Billionaire investor George Soros said U.S. commercial real estate will probably drop at least 30 percent in value, causing further strains on banks.
“Commercial real estate has not yet fallen in value,” Soros, 78, speaking at a forum in Washington, said. “It is inevitable, it is written, everybody knows it, there are already some transactions which reflect and anticipate it, so we know, they will drop at least 30 percent.”
Soros said the risk of further declines in property prices is reason for the administration of President Barack Obama to move quickly to recapitalize banks. Soros said Obama acted too slowly on a banking overhaul and should have moved immediately upon taking office.
“At that moment of enthusiasm, fresh out of the gate, he would have gotten that money, and then we could have recapitalized the banks the right way, which would be to draw a line over the existing past accumulated bad assets and create new banks on top of these old banks,” Soros said.
Soros also said that the U.S. may face a new round of inflation should the flow of credit recover because of the large increase in the money supply stemming from the Federal Reserve’s purchases of Treasury securities.
“In order to make up for the collapse of credit, we are effectively creating money,” Soros said. That creates “an incredibly swollen monetary base, which, if it were leveraged, you would have an explosion of inflation.”
China’s stimulus spending will help its economy overcome the global recession sooner than the U.S. and other countries, investor Jim Rogers said.
China’s reserves allow the government to spend on projects that will make the nation more efficient and competitive as the global economy recovers, said Rogers, the author of “A Bull in China: Investing Profitably in the World’s Greatest Market.” Signs China is taking steps to liberalize its currency will also benefit the country, he added.
“I certainly expect China to come out of it sooner than the U.S.,” Rogers, chairman of Singapore-based Rogers Holdings, said in a Bloomberg TV interview in the city-state. “They seem to be spending the money on the right things. China is doing a far better job than the others.”
Premier Wen Jiabao reiterated last week the government’s pledge to “significantly increase” investment in 2009 to help counter the slowest growth in seven years. He didn’t specify new stimulus spending in addition to a 4 trillion yuan ($585 billion) plan announced in November.
The People’s Bank of China cut interest rates five times in the final four months of last year, including the biggest single reduction since the 1997-98 Asian financial crisis. The government is targeting growth of 8 percent in 2009, after the economy slowed to a 6.8 percent gain in the fourth quarter.
Yuan, Yen, Dollar
China will allow trade settlement in yuan with Hong Kong soon, central bank Governor Zhou Xiaochuan said at a briefing in Beijing on March 6. President Li Lihui of Bank of China Ltd., the nation’s largest foreign-exchange lender, said yesterday in Beijing the bank is already conducting trial international yuan settlements in Shanghai and Hong Kong.
“I’m glad to see they’re taking yet another step towards convertibility,” said Rogers, who in April 2006 accurately predicted oil would reach $100 a barrel and gold $1,000 an ounce. He said he owns Japanese yen as he expects more of the money to “come home.”
Rogers added he plans to sell his remaining U.S. dollar holdings later this year because the world’s largest economy isn’t a “safe haven” for investors.
“I plan later this year to get out of the rest of my U.S. dollars,” he said. “It’s had an artificial rally too but it’s a terribly flawed currency. The U.S. is printing money as fast as it can and that’s always throughout history led to currency problems down the road.”
Rogers on June 30 advised investors to avoid the dollar “at all costs” as the U.S. economy slows, and favored commodities. The dollar has risen against nine of the Group of 10 currencies since then, according to data tracked by Bloomberg.
Rogers added he remains bullish on agriculture and that commodities are “the only area of the world economy I know which is benefiting.” He said he owns “some” gold and silver, and regards silver as “cheaper.”
Water, power and other infrastructure companies’ shares are favored because their earnings are less vulnerable during the global slowdown, Rogers said.
“Gold is a commodity but gold is one of my least favorite commodities. There are other commodities that are going to do a whole lot better. Supply and demand are completely out of whack for nearly all commodities, and the inventories – they've run down the inventories of nearly every commodity in the world. The exception, of course, is gold.
Gold exploration has continued to expand for the past 20 years, gold mining production has continued to expand – it certainly hasn't declined in the past 25 years even though gold is down, and gold inventories are at the highest in the history of the world. I mean all the gold that's ever been mined is still out there. The Central Banks own it. The Central Banks want to sell it. I'm not saying they're right or wrong, mind you, don't get me wrong. I'm not making a value judgment here. I'm just dealing with facts. So I own gold. It's in my index. I own a couple of gold-mining shares but I am less optimistic on gold than I am on most other commodities. But I do own it. For centuries, people have tried to figure out how to turn lead into gold – do you know that alchemist's quest: "If we could figure out how to turn lead into gold, we'd all be rich." I would submit to you that you should figure out a way to turn gold into lead and you'd make a lot more in the next few years because lead would go up more, percentage wise.”
Resorts and luxury entertainment are now feeling the same pain as retailers and mortgage lenders, with MGM Mirage saying intoday's news that it might default on its debt. But, as with the retail and financial industries, it may be risky to attempt to catch a falling knife. Japan's "Lost Decade" offers a valuable lesson for investors; Goldman Sachs made a fortune investing in Japanese golf clubs during the 2000s, which you can read about here and here. But Goldman began buying a full decade after the real estate market crashed in Japan. Caveat emptor!
One thing you can be sure of in an economic downturn is that industries that thrive on extreme material excess will go through their own market correction. The resort and destination club sector is a case in point.
We're not talking about the summer resorts in the mountains or down at the beach, but the high-end stuff. Places you have to fly to, places where you are part of a big-bucks set. What's so incredible is how many of these resorts and destination clubs exist, which really speaks to just how decadent the spending on vacations and pleasure had become.
And now those resorts and destination clubs are failing as fast as the economy is tanking. The trend may have started innocently enough on July 18 with the bankruptcy filing of Rothbury, Mich.-based Double JJ Ranch Inc., a resort operator founded in 1937 that attracted blue-collar families with its indoor water park and horseback riding activities. But since then, tonier resorts have started visiting the bankruptcy court.
For example, there was the Nov. 11 filing of Yellowstone Mountain Club, which reportedly counts billionaire Bill Gates among its clientele. Established by Edra and Tim Blixseth in 2000, Big Sky, Mont.-based Yellowstone owns a high-class private ski and golf community on 13,600 acres of land located about 20 miles from Yellowstone National Park (the couple is now divorced, with Edra owning Yellowstone). The property includes ski trails, a golf course, lodges, residences, restaurants and other resort facilities.
Others have tumbled every month since. On Dec. 9, Minnetonka, Minn.-based VREP LLP, which operates an international destination club under the name Lusso Collection, entered bankruptcy, claiming its wealthy clientele evaporated "almost overnight." Denver-based High Country Club, a luxury destination resort company, filed for Chapter 7 liquidation on Jan. 27.
On Monday, March 2, came the latest victim: Sedona, Ariz.-based ILX Resorts Inc., an operator of timeshare resorts. ILX owns and operates eight resorts in Arizona, Indiana and Colorado, as well as in Mexico. It also owns additional undeveloped land in Arizona and Mexico that it had acquired to build additional resorts. The company blamed its need to file bankruptcy on unstable credit markets.
The credit markets have become the convenient excuse for bankruptcy filings these days. But for resorts and destination clubs, the inference is that it's the folks who once worked in those credit markets moving the money around that have disappeared. They aren't throwing the bucks around to sip cocktails on the veranda. Or maybe corporations finally got embarrassed by the American International Group Inc. (NYSE:AIG) executives who, fresh off receiving an $85 billion government bailout, were found to be attending a conference at a posh resort.
How many of these resorts are there? We'll likely find out soon when they trudge into Chapter 11 or Chapter 7. So many sprung up when everyone this decade really believed that they could live the life of the rich and the famous. Problem is, even the rich and the famous have maxed out their credit cards, so you can only imagine what kind of shape the pretenders are in.
Something that gold investors often fail to realize is that the aboveground supply of gold can increase just as fast as – or much faster than – the supply of money. This is an important part of why the view of gold as a “solid currency” is a fallacy.
Gold inventories are currently the highest they've been in the history of the world. And throughout the twenty-year bear market in base metals, gold exploration skyrocketed. Even in 2003, 75% of mining exploration was allocated to gold, up from 50% only three years earlier.
I do not have the current CRB Commodity Yearbook figures, but it is without a doubt that gold exploration has dramatically increased since then, with new mines coming on stream, in response to high market prices.
In other words, the supply of gold is huge and expanding, especially relative to that of every other commodity. And since gold is an element, it cannot be destroyed. Compare this with a commodity such as crude oil, which gets used up and can't be renewed.
As you can see, production skyrocketed after 1980, even when prices went into a multi-decade bear market. The current numbers are probably substantially higher than what is reported there, possibly going right through the top of the chart, in response to such high market prices.
As for the demand side, the demand for gold used in jewelry – the commodity's staple use – is so small that the CRB Commodity Yearbook doesn't even bother to report the figures anymore. All demand for gold has been falling – except for use by financial speculators.
I have no idea where the gold price will go, but with the market at a thirty-year high, today's buyers have no margin of safety. And in terms of supply and demand, I can hardly see why gold investors would be concerned about the money supply: unlike the supply of gold, the money supply has not increased by several hundred percent.
If we look at M2, the monetary aggregate used to forecast inflation, it has only expanded by about 10% from where it was a year ago:
Individual money market accounts are included in M2, but wider measures of the money market – like commercial paper and repurchase agreements – are included in M3.
The Fed discontinued its reporting for most of the components of this latter aggregate, but my guess is that the extreme stress in the credit markets probably would have shown M3 sharply contracting, hence the need for a massive liquidity injection.
While the Federal Reserve can print money, so can the giant mining companies ramp up gold exploration and production. And the facts show that the latter have been much more successful in supplying the market.
While this may be a vote of confidence for the free enterprise system, it presents an ugly picture for today's buyers of gold.
Distressed assets offer the best investment opportunities this year as the global recession deepens, billionaire hedge-fund manager John Paulson said.
“The decline in the market has created a very good buying opportunity,” Paulson, 53, whose New York-based Paulson & Co. oversees about $30 billion, said in a speech at a hedge-fund seminar hosted by Societe Generale and Lyxor Asset Management in Tokyo today. “Distressed opportunity in the U.S. is shaping up to be the best opportunity in a lifetime.”
Paulson said he’s focused on assets such as mortgages and debt from bankrupt companies, while in the equities markets he cited the utilities, consumer staples and pharmaceutical industries. Financial stocks remain risky, Paulson said.
In the 15 years since starting its first funds, Paulson & Co.’s one down year was 1998. All his funds were profitable in 2008, with the flagship fund returning about 38 percent, compared with a loss of 19 percent for hedge funds worldwide on average. The 2008 returns came after his funds made more than $3 billion for the firm in 2007 by anticipating the collapse of the U.S. housing market and subprime mortgages.
Investors are chasing distressed assets after more than $1.1 trillion in losses at financial firms globally and frozen credit markets helped drag the U.S., Europe and Japan into their first simultaneous recessions since World War II.
Deep Recession
“In 2009, we expect this recession is going to be deeper and longer than consensus estimates,” Paulson said. “We don’t think we’re through the banking crisis yet. We think that in many cases, losses the banks will experience will exceed their common equities.”
Hedge funds are private, largely unregulated pools of capital whose managers can buy or sell any assets, bet on falling as well as rising asset prices, and participate substantially in profits from money invested. Managers typically charge fees equal to 2 percent of client assets and 20 percent of investment profits.
“We’re bearish on the economy, but very bullish on opportunities in front of us,” Paulson said.
It turns out that the Zell-Blackstone deal, as well as the Blackstone IPO, marked the exact top of their respective markets: http://www.nytimes.com/2009/02/07/business/07properties.html?_r=1&em=&pagewanted=all As a general rule, mega M&A deals always tend to mark the top of a market. We saw this in the 1980s with Merger Mania, culminating in the historic $30 billion RJR Nabisco LBO – right in front of the early 1990s recession. We saw it in early 2000, with the $164 billion AOL-Time Warner deal, one of the greatest value-destroying transactions of all time. The merger agreement was filed in February of 2000, the market's apex. By 2002, the value of AOL was written down by $100 billion. And, of course, the financials: MBNA and Bank of America in 2006; Bank of New York and Mellon in summer of 2007; and Bank of America buying Countrywide Financial in early 2008, to name a few. However, the worst may be RBS and Fortis' colossal $100 billion acquisition of ABN AMRO in October of 2007 – again the exact top of the market. Fortis is now defunct and RBS is being propped up by the British government. By contrast, heavy bankruptcies are a positive sign. And sharply-reduced capacity and inventories, especially when they have been depressed for long periods of time and demand appears to be improving, are signs of a market bottom. This is probably where agriculture markets are right now. It continues to appear that agriculture may well enter a bull market over the next few years.
George Soros’ $21 billion fund returned 8% last year, which is incredible not only in light of the global crisis, but also given his fund’s size. As you can see, Soros is now betting big on oil and agriculture, outside of the United States.
Soros Fund Management LLC bought 16 million shares of the Petrobras’ U.S. traded shares, bringing its stake to 1.45 percent, according to a filing yesterday with the U.S. Securities and Exchange Commission. The New York-based firm increased its holdings in Potash by 2.6 million shares to 2 percent in the fourth quarter. Petrobras and Potash are now the firm’s two biggest reported U.S. stocks.
“As long as you see through the current crisis there are a few compelling reasons to buy,” Hernan Ladeuix, the head of oil and gas research at CLSA Ltd. in Singapore, said in an e-mail. “Oil prices should go up, probably strongly in coming years. Petrobras is the only large international company where you can have confidence that production can grow 5 percent per annum.”
The purchases made Soros the second-biggest shareholder in the U.S.-traded shares of Petrobras, Brazil’s state-controlled oil company. Petrobras preferred shares fell 5.4 percent in Sao Paulo yesterday, the most since Jan. 12, driven by a drop in oil prices to below $35 a barrel.
Potash, the biggest maker of crop nutrients, also fell by the most since Jan. 12, declining 7.4 percent yesterday. Soros Fund is the eighth-biggest holder in shares of the Saskatoon, Saskatchewan-based company.
Best Buy, Wal-Mart
Soros Fund added 9 million shares of Best Buy Co., bringing its stake to 2.3 percent of the electronics retailer. The firm also started a new position in Desarrolladora Homex SA de C.V., the Mexican homebuilder, bringing its holdings to 4.9 percent of U.S.-traded shares, according to data compiled by Bloomberg. The firm bought 5 million shares of R.R. Donnelley & Sons Co.,North America’s largest printer, representing a 2.4 percent stake.
Soros’s hedge-fund firm sold 3 million shares of Wal-Mart Inc., bringing its stake in the discount retailer to 0.01 percent. The firm also sold all of its 2 million shares in Research In Motion Ltd., the maker of the Blackberry phone.
Money managers who oversee more than $100 million of equities or more must file, within 45 days of the end of each quarter, a Form 13F with the SEC that lists their U.S. exchange- traded stocks, options and convertible bonds. The filings don’t show non-U.S. securities or how much cash the firms hold.
Soros’s firm oversees $21 billion. Its Quantum Endowment Fund returned 8 percent last year. That compared with an average loss of 18 percent by hedge funds, according to data compiled by Hedge Fund Research Inc. of Chicago.
"Buffett agreed to buy a combined $750 million in debt from wallboard manufacturer USG Corp., motorcycle-maker Harley- Davidson Inc. and Sealed Air Corp., the maker of Bubble Wrap shipping products, in the past three months paying between 10 and 15 percent.
"Buffett also agreed in September and October to spend $8 billion on preferred shares of General Electric Co. and Goldman Sachs Group Inc. that pay 10 percent annual interest. This month, he agreed to buy convertible notes from Swiss Reinsurance Co. worth 3 billion Swiss francs ($2.6 billion) that pay 12 percent annually."
While Buffett’s bond investments might be mandated because he is using insurance float, it stands to reason that if he was overly concerned about very high rates of inflation, he would not be doing most of these transactions.
If Buffett was concerned about high inflation or a deteriorating dollar, he would simply do what he did before: forget about yield and invest in foreign currencies. For example, he could simply buy yen forwards or yen bonds if he thought the U.S. currency faced imminent destruction.
Granted, Buffett’s recent Swiss Re position has this dollar-hedge effect. But if Buffett expected hyperinflation, he would be making very different investments. He would be investing in hard assets or securities related to them.
With high domestic inflation, anything interest-bearing or financial is rat poison – yet Buffett has been investing heavily in dollar-based, fixed-income securities. Evidently he isn’t overly concerned about high inflation.
Fannie Mae and Freddie Mac, the mortgage-finance companies seized by regulators, may need more than the $200 billion in funding pledged by the U.S. government if the housing market continues to deteriorate, Federal Housing Finance Agency Director James Lockhart said.
The companies’ needs will depend largely on the direction of home prices, Lockhart said in an interview in Las Vegas yesterday. His comments followed statements from Fannie Mae in November and Freddie Mac Chairman John Koskinen last week that the government’s funding commitment through 2009 may fall short of what the companies need to make good on their obligations.
“When we sized the amount in September, we obviously looked at stress tests and what was happening in the marketplace,” Lockhart said. “There’s been some significant events since then that weren’t in our forecast.”
The U.S. housing market lost $3.3 trillion in value last year and almost one in six owners with mortgages owed more than their homes were worth, according to a Feb. 3 report from Zillow.com. Following a record boom, home prices are down 25 percent on average since mid-2006 amid a tightening of lending standards and an economic recession, the S&P/Case-Shiller Composite 20-city price index shows.
Freddie Mac and Fannie Mae are the largest U.S. mortgage- finance companies, owning or guaranteeing $5.2 trillion of the $12 trillion home-loan market. The government seized control of Fannie Mae and Freddie Mac after their losses threatened to further disrupt the housing market, and pledged to invest as much as $100 billion into each company as needed if the value of their assets drops below the amount they owe on obligations.
A ‘Hard Look’
Fannie Mae said in a November regulatory filing that “this commitment may not be sufficient to keep us in solvent condition or from being placed into receivership.” Freddie Mac is taking a “hard look” at whether it will need more than $100 billion, Koskinen said last week.
“It’s going to be a close question,” Koskinen said in an interview on Bloomberg Television’s “Conversations with Judy Woodruff.”
McLean, Virginia-based Freddie Mac has taken $13.8 billion in federal aid and said it will need as much as $35 billion more by the end of this month. Washington-based Fannie Mae said it may tap as much as $16 billion in funding.
Lockhart, who was in Las Vegas yesterday to speak before the American Securitization Forum’s annual conference, said Fannie Mae and Freddie Mac’s most recent requests for aid, which were larger than some expected, were driven by temporary market disruptions that may not translate into permanent losses.
“There were some temporary imbalances that made their numbers pretty dramatic,” he said.
Government Demands
Federal officials are now leaning on the government- sponsored enterprises to help stabilize the housing market. House Financial Services Committee Chairman Barney Frank said last week that the companies will be used “very aggressively” to help reduce record foreclosures.
Lockhart said Fannie Mae and Freddie Mac aren’t expected to take a loss “under any program” that requires their involvement. “We would expect them to be writing business that’s profitable at this point, not a large profit,” he said yesterday. “But we would not expect them to be writing business at a loss under any program.”
The Treasury, not the companies, would bear the cost under proposals to use the companies to drive down mortgage rates to about 4.5 percent, Lockhart said. That proposal was under consideration as part of a comprehensive housing-recovery plan being developed by the Treasury.
‘A Hot Idea’
“That was a hot idea for a while: It’s cooled off,” Lockhart said. “But Fannie and Freddie wouldn’t be asked to eat the difference. If it happened, that would be the U.S. Treasury.”
Fannie Mae and Freddie Mac may also be used to provide direct financing to single-family and multifamily residential mortgage lenders, Lockhart said. Currently Fannie Mae and Freddie Mac provide financing by either buying loans from lenders or helping them package the debt as bonds for sale to investors, thus freeing up cash to make more mortgages.
The FHFA is reviewing whether the companies’ congressional charters, which generally prohibit lending directly to the public, would restrict expanding into so-called warehouse financing.
Credit Standards
Mortgage bankers and other companies that have seen their sources of credit dry up in the past year have been pushing for the change, according to Lockhart.
“The problem is that unfortunately bankers have tightened their credit standards and withdrawn from some markets,” Lockhart said. “And as interest rates fall, if we have relatively large refinancings, we’re going to need to have mortgage bankers be able to provide mortgages in the interim before they sell them to Fannie and Freddie.”
After thinking this morning about commodities and inflationary prospects, I watched a Jim Rogers interview from 1995, which I have included below. You will have to fast forward a bit, because he appears toward the end. Here are a few of his predictions from 1995:
“Next year and the year after, I don’t think we’re going to have good times in the American stock market.”
“Inflation is coming.”
“Commodity prices are going through the roof.”
Best country to invest in right now: “Iran.”
“Everything in life comes down to timing.”
Well, it looks as if Jim's timing was profoundly wrong.
In fact, much of this flies in the face of what he said in Hot Commodities, published a decade later, which was to the effect of “if you went through the 1990s and didn't touch shares in technology companies then you missed out on massive gains," essentially meaning that it was a mistake caused by not being open to new things.
But, as you can see, he was saying the exact same stuff back then as he is today. And he certainly wasn't talking about technology.
Anyone who continues saying that inflation will come or commodities will rise is bound to be proven right at some point. This not to single out Rogers as being wrong, but to emphasize my stance on how difficult it is to predict macro events – unless, that is, you only have one perennial prediction.
What history shows is that, aside from short-term macro shocks, the best asset class to own, by far, is stocks. And if you can buy those stocks at depressed prices or in periods of intense fear, then your total return can be magnified significantly.
Land, labor, capital and commodities are combined to create businesses that increase productivity. And while any one of those factors may become relatively attractive during a boom, owning excellent businesses – or fractional interests, called stocks – is the best investment over the long haul.
Keynes predicted that the great financial fortunes – paper fortunes, such as the Rothschilds in his day – would be destroyed by long-run inflation. Clearly, this has not happened.
Quite the contrary: the countries with the most developed financial systems have always been the most prosperous, whether the Medicis in Renaissance Italy, the Rothschilds in 19th-century London, or today's commanding skyscraper in Lower Manhattan that reads, simply: "85".
Thus, while the gloom and doom is persuasive nowadays, I remain highly skeptical that the world – financial or otherwise – is coming to an end. I lean more towards John Paulson's prediction that massive returns will accrue to buyers of solid, yet beaten-down financial stocks, as the smoke clears and we emerge from this crisis.
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