Fund Manager
Norm Lamarche
Falling prices for energy, metal and grains led commodity share prices tumbling for the month. The governments’ inabilities to contain their capital market issues, accentuated the spiral in September and into October. Government Treasury offices as well as Central Banks worldwide, were forced to take greater remedial action to stem the contagion as evidence mounted quickly of its spread into the real economy. On the energy front, WTI crude dropped $15/bbl to close above $100 at the end of September. Nat Gas dropped 6.3% to close at $7.44/Gj. Both commodities today (at the time of writing) have a six handle! The metals side of the commodity group fared no better, with Silver, Copper, Aluminum, Nickel and Zinc all down 12%, 15%, 11%, 23% and 8% respectively. Bullion was the only bright spot as it rose 5%. Stocks followed suit. The Front Street Resource Hedge Fund fell 21.43% for the period. In Canada, the S&P/TSX Materials index gave up 18.8%. The more economically-proned, the worse its outlook and stock market performance. Within the Precious metals group, Bullion rose while its Silver and Platinum/Palladium cousins tumbled as the industrial prospects (particularly for the auto sector impacting Palladium/Platinum) dimmed. The Golds failed to mount any form of defense in the portfolio as investors dumped all and any shares. Barrick Gold was one of the few gold companies to rise during the month (+5.5%), while Goldcorp, Yamana Gold and OTHERS fell 7.4%, 24% or worse during the month.
Rather than share our views about how the Fund’s positions have been overdone, that many are trading at extreme low PE’s, low P/CF’s, below BOOK VALUES, below NAV’s, below REPLACEMENT VALUES and in many cases, below actual NET CASH VALUES, let’s focus on what’s taking place in the capital markets. The wholesale-like selling taking place in the equity markets is occurring for three reasons. The first is as a result of fear that the banking system worldwide is failing. The second is a result of the massive liquidation by managers facing redemptions, particularly from the Hedge Fund community. The third reason relates to the fear that the economy is weakening rapidly.
As for the Banking System, Federal Reserve Bernanke has failed us by letting confidence spiral endlessly into a state of seizure! It didn’t have to happen this way, but it has! The original strategy of punishing the greed and purveyors of problems will end up costing all innocent tax payers, as the Treasuries worldwide scramble to put forward costly remedial actions.
Central Banks are not of “last-resort” anymore, they are of “only resort”, as the conventional system has seized up! The most recent tranche of medicine, beyond the guaranty of bank deposits and the Gazillion dollar illiquid paper bail-out packages worldwide, is of most interest! Since it is the Banks that got us into this mess, it will be the Banks that will lead us out of it as well. The governments have, finally, in no uncertain terms, let capital markets know that what is left of the banking system, will not fail, and they are, and will throw everything at it! Of interest is the government guarantee over the next three years, of Bank newly issued commercial paper and all unsecured debt financings! Pretty powerful, as banks will now finance their assets at Treasury-like rates! It is Treasury’s intention to create massive profitability margins at the Banks that will enable them to write off the things that aren’t working! While credit spreads have begun to tighten somewhat, investors should begin to see its greater impact over the next month as Banks begin issuing commercial paper again, but at very attractive rates to them. As for the gazillion dollar bail-out funds, much of it will be used to buy out the most of toxic-illiquid paper off of the banks’ balance sheets, freeing up some liquidity. Of interest also, is the movement away from mark-to-market, towards other forms of cost-based accounting. Canada, in October, has joined France in allowing Banks and Insurance companies to price their economic assets as though they are economic! Notwithstanding the accounting issues the future may bring as a result, the change away from mark-to-market would free up substantial bank capital available for lending. There is no doubting that all of these measures will not only free up capital but importantly increase bank profitability. The resulting uncertainty remains how quickly the banks will transfer that capital to the real economy!
While governments would prefer to see the Banks’ fresh capital deployed as new lending in the weakened economies, the Banks will prefer the massive positive carry trade about to take place in the financial paper assets. The governments, as substantial equity holders of banks today, will likely use some form of moral suasion to convince them otherwise!
As for the redemptions in the equity markets, the Hedge Fund community has been the most aggressive, particularly in the credit, emerging and commodity based sectors. The end of the calendar year is a period that many managers have been focused on to meet their liquidity needs. Much of the selling has also been front running the impending selling. Cash levels in the conventional mutual fund world are running at high levels. We anticipate that the liquidation selling will subside as the year-end approaches.
That leaves us with the prospects of a rapidly deteriorating economic outlook. The current round of economic stats, and for the next year, will continue to show the impact to the real economy. Consumption and Investment decisions have all been put on hold, until stability (and financing) prevail! Much of it will be lost until the next economic cycle. Some of it will return in a more normalized economic world order.
In the commodity world, the headlines and stats are pointing to demand in rapid decline and inventories rising. Commodity prices have retrenched dramatically, some at levels testing economic viability of higher cost operations. Companies like Chesapeake Energy have begun shutting in their high cost and lower priced natural gas production. Other like Russian based Norilsk Nickel are evaluating their Australian and African operations. With commodity prices cut in half, all companies are re-evaluating their capex plans. Europe’s largest natural gas producer Gazprom is already walking away from planned projects. Many projects planned or under construction are being shelved or delayed as a result of the economic uncertainty or financing opportunities.
The emerging nations’ growth profiles are slowing. Some of the debtor nations (that have borrowed in foreign markets), particularly in Eastern Europe will be in need of IMF help to secure liquidity. The majority of the emerging nations, however, are well capitalized. As for our main theme, that is, of the Industrialization of the Emerging Nations, we should remind ourselves that it is not a recent theme. The ten years preceding the 98-99 currency-led emerging nation downturn was similarly characterized by rapid economic growth of these nations having a profound impact on all resource materials. The 1998-1999 downturn however, literally bankrupted many of those nations. They did however, outgrow their economic and financial distress and deliver another 10 years growth profile that has continued to reshape the economic and geopolitical landscape to what it is today. While the emerging nations are clearly in better financial shape today, they nevertheless require a sound and growing western economy.
All commodity prices, particularly energy and food prices have tumbled, making inflation of little concern. Expect more interest rate relief as well. As for the stock market fundamentals, as we stated earlier, stocks are trading at extreme low P/E’s, low P/CF’s, below BOOK VALUES, below NAV’s…
As investors’ fear about 1) the banking system failing subside and 2) when much of the redemption-driven liquidity process runs its course, investors should begin to compare the stock market valuations in this new economic reality. We think it’s been overdone! Watch for continued tightening credit spreads as a precursor to a better stock market world.
Front Street Resource Hedge Fund - Monthly Commentary
Date Published
Related Fund(s)
Fund Manager
Falling prices for energy, metal and grains led commodity share prices tumbling for the month. The governments’ inabilities to contain their capital market issues, accentuated the spiral in September and into October. Government Treasury offices as well as Central Banks worldwide, were forced to take greater remedial action to stem the contagion as evidence mounted quickly of its spread into the real economy. On the energy front, WTI crude dropped $15/bbl to close above $100 at the end of September. Nat Gas dropped 6.3% to close at $7.44/Gj. Both commodities today (at the time of writing) have a six handle! The metals side of the commodity group fared no better, with Silver, Copper, Aluminum, Nickel and Zinc all down 12%, 15%, 11%, 23% and 8% respectively. Bullion was the only bright spot as it rose 5%. Stocks followed suit. The Front Street Resource Hedge Fund fell 21.43% for the period. In Canada, the S&P/TSX Materials index gave up 18.8%. The more economically-proned, the worse its outlook and stock market performance. Within the Precious metals group, Bullion rose while its Silver and Platinum/Palladium cousins tumbled as the industrial prospects (particularly for the auto sector impacting Palladium/Platinum) dimmed. The Golds failed to mount any form of defense in the portfolio as investors dumped all and any shares. Barrick Gold was one of the few gold companies to rise during the month (+5.5%), while Goldcorp, Yamana Gold and OTHERS fell 7.4%, 24% or worse during the month.
Rather than share our views about how the Fund’s positions have been overdone, that many are trading at extreme low PE’s, low P/CF’s, below BOOK VALUES, below NAV’s, below REPLACEMENT VALUES and in many cases, below actual NET CASH VALUES, let’s focus on what’s taking place in the capital markets. The wholesale-like selling taking place in the equity markets is occurring for three reasons. The first is as a result of fear that the banking system worldwide is failing. The second is a result of the massive liquidation by managers facing redemptions, particularly from the Hedge Fund community. The third reason relates to the fear that the economy is weakening rapidly.
As for the Banking System, Federal Reserve Bernanke has failed us by letting confidence spiral endlessly into a state of seizure! It didn’t have to happen this way, but it has! The original strategy of punishing the greed and purveyors of problems will end up costing all innocent tax payers, as the Treasuries worldwide scramble to put forward costly remedial actions.
Central Banks are not of “last-resort” anymore, they are of “only resort”, as the conventional system has seized up! The most recent tranche of medicine, beyond the guaranty of bank deposits and the Gazillion dollar illiquid paper bail-out packages worldwide, is of most interest! Since it is the Banks that got us into this mess, it will be the Banks that will lead us out of it as well. The governments have, finally, in no uncertain terms, let capital markets know that what is left of the banking system, will not fail, and they are, and will throw everything at it! Of interest is the government guarantee over the next three years, of Bank newly issued commercial paper and all unsecured debt financings! Pretty powerful, as banks will now finance their assets at Treasury-like rates! It is Treasury’s intention to create massive profitability margins at the Banks that will enable them to write off the things that aren’t working! While credit spreads have begun to tighten somewhat, investors should begin to see its greater impact over the next month as Banks begin issuing commercial paper again, but at very attractive rates to them. As for the gazillion dollar bail-out funds, much of it will be used to buy out the most of toxic-illiquid paper off of the banks’ balance sheets, freeing up some liquidity. Of interest also, is the movement away from mark-to-market, towards other forms of cost-based accounting. Canada, in October, has joined France in allowing Banks and Insurance companies to price their economic assets as though they are economic! Notwithstanding the accounting issues the future may bring as a result, the change away from mark-to-market would free up substantial bank capital available for lending. There is no doubting that all of these measures will not only free up capital but importantly increase bank profitability. The resulting uncertainty remains how quickly the banks will transfer that capital to the real economy!
While governments would prefer to see the Banks’ fresh capital deployed as new lending in the weakened economies, the Banks will prefer the massive positive carry trade about to take place in the financial paper assets. The governments, as substantial equity holders of banks today, will likely use some form of moral suasion to convince them otherwise!
As for the redemptions in the equity markets, the Hedge Fund community has been the most aggressive, particularly in the credit, emerging and commodity based sectors. The end of the calendar year is a period that many managers have been focused on to meet their liquidity needs. Much of the selling has also been front running the impending selling. Cash levels in the conventional mutual fund world are running at high levels. We anticipate that the liquidation selling will subside as the year-end approaches.
That leaves us with the prospects of a rapidly deteriorating economic outlook. The current round of economic stats, and for the next year, will continue to show the impact to the real economy. Consumption and Investment decisions have all been put on hold, until stability (and financing) prevail! Much of it will be lost until the next economic cycle. Some of it will return in a more normalized economic world order.
In the commodity world, the headlines and stats are pointing to demand in rapid decline and inventories rising. Commodity prices have retrenched dramatically, some at levels testing economic viability of higher cost operations. Companies like Chesapeake Energy have begun shutting in their high cost and lower priced natural gas production. Other like Russian based Norilsk Nickel are evaluating their Australian and African operations. With commodity prices cut in half, all companies are re-evaluating their capex plans. Europe’s largest natural gas producer Gazprom is already walking away from planned projects. Many projects planned or under construction are being shelved or delayed as a result of the economic uncertainty or financing opportunities.
The emerging nations’ growth profiles are slowing. Some of the debtor nations (that have borrowed in foreign markets), particularly in Eastern Europe will be in need of IMF help to secure liquidity. The majority of the emerging nations, however, are well capitalized. As for our main theme, that is, of the Industrialization of the Emerging Nations, we should remind ourselves that it is not a recent theme. The ten years preceding the 98-99 currency-led emerging nation downturn was similarly characterized by rapid economic growth of these nations having a profound impact on all resource materials. The 1998-1999 downturn however, literally bankrupted many of those nations. They did however, outgrow their economic and financial distress and deliver another 10 years growth profile that has continued to reshape the economic and geopolitical landscape to what it is today. While the emerging nations are clearly in better financial shape today, they nevertheless require a sound and growing western economy.
All commodity prices, particularly energy and food prices have tumbled, making inflation of little concern. Expect more interest rate relief as well. As for the stock market fundamentals, as we stated earlier, stocks are trading at extreme low P/E’s, low P/CF’s, below BOOK VALUES, below NAV’s…
As investors’ fear about 1) the banking system failing subside and 2) when much of the redemption-driven liquidity process runs its course, investors should begin to compare the stock market valuations in this new economic reality. We think it’s been overdone! Watch for continued tightening credit spreads as a precursor to a better stock market world.