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The Bottom Line

The Bottom Line

Let’s get a few things out of the way: we’re not economists, or analysts, just two retail advisors with some strongly held opinions. Our opinions are based not on any one specific report or recommendation, but on our daily readings of reams of information that we have at our disposal, and personal relationships and discussions with other industry professionals, some of whom are economists, and analysts, but we still like them!

Over our combined 35+ years experience in the Brokerage industry, we’ve found that a large part of an advisor’s role is to digest all the economic, fundamental and technical gobbledygook one comes into contact with and reformulate it into something that your typical investor can understand and act upon. It wouldn’t be appropriate for us, without knowing you, the reader, to provide you with specific recommendations, nor would that be fair for our paying clients, but we will strive to write something that will hopefully leave you with a better understanding of the forces at work in the markets these days, and that will hopefully inspire you to find out more about the services that we, and our firm, Euro Pacific Canada, can offer you.

For our loyal clients, a lot of this will sound familiar, so apologies in advance….

But enough preamble, on to the amble!

While the world didn’t end on May 21st, the jury is still out on June 30th. That is the day that the US Federal Reserve’s program of pump-priming known as QE2 officially comes to an end. What impact this will have on the markets and other risk assets remains an open question and the subject of much discussion, but the positive spin the financial media such as “Bubblevision??? have been giving to the markets seems at odds with what some of the smartest investors have been saying and doing: the inimitable Jeremy Grantham of GMO, who called the 2009 low on the S&P right to the day became outright bearish in early May. Carl Icahn, one of the savviest and most aggressive investors out there, was recently quoted as saying that the markets had stopped working. Mark Mobius of Templeton Emerging Markets Group says that another financial crisis is right around the corner. Comments like this should give investors pause.

The $64 trillion question is whether there will be a QE3 (or a stimulus package by any other name).

Without additional stimulus is there more pain to be felt? The short answer is a resounding yes. Consider this: the largest asset for most people -namely their home- is still deflating in price. As of the end of May, the S&P Case-Shiller index of housing prices has dropped back to 2003 levels. Remember that this is against a backdrop of extremely low interest rates. Imagine what would happen if rates headed back to more normal levels!

As bad as the price deflation of housing has been to date, the reality of the US real estate market is probably far worse than the numbers show. This is because there are likely a huge number of houses that should be in the foreclosure process -meaning on their way to being offered for sale at foreclosure prices- that are instead in limbo as a direct result of the banks’ inability to prove that they actually hold the mortgages on the houses in question!

We could probably write a whole book on the absurdities of the housing market’s machinations over the last few years, and several good ones have already been written, but for the purposes of today’s discussion all you really need to know is that the banks relied on third parties to take mortgages and package them into “investment??? vehicles, which then got sold and resold untold times. The problem the banks have today comes from one simple issue: who actually holds the mortgage? The documentation of the progression of ownership of title (meaning when a given mortgage was sold by company A to company B, and then by company B to company C), which is absolutely necessary if you are insisting on getting paid, was in many cases done improperly, and, if you are to believe all 50 States’ Attorneys General, who are currently contemplating criminal charges against the major banks, fraudulently to boot. You may have read about this in the press, but if you haven’t, just do a search on “robosigning??? and you’ll have lots of fun bathroom reading in no time!

Back to Case-Shiller: even though we’ve seen a huge drop from the peak, what’s really scary is that we haven’t even reverted to the long-term trend line. That would take another 15% drop or so in housing prices nationally. Even scarier is the fact that when bubbles burst, they don’t just “revert to the mean???, they typically overshoot on the downside! We wouldn’t be surprised to see another 20% drop in US housing prices nationally before the market stabilizes. That would be a hit to American balance sheet that would be measured in the Trillions of dollars, on top of the $6 Trillion+ hit seen to date!

So housing is deflating, making Americans poorer by the day. How about employment? Surely the Trillions spent by the government on QE1, QE2 and all those other stimulus programs got Americans back to work? Not so much. A recent headline from “US labor market stuck in low gear??? pretty much sums it up. Jobless claims were again over 400,000 for the seventh week in a row, missing expectations again. The economy simply can’t do well with so many people out of work.

Perhaps you could make the argument that the risk to the financial system has decreased since QE1 and QE2 were introduced, but you’d probably be wrong. Just look at what is happening in Europe and you’ll see that systemic risk is possibly higher now than it’s been in quite some time. There is a real possibility of the European Union falling apart, something we’ve been explaining to our clients since 2005. Really, what we have a hard time figuring out is how the Union survives! Think about it: Europe is composed of two distinct types of countries: the strong, creditor nations (think Germany), and the weak, debtor nations (Greece, Spain, Portugal etc). This bipolar system has one central bank, with a singular policy goal of fighting inflation, when they have extremely divergent needs: Germany being concerned about inflationary pressures and the weaker states clamouring for easier monetary policy. To make matters worse, both groups seem unhappy with the status quo, and who can blame them? German taxpayers, who work longer hours, retire later in life, and have less generous pensions than their Mediterranean counterparts, have been asked to bail out their less-hardworking European brothers and sisters, while Greek taxpayers (all three of them!) have been asked to expect to (GASP!) live within their means for the first time in who knows how long, and to expect massive cuts to government programs and benefits.

If you think systemic risk looks better Stateside, think again: Moody’s just put the major banks’ debt on review for possible downgrade, and the reason for the review is that they worry about the effect the end of QE2 will have on the banks’ balance sheets and earnings prospects.

Against this backdrop, do you want to be long equity markets? Consider that Goldman Sachs, widely considered the “smartest??? US investment bank, has been selling stocks like Apple, even though they are on their “Conviction Buy??? list. In fact, Goldman sold 1 million shares or more of no less than 12 of their “Conviction Buy??? rated companies in the first quarter of 2011, and were net sellers of 31 names out of the total of 58. Do yourself a favour: do as Goldman does, not as they say!

In an investment environment where Sovereign nations’ credit is in question, and being downgraded routinely, where housing is deflating, the economy is sputtering and the banking system is fragile, where the very viability of currencies are being called into question, what’s an investor to do? Where are the values to be found?

Tune in next week!

Just kidding.

One way to take advantage of the race to the bottom we expect to see from many currencies as a result of excessive money printing is to own hard assets, and we particularly like the precious metals. We’ll keep the discussion of the vagaries of the silver market for another day, and focus on gold, but how best to capture the upside we expect to see from this precious metal? First, we should point out that we started buying physical gold for our clients at prices below $300 an ounce, so count us as long-term bulls on the commodity, and in terms of a long-term target price we’ll defer to our former Merrill Lynch confrere David Rosenberg on this one. He sees over $3,000 an ounce. We see no reason to argue with him on this. In fact there are few things we’d like to argue with him over! But is owning physical gold the best way to benefit from this potential price increase today? What about gold stocks? Yes, we know that most have significantly underperformed the metal. And yes, we are aware that you take company, not to mention the potential for political, environmental and a whole host of other types of risk owning individual companies. But hold on to the rotten tomatoes for a second and give us a chance to make our case, OK?

“This time it’s different” could well be the most dangerous words out there. We fall into the “history repeats itself” camp, and we think that there are some very interesting parallels between the precious metals stocks today and Nickel stocks earlier in this new century. And we don’t think this time is very different at all. Allow us to explain.

In 2001, Nickel was trading at just under $6,000 per metric tonne. By 2003, it was trading well above $17,000 per metric tonne, and by 2006 it had traded above $22,000 per tonne. Of course, we didn’t own Nickel, we owned two major producers of the metal, Inco and Falconbridge. Between 2001 and 2003, Inco seemed largely stuck in a $20 to $30 range, a fact a few of our clients liked to point out to us on a daily basis! Falconbridge fared no better, apparently stuck in a trading range of $15 to $20 from 2001 to 2005. So while the price of the commodity shot up, equity investors were left wondering when the companies that actually produced the stuff would start to benefit from the big rise in price, and they had to be patient. But the patience paid off: by 2006, Falconbridge was trading over $60 and Inco was over $85! What finally got the stocks moving was industry consolidation, i.e. takeovers, in these cases more like frenzied mate-swapping that might have made even “Jersey Shore??? residents blush!

Does any of this sound familiar?

We think that the significant increase in the price of gold will lead to a big wave of industry consolidation, and that many of the companies around today will be gobbled up by one or another of the supermajor mining players in the months to come. And that’s the bottom line. Which ones do we favour? For that you’re going to have to give us a call and get to know us a bit better. We look forward to it. As always, we appreciate your comments and feedback.

Paul Azeff and Kory Bobrow are Investment Advisors and market strategists in the Montreal office of Euro Pacific Canada and can be reached at 514 940-5093 or via email at or

Please note: all equity date provided by Bloomberg LP. The metals pricing gathered from Bloomberg LP and the LME.

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