Please, click here to read this article in pdf format: november-4-2010

The political week is not over yet and we have had three important events. Firstly, the Federal Open Market Committee (FOMC) announced $600BN of Treasuries purchases over 8 months. Secondly, the European Union is advancing on a crisis resolution mechanism, for “orderly” sovereign debt restructurings. And thirdly, Canada’s federal government last night rejected the takeover of Potash Corporation by BHP Billiton Ltd., or by any other foreign buyer, practically speaking.

These three events are all relevant and they all represent a victory of the political class versus taxpayers.

In the first case, yesterday’s announcement by the FOMC did not surprise so much in terms of the volume (although we admit is below the $100BN per month consensus) but in that purchases will be mostly in the 5-7 year duration, without a commitment to buy longer duration bonds. The announcement went out at 2:15pm. Three minutes later, it was disclosed that the 35% limit on SOMA holdings had been relaxed, signaling that the Fed was contemplating a significant crowd out in the issues it will target (i.e. The Fed was prevented from owning more than 35% of the supply offered on each issuance of the Treasury. By relaxing this limit, apparently only modestly, it sends the message that it intends to purchase a relevant portion of some of the issuances it will target). After this later disclosure, the sell-off in the long end of the curve (i.e. 30yrs) began, taking the 30-yr Treasury 3.72% down, by 4pm. This surprise forced the unwinding of curve trades and consequent volatility in the swaps/liquidity market, affecting ultimately the rest: Currencies, commodities, stocks and credit.
We think this stress on liquidity is what drove gold down to $1,330 intraday, post FOMC and personally, we took advantage of the situation to position ourselves with a longer term view on the headline.

Why did taxpayers lose with this? It is clear that fiscal deficits will be monetized and that anyone holding fiat currency will end up having it debased. Central banks around the world will have a hard time fighting the capital inflows coming from the US dollar zone and will postpone any return to normal rates. The emerging markets debt bubble is in full blossom.

In the second case, the creation of a crisis resolution mechanism without addressing the root of the problem, namely the absence of a real federal structure in the European Union with a unified bond market, only adds one more layer of complexity to the still alive uncertainty generated by potential contagion from the periphery to the core of the Union. A crisis resolution mechanism is buzzword for confiscation, for wealth redistribution from bondholders to governments. There is no other rationale for bringing this up, except to ensure that in the future, investors in sovereign risk see their seniority status diminished, subjected to the arbitrary designs of a crisis resolution council. This idiocy or naïveté, we don’t know which, will do nothing but make Euro sovereign debt more expensive to raise, in a more volatile, less liquid market, if the reform advances. It will certainly put a cap to the value of the Euro and a cloud of doubt to its prospects as a secondary reserve currency.

Finally, last night, Canadians saw their property rights damaged in favour of national socialism. Canada’s federal government blocked BHP Billiton Ltd.’s $40BN bid for Potash Corp. of Saskatchewan Inc. The reason? “…It will not provide a “net benefit” to the country…”. This is by far the most absurd excuse to protect the petty interest of a provincial political class. It seriously damages the valuation of investment projects, existing and future, in the exploitation of Canada’s natural resources; it makes Potash’s shareholders poorer and sends the wrong message to all those who had seen the Canadian dollar as an alternative reserve asset since the crisis of the Euro began this year. From now on, the investing community will ask: Why Canada? Why not Peru? Why not Brazil or Argentina? We think this is a valid question and Canada has lost the ability to answer it. The Canadian dollar has undoubtedly lost one of its supporting legs. What a contrast with last Tuesday’s Tea Party’s victory in the United States…

Martin Sibileau