Tuesday, August 21, 2007

In a Liquidity Crisis, Take a Hard Look at What Is Being Sold, and Then Consider What Will Ultimately Be Sought After…

21 August 2007

We have been writing recently about whether quality assets will be bought or sold in a liquidity crunch.



The truth is, the answer to that question remains to be seen.

However, what is increasingly coming to the market for sale --- and sitting there unsold --- is now quite evident, and that is debt.

The interesting thing is that, until a few weeks ago, even debt of the lowest quality was easy to sell. Now, suddenly, there are no buyers even for high quality debt. Everything has turned around.

A great story on this topic is to be found on Bloomberg News Let me share a bit of the story with you:

Commercial Paper Market Roiled With $550 Billion Due (Update1)
By Mark Pittman

Aug. 21 (Bloomberg) -- Ottimo Funding LLC, whose name is Italian for ``excellent,'' has the highest possible credit rating and doesn't own subprime mortgage bonds. That made no difference to investors who refused to buy Ottimo's $3 billion of short-term debt this month as losses on home loans to risky borrowers infect the global credit markets.

``It's pretty much a straight contagion,'' said George Marshman, chief investment officer of Stamford, Connecticut-based Aladdin Capital Management, which oversees about $20 billion, including Ottimo. ``We think the assets are good enough'' to attract investors, he said.

The $1.1 trillion market for commercial paper used to buy assets from mortgages to car loans has seized up just as more than half of that amount comes due in the next 90 days, according to the Federal Reserve. Unless they find new buyers, hundreds of hedge funds and home-loan companies will be forced to sell $75 billion of debt, according to Zurich-based UBS AG, Europe's largest bank.

Those sales would drive down prices in a market where investors have already lost $44 billion, based on Merrill Lynch & Co.'s broadest index of floating-rate securities backed by home- equity loans. That may hurt the 38.4 million individual and institutional investors in money market funds, the biggest owners of commercial paper.

`Uglier and Uglier'

``We're dumping all this collateral into the market and it becomes a death spiral for the assets,'' said Brian McManus, head of collateralized debt obligation research at Charlotte, North Carolina-based Wachovia Corp., the fourth-biggest U.S. bank by assets. CDOs contain pools of mortgage securities that have been repackaged and sliced into pieces.

Instead of commercial paper -- corporate debt that comes due in nine months or less -- money fund managers are running for the safety of government securities. Yields on three-month Treasury bills plummeted to 2.9 percent from 4.95 percent at the start of the month, even though central banks injected more than $200 billion into the financial system and the Federal Reserve cut the rate it charges banks for loans on Aug. 17.

The credit crunch, sparked by the highest level of defaults on subprime mortgages in a decade, is ``getting uglier and uglier,'' said Christopher Low, chief economist in New York for FTN Financial, the capital markets unit of Memphis, Tennessee- based First Horizon National Corp.

``This has moved beyond temporary. It's gotten beyond bailing out some hedge fund and into the broad economy.''

What do investment professionals have to say on the matter. Here are the words of an experienced Swiss banker:

Jean-Pierre Roth, president of the Swiss National Bank, said market turmoil was far from over as tremors from the sub-prime debacle continued to rock the world.

"We're certainly not at the end of the story. There are question marks surrounding the development of the American economy," he said. "Something unbelievable happened. People who had neither income nor capital got credit with very attractive conditions. Now reality is striking back," he said.

My earlier point was very simple. An entire class of investment assets has just been shunned by global markets – and this is a critical asset class, known as "debt paper." I know, it doesn't sound attractive to a mainstream saver or investor – but until recently, it was a source of high yields even for relatively conservative investors. Now, this is no longer the case.

We also know what is being sought after right here, right now, as the 90-day Treasury Bill interest rate has recently collapsed due to soaring investor demand.

Sitting by the wall, towards the corner, perhaps not yet noticed by many, is the actual belle of the ball - gold. Overshadowed historically by such assets as general equities and "debt paper," and now, more recently, by 90-day Treasury Bills, gold is the true – but still overlooked – quality investment in uncertain times. Suddenly, debt paper is getting few invitations, and the attendees at the gala are looking for new dancing partners.

Here's a tip. Gold is still available, and you can have the time of your life dancing with her. Pretty soon, there will be quite a line-up seeking her out. But if you act quickly and decisively, right here, right now, she is still available for you.

Go ahead, take a few steps in her direction, and ask her to dance. Get to know her now, while she remains easily approachable. Before long, others will be tapping you on the shoulder. My guess is that you'll be glad that you were there first. She is a most pleasant companion, whether for an evening of dance and sparkling conversation, or for a long-term committed relationship….

(By the way, Streettracks Gold Trust, the ETF investment vehicle that makes gold ownership easy for mainstream investors, conitnues to see accumulation. While mainstream investors flock to Treasury Bills paying lower and lower rates of return, contrarians are continuing to accumulate gold. Read Dan Norcini's take on this trend here.)

No comments:

Post a comment