Monday, March 25, 2013

Cyprus bail out terms agreed

Cyprus, the European Union and the IMF agreed to terms of a bail out.

In summary, share and bond holders of the 2 largest Cyprus banks are paying for Cyprus' share of the bail out package.  Depositors with accounts over 100,000 euros will also be paying, but their contribution has not yet been determined.  The Popular Bank of Cyprus know as Laiki will be shut down.  Accounts with under 100,000 euros will be transferred to the Bank of Cyprus (BoC).  Accounts with over 100,000 euros at Laiki and BoC will be frozen and used to resolve the banks debts.  The amount necessary to resolve the banks debts is not yet clear.  Some analysts have estimated 30% and Reuters quoted a couple EU finance ministers as saying it would be no more than 40%.

This is incredible!  The EU and Cypriot government decided that depositors at 2 specific banks should lose about 30% of their DEPOSITS to help fund a bail out of the country and its banking system.  The EU does not insure deposits over 100,000 euro and it seems they have asserted the power to appropriate large accounts for whatever purpose they determine.  Why would anyone keep over 100,000 euro in a EU bank account?

These measures are what the European Central Bank required in order to loan Cyprus about 10B euro.  So the bail out is not a reset or a write-off it.  It is a loan.  A loan that must be paid back.  So this bail out has kicked the can down a Cyprus alley, but not fixed the entire situation.  How is Cyprus going to pay back this loan and previous loans especially now that its banking services industry has just been sunk?  The economy and people of Cyprus are stuck in servitude to the ECB and the IMF for decades now.

Sunday, March 24, 2013

US Senators take JP Morgan Execs to task

On March 15th 2013 a US Senate Committee held a hearing on JPMorgan credit derivatives where executives and former executives of the bank testified.  Here's a link to the almost 4 hour long video on C-Span.

Former and current JPMorgan Chase executives testified about the practices that led to the firm’s $6.2-billion “London Whale” trading losses during a hearing of the Senate Homeland Permanent Subcommittee on Investigations. 
The hearing attempts to uncover how much top JPMorgan officials knew about the huge risks its traders were taking on complex derivative instruments.
The senators, Carl Levin, John McCain, and Ron Johnson do a nice job of identifying and summarizing JPMorgan's many legal violations, misleading statements, lack of financial controls that led to a surprise $6.2B loss on trading.  

The JPMorgan executives and former executives (presumably some were fired because of this trading loss) clearly had no regard for abiding by reporting rules and regulations.  JPMorgan submitted 'required' information to regulators when JPMorgan wanted.  If the information was bad they simply didn't report it.  JPMorgan and these executives felt no consequence for avoiding reporting requirements.  

JPMorgan created financial models and analyses that yielded results they wanted and disregarded contradictory analyses.  They implemented new analyses quickly and without testing because the new analyses (e.g. VaR) gave more favorable results.  Figures lie and liars figure.

The trading loses were on investments that are supposed to hedge or reduce the risk of the whole bank.  So in theory if JPMorgan lost $6.2B on these investments they should have gained $6.2B on other investments.  But JPMorgan had to write-off these investments as a one time charge, so they were clearly not hedging anything.  These investments were speculation.  And, certainly we only hear about speculation when it goes horribly wrong.  In the meantime the bank profits and executives get big bonuses while they speculate with government money.  Money that they currently borrow from the Fed at zero percent interest.  Speculation by banks that are critical to the banking system and therefore too big to fail should be illegal. 

At one point Senator Levin says that laws may have been broken and if not laws should be put in place to prevent this type of situation.  The Senators go to lengths to clarify that the government does not need to regulate all financial institutions.  They explain that JPMorgan is being investigated because they received bail out money, are significant to the global financial system, and lied to their shareholders and bank regulators.  

All of this is old news.  JPMorgan incurred the "London Whale" trading losses about a year ago.  Good for the senators to investigate and keep the issues alive.  Now what are we going to do about it?  Fine JPMorgan for flaunting the rules or at least the intent of the rules.  Prosecute several executives for not complying with reporting rules.  Take away some of JPMorgans government business in the bond market for example.  These would be nice steps.  But let's finally implement a real solution instead of band aids.  The global financial system needs to separate commercial banking and investment banking with a  Glass-Steagall type law.  That way investment banks can speculate all they want without concern for impacting the commercial banking system and the economy.

Update on Cyprus Financial Crisis

The Cyprus government and European Central Bank (ECB) leaders at still working to complete an agreement on terms of a bail out.  The latest rumor in the press is that a deposit levy of 20% will be assessed on account over 100,000 euros.
Media including Reuters and German newspaper Welt am Sonntag reported last night that a deal had been reached to apply a 20 percent levy on deposits over 100,000 euros at Bank of Cyprus Pcl, the country’s biggest lender, and a four percent tax on deposits of that size at other banks.
A 20% deposit levy means if you had 100,000 euros on deposit a week ago that when the banks re-open there will be 80,000 in your account.  The government is taking 20% to raise enough money to qualify for a bail out from the ECB.

The Cyprus banks have been closed for over a week now and have even limited the amount available for withdraw from ATMs.  It is not clear when banks will re-open.  There are reports that gas stations in Cyprus are shutting down because they do not have cash to pay for deliveries and customer do not have cash to pay for filling their tanks.  Interestingly, petrol seems to be a cash business in Cyprus.  Of course extending credit in the current situation would be risky.

Cyprus needs a bail out from the ECB in order to avoid defaulting on the bank's bonds and their government bonds.  If Cyprus defaults bond holders would get about 80 cents on the dollar*.  Defaulting would be a shock to the Cyprus economy because many businesses, institutions, and savings and pension plans are likely heavily invested in these bonds.  In addition the Cyprus government would have to dramatically reduce spending because they would no longer be able to borrow to finance deficit spending and revenue would drop due to the slower economy.  

If Cyprus defaulted they would likely be kicked out of the Eurozone and need to create a new currency, or use another currency such as the USD.  The default that leads to an exit would hurt the people of Cyprus.  Leaving the Eurozone would not necessarily be bad for the average citizen of Cyprus.  Iceland took the path of default and seems to have recovered nicely.  However, Iceland had its own currency, the Krona so Cyprus is blazing new ground.

The ECB does not want Cyprus and its banks to default because many European countries own its bonds.  Cyprus is using this leverage to its full advantage and trying to negotiate better terms.  As the saying goes "if you borrow $1M from the bank, the bank owns you; if you borrow $100B you own the bank". 

The ECB is demanding that Cyprus raise 5.8B euros of the total financial need of 17B euros.  Presumably the ECB bail out is to loan Cyprus the difference.  A loan will keep their banks and government solvent for the short term.  Long term structural problems (e.g government spending) will still need to be addressed.

Cyprus annual GDP is 18B euro.  Cyprus bank assets of 128B euro are so large compared to GDP because Cyprus is a banking haven for eastern European oligarchs.  Russian companies and individuals have an estimate 31B euros of wealth in Cyprus.

Several years ago large, off shore natural gas fields were discovered at Cyprus.  Conspiracy theorists suggest that the ECB is motivated to keep Cyprus in the Eurozone and indebted to gain control of these resources.

*my estimate of 80 cents on the dollar is based on reported total Cyprus bank assets of 128B Euros and total financial need of 17B euros rounded down.  

Sunday, March 17, 2013

Depositors at Cyprus banks to lose 9.9% to surprise Deposit Tax

Will this precipitate a Euro bank run?  

Cyprus needs a $13B bailout which is about 54% of annual GDP.  For perspective that would be equivalent to a $8.5 Trillion bailout in the US.  

The European Central Bank (ECB) has insisted that Cyprus impose a tax on deposits in Cyprus Bank accounts as a condition of a bailout.  Banks in Cyprus are scheduled to open on Tuesday so the government must decide quickly.

This action sets an incredible precedent.  Depositors in Euro accounts now know exactly how safe their money really is.  Depositors in Europe have been moving their money to German banks from Greek, Portugese and Spanish banks for years now.  Zerohedge has reported this type of data many times.  The ECB's actions should scare more money movement to other currencies and commodities and even real estate and equities.  If you are worried about unexpectedly losing 9.9% over the weekend you might rationally decided to spend it now, which will create inflation.

Can you imagine ending the week with 100,000 in your bank account, supposedly the safest place to keep your money and then by start of the next week you have only $90,100?  The oligarchs of eastern Europe who commonly use Cyprus as a haven for their wealth are about to experience it.

Deposit Tax

The debate on the law, which will impose a levy of 6.75 percent on deposits of less than 100,000 euros and 9.9 percent of more than that, will be preceded by more meetings between Anastasiades and political leaders. Anastasiades, who met with his ministers today, will convene another meeting of the cabinet tomorrow morning, CYBC said.
The measure, which is designed to raise 5.8 billion euros, means a smaller bailout for the east Mediterranean island nation than the 17.5 billion euros envisioned at one point. Cypriots woke up yesterday to find bank transfers frozen as the country’s authorities prepared to remove the tax from accounts before banks reopen on March 19.
Quick facts about Cyprus from wikipedia
Population: 1.1 million
GDP: $24 Billion
Member of the European Union
Member of the Eurozone - so their currency is the Euro 
Investment climateThe Cyprus legal system is founded on English law, and is therefore familiar to most international financiers. Cyprus's legislation was aligned with EU norms in the period leading up toEU accession in 2004. Restrictions on foreign direct investment were removed, permitting 100% foreign ownership in many cases. Foreign portfolio investment in the Cyprus Stock Exchange was also liberalized. In 2002 a modern, business-friendly tax system was put in place with a 10% corporate tax rate, the lowest in the EU. Cyprus has concluded treaties on double taxation with more than 40 countries, and, as a member of the Eurozone, has no exchange restrictions. Non-residents and foreign investors may freely repatriate proceeds from investments in Cyprus.[23] 
Role as a financial hub
As a result of the reforms in the past decade Cyprus has developed into one of the world's more important international business centers.[24] In the years following perestroika it gained great popularity as a portal for investment from the West into Russia and Central and Eastern Europe.[25] More recently, although Russia and Eastern Europe remain the most important investment destinations, there have been increasing investment flows from the West through Cyprus into Asia (particularly China and India), South America and the Middle East. In addition, businesses from outside the EU use Cyprus as their entry-point for investment into Europe. The business services sector is the fastest growing sector of the economy, and has overtaken all other sectors in importance. CIPA has been fundamental towards this trend.[26]


Wednesday, March 13, 2013

US Mint Gold and Silver Bullion Coins sales up 43% and 87% respectively YTD

There have been a lot of headlines about record gold and silver sales from the US Mint in January and February.  Gold and silver bullion sales data are available from the US Mint at:

Bullion sales of gold eagles, gold buffalos, and silver eagles are off to a very strong start in 2013.  This certainly indicates strong demand for physical gold and silver.  However, the data could be a little misleading because sales in some months could be low due to supply constraints.

Gold bullion includes Eagles and Buffalos.  US Mint sales of proofs and uncirculated collectible coins are not considered bullion.

Interestingly, the ratio of silver versus gold sold by the US Mint increased dramatically in the last several years.  Although the ratio is still not nearly as high as current relative market values of gold and silver ($1600/$30 or 53:1).

Tuesday, March 12, 2013

Gold Eagle Premiums - Dealers add about $33

The cost of purchasing gold American Eagles from an internet dealer is about $33 per coin more than purchasing directly from the US Mint.  The $33 premium covers shipping, handling and volume.  The US Mint has a 1,000 ounce minimum purchase order quantity for gold and prices are f.o.b. West Point, NY.  The US Mint also requires its customers to have a letter of credit and audited financial statements.  

Note: it is not 100% clear whether the US Mint charges a premium on the gold content (0.9167 ounces) as the analysis above assumes or on the total weight of the coin (1.000 ounces).  If the later is indeed the case it would add $4 to the US Mint cost (roughly 3% on 8%).

The 'Coin Dealer' cost data is from a popular internet dealer.  Dealer commissions vary and are known to change over time.

From the US Mint:
American Eagle Gold Bullion Coins
Public Law 99-185, enacted December 17, 1985, directs the United States Mint to mint and issue legal tender gold bullion coins. The coins are .9167 fine gold (22 karat), with the following weights and face values:  Weight – troy oz. Face value  of fine gold (denomination) 1 oz. $50  1/2 oz. $25  1/4 oz. $10  1/10 oz. $5 (In addition to the .9167 gold, the coins are composed of .0300 silver and .0533 copper.)
For the Gold Eagles, we charge 3%, 5%, 7% and 9% premiums for the one, one-half, one-quarter and one-tenth ounce coins respectively. Minimum ordering requirements are 1000 ounces.
The pricing of the precious metal content is established at the time of the sale: The London P.M. (second) Gold Fix on the date following the day of the order, excluding federal government holidays. The fixed premiums are a percentage of the gold price: 3 percent, 5 percent, 7 percent and 9 percent for the 1, 1/2, 1/4 and 1/10 ounce coins, respectively.
Purchased coins are authorized for release after receipt of payment is confirmed. All United States Mint gold bullion coins must be picked up freight-on-board (F.O.B.) at the United States Mint at West Point (West Point, New York). 

Monday, March 11, 2013

Gold Miners - No Growth in Production

The chart below show the trends for 7 large gold mining companies.  Gold production is down 2% CAGR from 2010 to 2013E despite dramatic increases in capital spending and cash cost.  Cash costs are increasing because miners are processing ore with lower yields and that is more difficult to mine (e.g. deeper in the earth).

Capital expenditures includes both sustaining and exploratory.  Exploratory capital investment will take longer than 3 years to pay back in this long cycle industry.  However some of these investments should be paying off now. Some of these investments must be paying off as increased production.  However, its seems that old reserves are being depleted at the same rate since total production is slowly declining.

The estimates for 2013 come from management reports and presentations made at the beginning of this year.  A couple of the miners commented that production growth in 2013 is partly due to strikes in south Africa that depressed production in 2012 and will, presumably not hamper 2013.

Source: company reports and presentations.  Gold includes gold equivalent ounces for companies that report GEO.

As a gold bull it is reassuring to see that supply is limited.  Historically gold has been a good deposit of value because supply growth was limited.  That remains the case even with 21st century technology.

Companies that can grow production earn a premium valuation, in an industry with slow growth.  My current research efforts are focused on identifying gold miners that are growing production.

Senator Warren re: HSBC money laundering and 'to big to jail'

Senator Warren summarizes HSBC's money laundering and 'to big to jail'.  At the end of 2012, HSBC was fined over $1.9B for laundering money for drug cartels and other criminals.
HSBC is the world's third largest bank.  HSBC's profit before tax in 2012 was $20.7B.  The fine for funding murders was equal to about one month of profits.  And no employees were prosecuted.


The blog-o-sphere is full of comments about how Senator Warren is grandstanding.  Grandstanding or not at least she is shining some sun light on our corrupt financial system.  As they say sun light is the best disinfectant.  Let us hope that more of our representatives perceive that reforming the financial system is the best way to serve and get re-elected.

Tuesday, March 5, 2013

Gold: high volume + large buyers = flat prices??

This link is to an interview with Eric Sprott.  He is the leader of Sprott Asset Management which runs several precious metals funds among other things.  He is in a good position to see the physical gold and silver markets because his funds have been buying physical for many years.  

Interview with Eric Sprott: Central Bankers are Gaming Gold

Eric believes that the world's central banks are manipulating the price of gold down.  Of course he cannot prove this.  However, there are some strong indications:
- the volume of gold that trades on the COMEX.  Some days the volume is close to the entire annual physical gold supply.  Such large volume must be mostly 'paper gold' or contracts to buy/sell gold.  There is not enough physical gold available to satisfy all contract holders if they demand physical gold at the same time.  The speculation is that central banks are supplying bullion banks who are on the sell side when necessary to meet the demands of contract holders.
- the volume of gold buying by China and India.  Eric supposes that some of that gold must be coming from other countries' central banks

The only way that gold prices could have been stable over the last 2 years while the markets trade huge volumes and China and India acquire more and more physical is if central banks supply some gold or at least promises (contracts) of physical gold.  

The question now is when.  When will the central banks stop selling their gold?  And how will markets and traders with paper promises react?  Will governments outlaw gold ownership and buying or selling gold before that day?  It is difficult to guess because the central banks are so opaque.  Central banks are not audited so even their current holdings of precious metals are unknown.

Sunday, March 3, 2013

US Gov't Ineptitude - even when they get one right

Jesse summarizes and links to an incredible story.  The US Federal Energy Regulatory Commission won a verdict for a $30M fine against a former natural gas trader at Amaranth Advisors for manipulating the gas market.  And now, incredibly another US government agency the US Commodity Futures Trading Commission (CFTC) is backing a suit asking a Federal appeals court to overturn the fine.  

The US government has become so corrupt and inept that they are working against each other - let alone for 99.9% of its people.  I wonder how many consulting contracts or promises of future employment the CTFC commissioners have received from Amaranth and this trader.

Rik Green's Investors Forum Growth Portfolio down 3.9% in February

Rik Green's growth portfolio <Port-faux-lio> lost 3.9% in February and the S&P500 was up 1.1%.  CVX was up 1.7% and continues to outpaced the S&P500.  The precious metals funds were down about 8% and GG was down 7.8% in February.

Year to date the growth portfolio is down 1.8% while the S&P is up 6.2%.  This volatility is tough to stomach!  Deep breath.  Anyone investing in precious metals must be prepared to weather some storms.  But it still hurts to think that an investment in the S&P index would have out performed my carefully selected investments.  We're only in the first inning.

From an earlier post you can see that I believe the recent decline in metal prices to be a buying opportunity.

Friday, March 1, 2013

Gold mine investors have gotten the shaft

As I wrote several days ago the gold miners have barely been able to increase production despite increased investment and higher gold sales prices over the last several years.  The 7 mining companies that I reviewed estimate that gold production in 2013 will increase only 2.3% from 2012.

Bloomberg published a nice summary of the situation. gold-miners-come-clean-on-costs-after-lost-6-years

Some comments on the Bloomberg article:

The article focuses on cost which should be viewed together with production or sales.  The most damning aspect of gold miner leadership is that their investments have not achieved increased production.  If ABX and GG were producing more gold, the investments would have a much better return since their all-in sustaining cost is currently $941 per ounce.  At this cost level continuing operating margins are over 40% assuming a gold sales price of $1,600 per ounce.  As an investor in gold mining companies I would be satisfied with lower margins (in percentage) as long as total operating profit (in dollars) is growing.

Barrick Gold Corp. (ABX) and Goldcorp Inc. (G), the two biggest producers by market value, have begun reporting “all-in sustaining costs” for the first time. The new measure averaged $941 an ounce between the two companies in the fourth quarter. That’s 50 percent higher than the $626 average so-called cash cost they disclosed in the preceding three months
The average cash cost of 10 of the biggest gold miners was $694 an ounce in the third quarter, 49 percent higher than in the same period two years earlier, according to data compiled by Bloomberg. The average gold price rose 35 percent in the same comparison.
Cash cost has been increasing mostly due to lower yields and partly from "pressure from rising prices for labor, equipment and raw materials".   New mines starting production have lower yields than the old mines that have been depleted.  And, ongoing mines are also seeing lower yields.  Lower  yields means that more fill must be excavated and more tons of ore milled to produce the same amount of precious metals.  At an underground mine it means that more and usually deeper and therefore more expensive tunneling is necessary just to reach ore deposits.

With an average cash cost of $694 per ounce the miners should be producing as much as possible - and I think they are.  There is a lot of room for production at lower yields if you sell something that cost $649 for $1,600.  Miner that can grow production will carry a premium valuation.

What exactly is cash cost and all-in sustaining cost?  Cash cost typically refers to cash cost by-product.  However, many mining companies also report cash cost co-product.  

Cash Costs by-product exclude depreciation and depletion and include:
- the cost of labor, equipment, spare parts and utilities
- the cost of royalties
- the cost of treatment and refining charges
- the benefit of by product sales, such as silver, copper, lead and zinc sales

Cash Cost co-product includes the same types of costs as for by-product.  The costs are allocated to each product (gold, silver, copper, lead, etc) separately.  In this way no profit on silver, copper, lead and zinc is included or benefits the co-product cost of gold production.  

All-in sustaining cost is defined as:
- cash cost by-product 
- sustaining capital
- exclcudes capital for new mines not yet in production
- corporate general and administrative
- exploration expense
- excludes reclamation and closure costs

The industry is currently working on standard definitions for all-in sustaining cost.  Many of the publicly traded mining companies have started reporting their own version of all-in sustaining cost.  All-in sustaining cost is a better measure of total profitability because it includes sustaining capital and G&A.