Berkshire, next default target?

The cost of protecting against default by Warren Buffett's AAA-rated Berkshire Hathaway Inc. has almost tripled in two months, based on CDS, jumping to 388 basis points from 140 basis points two months ago. That translates to a cost of $388,000 a year to protect $10 million for five years. This is a sign of just how skittish investors have become amid the global financial crisis.

At those levels, the swaps are typical of companies rated Baa3 by Moody's Investors Service, one level above junk. The price may have risen on concern that the billionaire's firm could lose a $37 billion bet on world stock market values more than a decade from now. Not only Berkshire would have to exhaust its $33.4 billion cash hoard, but also Buffett's decades-long record as the world's most successful investor would have to come to a cataclysmic end. President-elect Barack Obama, Goldman and GE all turned to Warren Buffett for advise or capital.

The increase may be tied to a series of bets that Buffett has taken on four stock indexes across the globe. Buffett sold contracts to undisclosed buyers for $4.85 billion that protect the buyers against declines in those markets. Under the agreements, Berkshire will pay as much as $37 billion if, on specific dates beginning in 2019, the market indexes are below the point where they were when he made the agreements. By Sept. 30, Omaha, Nebraska-based Berkshire had written down the contracts by $6.73 billion as the S&P declined for a fourth straight quarter.

Buffett defended those structured products as he said: “I believe these contracts, in aggregate, will be profitable We are always ready to trade increased volatility in reported earnings in the short run for greater gains in net worth in the long run. That is our philosophy in derivatives as well.”

People should realize that he was able to obtain that capital gained from sales of CDS to invest on such attractive terms for years before the chance comes that he'll have to pay. However, before the market gets stabilization, the increasing cost of Berkshire credit protection in the swaps market isn't crazy in light of the way the markets performed.

China Passes Japan as Biggest U.S. Treasuries Holder

China surpassed Japan in September to become the biggest foreign holder of U.S. Treasuries, as foreign investors sought the relative safety of government debt. China leapfrogged Japan, increasing its Treasury holdings by $43.6 billion to $585 billion. Japan, now the second-largest foreign owner of U.S. government debt, reduced its holdings by $12.8 billion to $573.2 billion.

The trend behind it is that China led all foreign official investors in September by posting a net increase in U.S. Treasuries for the sixth month in the past seven. Japan was a net seller of Treasuries for the fourth month in the past six. China’s ownership of U.S. government debt has doubled since July 2005, while Japan’s holdings are down from a peak of $699 billion in August 2004.

It paints a much more positive picture of cross-board investments than expected. China, along with others, is showing more demand than anticipated for U.S. assets. Maybe, I am just guessing that the continuous increase of China’s stake of U.S. Treasuries is under an agreement between Beijing and Washington.

Total net purchases of long-term equities, notes and bonds increased a net $66.2 billion in September from $21 billion the previous month, the Treasury said today in Washington. Including short-term securities such as stock swaps, foreigners bought a net $143.4 billion, compared with net buying of $21.4 billion the month before.

China Life is ready to take actions

I am always feeling that in this financial crisis, some deep-pocket Chinese financial institutions are facing golden, or even once-in-life opportunities to spread business over the world. In the short term you may see some losses and corresponding slowdown in Chinese investment overseas, but I don’t think we should all close our doors because of the risks.

China Life, the world’s largest life assurer, is eyeing overseas acquisitions as it seeks to take advantage of the global financial crisis to gain a foothold in foreign markets.

Liu Lefei, chief investment officer, said the crisis in financial markets was not yet over, but China Life believed the moment to begin making overseas investments was fast approaching. Mr Liu also said they were cautiously but actively looking for M&A opportunities. After doing a lot of research, the opportunities were becoming more and more obvious.

China Life has yet to make any overseas strategic investments, and its investment portfolio is also almost entirely domestic. As China’s largest insurer and a big institutional investor, they had Rmb30.5bn of cash on its balance sheet. So for a such well-funded Chinese financial group, the recent market chaos is seen as a window to make opportunistic investments.

Potential targets were more likely to be small or medium-sized financial groups and could be anywhere in the US, Asia and Europe. China Life has been mentioned as a potential buyer for parts of AIG’s Asia-Pacific business if the troubled insurance group puts the assets up for sale.
Chinese groups made a number of high-profile investments last year in overseas financial groups before the worst of the credit crisis hit the sector.

China Investment Corp bought stakes in Blackstone and Morgan Stanley, which have dropped sharply in value. Ping An made the first overseas investment by a Chinese insurer when it bought a 5 per cent stake in Fortis, which was later partly nationalized. The group booked a Rmb15.7bn ($2.3bn) loss on the Fortis investment.

Due to such big previous overseas investment loss, Chinese officials have signaled that big investments in overseas investment groups were now on hold. However, while there are apparently huge risks lurking in the way ahead, this provides at the same time huge investment opportunities.

Paulson hedge fund buys into mortgage securities

John Paulson, the hedge fund manager who was called before Congress last week to discuss the big profits he made by foreseeing the collapse of the subprime mortgage market, has started to buy securities backed by residential mortgages.

Mr Paulson’s move marks the latest example of a famously bearish investor shifting gears to profit from depressed prices in the global credit markets.

US residential mortgage securities fell in value last week after Hank Paulson, Treasury secretary, said that the federal government had decided against buying toxic assets as part of its $700bn troubled asset relief program (TARP).

John Paulson, who is not related to the Treasury secretary, has told his investors that he started buying troubled mortgage-backed securities at the end of last week, hoping to capitalize on price falls that followed the Treasury announcement.

According to Alpha Magazine, Mr Paulson made $3.7bn in 2007, reflecting the success of his strategy – begun in 2006 – of betting on a collapse of the subprime mortgage market. At the end of the third quarter of this year, his funds were up 15-25 per cent. His funds also made profits in October, his investors say.

For several months Mr Paulson has been considering investing in distressed subprime mortgage securities, financial firms and debt used to back private equity deals. He estimated there are $10,000bn in total in such assets.

He signalled a potential new direction on October 1 by launching his Paulson Recovery Fund, which will take equity stakes in financial institutions. He also has moved to start a real estate fund.

However, Mr Paulson has been careful to avoid moving into distressed markets too early. For example, he refused in April when approached to invest alongside TPG in Washington Mutual. The debt and equity of WaMu was wiped out when it was taken over by JPMorgan in September. In a letter to investors at the end of the third quarter, Mr. Paulson said his strategy was “to reduce leverage, maintain market exposure and maintain short credit bias”. He said: “The majority of our gains came from short positions in the equities of declining financials and CDS on financials. Generally our short exposure has been reduced as many of the companies we were short have failed.”

Why China Stimulus is necessary

The truth is the world is entering a recession, possibly the worst since the second world war. The open world economy forces every player to act at home and abroad.

In the short term, there is no alternative to another massive fiscal boost, strongly supported by aggressive monetary policy. Forecasters have been downgrading their views of 2009, for both the US and the rest of the world, at an extremely rapid rate (see chart). Last week the IMF reduced forecasts for world economic growth in 2009 from the 1.9 per cent forecast as recently as October to a mere 1.1 per cent. The advanced economies are now forecast to shrink by 0.3 per cent.
Let’s start from U.S. A bigger US fiscal deficit would offset the rise in the desired financial surplus – the excess of income over spending – in the private sector at a time of recession. In the early 1980s, the private sector surplus reached 6 per cent of gross domestic product (see chart). But the US would also probably run a current account deficit of 4 per cent of GDP at high levels of employment. Since the private, foreign and government balances must sum to zero, the fiscal deficit may need to be as huge as 10 per cent of GDP.

Such vast fiscal deficits are only a temporary solution. So how might they end? In the US and other countries with highly indebted private sectors, such as the UK, a return to large private sector financial deficits would be highly undesirable, even if achievable. A vastly better outcome would be bigger savings and a reduction in current account deficits. Thus, the expansion in net exports that has recently been so vital for US growth must continue (see chart).

If the US external correction is to be consistent with global growth, demand must expand vigorously elsewhere, particularly in chronic surplus countries. The new administration should lead the world towards an understanding of a point that concerned John Maynard Keynes: it is hard to accommodate countries with massive and persistent current account surpluses. If that’s the truth, the counterpart will remain in deficits, and if prolonged, almost always lead to financial crises. The way out is for most surplus countries to spend more at home. So the expansion program announced by the Chinese government early this week is a must now, maybe just a beginning.

China’s export slows

Everybody realized that China’s export slows in the worldwide financial turmoil and economic slowdown. Here is the concrete example: overseas orders showed significant decline at the recently concluded Canton Trade Fair, China's largest and most well-known fair for international buyers. The total value of contracts signed at the fair was $31 billion, down 17.5% from the fair held this spring and down 16% from the autumn fair last year. The last time export orders declined was in 2003, when China was hit by the SARS epidemic.

According to a survey at the fair, many overseas customers are concerned about the global economic slowdown, which has led them to either cancel the orders or only make purchases for the short term. Because most of the foreign buyers at the fair placed orders for next spring's delivery, we expect more exporters will find themselves in trouble in 2009.

The other side of the coin is the deteriorating consumption in major importers of China products. In U.S. the October unemployment numbers came out were ugly, showing a loss of 240,000 jobs. But the really bad part was the negative revision to August and September, by a further loss of 179,000. As the unemployment and recession accelerating, U.S. consumers might and are forced to change their consumption behavior. Household debt, including mortgages, skyrocketed from 47% of personal income in 1959 to 117% in the fourth quarter of 2007. It’s predictable that consumption - the strongest U.S. economy drive will cool.

Mexico hedges all of its oil export

We have witnessed a bunch of crisis here: subprime-mortgage crisis, hedge fund redemption crisis, derivatives crisis and of course, commodity crisis. Oil prices hit an all-time high of $147.27 a barrel in July but have since fallen to less than $65 as the global economy cools. Some economies largely depending on oil have been hard hit. Some countries have taken actions to protect themselves from the falling oil price.

Mexico, the world’s sixth biggest oil producer hedged almost all of next year’s oil exports at prices ranging from $70 to $100 at a cost of about $1.5bn through derivatives contracts. This is the sign showing the concerns of concerns of producer countries at the impact of the global economic slowdown on their revenues, as Mexico relies on oil for up to 40 percent of government revenue. Last year, Mexico only hedged about 20-30 percent of its oil exports.

These trades appeared to have occurred in late August and early September, at that time the oil was traded within $90-$110. So the hedge seems a good move and a presumed cost of some $1.5bn is immaterial relative to risks. Without the hedge, the recent price falls would have been a serious concern for Mexico.

Actually there were already signs that a big producer was hedging over this summer as traders in New York noted a significant surge in options for December 2009. Mexico’s action could have added some downward pressure to spot oil prices as some banks including Barclays Capital and Goldman Sachs, who predicting the oil price would be remain at $150 by the end of year, offloaded some of their risk, selling futures.

20% year-end rally for S&P 500?

Even after cutting estimates at the fastest rate ever, Wall Street strategists still need the biggest year-end rally in the S&P 500 for their forecasts to come true.

The average Wall Street forecast calls for the S&P 500 to break out of a bear market and surge 20 percent to 1,118 by Dec. 31 -- more than twice as much as the biggest-ever advance to close out a year, according to data compiled by Bloomberg.

David Kostin of Goldman Sachs Group Inc. predicts an advance because U.S. companies are cheap relative to earnings. He reduced his S&P 500 prediction by 29 percent on Oct. 13 to 1,000, saying economies around the world deteriorated and oil prices slid faster than he expected. Strategas Research Partners' Jason Trennert expects the S&P 500 to increase 18 percent to 1,100, counting on a resumption in bank lending to lift equities. Thomas Lee at JPMorgan Chase & Co. says stocks are swinging so much that a 25 percent jump by Dec. 31 isn't out of the question, saying the S&P 500 may rise to 1,125.

Merrill Lynch & Co.'s Richard Bernstein also reduced his forecast last week. Bernstein, Merrill's chief quantitative strategist, cut his 12-month projection for the S&P 500 to 1,047 from 1,248.

The strategist who cut his projection the most since September was Deutsche Bank AG's Binky Chadha, once one of the biggest bulls. Chadha abandoned his year-end call for the S&P 500 to reach 1,350, decreasing it on Nov. 7 to as low as 800 and becoming the first strategist to acknowledge the possibility that stocks may fall for the rest of the year.

Still, the 20 percent rally strategists predict must overcome a deteriorating economy as the fallout from the credit crisis spreads.

CCB is to launch hedge fund in healthcare

The investment banking arm of China Construction Bank plans to launch a 5 billion yuan ($731.3 million) fund to focus on investments in the country's rapidly growing healthcare sector, state media reported on Tuesday.

According to the official Xinhua News Agency report, Hong Kong-based CCB International is leading the fundraising but has not yet reached the initial target of 5 billion yuan. Once launched, the fund would focus on investments in healthcare-related sectors including pharmacy, medical equipment manufacturing, medical institutions and services. The fund, to be called China Healthcare Investment Fund, would be the first domestic investment fund specialising in investments in China's heathcare industry.

With China's economic growth and aging population, healthcare investments have become a priority of the government. Besides, China's economic boom has resulted in stark health inequity between its urban and rural populations, and health experts have urged the Chinese government to work harder at improving healthcare options for China's rural population. Beijing is reforming its medical and pension system in an effort to bridge this gap between the poor and rich.

In the market, many global private capital investors have already invested large sums in Chinese medical firms in hopes of making hefty profits, and some of them, such as Mindray Medical International Ltd, have successfully listed or expanded abroad.

Goldman Sachs to reduce hedge fund client numbers

One little-discussed byproduct of this financial crisis in hedge fund industry is broker business. As many brokers are ally with hedge fund in bull market, now brokers turn their face and are against hedge funds. Goldman Sachs is cutting back the number of its hedge fund clients in an indication of tougher market conditions and of the changes sweeping through what was once the premier investment bank. Their ability to leverage themselves has been affected by their new reiteration. They are reviewing many of their relationships.

That review is especially intensive for hedge funds pursuing strategies that involve trading securities that aren't very liquid, such as convertible bonds, or that rely on the massive use of borrowed money, such as the computer-driven strategies that seek to profit from small price discrepancies. During the bull market, such strategies appeared liquid and borrowing was cheap. But in recent months, prime brokers raised the cost of funding and many hedge funds were forced to sell convertible and junk-rated bonds that dealers can't readily lend.

For the first time, as opposed to annually, clients are asked by Goldman to move off their platform.

These cutbacks are believed to have more to do with the changing of hedge fund circumstances and market conditions than Goldman's changed circumstances. Goldman's shrinking prime brokerage is adding to consolidation in the business of catering to the needs of hedge funds. Other banks pick up market share and at the same time, consolidation is leading to higher pricing, adding pressure on hedge fund performance across many strategies.

Single-family offices moving forward on hedge funds

Advisers for ultra wealthy investors are bullish on hedge funds, with many planning to increase their allocations to the alternative investments next year, according to On the Rise survey. The study was co-sponsored by Red Bank, N.J.-based G Capital Management LLC and Rothstein Kass & Co. PC of Roseland, N.J.

A majority (58%) of single-family offices around the globe participating in the this study indicated plans to increase asset allocations in hedge funds for 2009. The study of 146 single-family offices was first completed in late August, before the Wall Street turmoil began in mid-September, and as a result, many of these firms were contacted again to see if their plans were changing. However, in the ensuing follow-up interviews, an even greater percentage (62%) said they would boost hedge fund allocations next year.

The September follow-up interviews also showed a change in single-family offices, saying that they would reduce allocations to hedge funds (11%), compared with 19% from the August survey. 27% of single-family offices at the end of September planned to keep hedge fund exposure the same, compared with 24% when the survey was taken the first time.

The single-family offices surveyed had investible assets ranging from $312.2 million to $1.3 billion, with a majority of the firms (58%) based in Canada and the United States.

Many high-net-worth investors are planning this alternative strategy due to a belief that the market's volatility will last well into 2009 and that hedge funds tend to perform better than other products. They want to avail themselves of any type of strategy that can mitigate risk. When there is blood on the street, it creates opportunities for them.

A hole in the ground surrounded by liars

Mark Twain's definition of a gold mine. And it applied for the role of UBS on gold. UBS has again lowered its 2009 forecast for gold, this time from US$825 per ounce to US$700, while other investors rate gold as a buy in intermediate term.

The revised UBS commodity price outlook reflects an extended recessionary scenario with base metal prices in both 2009/2010 that are mostly below the marginal industry costs and current spot prices.

UBS believes gold will remain under pressure in 2009 from a combination of slowing demand for jewelry and disinvestment as inflation slows.

But many money managers hold the exactly opposite views and they believed there could be a price manipulation. I believe the purpose of this claim made by UBS is definitely of personal interest rate. Remember Goldman projected the oil will remain at $150 by the end of this year? Currently global monetary stimulus have addressed the economic downturn. So the interest rates around the world will continue to go on a downward path on the short end of the curve. And we've already seen this in the short term — the balance sheets of the governments are expanding at a historically unprecedented rate. So the supply figures will be shooting up.

From my perspective, this means that the value of currencies, whether in the US, Europe, or elsewhere, will likely decline relative to the value of gold. In intermediate-term prospect, gold is a good hedge against this extreme level of monetary reflation we're likely to see.

Gold also has the advantage of not being as linked to the physical cyclical demand environment that industrial metals face. We thus think gold is likely to appreciate over this intermediate period — for the next year or so — against most currencies.