll tell you something — I don’t trust the reason.”

“My guess is that gold has bottomed. Too many investors and too many cental banks are potential buyers of gold. And they are ‘bottom-fishing.”

“As far as I’m concerned, the “word” is out. The US will default on its monster debts. The US will default via systematic inflation. This will gradually “kill” the dollar. The protection against declining purchasing power of the dollar (brought on by Fed inflation) is gold.”

Posted: August 2, 2010 by Crescat (Fixed Income Bubble, Global Fiat Currency Crisis)
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The latest FinReg incarnation gets a couple of things right, notably pushing some derivatives trading to clearinghouses and exchanges, requiring collateral to support derivatives trading, and creating a mechanism to facilitate wind-down of systemically important yet failing institutions. Sadly, however, the bill otherwise seems to deliver the worst of both worlds. It doesn’t address the fundamental causes of the 2008 subprime mortgage crisis, and it complicates an already complex regulatory structure. To wit:

• The restriction on proprietary trading is sufficiently loose that it will likely have no impact on the major banks, either because their prop trading – as defined in the new law – is less than the 3% threshold or because the banks will probably be able to set up offshore subsidiaries to do the trading within their bank holding company structure. It also seems that prop trading is defined in a way that it doesn’t include the massive off-balance-sheet derivatives trading being done by the banks. Chalk up a victory for the lobbyists.
• The limitations on the reach of the derivatives trading ban is so wide that most of the total derivatives exposure is exempted, especially interest rate and foreign currency swaps which comprise 92% of the $216.5 trillion in off-balance-sheet derivatives exposure held by U.S. banks. The legislation implies that these derivative exposures are not risky, which is absurd. Chalk up another victory for the lobbyists.
• Banks will still be allowed to choose ratings agencies, whose ratings – thanks to the reality of incentives – will inevitably continue be a factor in the banks’ selection of ratings agencies. Chalk up another victory for the lobbyists.
• The law does nothing to address the flawed nature of the government’s sponsorship of Fannie Mae and Freddie Mac, the largest players in the home mortgage market. The government’s sponsorship allows risk to be transferred from Fannie and Freddie shareholders to the U.S. taxpayer, thus implicitly encouraging those entities to take risks.
  
• The bill will create an $850 million Consumer Protection Agency. I know billion $ legislation seems so yesterday when our government now routinely passes trillion $ legislation. However, $850 million per year is a lot of dough. And for what purpose? I continue to struggle with how consumers were victims of the subprime mortgage crisis. In fact, it seems that most of the lower-credit borrowers made smart personal decisions when they saw a good deal: no money down to live in a house that they might not have otherwise afforded.
• The bill won’t dilute the Fed’s unconstitutional reach in any way and in fact gives it more authority. The easy money policies of the Fed are important drivers of our big bubbles over the last twenty years. The Fed has already failed miserably in its regulatory authority over banks. So why give it more authority?
• The bill won’t simplify the already complex regulatory structure in place for the financial services industry. Why not consolidate them into a single regulatory authority with a clear mission? Chalk up another victory for the lobbyists, this time the lobbyists of the regulatory agencies!
• The bill will create a new risk monitoring council comprising multiple agencies such as the Fed, the SEC, etc. Please! Why would a new layer of bureaucracy make an already jumbled regulatory structure better? And since the bill still leaves many of the regulations to be determined by these agencies in the future, the lobbyists will have plenty more influence still to come.

To protect against another crisis, Uncle Sam needs to make it clear that he will not bail out the banks in future crises (thus discouraging excessive risk taking) or Uncle Sam needs to restrict the banks from the excessive risk taking. This new legislation doesn’t do either very well.

The banks are clear near-term winners of the latest rounds of negotiations for FinReg. And unfortunately the rest of us lose. We can expect continued excessive risk-taking by the financial sector due to moral hazards of crony capitalism, regulators bought and paid for by the banks themselves. This legislation has done little to prevent the next banking crisis and in fact probably  makes it more inevitable. While the bill does protect taxpayers from being called upon to bail out a large failed bank, the Fed still has extraordinary money printing powers to mop up such crises.  In the end, we are only assured of more of the same: money printing, crony capitalism, and regulatory incompetence, the same issues that created the mess in the first place.

Posted: June 28, 2010 by Crescat (Financial Sector Bust, Uncategorized)
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