Friday, June 24, 2011

Spain and Italy Tank; China and India Rally

by Bespoke Investment Group

After declining more than 2.5% yesterday, the major equity indices in Italy and Spain are both down nearly 1.50% today. As shown in the top two charts below, both are currently in "don't catch a falling knife" patterns to put it bluntly.

While Europe falls apart, India and China have both seen huge price moves to the upside this week. China's Shanghai Composite has rallied 4.77% since Monday, while India's Sensex is up 4.20%. 

Which areas of the world would you rather see rallying? India and China or Europe?

See the original article >>

Invest now in new gold called molybdenum

By Carlo Biancardi

An investment will and should be in a precious metal needed for life to occur, plants and animals need Molybdenum to live. There is nothing more fundamental or basic than an element. We need elements to build or grow anything. We need Molybdenum (an element) to grow any plant or life form. There are 3 types of elements: poisonous, inert and life giving. Which elements would you want to be around? Which elements would you keep away? Gold does not support life. Silver does not support life. As for Platinum, Palladium and Rhodium you can probably guess what I will say next. Molybdenum is the finest metal to be a part of (literally). Molybdenum has many uses.

Molybdenum has the lowest abundance of the life giving elements in the Earth's crust (other than industry useless Selenium) at 1 ppm (0.0001%).

Molybdenum has the 6th highest melting point of all the elements, and by far the highest melting point (4753 degrees fahrenheit) of all the metals needed for life.

If I were leaving Earth forever, I would build the ship out of Molybdenum. I would only bring life giving elements with me, that is the same mentality I have here on Earth, that is to invest in physical Molybdenum. I could grow hydroponic plants which need Molybdenum and other life giving elements to survive. I would not bring Gold with me.

China has high rates of esophageal cancer and/or strokes because of low Molybdenum amounts in their soil. To fertilize farmland you need half a Pound of Molybdenum per acre (International Molybdenum Association) some websites suggest up to 6 pounds per acre, on a 1-3 year basis. There are about 1 billion acres of farmland in the U.S.A. and billions of acres of deficient farmland worldwide, which clearly means there is not enough Molybdenum for everyone.

Nuclear power is not leaving, nor are oil and gas pipelines. Nuclear power plants need high Molybdenum content stainless steel cooling pipes (6.5% or higher Molybdenum) because it prevents corrosion. Salty ocean water is very corrosive to the water cooling pipes. All nuclear power plants are near large bodies of water and need lots of water for cooling the reactors. Pipelines use high amounts of Molybdenum and will be using higher percentages of Molybdenum content in the future to combat corrosion and reduce friction of crude oil delivery in the pipelines. Corroded infrastructure and new infrastructure will need Molybdenum for the Steel used. Molybdenum also greatly enhances Steel strength.

China is calling molybdenum a national resource and is limiting the mining of molybdenum because they know it is more valuable left in their mines and in the ground, they will buy everyone elses at low cheap prices now. They will import this metal. China realizes that irreplaceable molybdenum is important for their country going forward.

The world total yearly amount of Molybdenum mined and CONSUMED is 500 million pounds. What does that amount look like? Well it's 150 meters x 150 meters x 1 meter high. That is not much at all! ONE small project could easily consume this all. All the data on the internet mentions tonnes and millions of pounds and when you look at the total amount mined in volume (cubic meters), it is very tiny.

ONE investor could buy the whole planets yearly Molybdenum production for $8 billion dollars (Jan 2011). Molybdenum only costs $1 per ounce. In comparison, to buy all the Gold that is available and that has ever been mined, it would cost you $7.4 trillion dollars (Jan 2011) to buy the 375 million pounds of useless bling!

Courtesy :

Guest Post: Austria's Green Party In Position To Kill The Greek Bailout Package

by Tyler Durden

While EU leaders look forward to a multitude of emergency meetings until July 20, when Greece has to pay back a government bond with a volume of €6.6 billion, the fate of Greece's bailout may ultimately lie in the hands of the Green party in the dwarf nation Austria.

Austria's Green Party sent an open (German language) letter to the country's chancellor Werner Faymann on Thursday, threatening to boycott a vote in the Austrian parliament where a 2/3 majority is needed for a change of the constitution that would allow Austria to participate in the €138 billion bailout package for the Hellenic peninsula. As a Euro member Austria has the obligation to take part in the bailout that is hugely unpopular with voters/taxpayers.

The Greens got 9.8% of the votes in Austria's latest elections, making them the 4th biggest party in the five party Austrian parliament.

In their German language letter published on the party's website the Greens demand 2 key adaptions of the bailout package from Austria's socialdemocrat-conservative coalition government. The letter is signed by Chairwoman Eva Glawischnigg, budget speaker Werner Kogler and foreign policy speaker Alexander van der Bellen.
  • Firstly the Greens demand an obligatory inclusion of private creditors (that's the banks) and the regulatory introduction of an orderly default mode for bankrupt Euro members that shall be part of the final version of the legislature of the moneyless €750 billion European Stability Mechanism (ESM) that shall come to life in 2013 when the current European Financial Stability Facility (EFSF) will end. The greens explicitly noted that chancellor Faymann should inform the other Euro governments of their intention to block a constitutional change for the ESM if such measures are not taken.
This initiative finds my full support as it is clearly written on the wall that the Eurozone will see more defaults than Greece only. This was also indicated by Dutch central bank governor Nout Wellink last week. He proposed to double the ESM to an almost unimaginable €1.5 Trillion. This sum may still not be enough as Greek debt currently stands somewhere between €310 billion and €467 billion.
Europe needs a clear framework for such events that are historically much more frequent than politicians want to admit. In the last 2 centuries almost every European country has defaulted at least once. It was a major political blunder in the creation of the Euro not to include rules for those who turn out to be too weak for the Euro.
  • Secondly the Greens would support the issuance of Eurobonds by the European Central Bank (ECB) as proposed by outgoing ECB President Jean-Claude Trichet, arguing that this would strengthen European solidarity and could also help preventing another attack of speculators on bonds of single countries.
This second point is rubbish as such a Eurobond would raise financing costs for the Euro hardcore comprised of AAA-rated Austria, Germany, Finland, Luxembourg and the Netherlands. Sorry, there is no solidarity among these populations with the book-cooks from the souther European hemisphere and never will be. Why should Austrians or other Eurozone inhabitants accept that Greek public servants retire with 53 years when their own politicians already discuss to push out the legal retirement age past the 65 year limit applied in most Euro countries?
It has yet to be seen if the Greens will stick to their strategy and really prevent the Greek bailout package as it it highly improbable that the Eurozone will come up with a framework for sovereign defaults before the deadline on July 20, when Greece will have to pay back a maturing bond.
But they would very likely gain in popularity for the courage to stand up against the worldwide political concept to fight debt with more debt.
The Greens in Austria are in dire need of a popularity booster as they fell behind far right-wing party FPÖ in the last elections and are soul-searching for a policy line that does not estrange their core constituency of environmentalists and the young left that does not find a home under the roof of the socialdemocrats.
Standing up against the financial tyranny of the EU would also help to win back anti-EU voters which are currently lured by the two xenophobic parties, the FPÖ (Freedom Party) - now leading in polls with 30% ahead of the two coalition parties SPÖ (Social Democrats) and ÖVP (Christian Conservatives) - and the BZÖ (Alliance for the future of Austria).
Occupying a critical position towards an undemocratic EU would break the dam that only right-wingers publicly oppose the repressive regime of the Moloch in Brussels that tends to overregulate every aspect of life while salting away billions in taxpayer money by widespread subsidy fraud.
It would also help restore the image of an autonomous party favoring liberal policies over Brussels' law-spewing machine that is increasingly opposed by most Europeans except the politicians that live very well from and with the EU.
Therefore I call on the Greens: Please give financial sanity a chance in the world and do not back down from your key demands. It is now entirely in your hands to push Eurozone policies back on a sound path. Bailing out Greek again will only lead to more expensive bailouts as it delivers a bad example to the other budget sinners in the Eurozone. Help stop the money printing madness arranged by a clueless set of Euro politicians that will retire comfortably no matter what happens instead of becoming a complicit partner in the robbery of Europe's future.

Morning markets: Greece deal puts crop markets on front foot


Financial markets looked to end a difficult week on a brighter note.
Greece's agreement with international lenders to further measures to improve its finances lent a sunnier air to risk assets. Tokyo shares, for instance, closed up 0.9%, and Shanghai stocks stood 2.1% higher in late deals.
Furthermore, the dollar took one step backwards, easing 0.1% against a basket of currencies, as the idea that this chapter of the Greek debt saga was over, on consent by Athens to further spending cuts on top of the E28bn ($40bn) plan settled last month, so winning a (further) E12bn rescue package.
A weaker dollar improves the case for dollar-denominated assets, making them cheaper to buyers in other currencies.
Next week is coming...
Copper gained more than 1%, while New York crude recovered 0.7% to stand at $91.67 a barrel at 07:20 GMT (08:20 UK time).
And grains showed even stronger gains, building on their recovery late in the last session on the idea that the selling of recent sessions had gone further than could be justified, for now at least.
Of course, investors will gain a better idea of where grain fundamentals are next Thursday, when the US Department of Agriculture releases data on American inventories and sowings.
"The market has to be looking ahead to the June 30 stocks and acreage reports which are just a week away, and that should provide some underlying support and consolidation as we move forward over the next four sessions," Jon Michalscheck, at Benson Quinn Commodities, said.
Wet weather
Corn led Friday's bounce, adding 1.5% to $6.90 ½ a bushel for July, further expanding its premium over the new crop December lot, which managed only a 1.0% rise to $6.52 ¼ a bushel.
And this despite the December contract having managed, unlike earlier lots, to retake its 100-day moving average in the last session, a tick in the box for chart-followers. (Another tecnical point to note is the expiry of July options, which could provoke some unusual moves.)
Wheat gained 0.9% to $6.54 ¾ a bushel, a touch behind the new crop September lot, which added 1.1% to $6.76 ½ a bushel, with some observations of poor weather ahead too.
Lynette Tan at Phillip Futures said that a "forecast of more rain in northern US Plains for the next few days could prevent some farmers from planting all their intended wheat acreage". That is, if they haven't given up already.
"Rainy conditions in southern US Plains may also delay harvest of hard red winter wheat," she added, although has not heard yet of mention of the rains turning observations of better-than-expected quality into reverse.
Against the tide
Soybeans for July added 0.4% to $13.23 ¼ a bushel, creeping back from the edges of the oilseed's recent trading range, which it was helped to on Thursday by Canadian data showing that farmers had intended higher-than-expected canola sowings.
(Although whether they found enough breaks in the rain to plant them is a different matter, of course.)
And cotton set course for the somewhat remarkable feat of closing higher, for July delivery, every day this week, even while prices of other crops have collapsed. Who said all agricultural commodities moved in the same direction these days?
The lot has been buoyed by covering of short positions ahead of the start of the expiry process today, a period which, for the May lot, caught out holders short of cotton big time.
It added 1.1% to 166.38 cents a pound on Friday, with the December lot gaining this time too, by1.8% to 121.49 cents a pound.
Seven-month low
Elsewhere, palm oil continued its march south, touching a seven-month low of 3,118 ringgit a tonne in Kuala Lumpur, for September delivery, before recovering a little ground to stand at 3,125 ringgit a tonne, down 0.4% on the day.
The vegetable oil is being depressed by much improved hope for production, which drove Malaysian stocks in May to their highest in 16 months.
However, there is hope for bulls. "The downside could be capped as the strong buying interest from China and Middle East could continue," Ker Chung Yang at Phillip Futures said.
"The demand for palm oil has risen due to a wide discount to competing soyoil, and as countries gear up for the Islamic fasting month of Ramadan," which starts in August.
Soyoil, indeed, added 0.3% to 55.32 cents a pound in Chicago for July delivery, helped by better-than expected US crush data published on Thursday.

Rising Food Prices Are on the Menu Regardless of G20 Action

By David Zeiler

You've no doubt felt them in your wallet already. And just a few days ago, we again warned you about the storm that's been brewing in the agricultural sector.

Well yesterday (Thursday) the Group of 20 (G20) decided to take action by announcing it would curb rising food prices by creating a more transparent system of tracking food supplies.

But sadly, that won't be enough.

"The plan of action tries to address the symptoms of price volatility on agricultural markets," Olivier De Schutter, the United Nations special rapporteur on the right to food, told the Guardian, "but it fails to address the causes."

Those causes have been well-documented in Money Morning: The steeply rising global population, growing demand from emerging markets such as China, the spillover effect of rising energy prices, mandates on biofuels, and a weak dollar.

And those factors together mean rising food prices for the foreseeable future - regardless of what the G20 tries to do.

It's a pain we will all share - and that will be felt most acutely in poorer countries - but companies involved in supplying and transporting food such as Archer Daniels Midland Co. (NYSE: ADM) and Bunge Limited (NYSE: BG) should do well.

Another company that should fare well is Deere & Co. (NYSE: DE), which last month raised its 2011 guidance based on rising sales of farm equipment.

Certainly, the G20 plan, officially known as the Agricultural Market Information System (AMIS), is well-meaning. The group believes volatility in agricultural commodities results from irresponsible speculation and a lack of information on global food stocks and the supply and demand of crops.

The G20 is betting that collecting that information from nations as well as private companies - and making it public - will help foil speculators and calm markets.

"What we saw when prices started to surge in 2008 was that the lack of information on stocks and availability can lead to panic in markets, and panic is what leads to price hikes," World Bank President Robert Zoellick said at a news conference. "Uncertainty leads to volatility."

Of course, a major flaw in the AMIS plan, aside from its failure to address why food prices are rising, is that it requires the full cooperation of nations and corporations.

French Agriculture Minister Bruno Le Maire even admitted that China and India have resisted disclosing details about their food supplies, citing national security. Both nations have already been given extra time to provide the requested information.

The private corporations present an even bigger challenge. Four companies - Cargill Inc., Bunge Limited, Archer Daniels Midland, and Louis Dreyfus Commodities - control more than 90% of global grain trading.

Although Le Maire has met with these companies in an effort to win their cooperation, the G20 can't force them to disclose their data, and they may resist revealing sensitive information to competitors.

Beyond Their Control

This isn't the first time the G20 has tried to exert some control over an erratic and troublesome commodity market.

Back in 2002 the G20 launched the Joint Oil Data Initiative (JODI), an attempt to arrest volatility in the oil markets. Participants in the oil markets have been slow to cooperate, and a glance at any recent oil price chart will tell you that the oil markets are as volatile as ever.

Similarly, the many pressures on agricultural commodities, most of which are beyond the G20's control, will keep the market volatile while pushing prices upward.

In a report last month, the United Nations revised up its estimate for the global population in 2050 by 150 million people to 9.3 billion, and projected a peak of 10.1 billion by 2100. That will require a 70% increase in global food production, an issue the AMIS plan doesn't even begin to address.

More immediately, you have the rapidly rising appetite of countries like China, which already is using 47 times more corn than it did 10 years ago.

And then there is the inscrutable emphasis of governments on biofuels that convert crops such as corn into fuel. The U.S. ethanol industry expects to convert 5 billion bushels of corn into ethanol next year, encouraged by the Renewable Fuel Standard mandate requiring the blending of ethanol with gasoline.

Recent spikes in energy prices also have affected food prices, with crude oil rising 10.3% in March, 36% higher than the same period in 2010.

"These oil price increases impact the price of food -- a 10% increase in crude oil prices is associated with a 2.7% increase in the World Bank Food Price Index -- through multiple channels," a recent World Bank report stated. The organization's Food Price Index has remained stuck near the all-time high it set in early 2008.

Finally, there's the weak dollar. As the world's reserve currency, commodities are usually priced in dollars, so a weak dollar tends to make commodities more expensive.

All told, it looks like the G20 has bitten off more than it can chew.

"Fixing the global food system and ending the food price crisis requires major surgery yet the G20 produced little more than a sticking plaster," Jean-CyrilDagorn, policy advisor for Oxfam's GROW campaign,said in a statement. "Agriculture Ministers agreed to address some of the impacts of high and volatile prices but failed to introduce the measures needed to prevent prices spiraling out of control in the first place."

Gold Prices: Will Gold Equity Investors Reap Big Gains?

By Frank E. Holmes

Gold prices passed the $1,500 per ounce mark for the first time ever in mid-April and, aside from a couple of short pullbacks in early May, have set up shop in the neighborhood of $1,525 to $1,550 an ounce (gold closed at $1,553.40 on Wednesday).

So far in 2011, it's been relatively status quo for those investors who've embraced gold as a way to protect themselves from currency debasement, excessive money printing and inflation as prices have increased 7.67%. Bank of America-Merrill Lynch (NYSE: BAC) analysts are forecasting gold prices could fall to $1,400 an ounce during seasonal weakness in July before rebounding as high as $1,650 an ounce by early fall.

While the party continues for gold bullion prices, stocks of gold companies have been a no-show. The NYSE Arca Gold Bugs Index (HUI) has fallen more than 13% year-to-date and the Philadelphia Gold & Silver Index (XAU) has toppled more than 16%. Companies such as High River Gold Mines Ltd., Jaguar Mining Inc. (NYSE: JAG) and NovaGold Resources Inc. (AMEX: NG) are off more than 45% from 2007-2008 highs.

This underperformance has been exacerbated in recent weeks making it a hot topic of discussion among investors, analysts and portfolio managers.

An Analyst's View of Gold Prices

I recently had lunch with CIBC (NYSE: CM) analyst Barry Cooper, gold-company wizard and one of the industry's best. He sees this recent phenomenon as "a market-sentiment-driven event that will pass as fundamental financial drivers kick in to support share prices and drive them higher."

However, the trend could continue as long as the cost of mining operations continues to inflate. Cooper modeled a case study that showed equities can produce an inferior return relative to bullion when the price of an ounce and the cost to produce it rise in tandem despite the opportunity for companies to use higher gold prices to expand production or increase reserves.

According to Cooper, "the average global cost per ton has been rising at a rate that is slower than the gold prices increase; however, it has also been accompanied by a declining grade profile for most operations." The average grade of a gold deposit has declined 21% since 2005, but higher bullion prices have made it economically viable for gold companies to pursue higher cost projects and keep lower-cost, high-grade operations off line in case gold prices pull back.

Further, Cooper says this means that "the market seems to have penalized companies for the rising costs associated with lengthening the life of a mine operation ... the market does not seem to be paying for the optionality offered by increasing reserves when they come with increased costs."

The strongest periods of underperformance seem to correspond with times when cost inflation was high. Cooper concluded that "investors seeking gold exposure also want safety in terms of cost containment, and when part of the reason for buying stocks falters, the choice is abandoned for alternative investments."

The financials for the majority of gold companies have been improving for years. According to Cooper, many gold companies "have been generating positive [cash flow] and growing earnings on a per-share basis." Although it hasn't showed up in share price performance, senior gold miners have seen the strongest gains with average per share earnings increasing roughly 67% since 2009.

Corporate cash flows for gold producing companies have also increased significantly. The average senior gold miner now has more than twice the amount of cash flow; mid-sized intermediate gold companies' cash flow has more than tripled.

This year's carnage has created a substantial opportunity to buy healthy, gold mining companies at historically low prices compared to gold bullion. Cooper says that "the net result is that gold companies can now be purchased for about their intrinsic value for the spot price of bullion."

Gold-Mining Dividends - Getting "Paid to Wait"

One way gold companies can lure investors is by sharing their profits through dividends. This would provide a cash incentive to hold shares of the company and allow investors to participate in rising earnings. We like the idea of investors getting "paid to wait" or reinvesting those dividends and purchasing additional shares at potentially lower prices.

Newmont Mining Corp. (NYSE: NEM), a company whose share price is about 15% off of its highs, recently initiated a dividend program and has a current yield of 1.55%. Companies such as Compania de Minas Buenaventura SA (NYSE ADR: BVN) (1.82%), Yamana Gold Inc. (NYSE: AUY) (1.59%), Gold Fields Ltd. (NYSE ADR: GFI) (1.39%) and Barrick Gold Corp. (NYSE: ABX) (1.11%) also offer attractive yields.

The ongoing debt crisis in Greece should remind everyone that global markets are still recovering from 2008's trauma. The system is not nearly as strained as it was then but we are by no means out of the woods in terms of global economic stability. This should continue to provide a catalyst for strong gold prices.

See the original article >>

Risk Mood Turns Sour After Italian Banks Unicredit And Intesa Sanpaolo Suspended Following Plunge

There has been a decidedly bearish turn to risk sentiment in Europe, where the EURUSD briefly touched over 1.43 just under two hours ago, only to see virtually all the gains from the Greece "bailout acceptance" non-news wiped out, and dipping by over 100 pips in the span of a little over an hour. The reason for this dramatic change in mood is attributed to a trading halt in Italian banks UniCredit and Intesa Sanpaolo both of which tumbled by 8% earlier before being halted.

Among the reasons for the plunge cited by traders are rumors for a cap increase for UniCredit due to risk of not passing the stress test. There is also speculation that there was a major selling program advertised by Goldman several minute before the Moody's headlines of putting Italian banks on downgrade review. Attached is Reuters take. Bottom line - Europe is so jittery that no matter how the Greek hole is plugged, the law of connected vessels merely will mean that vigilantes will next focus their attention to one of the next two dominoes: Spain and Italy.

Post-QE2 Blues: Time for a Debt Rehab? (Guest Post)

By Andrew Butter

Nouriel Roubini’s big idea was [IF] you spend more than you earn, [THEN] you have to borrow so you can pay your bills; but in those circumstances, [IF] you run out of credit, [THEN] you can’t pay your bills. That may not sound like rocket science, but sadly it’s not something you learn in Econ-101, economists need a PhD before they can work that one out and many can’t, even then, which is why they had the credit crunch.

Of course if you own your own fiat currency, that’s not a problem, when you run out of money, well, you just print some more, easy. The problem however is when “aliens” get in the picture. So when America pays out more money for importing oil and auto parts made in Japan, than she earns selling fixer-upper suburban houses in Detroit (to aliens), she needs to find some aliens to give her credit, for example, by buying U.S. Treasuries and other “U.S. government securities,” and so on.

In 2003 Nouriel Roubini noticed that the U.S. current account deficit was ballooning; that’s the difference between what America sells to aliens compared to what she buys. He pointed out that sales of U.S. 

Treasuries and so on (to aliens) were starting to be not sufficient to finance that; and thus unless “something was done,” well, there would be Armageddon. That’s when he got his nickname “Dr Doom.”

Luckily, “something” was done. Legions of “God’s Workers” all labored feverishly to originate and distribute toxic assets, which they then sold to unsuspecting foreigners as in Norwegian pension funds and self-important morons from RBS, who now have court orders stipulating we are not allowed to mention them by name, so as to protect their “rights” to peacefully spend the perks they got presiding over that Charlie Foxtrot.

So a crisis was averted, between 2004 and 2007 God’s Workers cleverly managed to get dumb foreigners to hand over $2.5 trillion in return for what turned out to be a load of junk, which was a stroke of genius. My vote is that the God’s Workers should all be awarded the Congressional Medal of Honor and they should keep their “hard-earned” bonuses, because they saved America (for a while).

And that’s when the talk of “A stopped clock is right, twice a day”, started. As in Roubini’s dire predictions were proved to have been totally wrong (for a while). Then the darned aliens stopped buying the junk and then there was a “credit crisis,” as in no one could do the old “Rolling Loan Gathers No Loss” trick, anymore.

And here we are, post-crunch, but although these days America’s current-account deficit is averaging $100 billion a quarter, which is half what it was is the heady days when it averaged $200 billion a quarter. $100 billion a quarter is still a lot of money, even these days, for example, that’s even more than it costs to run a decent sized war.

The difference is that when it was $200 billion a quarter you could sell a AAA toxic asset with “Made in America With Pride” stamped on it’s rump, to just about anyone (imagine in Q2 2007 they sold over $300 billion of that stuff to the aliens).

Those were the days!

Sadly, all good things must end. Recently released numbers from the BEA show that in QI 2011, the aliens sold back (presumably at a steep loss) $7 billion more toxic assets than they bought; (that’s on Line 66 of International Transactions, by the way).

Sales of U.S. government securities (to alien governments as well as ordinary aliens — lines 57 & 65) was down too, $74 billion in Q1 2011 compared to $185 billion in Q3 2010.

Perhaps that was an unintended consequence of QE2 where the Federal Reserve was supporting the price of U.S. Treasuries in USA, by buying them, and that might have discouraged the aliens? Or perhaps that was intended, certainly there has to come a point at some stage where America needs to make a real effort to sell more “things” to aliens than it buys from them?

Perhaps that Bernake chap is not half as dumb as he looks?

Is the Fed the World’s Largest Fixed-Income Hedge Fund?

By Global Macro Monitor

The following data is taken from Congressional testimony of the well respected banking analyst, Bert Ely, illustrates how the Federal Reserve has gone from being a taxpayer subsidized monetary authority to one of the world’s largest and most profitable bank/fixed-income hedge funds. Mr. Ely points out the pre-crisis Fed balance sheet (Table 1) consisted mainly of “Fed-issued currency intermediated into Treasury securities with both of those items compromising 90% of their side of the Fed balance sheet.” On the income side, Table 2 shows that in 2007, which Ely calls the last “normal” year, the U.S. taxpayer provided a $5.7 BN indirect subsidy to the Fed by paying $40.3 BN (line 1) of interest of the Fed’s holdings of Treasury securities, of which a $34.6 BN surplus (line 17) was returned to the Treasury.

Table 1 also illustrates how, since the crisis began, the Fed has more than tripled the size of its balance sheet, increasing its Treasury holdings by $650 BN and purchasing of over $1 TN of MBS and Agency debt. As of May, according to Ely, the Fed held 14 percent of the total debt and MBS issued or guaranteed by the three housing-finance GSEs and Ginnie Mae. The balance sheet growth was financed almost entirely by the creation of bank reserves held as deposits at the Fed (line 10). These reserves now account for almost 10 percent of total banking-industry assets, which, prior to the crisis was effectively a rounding error.

Table 2 shows the Fed’s net income has grown from $38.7 BN in 2007 to $81.7 BN in 2010 (line14). Though the sharp decline in interest rates reduced the Fed’s interest income on Treasuries from $40.3 BN to $26.4 BN, the more than $1 TN purchase of agency debt and MBS helped to generate $53 BN in interest income (line 3) in 2010, up from $.6 BN in 2007. The Fed returned $79.2 BN to the Treasury in 2010 (line 17) and after accounting for the $26.4 BN of interest on Treasuries generated a $52.9 BN profit for taxpayers.

The risks? Take a look the leverage ratio in Table 1 (line 13). John Hussman points out the Fed’s leverage ratio in now higher than that of Bear Sterns and Fannie Mae with similar interest risk though less credit risk. He writes,
The maturity distribution of these [Fed] assets works out to an average duration of about 6 years, which implies that the Fed would lose roughly 6% in value for every 100 basis points higher in long-term interest rates. Given that the Fed only holds 2% in capital against these assets, a 35-basis point increase in long-term yields would effectively wipe out the Fed’s capital…
To avoid the potentially untidy embarrassment of being insolvent on paper, the Fed quietly made an accounting change several weeks ago that will allow any losses to be reported as a new line item – a “negative liability” to the Treasury – rather than being deducted from its capital. Now, technically, a negative liability to the Treasury would mean that the Treasury owes the Fed money, which would be, well, a fraudulent claim, and certainly not a budget item approved by Congress, but we’ve established in recent quarters that nobody cares about misleading balance sheets, Constitutional prerogative, or the rule of law as long as speculators can get a rally going, so I’ll leave it at that.
We’re not sure of the endgame and when and how all this is going to play out. But we do agree with Mr. Hussman that “the predictable outcome is instability.” Toto, I have a feeling we’re not in Kansas anymore.

See the original article >>

Crop prices revive after tripping over firm dollar


Grain prices recovered some of their losses, as an early tumble blamed on Chinese, European and US economic concerns, which sent wheat and corn down 5% in Chicago, encouraged bargain-hunting.
Wheat for July tumbled 5.1% in Chicago to $6.06 a bushel in opening live deals, its lowest since July last year.
Chicago corn fell more than 5% to drop below the 200-day moving average, a key technical signal, for the first time since August. Soybeans too fell below the 200-day line, for the first time in nearly a year, as they dropped to a three-month low below $13 a bushel.
Grains fell in Europe too, with Paris wheat for November, the best-traded lot, down 4.4% at one stage.
Bad news cocktail
The early declines reflected a move out of risk assets across the board, with shares closing down 1.7% in London and down 0.9% in New York in afternoon deals, thanks to a spate of negative news.
Crop prices at 18:45 GMT
Chicago wheat: $6.44 ¼ a bushel, +0.9%
Paris wheat: E195.00 a tonne, -0.8% (closed)
London wheat: £164.10 a tonne, +0.1% (closed)
Chicago corn: $6.80 ½ a bushel, +0.4%
Prices for July contracts on US exchanges, and November lots in Europe
This included a weak US jobless claims report and, in China, data from HSBC showing the country's manufacturing activity running at its slowest pace in nearly a year.
The dollar, seen a safe haven asset, received an extra boost after Jean-Claude Trichet, the head of the European Central Bank warned that the Greek sovereign debt crisis risked destabilising the eurozone.
The greenback surged 1.0% against a basket of currencies, as of 17:40 GMT, making dollar-denominated assets, including many commodities, less competitive on export markets.
One of these assets, oil, received an extra drag from an International Energy Agency release of 60m barrels from strategic oil stocks held in the main by the US, but also by the likes of Germany and Japan. New York crude fell 4.1% to $91.50 a barrel, with Brent crude tumbling 5.1% to $108.44 a barrel.
Export calculations
However, investors called time on declines., bringing London wheat back just into positive territory. amid further evidence that low prices were luring out buying by end users.
After US ethanol data on Wednesday showed an unexpected recovery in ethanol production, signalling strong use of corn by biofuels plants, Thursday bought American wheat exports which, at 660,000 tonnes beats forecasts.
Furthermore, Egypt unveiled its largest wheat purchase in six months, of 240,000 tonnes, defying expectations that it would come in with a token order.
"I would have thought anyone would wait a few weeks until Russia is back in the market in earnest, when they would be able to get as much as they like for not much," a trader told earlier.
'Weather non-threatening'
Nonetheless, the result highlighted the competitiveness needed to win trade with US wheat, at $268 a tonne, bought $38 a tonne cheaper than in Egypt's last tender, announced on Tuesday last week. Cairo bought European wheat at $283.67 a tonne, down nearly $44 a tonne.
Furthermore, weather for crops has improved too. Pierre Begoc, at consultancy Agritel, said that Black Sea crops were "getting much, much better" following recent rains.
"The potential for spring crops is getting better every day," he said, adding that Agritel was "no longer worried" about harvest prospects in Russia and Ukraine, where dryness last month had raised concerns.
Broker US Commodities said that "the weather around the world is non-threatening", with dry areas of China receiving rain, and concerns waning for a dry spell due in the US early next month.
However, Mr Begoc, while saying that the outlook for crop markets did "not look optimistic for the coming days", highlighted potential support for the market from "very tight" corn supplies.

See the original article >>

Hard hat time?

by Kimble Charting Solutions

Gold Gets Hit With the Ugly Stick

by Bespoke Investment Group

A look at gold shows how quickly a chart can go from looking good to looking ugly. Yesterday, it looked as though gold was going to break above its early June highs and make a run for its all-time highs from the beginning of May. Today, gold is on pace for its worst day since January, and it is now trading slightly below its 50-day moving average.

Betting The Farm On Hedge Funds?

Following my last comment on Japan's pensions betting on hedge funds, Jonathan Jacob of Forethought Risk sent me an Institutional Investor article by Imogen Rose Smith, Public Pension Plans Bet Their Future On Hedge Funds:
It didn’t sound like much, even at the time. In April 2002 the California Public Employees’ Retirement System invested a total of $50 million with five hedge fund firms. For the then-$235.7 billion CalPERS, the largest state pension plan in the U.S., writing $50 million in checks was hardly a noticeable occurrence. But as the first step in an initial $1 billion allocation, the investment was a monumental moment for the hedge fund industry. It marked one of the first significant commitments by a public pension fund to a program of investing with hedge fund managers, a group that the pension community and its advisers had previously shunned as too risky and secretive. And in ways that are only now starting to become completely clear, it would dramatically change how public pensions invest.

CalPERS had good reasons for wanting to get into hedge funds. By 2002 the U.S. stock market, which had overheated during the late 1990s as the mania for technology and telecommunications stocks generated trillions of dollars in paper wealth for individuals and institutions, was plunging in a bear market rout. Like most U.S. public pensions, CalPERS had heavily invested in such securities as part of an outsize allocation to large-cap equities that had made the plan rich during the boom years but hurt on the way down. The fund lost $12.3 billion in the fiscal year ended June 30, 2001, and $9.7 billion the next year. CalPERS had gone from having 110 percent of the assets it needed to meet its future pension liabilities in fiscal 2000 to being underfunded, with a 95.2 percent — and falling — funding ratio.

One person who saw the writing on the whiteboard was Mark Anson. A lawyer with a Ph.D. in finance, Anson had been recruited to CalPERS from OppenheimerFunds in New York in 1999 to head up its alternative investments. By the time he became CIO in December 2001, he was seriously worried.

“I could see the dot-com bubble popping and the impact it would have,” Anson tells Institutional Investor. “I was concerned that our asset growth would not be faster than what I could see on the liabilities side.”

Anson believed that hedge fund investing would help protect CalPERS during times of market stress. For Anson, hedge funds are their own asset class and a valuable tool for diversifying a portfolio beyond traditional bonds and equities. In The Handbook of Alternative Assets, which Anson wrote while at CalPERS and published in 2002, he devoted more than 150 pages to hedge funds, including sections on how to set up an investment program and handle risk management. Unfortunately, by the time CalPERS began seriously investing in hedge funds, it was too late to prevent the carnage from the 2000–’02 bear market, but Anson remained convinced that the asset class would help the retirement plan in the future.

He was not alone. In New Jersey newly elected governor Jim McGreevey in 2002 appointed hedge fund manager Orin Kramer to the board of the New Jersey State Investment Council, which oversaw management of the Garden State’s then-$62 billion retirement system. Like CalPERS, the New Jersey fund had been badly scarred by the bear market; it was also laboring under a debt burden in the form of $2.75 billion in pension obligation bonds. Kramer started pushing for the system to invest in alternatives, stressing the diversification and risk management benefits. But the politically charged environment made change difficult.

In Pennsylvania, Peter Gilbert was having more luck. As CIO of the Pennsylvania State Employees’ Retirement System, Gilbert had gotten permission from his board in 1998 to start investing in hedge funds. After a failed attempt at “going direct” by investing in four long-short equity managers, he says, the then-$23 billion in assets PennSERS in 2002 hired Blackstone Alternative Asset Management (BAAM), the hedge fund arm of New York–based private equity firm Blackstone Group. Gilbert was one of the early public fund adopters of “portable alpha,” the strategy of taking the alpha, or above-market returns, of an active manager — often a hedge fund — and transporting it to the more traditional parts of the portfolio (large-cap U.S. equities, in the case of the Pennsylvania retirement system).

Between 2002 and 2006 other large state pension funds began investing in hedge funds, with varying levels of sophistication. They included New York, Missouri, Massachusetts, Texas, Utah and finally New Jersey. By May 2006, Marina del Rey, California–based investment consulting firm Cliffwater, itself a product of the growing interest by institutional investors, found that 21 U.S. state retirement systems were using hedge funds, with a total investment commitment of $28 billion. But there were also funds that held back, like the Public Employee Retirement System of Idaho and the Washington State Investment Board. Some were legally prohibited from making investments; others were not convinced hedge funds were right for public plans. Hedge fund investing remained controversial.

The hedge fund experiment was put to the test in 2008, when, under the pressure of too much bad debt, the U.S. housing and mortgage markets collapsed. That was soon followed by the near-failure of the banking system, the credit markets and the entire global financial system. State pension plans lost, on average, 25 percent in 2008, according to Santa Monica, California–based Wilshire Associates’ Trust Universe Comparison Service. That was better than the broad U.S. stock market — the Standard & Poor’s 500 index plummeted 38.5 percent in 2008, its third-worst year ever — but it lagged the performance of the typical hedge fund, which was down 19 percent, according to Chicago-based Hedge Fund Research.

Hedge fund managers often like to tell investors they’ll be able to deliver positive absolute returns regardless of what happens to the market, but in 2008 most managers didn’t live up to those expectations. Hedge funds did, however, cushion their investors against the near-record drop in the stock market and proved their value as portfolio diversifiers. Now, a decade after the first generation of public pension plans started to invest in hedge funds, more and more are looking to do so. In fact, today some of the biggest holdouts from the past decade are beginning to embrace hedge funds, including the $153 billion California State Teachers’ Retirement System, the $152.5 billion Florida State Board of Administration and the $74.5 billion State of Wisconsin Investment Board.

If things looked bad for defined benefit pension plans in 2002, they look a whole lot worse today. The 126 public pension systems tracked by Wilshire Associates had, on average, a funding ratio for the 2009 fiscal year of 65 percent — meaning they had only 65 percent of the assets needed to pay for the current and future retirement benefits of the firefighters, police officers, schoolteachers and other public workers covered by their plans. The situation has been exacerbated in states like Connecticut and Illinois, which in the intervening decade decided to increase benefits without increasing their contributions to pay for them.

“The pension benefit promises that have been made to unions by politicians have been in many respects unrealizable,” says Alan Dorsey, head of investment strategy and risk at New York–based asset management firm Neuberger Berman.

To make up for the shortfall, public pension plans have few places to turn. In the current economic environment, it is political suicide to even broach the topic of raising taxes. And despite calls from some high-ranking officials, like New Jersey Governor Chris Christie, to reduce health care and retirement benefits for public workers, getting state legislators to approve such cuts won’t be easy. For beleaguered public pension officers, the best and perhaps only solution is to try to figure out a way to generate better investment returns.

“Hedge funds start looking attractive because of their superior liquidity relative to private equity and real estate, and superior risk-adjusted returns relative to the overall market,” says Daniel Celeghin, a partner with investment management consulting firm Casey, Quirk & Associates, who wrote a seminal paper on the future of hedge fund investing in the aftermath of the 2008 crisis.

That is, of course, assuming that hedge funds continue to put up superior risk-adjusted returns. Capturing alpha — skill-based, non-market-driven investment returns — is, at the end of the day, the whole point of putting money in hedge funds. Although hedge funds as a group didn’t produce the same amount of alpha in the past few years as they did early last decade, it appears that they added some.

The ability to generate alpha enables hedge funds to justify their high fees. Managers typically charge “2 and 20”: a management fee of 2 percent of assets and a performance fee of 20 percent of profits. It’s been harder for funds of hedge funds to make the case for their management and performance fees — typically 1 and 10 — which investors must pay on top of the fees of the underlying managers. As a result, many fee-conscious pension plans that initially invested through funds of funds are now electing to go direct. That approach, however, can make hedge fund investing much more challenging, especially for pension plans with small investment staffs.

Hedge funds are not like traditional money managers, says former PennSERS investment chief Gilbert, now CIO of Lehigh University, responsible for managing the Pennsylvania school’s $1 billion endowment. Hedge fund managers require more due diligence and constant monitoring because in their search for alpha they operate with few if any constraints. “You really have to know what to expect from each particular hedge fund manager and how you are going to use them,” Gilbert says. Most investment consultants, the group that public plans typically rely on to help with manager selection — which can step in to take over the role of a fund of funds at a lower cost — are still grappling with advising on hedge funds.

Public pension plans, for their part, with their billions of dollars and stringent investment requirements, are changing the parameters of the hedge fund experiment. In a January 2011 report, consulting firm Cliffwater found that 52 of the 96 state pension plans it surveyed had a total of $63 billion invested in hedge funds as of the end of fiscal 2010, more than double the amount from four years earlier. “Public pension funds are the investment group that is going to shape the hedge fund industry,” says Scott Carter, head of global prime finance sales and capital introduction in the U.S. for Deutsche Bank, as well as co-head of hedge fund consulting.

Christopher Kojima, global head of the alternative investments and manager selection group at Goldman Sachs Asset Management in New York, would agree with Carter’s assessment. “The debate we are seeing at public plans today is much less about whether hedge funds are a sensible contributor to their objectives,” Kojima says. “The question we encounter much more is how to invest with hedge funds.” Pension funds are looking at how to identify and monitor top managers, think about risk management and connect hedge funds to their broader portfolios. “Are hedge funds even a separate asset class?” Kojima asks. More and more, the answer is no.

Public pension plans were not the first institutional investors to experiment with hedge funds. During the late 1980s and early ’90s, a group of influential endowment and foundation investors steeped in Modern Portfolio Theory started exploring the notion that these managers, freed from the constraints of more-traditional funds, could enhance their returns. The hedge-fund-investing hothouses of those early years were located on the campuses of a handful of universities, including Duke, Harvard, North Carolina, Notre Dame, Virginia and Yale.

As head of the Yale University Investments Office in New Haven, Connecticut, David Swensen pioneered an approach to endowment investing that put a heavy emphasis on alternatives, including hedge funds. Swensen’s acolytes at Yale would go on to run a network of school endowments, taking his ideas with them. Duke, North Carolina and Virginia were close to Julian Robertson Jr., founder of New York–based Tiger Management Corp. and one of the top hedge fund managers of that era. They embraced the Tiger investment ethos — fundamentally focused long-short strategies, sometimes with a tilt toward macro — as a source of returns.

For those early adopters, hedge funds proved their worth. In 1993 the HFRI fund-weighted composite index was up 30.88 percent, more than three times the total return of the S&P 500 composite index, which was up 10.1 percent. As the bull market started to roar, hedge fund results, on a relative basis, didn’t look so impressive. In 1997 the HFRI index rose 16.79 percent, roughly half the total return of the S&P 500, which was up 33.34 percent.

The first public plan to start looking seriously at hedge funds was the Virginia Retirement System. In the early 1990s the fund had made a controversial investment in a railroad company, leading to a legislative review, published in December 1993, that found the system had too many active managers and was paying too much in fees while not seeing much in the way of results. The review recommended that state law be amended to allow the retirement system broad discretion in the types of investments it could make. The change was enacted the following year, opening the door to hedge fund investing. By 1998, Virginia had invested $1.8 billion of its then-$23 billion in assets in market-neutral, long-short managers while at the same time indexing a significant portion of its equity portfolio.

In 2001, Virginia started talking to D.E. Shaw & Co. about having the New York–based hedge fund firm run a benchmarked long-only strategy for the retirement system. D.E. Shaw, a quant shop founded in 1988 by computer scientist David Shaw, was the classic hedge fund firm: supersecretive, using leverage, charging high fees and focused on finding returns. The firm didn’t have any close relationships with public pension plans before Virginia, but it quickly realized their potential value. “For years and years we had an absolute-return focus,” says Trey Beck, head of product development and investor relations at D.E. Shaw in New York. “This gave us an opportunity to go into the benchmarked business.”

The decision to build an institutional business meant that D.E. Shaw would need to produce funds that could perform on a relative basis. It would also need to become more transparent, which the firm had already started to do (in 1999 it had registered with the Securities and Exchange Commission as an investment adviser). D.E. Shaw began to expand its investor relations and reporting. “We had to get up the curve very quickly,” Beck says. “Because ten years ago the demands placed on managers by hedge fund investors were very different from the demands placed on investors in more-traditional products.”

The CalPERS hedge fund story begins with Bob Boldt, who was brought in from money manager Scudder, Stevens & Clark as senior investment officer for public markets in December 1996. Boldt was a big advocate for hedge funds, and by September 1999 it looked like he had gotten his way. CalPERS hired its first hedge fund manager, investing $300 million with San Francisco–based, technology-focused Pivotal Asset Management, and Boldt’s plan for CalPERS to invest $11.25 billion in hedge funds surfaced in the press. Then, Boldt left in April 2000. Seven months later he landed at Pivotal.

Paying talent has always been an issue for public pension plans. But the added challenge of running the more-sophisticated portfolios that typically accompany hedge fund investments makes it an even bigger issue, especially given the wide gulf in compensation scales between the hedge fund industry and the public pension world. Boldt was not alone in making the switch, though his stint at Pivotal would be short. (The firm folded after the dot-com bubble burst.)

In the absence of Boldt, CalPERS continued to take steps toward building a hedge fund program. In November 2000 the board approved a plan to invest $1 billion in hedge funds. (By that time, Anson had been promoted to senior investment officer for public markets.)

The following May, CalPERS hired fund-of-funds firm BAAM as a strategic adviser to its hedge fund portfolio, to help identify and interview potential managers, perform due diligence and provide risk management and reporting. This was a major change in the way an institution worked with a fund-of-funds firm. CalPERS paid less in fees than it would have if BAAM had been managing the money, and it had more control over the portfolio and transparency into the underlying managers. It also got to educate itself about hedge fund investing and grow its in-house expertise.

“We had not yet built up the staff within CalPERS, and we did not have feet on the ground,” says Anson, who became CIO in December 2001. “There were only so many due diligence trips I could take myself as CIO. We needed to really outsource some human capital.”

For all its pioneering work, CalPERS was actually slow to invest its first $1 billion in hedge funds. By December 2002, PennSERS had overtaken it as the largest public pension investor in hedge funds, with $2.5 billion allocated to four absolute-return fund-of-funds managers: BAAM, Mesirow Advanced Strategies, Morgan Stanley Alternative Investment Partners and Pacific Alternative Asset Management Co. (Public pension funds like PennSERS preferred the moniker “absolute-return funds” over “hedge funds” because it was more politically palatable when discussing their investments.)

But rather than carve out a separate allocation, PennSERS housed its hedge fund investments in its equity portfolio as part of its portable-alpha strategy. That made it much easier for then-CIO Gilbert to build a hedge fund portfolio that rivaled many endowments’ in size and scope. By June 2006, PennSERS had invested $9 billion of its $30 billion in assets in hedge funds.

New Jersey’s Kramer is also a big believer in the benefits of investing in hedge funds. But when he became chairman of the board of the New Jersey State Investment Council in September 2002, he couldn’t act on that belief because the state’s antiquated pension system was prohibited from using any outside managers — alternative or traditional. By November 2004, Kramer had gotten the Investment Council to agree to allocate 13 percent of its assets to alternatives (private equity, real estate and hedge funds), overcoming the objections of state unions, which accused Kramer and his fellow board members of wanting to give fees to their Wall Street fat-cat friends. New Jersey made its first hedge fund investments in the summer of 2006.

“There is no avoiding politics at public plans, in the same way that you would have it at a school district or at an investment board,” says Neuberger Berman’s Dorsey. “What winds up happening is that you end up handcuffing the investment performance.”

With their high fees, wealthy founders and reputation for risk-­taking, hedge funds became an attractive political target. Hedge fund managers, for their part, were not used to dealing with the scrutiny that invariably comes with running public money. Some decided it wasn’t worth the hassle. For those managers that did take public money and suffered major losses, the headlines were especially unforgiving. Just ask Nicholas Maounis, the founder of Amaranth Advisors, a Greenwich, Connecticut–based multistrategy manager that at one time was among the 30 largest hedge fund firms in the world. In the summer of 2006, the press skewered Amaranth after the firm’s supposedly diversified flagship fund lost more than $6 billion betting on natural-gas futures and had little choice but to shut down.

Amaranth’s investors included some of the U.S.’s biggest public funds, including the New Jersey system, PennSERS and Massachusetts’ Pension Reserves Investment Management Board, though most of their exposure was through funds of hedge funds. New Jersey’s CIO at the time, William Clark, pointed out in a January 2007 memo to the Investment Council on Amaranth and the lessons learned that the fund had taken greater hits from individual stock positions that same month. (New Jersey’s total exposure to Amaranth was $21.8 million, or 3 basis points of its total investment portfolio.)

Before Amaranth, the largest hedge fund disaster had been another Greenwich-based firm, Long-Term Capital Management, which famously lost 44 percent of its capital in August 1998, after Russia defaulted on its debt, and had to be bailed out by a consortium of 14 banks assembled by the Federal Reserve Bank of New York. The group put up $3.6 billion for 90 percent of the fund. But LTCM had little or no institutional money.

Public pension plans did not get off so easy during the recent financial crisis, which began with problems in the subprime mortgage market in 2007 and spiraled out of control in September 2008 when Lehman Brothers Holdings filed for bankruptcy. That month the HFRI index dropped 6.13 percent. In October 2008 the index lost a further 6.84 percent, and hedge funds started putting up gates to prevent investor redemptions. Firms liquidated struggling funds or moved troubled illiquid assets into so-called side pockets, trapping the invested capital until the walled-off assets were unwound. A record 1,470 hedge funds liquidated in 2008, according to HFR. It was an exceedingly tough time to be a hedge fund investor.

Between 2002 and the start of 2008, the hedge fund industry tripled in size, skyrocketing from $625.5 billion in assets to nearly $1.9 trillion, according to HFR. The bulk of the new money — approximately $610 billion — came from institutions, including public funds. These large investors wrote bigger checks than most managers were used to receiving; direct commitments of $50 million to $150 million were not unusual. In much the same way that scientists can change the results of an experiment simply by observing it, the influx of institutional investors, though they were more than mere observers, was bound to impact the return profiles of hedge funds.

As the last decade progressed, some experts began to suspect that much of hedge funds’ returns was not in fact alpha but market-driven returns, or beta, that had been leveraged using borrowed money to produce seemingly superior results. The events of 2008, when the markets collapsed and suddenly it became very expensive to borrow, bore this out. Neuberger Berman’s Dorsey and former CalPERS CIO Anson are among the money managers looking into beta creep, the notion that over time hedge fund performance has become increasingly market-driven. “Or, as I like to call it, ‘creepy beta,’?” quips Anson, who is now a managing partner with Oak Hill Investment Management in Menlo Park, California. It’s not that beta itself is bad, just that investors do not want to pay hedge funds 2-and-20 for market returns.

After Anson left CalPERS in 2005, the hedge fund program picked up speed under the guidance of senior portfolio manager for global equities Kurt Silberstein. Two years earlier, CalPERS had replaced BAAM with Paamco and UBS and embarked on a program of direct hedge fund investments as well as fund-of-funds commitments. Silberstein is proud of what the U.S.’s biggest public pension plan has achieved. “We run a very conservative portfolio, and for each unit of risk we take, we have been rewarded with a unit of return,” he says.

Going into 2008, however, CalPERS had too much beta in its hedge fund portfolio, which fell 19 percent that year. Silberstein freely admits that 2008 was “a really black eye” and that the pension system would probably not still be investing in hedge funds “if 2008 had happened two years into us building out the program.” Since the crisis, Silberstein has almost completely redone the direct hedge fund portfolio, terminating relationships with many of the long-short equity and multistrategy managers that underperformed in 2008. Today he prefers to invest with smaller managers he believes are more likely to add alpha.

CalPERS has also taken much closer control of its hedge fund investments. It now demands what it perceives as a better alignment of fees from its hedge funds, enabling the California plan to reclaim some of the 20 percent performance fee it pays during a good year if a manager loses money the next. Cal­PERS invests whenever possible using separate or managed accounts instead of commingled funds; this means it, not the manager, holds the underlying securities.

“You can mitigate business risk by having control of your assets,” says Silberstein. “Once you have control you don’t have to be so adamant on the terms of the contract, because if I don’t like what a manager is doing, I can just take my money and walk.”

CalPERS is not alone in making such demands. Its crosstown Sacramento counterpart, CalSTRS, is making its first move into hedge funds with a global macro program that will be handled exclusively using managed accounts. At the $19.8 billion Utah Retirement Systems, deputy chief investment officer Lawrence Powell also has been playing hardball with hedge fund managers over fees.

Fees continue to be a big issue for funds of hedge funds, as more and more public funds opt to use less expensive investment consultants to help them construct and monitor hedge fund portfolios. Still, Neuberger Berman’s Dorsey, who worked at Darien, Connecticut–based consulting firm RogersCasey from 2002 through 2006, thinks funds of funds can play an important informational role for public plans. “Most funds of hedge funds have a large staff, and these people are engaging in continuous contact, monthly conversations and conference calls with hedge fund managers,” he says.

Although some public pension officials were disappointed with the 2008 performance of hedge funds, they are increasingly starting to look at hedge funds not as a distinct asset class but as a way of managing money. The Virginia Retirement System, for example, doesn’t separate hedge fund managers into their own group but categorizes them according to the types of securities in which they invest. Scott Pittman, CIO of the New York–based Mount Sinai Medical Center Foundation, which has more than 70 percent of its $1 billion endowment invested in hedge funds across different asset classes, thinks this approach makes a lot more sense.

“When you take hedge funds that have lots of different securities and strategies and group them together and call it an asset class, you are ignoring the consequences of those exposures on the overall portfolio, both unintended and intended,” Pittman says. “Hedge funds are just a vehicle by which we invest.”

One of the effects of 2008 was to increase discussions about risk management. Institutional investors realized they had not been doing a good enough job of paying attention to risk. The result is that some institutional investors — including Alaska Permanent Fund Corp., CalSTRS and the Wisconsin Investment Board — have been working with hedge funds or money managers that offer hedge-fund-like strategies to put together portfolios that, through tactical asset allocation and hedging, can offer overall risk protection.

“We are trying to develop a system that does not seek to time the market but does try to identify those extreme left-tail events,” CalSTRS CIO Christopher Ailman recently told Institutional Investor, referring to statistically rare events, like those experienced in 2008, that can have a seismic impact on markets and returns. Funds designed to hedge against tail risk often rely on derivatives-trading strategies and as a result have their own built-in leverage. Such funds can act as a drag on a portfolio when markets are rising, but they are expected to provide a valuable hedge in times of significant market stress and volatility.

The real key to pension fund investing has always been asset allocation — long the purview of investment consultants. As hedge funds, which roam all over the capital structure looking for returns, become a more integrated part of what pension plans do, investment officers and their boards are leaning on their managers to answer more of their general asset allocation and investment concerns.

Hedge funds have had to learn to become more receptive to such inquiries from their largest clients. “The industry mind-set has changed,” says D.E. Shaw’s Beck. Hedge fund managers realize that public funds want to be able to call up investment professionals at their firms for insights into what is happening in the markets and for their views on macroeconomic events.

The Washington State Investment Board is looking forward to just such a relationship with D.E. Shaw. In April the board voted to approve the firm for a global non-U.S. active equity mandate. “Part of the reason we chose the manager was not just for the product but because of the depth of resources and talent at the investment manager that we will have access to,” says CIO Gary Bruebaker. “I call it noninvestment alpha.”

Bruebaker was a member of the President’s Working Group on Financial Markets’ investors’ committee when it released its report on hedge fund investing in April 2008. Although he appreciates the merits of D.E. Shaw, he has no plans to invest in the firm’s hedge fund strategies or, indeed, with any hedge funds at all.

“I take my responsibilities very personally; I manage the financial future of over 400,000 public employees, many of whom work a lot harder than I do,” says Bruebaker, whose mother was a public employee. “If there was a way I could make more money on a risk-adjusted basis, I would find a way to do it.” But he just does not believe the $82.2 billion Investment Board has any competitive edge when it comes to investing in hedge funds.

Public funds, he says, should be cautious investing in hedge funds: “Many of them don’t have the flexible budgets or the dollar amounts to hire the kind of skill sets they need to help them do the due diligence that would be necessary to do it correctly.”

New Jersey lost a highly skilled investor when Kramer resigned from the Investment Council in February. In his last year on the board, he successfully pushed to raise the limits on how much New Jersey could invest in alternatives. But even Kramer was finally exhausted by the years of battling to move the $74.7 billion retirement system into the modern investment era. Though public scrutiny serves an important role as a guard against corruption, the political nature of the public pension system can alienate the very best investment talent. And yet it is the resource-constrained, funding-challenged public funds that need the most help, especially as their investment portfolios become more and more complex.
Bruebaker is right that public pensions should be cautious about hedge funds. But I am very surprised that he invested with D.E. Shaw to leverage off their knowledge investment managers because D.E. Shaw is the quintessential epitome of a ultra-secretive "black-box" hedge fund which is why after 2008, some of the public pension fund managers I know, pulled their money out of D.E. Shaw and other black-box shops.

When it comes to hedge funds, public funds have to understand a few critical things. First, the data is full of biases so take the aggregate returns of hedge fund databases with a shaker, not a grain of salt. Second, hedge funds are not an asset class, they're a way to manage risk efficiently. At least that's what they're suppose to do, protect against downside risk as they deliver true alpha. But the truth is hedge funds are selling beta as alpha. It's ludicrous to pay 2 & 20 in fees for beta, and yet that's exactly what's going on right now.

The final thought I want to leave you with is that hedge funds are not a panacea or cure-all for public pension funds. There is a symbiotic relationship between public funds and hedge funds. This relationship is being transformed ever so slowly, but the truth is hedge funds need public funds and public funds need hedge funds, but this model is not going to "cure" chronically underfunded pension plans. Only tough concessions from all stakeholders will put public pensions back on the right track. In other words, tough political discussions have to be made. In the meantime, public pensions will continue allocating billions to hedge funds, at least until the next crisis hits. Then we'll see if these bets pay off.

"Other Fed Assets" Hits Record $133 Billion, More Than The GDP Of Kuwait

That the Fed's balance has hit another record high (and will do so for at least two more weeks) should come as a surprise to nobody. After all, when something is at a record and grows relentlessly, it is pretty safe to say next week will be another record. That said, there were several curious observations in this week's H.4.1 update. First and foremost is that the "other Fed assets" category just hit an all time high of $132.7 billion. This category, which is now larger than the GDP of Kuwait, is apparently so comprehensible and transparent to the hoards of FOMC precleared journalists, that for the second meeting in a row, nobody feels like asking a question about just what is contained in this asset class. We also hope that nobody attempts a correlation between the Other Fed Assets class and the S&P. Another notable thing is that as we suggested back in January, the amount of MBS prepays continues to drop and has slowed down to a trickle. Elsewhere, the Fed's excess reserves are once again back to chasing Bernanke's expanding asset class, with over $40 billion more in cumulative asset expansion since the start of QE Lite, than excess reserves. Lastly, looking at the Fed's custodial treasury holdings, there was another small decline in USTs held in proxy by the Fed: the first decline in 4 weeks, since the May 25 second biggest historic drop, discussed previously on Zero Hedge. Aside from these, it was smooth sailing for the Fed, where the average maturity of SOMA holdings declined just modestly from 61.6 to 61.5 months. 

Full balance sheet:

Other Fed Assets:

The ever declining amount of MBS prepays:

Cumulative change in Excess Reserves and total asset holdings since QE Lite:

And lastly Treasurys held in custody at the Fed:

And the maturity distribution of the SOMA holdings:

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