The Market, Gold and Royalty Trusts…

On the General Market and the Fiscal Cliff: 

The market continues to go wild, going down 100 points on the dow by 10am and then up 100 points by the end of the day.  A home sales report this morning came in below expectations in October while revising September’s number lower (home sales were down sharply in the Northeast due to Hurricane Sandy, while up significantly in the midwest).  A lot of the fear and hope still has to do with the “fiscal cliff” issue, as investors draw heavily on speculations from one side or the other over whether the house Republicans can agree with the Democratic senate and white house to reduce the level of fiscal tightening.  There is talk again over creative financing solutions for Greece as well, this time with a bond exchange that keeps the face value of the bonds the same but doesn’t allow them to mature until Greece’s economy improves.

John Mauldin had an interesting conference on the post-election economy, with some big players weighing in on a number of economic issues:

The fiscal cliff and deficits: Mauldin is clear on the point that he sees the deficit as the major problem, regardless of the fiscal cliff issue, arguing that we won’t have as much time as we think to turn it around.  He fears that the debt crisis in Europe will continue, a debt crisis in Japan will begin in the next couple of years, and in this backdrop the sights will hit the US if deficits remain large and debt continues its swift rise.  Mohammed El Arian from Pimco said the problem with the fiscal cliff is that with such a slow-growing economy, it could push us into recession which will only make the debt situation worse – but that he guesses a 75% chance of an agreement being reached because neither side wants that to happen.  Reynolds argues that even if the fiscal cliff hits in full, the result will slow us down but more mildly than we think and will at least address the deficit.  The consensus was that long-term deficits needed to be addressed and needed to include entitlement programs such as Social Security and Medicare as well as long term tax rates.

Housing:  Barry Habib, CEO of MBS Highway spoke at length suggesting that it seems housing has found a bottom.  He was long-term bullish, saying that even though the age groups that can afford housing have been pushed outward (It takes longer to be able to qualify, they will stabilize – and that at some point pent up demand from the younger age groups to be released because programs still exist through the FHA to purchase with only 3.5% down.

Investment Sectors:  Many suggest looking for growth outside the US, John Mauldin suggests hedge funds which can do market-neutral strategies such as long-short and invest in things like agriculture.  US Government bonds are seen as safe in the 5-7 year window because that is the “sweet spot” for purchases from the Fed, and the Fed will not allow the rates to significantly rise.  Government bonds are not for individual investors though – mainly for big players who need something they can liquidate fast, such as a mutual fund that needs to cash out investors in stock market drops.

On Gold: 

Grant Williams had a fascinating bit on Gold in his newsletter this week (free at http://www.mauldineconomics.com/ttmygh ).  Official gold holdings in major western central banks  have been dropping dramatically from 1990 onward.  Meanwhile, eastern central banks – particularly China – have been big buyers.  China is not only the largest producer of gold in the world, but also the largest net importer of gold.  They see it as protection from central bank devaluations in all the major currencies, as the average G7 debt (including Japan) is at 120% of GDP – seen by many economists as an upper limit to sustainable debt.

Mauldin quotes an article by gold expert Eric Sprott: “Do Western Central Banks Have Any Gold Left???” at sprottglobal.com/markets-at-a-glance/maag-article/?id=6590  … the gist of it is that Western Central Banks may have significantly less gold than is reported because:

1. Global gold supply excluding Russia and China (those countries don’t export any gold) is lower than it was in 2000.  After the announced IMF sale of 403 tonnes of gold in December 2010, there has been no large announced sale of gold and yet demand has been stronger than ever.

2. Central banks are the only large holders of gold who can supply large amounts without it readily being tracked.

Most central banks have gold holdings in a number of other central banks to facilitate trading.  These reserves are held all at banks such as the US Federal Reserve, the Bank of England, the German Bundesbank, the Swiss Central bank, and so on.  None of these banks will allow any form of audit of their gold reserves, which recently became an issue as German politicians have been denied any form of audit or check on their gold holdings at the US Federal Reserve.  The Bild newspaper quoted Haustein of the FDP saying that “all the gold has to be shipped back.”  Currently, the Bundesbank holds 1536 tonnes of gold with the US Federal reserve and has settled at a return of 50 tonnes per year.

If a number of countries, worried about their own debt and currency problems, started demanding their gold reserves back then it makes you wonder if it could escalate into a form of bank run.  The central banks are certainly illusive entities which are used to using bank deposits to create money out of thin air, and it makes you wonder how short they are on their reserves.  Any escalation in this would certainly push up the price of gold (and would certainly increase diplomatic pressures).

On Royalty Trusts:

I have been fascinated with energy royalty trusts ever since their phenomenal drop in price following that WSJ article in August reminded investors that they were temporary vehicles, which ended with a value of zero, so their dividends include a return of capital.

Look at WHX for example:

Image

This chart not shows you how amazingly mispriced these vehicles can become, despite what should be a relatively easy calculation. This is the official website for this security:  http://www.whiting.com/whiting-usa-trust-i/faqs/

The website states 2 important things:  1. This security is based on a fixed amount of oil & gas production and will have no value following it’s last payout.  2.  The last payout is estimated to be 3 years from now.

A very simple calculation can therefore be done to calculate it’s value:

Image

It isn’t always easy to locate the company website and find the estimated termination date for an SDR, but you can generally assume production will increase, then stabilize and usually power straight through until the last bit of oil or gas per contract is sold (the rest reverts back to the exploration company which sold the product in the first place).

I’ve written way too much already, so I’ll close it and say goodnight.  I hope I’ve left you some food for thought here.

John Taylor

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About johnonstocks

I've been trading stocks since 2003, active on Motley Fool's discussion boards and using first Hidden Gems, then Global Gains. I no longer have the newsletters, but I keep up on the WSJ and read David Rosenberg everyday at gluskinsheff.com. Education: CFA level 2 candidate MBA-focus in Finance, Marshall, University of Southern California - expected Dec 2010. BS Mechanical Engineering, UC San Diego, June 2002
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One Response to The Market, Gold and Royalty Trusts…

  1. Geoff says:

    It will take 31 years for Bundesbank to get all their bullion back!

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