Tags: The | Iceman | Cometh

The Iceman Cometh

Friday, 07 April 2006 12:00 AM

Dear MoneyNews Reader:

Since moving to South Florida some years ago, I have developed a love and respect for a substance I never had much use for back home on the other side of the pond: ice.

On any given hot summer day here in sunny South Florida, you will find me regularly raiding the freezer, clutching desperately at a precious handful of the frozen water cubes and plopping them into a glass to make a nice, cool drink for myself.

In England we barely acknowledge the existence of ice, but now I often wonder how long I will be able to go on without an automatic ice-maker.

As an Englishman, I must admit that I am relatively new to the wonders of cold beverages.

But now, having long departed that cruel and depraved world of luke-warm drinks, I am especially sensitive to the hell of discovering that there is no ice left because the previous visitor withdrew his frosty cubes but failed to replenish the supply.

Now, Mrs. Edge loves ice even more than I do.

I bear the welts and scars she's left behind in her gentle attempts to remind me that as we do not live in the Arctic Circle, ice doesn't simply materialize by itself – so someone has to be sure to make more.

Now consider the horror scenario I will be facing shortly.

In just a few months, as we suffer through yet another hurricane season down here in Florida, ice is destined to become as precious to me as any commodity.

Last year, in addition to having large portions of our roof ripped away from us, we lost both our power and our all-important water supply.

That's when I pulled out the wallet and paid big bucks for (gasp!) ice – yes, frozen water. After a hurricane has hit and they are sitting there hot, sticky and powerless, people will gladly pay for ice. And there will always be enterprising people ready to capitalize on a potentially lucrative situation.

Here's where I'm going with all this.

Perhaps you've heard about the recent and relatively sudden downturn in Iceland's economy and krona currency, which had previously risen an astounding 63% over the last four years, accompanying 6% economic growth in Iceland.

Foreign investors jumped right on it, exploiting that growth until not too long ago, when a large portion of them bailed. The result was a massive withdrawal of foreign investment. Iceland's currency suffered a huge drop – almost 12% against the dollar so far this year.

According to Bloomberg: "The world's second-biggest economy [Japan] became entwined with an island of 300,000 people [Iceland] as hedge funds borrowed in Japan, where overnight lending rates are near zero, to finance purchases of AAA-rated Icelandic bonds paying more than 9%. Speculation the Bank of Japan would begin raising rates, confirmed March 9, caused investors to unwind these so-called carry trades."

That's where the trouble began – and that's also where my ice analogy comes into play.

Global investors were like ice salesmen after a storm.

They discovered a large and spacious freezer (the Icelandic bond market, with its 9% returns), paid essentially nothing for Japanese tap water (near-zero-interest loans), began filling their trays, then made ice – lots of it.

But "the Bank of Japan's decision to end a five-year policy of fighting deflation, opening the door for rate increases later this year, helped damp investor appetite for Icelandic bonds," says Bloomberg.

At the end of 2005, the benchmark rate in Iceland had been 10.5% – compared to 2.25% for Europe as a whole and 1.75% for Switzerland.

But as short-term hedge fund investors from around the globe swooped in (like vultures descending on a fresh carcass) to buy up Icelandic bonds offering massive yields, Iceland made moves of its own.

In an attempt to diversify its economy – one that was for so long solely dependent on fish and tourism – the Icelandic government lured U.S. firm Alcoa, the world's leading aluminum producer, with the promise of cheap electricity that could be gleaned from the island-nation's abundant water sources.

Next, about $2.5 billion (or 16.5% of the country's GDP) was injected into aluminum production ventures there.

Alcoa built a 344,000-metric-ton plant to take advantage of relatively cheap geothermal and hydroelectric power, and the state-owned power company is currently constructing a hydroelectric dam that is taller than the Empire State Building.

But "massive investments like this one have served to suck in imports, in effect widening Iceland's current account deficit," according to Bloomberg. "The current-account gap widened to 164.1 billion kronur ($2.4 billion), or 16% of gross domestic product, last year from 85.3 billion kronur in 2004, the central bank said on March 7."

All this leaves Iceland vulnerable and exposed, with an economy headed for serious recession and a currency set to suffer a 25% drop in value.

Annual inflation is at 4.5% and has surpassed the Icelandic central bank's expectations by two full percentage points since April 2004.

The ramifications of a change in Japan's cheap money policy on a tiny nation like Iceland remind me of what's called ‘Chaos Theory.'

The basis for most views is gleaned from competing outlooks – which are available wherever the diligent analyst cares to search.

And that search could entail something as simple as keeping up with the press, perhaps making sure you catch your favorite news program each day.

During my time at the bank I previously worked for, on plenty of occasions I could be found in a tiny office locked away from the busy dealing desk. There, distractions were few and far between.

This week I picked up a piece of research from the Global Investment Strategy team at the famous Swiss investment bank UBS AG. They were testing the assertion that commodities are a reasonable play against inflation.

Because commodity price returns are only weakly linked to stock and bond returns, it is assumed that commodity prices must provide a reasonable degree of diversification in a portfolio.

But UBS concludes that the emperor hiding behind this conventional wisdom simply has no clothes!

Their study shows that spot or current historic commodity prices have underperformed the consumer price index over the past 36 years by a cumulative 21%. Also, had an investor held interest-bearing cash throughout the period, he or she would have outperformed commodity prices by 46%.

UBS blames the returns on technological advances, which inevitably reduce the cost of production and depress commodity prices.

They also point to a sharp run-up in spot prices during the first few years of the 1970s and the last couple of years. They claim that this completely accounts for the strong performance of the Goldman Sachs Commodity Index for the 36-year period under review.

Basically, had it not been for these two periods of strong performance, commodities wouldn't have turned up on investors' radar screens.

For them to feel comfortable holding commodities, they claim that the returns are based on two blips over the 36-year period and that the most recent is utterly dependent on energy prices soaring.

For the past 13 years, returns have been negative – leading them to conclude that commodities just ain't worth the risk.

Commodity funds are bringing in boatloads of cash. Hedge funds, big investors in commodities are leading the way.

This has led to bold predictions that there is a hedge-fund bubble and that some day one of them will go bust and drag down the global economy, a la "Long Term Capital Management."

The rise of the hedge fund industry has been stellar, catching the attention of many famous forecasters.

George Soros, chief at the Quantum Fund, allegedly made a billion British pounds by taking on the Bank of England in 1992 as the pound collapsed. He is credited with founding the entire industry.

Yet in January of this year he told world leaders at the World Economic Forum in Davos, Switzerland, that "hedge funds have become a little too popular" and that they may become "more difficult to set up."

Bill Gross – managing director at PIMCO, the world's biggest bond fund – predicted a slowdown in fund growth. At the time he blamed increasing competition, excessive fees and too much leverage.

At that same time, a major German bank group forecast that the bubble had peaked. Exactly twenty months later, Swiss central banker Philipp Hildebrand loudly announced that hedge funds were due for a "definite clean-out."

Some of the negative views are predicated on the fear that each fund is structured like a house of cards and therefore must ultimately fail.

However, hedge funds are more robust than that. Sure, they are highly geared and get involved in obscure investments, but ultimately if the demand wasn't there, these funds wouldn't thrive.

You see, hedge funds take on excess risk with the express aim of outperforming some given benchmark. They'll move from one hot area to another in search of returns.

And investors pay big money for the privilege and potential returns that hedge funds offer. Most managers demand a 20% cut of any annual profits.

Punters seem willing to pay that price for a stock that outperforms, and it appears that investors are happy to have an expert walk them through the minefield of true diversified global investing.

The average man on the street cannot claim to be an expert in commodities, foreign exchange, precious metals and bonds. So 20% seems an agreeable charge.

These days, performance at hedge funds is recovering, owners are selling off parts of their businesses in the form of IPOs, and share prices are rising.

According to a recent Goldman Sachs Group industry survey, investors were expecting to add 28% more to hedge funds than the previous year.

EuroHedge Magazine recorded the founding of 250 new funds in 2004. The following year, 330 new funds emerged. At the same time, assets at these new funds jumped by 22%.

Chicago-based Hedge Fund Research Inc. notes that there are 8,661 hedge funds worldwide and they managed $1.1 trillion at the end of 2005.

Share prices of Man Group Plc and RAB Capital Plc in London have doubled in under a year. Shares in newly listed Partners Group rose 33% on their first day of trading in Zurich last week.

It doesn't look like the demand for hedge funds will slow in the coming years.

In fact, they are becoming even more accessible. Once the playground for the rich, hedge funds are now about to become available to retail investors.

Just recently the British Financial Services Authority took a step closer to allowing hedge funds to market themselves to retail investors. In other words, you won't need a net worth of a million dollars to have your assets invested in coffee, live cattle, gold futures or Japanese yen.

To that end, I'm launching my very own hedge fund right here. My goal is to give individual investors the opportunity to beat the markets by utilizing hedge-fund strategies.

You may remember a couple of weeks ago I advised buying silver futures. Silver hit another record this week, and the profits are piling in. The position is up 225% since my recommendation. That's an amazing return and I can't guarantee that all trades will be like that, but I aim to swing for the fences with this new service.

For those of you who raised your hand early, you'll hear from me this weekend. Be sure to check your mailbox for more information.

Commodities Corner

 

You see, at the end of the day there's analysis, there's the way things should be and then there's the reality of the way things really are.

In fact the average change of these twenty futures is 17.1% during the last twelve months. Half rose and half fell.

In the months ahead, I will have plenty of analysis to keep us abreast of Wall Street's best.
Watch this space


Have a great week!   

Andrew Wilkinson
Senior Newsletter Editor

P.S. Join my Triple Edge Alert Option Service today and save $400!  Don't miss out on a great-and most profitable 2006. Call our Triple Edge Alert representative Aaron DeHoog today at 888-766-7542, ext. 253 or Go here now.

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Dear MoneyNews Reader: Since moving to South Florida some years ago, I have developed a love and respect for a substance I never had much use for back home on the other side of the pond: ice. On any given hot summer day here in sunny South Florida, you will find me...
The,Iceman,Cometh
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2006-00-07
Friday, 07 April 2006 12:00 AM
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