AUM: the mantra for the East and the West

Posted on September 14, 2011 by Suresh

Wikipedia describes the mystical chant of the East AUM, as follows:

“AUM” is the reflection of the absolute reality, it is said to be “Adi Anadi”, without beginning or the end and embracing all that exists.[3] The mantra “AUM” is the name of God, the vibration of the Supreme. When taken letter by letter, A-U-M represents the divine energy (Shakti) united in its three elementary aspects: Bhrahma Shakti (creation), Vishnu Shakti (preservation) and Shiva Shakti (liberation, and/or destruction).[3]

I don’t know much about the creation of the Universe and Eastern mysticism. But AUM, in a different form is clearly the mantra for the West, especially Wall Street.

Imagine it is 2006 and you and your neighbor have $10,000 to invest. You could invest it in the broad stock market – say, Vanguard Total Market ETF (symbol: VTI) or you could invest it with Fidelity Magellan Fund (FMAGX).

You choose the Magellan Fund while your neighbor went with VTI. Fast forward to to-day. How would you have done compared to your neighbor?

His 10,000 dollars would have become 10,719. Your 10,000 would have turned into 9,385 – a difference of $1335 or 13% of your original investment. In other words, your neighbor is 13% better off than you are over the same period.

You gave your money to the active management skills of Harry Lange. In those 5 years, he managed to make you 13% worse than your neighbor. Along the way, he made several million dollars in compensation for his efforts at making you 13% poorer than your neighbor.

Harry Lange was fired yesterday – but only from his position of Portfolio Manager. Fidelity is ‘looking for other opportunities for him’.

This magic is made possible by the mystical AUM – Assets Under Management. Fidelity charged 0.6% of the total assets under management as fees. Each year, Fidelity Magellan Fund alone, based simply on its current 14 billion size, created $84 million in fees – which was largely divvied up between its various ‘star’ managers.

So, you lost 13%, he made several millions off your money.

Why does this model of compensating Portfolio Managers still survive?

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The Emperor is dead! Long live the Emperor

Posted on September 12, 2011 by Suresh

Unless the ECB (and Germany) agree to lay aside their righteous anger at deficit financing and take clear action to defend Greece and Italy, the Euro is coming apart at the seams.

Ordinarily I would argue that may be a good thing, but a disorderly unwinding of the euro would create massive chaos and send gold skyrocketing. Along with gold would go US Treasury and Japanese Yen.

As an interesting side note, the Chinese are sitting on the sidelines and watching this unfold, primarily because they know that US Treasuries are the safe haven currency and they hold an awful lot of it. But the joke will be on them if the Euro falls apart – a worldwide recession will stop China in its tracks and you don’t stop an engine that big suddenly without some really bad effects.

I think it is too late to reverse the damage in Europe. Curiously enough, it is the bond vigilantes who are taking Greece down – but for the opposite reason than what the deficit scolds had been arguing for. Every major Euro nation is in the grip of ‘Austerity’ and the resulting economic stagnation is destroying faith in their sovereign debt. As Krugman points out, unless the ECB starts buying Euro debt, Greece is bound to default.

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Crying Wolf

Posted on September 7, 2011 by Suresh

Martin Wolf of the Financial Times points out the obvious on what the bond markets are telling us: Take our money, Please. (and spend it).

He makes an interesting point:

As Richard Koo of Nomura Research has argued, fiscal deficits help the private sector deleverage.

I think that is exactly right. The markets have also showed us that the private sector has been able to deleverage massively without a significant hit to their bottom lines. I am convinced that was largely due to the demand being kept up – artificially – by the various QEs and by the stimulus package – inadequate as that was.

Unfortunately, his advice will fall on deaf ears in the White House. By all indications, the big jobs idea due to come out of the White House tomorrow is about $150 bln in continued payroll tax breaks and another 150 bln in extension of unemployment benefits. Unless there is a bold statement that we will increase our deficits and spend it on boosting employment this will have no impact on the upcoming recession. But Obama is so cowed by the deficit scolds that he is not going to propose anything of that sort tomorrow.

We may get lucky and avoid a recession, but I don’t think so. I expect that we are currently in a recession and the data will show it in January 2012.

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Thinking Golden thoughts

Posted on September 1, 2011 by Suresh

What is the fair value for gold?

Traditionally, value is assigned either by present value of future cash flows or by cost plus profit. But gold has no future cash flows that it generates. That leaves the only logical method to determine fair value of gold as the cost plus approach.

It is not always easy to estimate the cost of producing gold. As this CNBC article illustrates, the raw cost of production ranges from zero to $650 depending on who you ask. Throw in other costs like depreciation etc and it hovers between $300 and $1000.

I am sceptical about the $1000 cost simply because gold has really not traded near $1000 for very long (relatively speaking) which means these producers were running their operations at mammoth losses. I am reminded of Hollywood accounting for movie profits.

Assuming the production cost of gold is about $600, what is its fair value?

The simple answer is, there isn’t one. There is no natural ceiling for gold prices – it is driven entirely by fear. Nor is there a natural floor (other than, of course, zero). The demand / supply equation for gold is also very distorted since the ornamental value of gold is a matter of perception – Indians generally are disdainful of anything less than 22 carat gold while most westerners are quite happy with 14 carat gold.

At the end of the day, I tend to ignore all predictions of gold prices – and all claims of it being over or undervalued. Buy it if you think everybody else is going to be afraid of the economy.

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From the ‘this is a really bad idea’ department….

Posted on August 24, 2011 by Suresh

CNBC is running a story that argues that if the markets want a Eurobond, the only way they are going to force Merkel’s hand is by creating a Lehman like crisis.

Like Paulson in the autumn of 2008, selling a shock-and-awe response domestically could be a lot easier in the face of a major crisis.

Paulson now admits to what many of us had known all along: the US Congress was not going to agree to a multi-billion dollar bailout of the US banking industry without something to really, really scare them. Ergo, Lehman had to go by the wayside. As Naomi Klein documents so presciently in Shock Doctrine, this is now capitalism’s modus operandi – gin up a disaster and use it to get policy action that would otherwise be impossible to achieve.

Why is this such a terrible idea? Firstly, disasters (whether ginned up or naturally occurring) tend to be extraordinarily destructive. The destruction is often completely random. Secondly, no one has the smarts, even the Masters of the Universe (who, oddly enough, all seem to work on Wall Street…) can predict the collateral damage – for Lehman, one particular collateral damage was billions of dollars lost to money managers who used Lehman as a prime broker.

Now that the idea is ‘out there’ that we need a disaster to force Merkel’s hand (who we cheered a couple of days ago for displaying a spine) is it possible that a spectacular failure is in the cards for Europe? Far fetched as it may seem, I wouldn’t exactly rule it out. I would actually not be surprised to see a run on Italy’s bonds as the most vulnerable to pressure.

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Do as I say not as I do – Texas edition

Posted on August 22, 2011 by Suresh

Brad Delong points to Jared Bernstein mentioning the unmentionable:

Turns out Texas was the state that depended the most on those very stimulus funds to plug nearly 97% of its shortfall for fiscal 2010, according to the National Conference of State Legislatures.

If anything, Rick Perry’s Texas seems to have followed a textbook Keynesian recovery – one that is still underway.

 

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Two Cheers for Angela Merkel

Posted on August 22, 2011 by Suresh

Ms Merkel is the subject of a headline I have been looking forward to for some time now. The FT headline:

“Merkel defies markets on debt crisis”

About time somebody other than Krugman called the bond-vigilante bluff. Ms Merkel basically told the self appointed bond-vigilantes to take a hike.

“Politics cannot and will not simply follow the markets “

This is in response to the markets demanding the issuance of a eurobond to assure the bailout of Greece and Italy and all other comers. Otherwise, they ominously mutter – we will… we will… huff and puff and blow your house down. In effect, they are asking to be made whole on their holdings of Greek debt on the backs of all europe.

But the basic principle of capitalism is he who takes the risk bears the outcome. The investors in Greek bonds have included money managers who recklessly bought the debt even after that country’s fiscal woes were apparent. They gambled that Europe would view Greece as they expected the Fed would view Lehman.

If only David Cameron had had the courage to do ignore the wolf, he could have spared the UK its ill advised austerity program and the riots last week.

So, why only two cheers?  I am saving the last for when Ms Merkel adds .. “we will consider raising short term deficits in a controlled manner in concert with long term stability measures for the paramount need to spur employment and growth”.

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All that Shines

Posted on August 20, 2011 by Suresh

With Gold breaking through $1800, people have asked me if it is going higher.

To be honest, I am of two minds on gold. On the one hand, the pure economic argument would point out that Gold is as much a store of value as, say, a Picasso or a Reuben. It is valuable only because others think it is valuable. It generates no income, creates no business, grows nothing.

On the other hand, it is the one thing everybody has chosen to agree on as a store of value over the last few thousand years. Not much else comes close to the longevity of Gold as a safe haven. Which allows me to turn the ‘to buy or not to buy’ into ‘to safe haven or not to safe haven’.

With the dollar being beaten to a pulp by feckless US legislators, the Euro being torn asunder by Greece and now Italy, the yen and franc are emerging as currency havens. But I am not convinced that Japan (or the franc) can truly provide reserve currency status. In other words, the swiss franc is taking the place of gold. So, would I buy swiss franc or gold?

I know the answer to that – I would buy gold. But not more than perhaps 5% of my portfolio.

From here on out, any upward movement of gold should be seen as a clear measure of panic. And an expression of total disgust with governments in Europe and the US.

As an interesting side note: what are the three biggest draws as safe havens (other than gold) right now? Swiss Franc, Japanese yen and (drumroll please…) the US Dollar.

Of these, two are issued by countries with AA rating by S & P.

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To Panic or not to Panic?

Posted on August 1, 2011 by Suresh

Up 500 points one day and down 400 the next day.  If you have at least 10% of your assets in cash, our advice is to sit tight.  There is no sign that the markets have settled on to one sentiment.  This is a completely irrational market and either buying or selling in this market is just inviting trouble.

 

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