The Leather Apron Letter 10-11-2013

7/27/2019 The Leather Apron Letter 10-11-2013

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October 11, 2013

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~ Fact of the Week ~

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Two headlines obviously dominated the news in the past couple weeks, with Janet Yellens fed head nomination overshadowed by the ongoing debt ceiling debate. While she brings some much sought after certainty to the continuation of curent fed policy; the stand-off among our countries politicians has neutralized that effect. Whether the presumed can-kicking has been priced in or not will become clear with hindsight. The real question is whether theyll make a real de

or a deal to make a deal in a few weeks; time will tell...

Now without further ado, lets jump into this slightly abbreviated LAL...enjoy the Columbus Day holiday!

-Ben Franklin

The ten bagger investment is the envy of the investment world.

It is an investment that returns 10x yourmoney, or 1000%; turning a $10,000 investment into $100,000. The phrase was coined by the king of mutual fundsPeter Lynch, best known for his 30% annual returns over 20 years. Wikipedia explains how he came up with theerm [it] was adapted from baseball where "bag" is a casual term for "base", and extra-base hits like doubles, tri-

ples, and home runs are colloquially called two-, three-, or four-baggers. A "two bagger" would be a double, so by

extension, two home runs and a double would be a "ten bagger".

~ A note from Ben ~
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October 11, 2LeatherApronLetter.com 2

1. As we had noted last issue, the news that was likely to dominate the market was the coming debt ceiling and government

shutdown...as we has predicted the market bumped off a major trendline and we caught a 70pt short swing because of the

government mudslinging...since then, sentiment has shifted to the other extreme and the gloom and doomers are out in

force...when consensus is formed, we tend to fade...

Its important to note that Credit Default Swaps (CDS) have been skyrocketing lately as people buy insurance for the possib

event of a US default...for those of our readers not involved in the markets, a CDS, simply put, is insurance on a bond...a b

er of a CDS pays a premium for insurance in case the borrower goes into default, in which case the seller of the CDS will

cover some losses...the spike on the chart below shows that the premium for this insurance on government bonds has in-

creased as investors and traders buy this protection...

Note that CDS spikes of this magnitude have tended to signal interesting buying points for the markets (see Feb/Mar 2008,

2011)...while we cant predict what the government will do our interest is piqued...

Meanwhile, if the big swingers aren't hedging through CDS they are simply liquidating

USATodayFidelity Investments, the nation's largest money market mutual fund manager, has sold all of its short-term U.S

government debt the latest sign that investors are increasingly nervous about the possibility of a government default.

Money market portfolio managers at Fidelity Investments started selling off short-term U.S. government debt a couple of weeago, Nancy Prior, president of Fidelity's Money Market Group, said Wednesday. While Fidelity expects the debt ceiling issue

be resolved, the Boston-based asset manager said it has taken steps to protect investors.

"We expect Congress will take the steps necessary to avoid default, but in our position as money market managers we have to

take precautionary measures," Prior said.

Comments: As we go to press, Obama and republicans led by John Boehner as troupe leader hit the media outlets indicatin

their willingness to negotiate...markets ripped and once again we are in a headline driven market...caution must be paid, b

in all likelihood we muddle through this without a hitch...did Obama just set a bear trap???

~ Articles of the Week ~
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2. Staying on subject, we find it interesting that the market tends to trend up when the government is not around to interfer

Mark Twain said it best...

"No man's life, liberty, or property are safe while the legislature is in session."

Furthering this argument is a study done showing market returns when the Congress is in session vs. out...We find a strong link between Congressional activity and stock market returns that persists even after controlling for knowndaily return anomalies. Stock returns are lower and volatility is higher when Congress is in session. This Congressional Effeccan be quite largemore than 90% of the capital gains over the life of the DJIA have come on days when Congress is out of ssion. The Effect varies systematically with the public's opinion of Congress: returns are lower and volatility higher when a rel

tively unpopular Congress is active. Public opinion appears to play a fundamental role in market prices. This is consistent witmood-based explanation that sees Congress as depressing the average investor. Alternatively, our results can also be reconciwith rational explanations that view Congressional activity as a proxy for regulatory uncertainty or rent-seeking behavior.(Ferguson/Witte)
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3. Lets take a quick look at what some of the traders/investors are saying on the debt ceiling subject and general market

FORTUNE-- Fighting about the debt ceiling "ought to be banned as a weapon," says Warren Buffett. "It should be like nuclebombs: too horrible to use."

"It's deeply immoral," adds Charlie Munger, vice chairman of Berkshire Hathaway (BRKA), where Buffett is chairman andCEO. Munger calls the recent U.S. government shutdown "deeply irresponsible" and says, "I think if my Republican friends kdoing this, they're going to pay a terrible price."While the legendary investing partners have agreed on stock-picking principles for 54 years, they've never been extremely insync on politics -- Buffett has supported Democrats, while Munger is a Republican. But when I interviewed them Thursdayevening, they agreed on the inanity of the current showdown in Washington. And they noted lessons from five years ago, wheCongress united to pass the historic bailout bill and stabilize the economy."Go back and behave like that," Munger, 89, advises Congress.Buffett, 83, agrees, hoping that Democrats and Republicans recall the value of cooperating in 2008 -- and learn from the currecrisis. "Some good may come out of this," Buffett says. "This may be like after we dropped a couple of atomic bombs. We sawthat we didn't want to do it again."

ZeroHedge"I think we're in the middle of a kind of bubble market, where it's going to take something bubble-like t

happen to prick the bubble and will probably have pretty bad reaction to the breaking of the bubble," Julian Robertsosaid. "Probably will not [happen] right now and somehow I think we'll wallow through the political and fiscal crisis we havefront of us and then we'll sort of see what happens."

CNBCJim Rogers has a two-word message for U.S. investors: "Be careful.""The U.S. is the largest debtor nation in the history of the world," Rogers told CNBC.com Wednesday night by phone from Sigapore. "We may well have a big, big rally in the U.S. stock market, but it's not based on reality. I would encourage investors know you're in a fool's paradise, be careful, and when people start singing praises, say, 'I've been to this party before, and I knit's time to leave.'"For Rogers, the author of "Street Smarts: Adventures on the Road and in the Markets," it is only a matter of time until the U.S

stock market runs into devastating problems due to the Fed's quantitative easing program and the prevalence of similar stimutive programs around the world."First of all, throughout American history, we've always had slowdowns every four to six years. That means that sometime innext couple of yearsthree years, maximumwe are going to have problems again, caused by whatever reason," Rogers said"For instance, there was 2001 and 2002, and then 2007 and 2009 was much worse. Well, the next time it's going to be worse sbecause the level of debt is so, so, so much higher. Every country is increasing its debt at the same time."Stimulative measures by central banks, such as the purchasing of assets with created money, boost asset prices in the short terBut Rogers said that central banks can only do so much."This is the first time in recorded history that we have every major central bank in the world printing money, so the world is

floating on an artificial sea of liquidity. Well, the artificial sea is going to disappear someday, and when it does, the catastrophwill be even worse. Yes, it's coming," Rogers reiterated, adding: "If I was smart enough to tell you when it's going to happen, would get rich."

Indeed, even though he predicts a catastrophe, Rogers is not yet advising investors to sell."I don't see any reason to rush out and sell stocks now, because of these artificial currents which are taking place," he said. "I'not buying U.S. shares at the moment, but I'm not shorting either, because I am concerned this may turn into a huge bubble. SI'm sitting and watching.""If the market doubles in the next six or eight months, which it's done in the past, then I'd have to start thinking about sellingshort," Rogers said. But until then, "because of the uncertaintyat least in my mindI'm not doing anything."
http://localhost/var/www/apps/conversion/tmp/scratch_15/LeatherApronLetter.comhttp://localhost/var/www/apps/conversion/tmp/scratch_15/LeatherApronLetter.comhttp://postcards.blogs.fortune.cnn.com/2013/10/04/buffett-debt-ceiling-shutdown/http://postcards.blogs.fortune.cnn.com/2013/10/04/buffett-debt-ceiling-shutdown/http://www.zerohedge.com/news/2013-10-07/julian-robertson-warns-we-are-bubble-market-and-yellen-way-too-easy-moneyhttp://www.zerohedge.com/news/2013-10-07/julian-robertson-warns-we-are-bubble-market-and-yellen-way-too-easy-moneyhttp://www.cnbc.com/id/101083671#_gushttp://www.cnbc.com/id/101083671#_gushttp://www.cnbc.com/id/101083671#_gushttp://www.zerohedge.com/news/2013-10-07/julian-robertson-warns-we-are-bubble-market-and-yellen-way-too-easy-moneyhttp://postcards.blogs.fortune.cnn.com/2013/10/04/buffett-debt-ceiling-shutdown/http://localhost/var/www/apps/conversion/tmp/scratch_15/LeatherApronLetter.com


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4. Jumping over the pond, with the German elections in the rear-view mirror, we are left to wonder whether the EU beginssoften their stance on the Euro and austerity...will a coalition lessen the hard-nose policy of Germany or will it be austerityusual?? The Euro is at an interesting inflection point...

TheGuardianEuropeis sinking into a protracted period of

deepening poverty, mass unemployment, social exclusion, great-er inequality, and collective despair as a result ofausteritypoli-cies adopted in response to the debt and currency crisis of thepast four years, according to an extensive study being publishedon Thursday.

"Whilst other continents successfully reduce poverty, Europeadds to it," says the 68-page report from the International Federation of Red Cross and Red Crescent Societies. "The long-termconsequences of this crisis have yet to surface. The problems caused will be felt for decades even if the economy turns for thebetter in the near future We wonder if we as a continent really understand what has hit us."

The damning critique, obtained exclusively by the Guardian, of the policy response to the debt crisis that surfaced in Greece ilate 2009 and raised fundamental questions about the viability of the eurosingle currency, foresees extremely gloomy prospecfor tens of millions of Europeans.

Mass unemployment especially among the young, 120 million Europeans living in or at risk of poverty increased waves oillegal immigration clashing with rising xenophobia in the host countries, growing risks of social unrest and political instabilitestimated to be two to three times higher than most other parts of the world, greater levels of insecurity among the traditionalmiddle classes all combine to make a European future more uncertain than at any time in the postwar era.

Quartz The euro zones economic ills, in a nutshell, derive from too much debt. Still, there are many blameless borrowersparticularly small businessesthat find it difficult to get credit as banksare preoccupied with nursing their own balance sheets back to health.Loans to euro-zone businesses, as detailed in the latest monthly bulle-tin(pdf) from the European Central Bank (ECB), are falling faster than

ever.This, and the general shakiness that continues to stalk the euro zonesbanking system, is stoking talk about reviving an emergency liquidity pro-gram for the regions lenders. In late 2011 and early 2012, the ECB doledout 1 trillion ($1.35 trillion) in three-year loans with a rock-bottom 1%interest rate in a program known as Long-Term Refinancing Operations.Hundreds of banks took the ECB up on its offeralthough many, ratherthan using the funds to write more business loans, bought bonds and other securities in the hope of turning a quick profit.

Now, rumors of a new round of emergency liquidity injections are gathering steam.Nobody wants to have a liquidity accidenstanding between now and the recovery, said ECB president Mario Draghi last week.

Although not on the Euro, the UK is still experiencing their difficultiesand the GBP is finding resistance...

IBTimes The Red Cross will distribute food to the needy inthe UK for the first time since World War Two to help deal withthe rising numbers of people struggling to feed themselves.

The Red Cross said volunteers will be sent to supermarkets forthree days to ask shoppers to donate dry food items, which willthen be sent to food banks through the charity FareShare. Wel-fare cuts and austerity measures have seen a rise in the number ofpeople turning to food banks and soup kitchens as families strug-gle to put food on the table, according to the Independent.
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5. Moving on to another hot market, lets check in on the real estate market...readers will remember we caught a quick shor

trade when we called the top of the real estate market back in Q2...since then we have had no skin in the game but lets che

in on Mark Hanson, who we respect greatly for his real estate insights...

BloombergTalk to Mark Hanson about the housing market for five minutes and you may find yourself wanting to sell yourhome and park the cash in a suitcase.

The Menlo Park, California, real estate analyst, blogger and founder of consultancy Hanson Advisers predicts a declinof 20 percent in housing prices in the next 12 months. Half the gains since the latest housing bottom in 2011 could be erased ithe hot areas -- Florida, California, Nevada, Arizona and Georgia -- by rising interest rates and a thinner herd of speculative pvate-equity buyers, he says.

Less bearish real estate experts such as Stan Humphries, chief economist at Zillow and a Hanson fan, also see signs ofroth. Existing home sales jumped 6.5 percent to 5.39 million this July, their highest level in three years. In August those salesfell 1.6 percent despite a surge in 30-year mortgage rates -- a move Humphries says was healthy because the market needed tocool off, and that relatively mild reaction showed there was still buying in the face of rising rates.

"Theres a strong distinction between a normal slowdown and the wheels coming off the housing recovery," says Humphries. "That's where I depart from Mark's take."

Hanson's critical view of the housing market, which he shares with mutual fund and hedge fund clients, extends downhow those very statistics are generated. A reporting lag makes existing-home sales stats deeply misleading, he says. The statisare calculated 30 to 60 days after sales contracts are signed. Julys positive data, for example, were mainly for homes sold befmost of the rate increase.

Digging into the data does, however, reveal one reason why Hanson is so leery of housing now. Some 58 percent of eisting-home sales in 2013 have been made by all-cash investors purchasing large swaths of distressed properties to lease torenters. Hanson says private-equity firms caused about 50 percent of the price appreciation in cities like Phoenix and Las Vegand generally overpaid by 10 percent to 20 percent, according to his calculations.

With gains of more than 35 percent since the crash for properties in Las Vegas, Phoenix and other of the hardest-hit rgions, these vultures will begin to lose interest, he figures. With property prices and interest rates both higher, they may find bter opportunities in Treasury and high-yield bonds than in houses. Thats because as house prices rise the yield you can get frorenting the house declines. The loss of some of these buyers will remove what Hanson sees as an artificial support for prices.

A lack of buyers for new homes is also part of Hanson's downbeat outlook. He points to new-

home sales as a better incator of the health of the housing market than existing-home sales. They're more current, reported as soon as sales contracts asigned, and 85 percent of sales are to traditional buyers with mortgages.

Such buyers have already begun to feel the sting of higher rates. New-home sales fell 27.4 percent in July, says Hanson. The only other time theyve ever fallen that much was when the home-buyer tax credit expired in May of 2010. The adusted Census Bureau numbers he tracks show new-home sales flat from July to August, but the number of new homes being

sold is so low to begin with, he says, at 35,000, that they are "recession-level" sales numbers.Whether homes become unaffordable as a result of rising rates is a key question for the housing market. Zillow's Hum

phries points out that in markets such as Phoenix it costs only 13 percent of the average familys household income to cover it30-year monthly mortgage payments despite the rate increase. That compares with the 20 percent of income it used to cost in years leading up to the housing bubble. So, in his view, houses in Phoenix are still very affordable.

Hanson says apples-to-apples comparisons of affordability for pre- and post-crisis periods are problematic. While hom

prices were higher and 30-

year mortgage rates were typically above 6 percent prior to the 2008 crash, houses were actually maffordable back then because of the types of loans people had, he says -- such as loans with zero-interest teaser rates and adjusble-rate mortgages with lower rates than today's fixed ones.

In one of Hanson's latest blog posts he remarks that perhaps he is the only housing bear left. But as anyone familiar with financial history knows, its when there are no more bears left that the bear market begins.
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6. Speaking of those private equity guys in real estate

ZeroHedgeWith mortgage applications down around 60% from their peak in April, the last best hope for sustained "recoverin housing 'was' the cash-only bid from private equity and hedge capital in the REO-to-rent or flip-dat-house trades. As we ha

noted previously, that last pillar was starting to falter and as Bloomberg reports, it seems is now in full crack mode as CarlyleGroup switches from marginal buyer to marginal seller in its $2.3 billion real estate funds. "Our capital was useful at thefront edge of the recovery," the firm notes - implying the big gains are over as rent growth fades (as employment and incomegrowth slows). Crucially, they add, "investors really want the new Class A properties so were selling into that demand." Wassume that by "investors" they mean greater-fool bag-holders.

Carlyle Group LP (CG), the private-equity firm with more than a third of its $2.3 billion U.S. real estate fund in apartments, is

reducing holdings of multifamily housing as rent growth slows from a post-recession surge.

The company is considering apartment sales as rising construction reduces multifamily shortages and price gains for rental prerties make them less attractive for private-equity firms that seek returns of 20 percent or more, said Robert Stuckey, the Wasington-based firms head of U.S. real estate investing. Carlyle has invested or committed about $800 million of equity in 61 m

tifamily properties since the start of 2011, he said.

We went from an unusually high-growth market to a market that is growing and attractive but more stable, Stuckey said in a

interview. Our capital was useful at the front edge of the recovery.

As it sells apartments, Carlyle is focusing investments in areas such as senior housing, self-storage units and manufacturedhomes, where demand tends to be driven by life changes such as retirement or marriages, and isnt so closely tied to changes employment and gross domestic product, Stuckey said. About one-third of the firms real estate investments are in propertiesthat are more directly affected by the economy, such as office and retail. Our basic view is were in a low-growth environme

Stuckey said.

NYTimes...five years after the start of the financial crisis, the housing market has come back, and many of these investors a

cashing in. According to tabulations by Redfin, an online real estate listings site, banks have already sold about 1.5 million ofnearly 2 million homes that were foreclosed on during the past half-decade. Resales are becoming more common and can behugely profitable. A house in Redwood City, Calif., for instance, was sold in a foreclosure auction in 2011 for less than half wthe evicted owner paid in 2006. Ten months later, it was flipped for close to its previous price. Another house in Los Angeleswent into foreclosure in 2012 and was flipped seven months later for a markup of $254,000, or 66 percent. Of the 87,062 foresures in the last five years that were bought by corporate investors and have been flipped, about a quarter were sold for at leas$100,000 more than what the investor originally paid, according to Redfin. (Although its impossible to know how much inve

tors spent on upgrades or renovations.)

Comments: The smart money is bailing and

the flippers are in full force...over the long

term, rates must go up, so what does that

spell for RE??...
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8/25


7. While on the real estate topic, lets finish up with Zells view of the market...last month we published his bearish view

on the RE market, this week he touched on a current trend undertaken in the US...re-urbanization

YahooYoung people shunning the suburbs in favor of the hustle and bustle of city life are leading the charge in the

"reurbanization of America," real estate mogul Sam Zell told CNBC on Tuesday."You're drawing all the young people in America to these 24/7 cities. The last thing they want to do is live in the sub-

urbs," Zell said in a " Squawk Box " interview. "In that respect, you're increasing demand for housing in the urban markets."The demand for the suburban lifestyle had been driven mainly by safety and schools, he said. "If you wanted to see the end ofsuburbia, all you'd need to do is make the school systems in the cities triple-A and why would anybody live in the suburbs," Zsaid.

One of the byproducts of people moving to cities is soaring demand for apartments. "We are seeing 96 percent occupacy," said Zell-who's chairman of the real estate investment trust Equity Residential (EQR), one of the largest apartment group

the country. Of the 18,000 units the REIT manages in New York City, Zell estimated 45 percent are occupied by just one pers

"It's probably going to happen here in New York first," he said. "You're going to see 300-square-foot apartments, direly related to that one person wanting to live alone-and saying, 'I'll give up space for privacy.'"

Comments: Tough trend to play through public equity, short REITs in the suburb vs long urban REITs??

Another country undergoing a massive re-urbanization is China...but Aeon magazine published an interesting article this

week, arguing another trend is helping to prop up China RE...

QuartzKeeping a mistress is a normal part of life for successful Chinese businessmen and government officials, and in somways they have become more visible in recent years, playing roles in corruption scandals and even, sometimes, turning in theilovers.

They and their big-spending partners may also be contributing to ever-increasing real estate prices in some of Chinasbiggest cities. Thats because these women, often from rural areas, are regularly kept in apartments that their lovers buy for th

in urban centers, near his work or home. The practice has created entire neighborhoods of apartments in big Chinese cities fillwith women who would otherwise be living at home with their families, or perhaps sharing a rental.Ina colorful article todayLondon-based magazine Aeon,one ernai or second woman living in a $400,000 Beijing apartm

explains:

Local estate agents target provincial officials and businessmen looking to put their money into Beijings property bubble, andthe men fill up the apartments, bought as investments, with their women. Half of the apartments are empty, she explained. A

the other half are full of girls.Quantifying how many apartments there are housing mistresses in China is close to impossible, but the practice of having, an

keeping a mistress is widespread among the wealthy. About 90% of the top officials brought down by corruption scandals hmistresses, a government report from 2007 found. One had 18, it suggested. Keeping a mistress is just like playing golf, onreal estate developer who spent $6,100 a month to support a 20-year-old art major told The New York Times in 2011. Both a

expensive hobbies.

The state-run Beijing Evening Daily estimated back in 2010 that there were 200,000 mistresses living in apartments in Beijingalone, and said that if they could be driven out of the city as part of an on-going prostitution drive, there would be a turning

point in housing prices there.

Since then, home prices have only gone way, way up.
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9/25


9. Jumping over to another topic we touch on seemingly every other week...

Bloomberg Takeshi Fujimaki, a former adviser to billionaire George Soros and now a member ofJapans upper house ofparliament, said a fiscal crisis in Asias second-biggest economy is inevitable and neither a higher sales tax nor the 2020 Olym

pics will be able to stop it.

I decided to become a politician because I think financial crisis will come sooner or later, Fujimaki said in an interview in Tkyo. This total debt will continue to increase. I dont think Japan can survive until 2020.

Yields on 10-year Japanese government bonds may jump to 70 percent based on what happened in Russia when it defaulted in1998, Fujimaki said. The benchmark yield is now the lowest in the world at 0.68 percent and the cost to protect the sovereigndebt from default is near a four-month low at 62 basis points.

Before sweeping to power in December elections, Prime Minis-ter Shinzo Abes Liberal Democratic Party outlined in 2011 aplan known as the X-day project to fend off a potential bondcrash. Public debt totaled 924.4 trillion yen ($9.37 trillion) that

year and has ballooned to more than one quadrillion yen, morethan twice Japans gross domestic product, the highest ratioglobally. Abe is set to decide on Oct. 1 whether to raise the 5percent consumption levy.

Its inevitable we will see a very big mess and the LDP has tostep down, said Fujimaki, who won his upper house seat on a Japan Restoration Party ticket in the July 21 ballot.

The Bank of Japan is aiming to stoke 2 percent inflation in two years by buying more than 7 trillion yen of JGBs a month. Cosumer prices excluding fresh food rose 0.8 percent in August from a year earlier, the fastest increase since 2008, as energy cosclimbed, the statistics bureau said today.

Because the BOJ is buying huge amounts of JGBs, market principles in this country do not work, Fujimaki, who served asmanaging director and treasurer in Tokyo at Morgan Guarantee Trust Co., which later merged into JPMorgan Chase & Co.Monetary easing is creating a JGB bubble. Sooner or later the market will reflect credit risk.

Comments: Abe/BoJ recently announced a tax hike and subsequent stimulus...will this be enough? Note the yen chart abis bouncing off a significant trendline, we are short, but will it hold?? Will the market lose confidence in JGBs and yen??Regardless, the general mood of Japan is improving day by day...with Abe focusing his attention on wage increases, consuer and luxury goods are seeing an uptick in demand...

Bloomberg Fiat SpA (F)s Ferrari said sales in Japan will rise by 30 percent this year as Prime Minister Shinzo Abe seeks lead the country out of 15 years of deflation.The carmaker said sales will be boosted by an improving Japanese economy, Giuseppe Cattaneo, who heads Ferraris Far Easbusiness including Japan, South Korea, Southeast Asia and Australia, said in an interview in Tokyo. Ferrari, which showcased

458 Speciale sports car in Japan yesterday, sold 302 cars in Japan last year, according to Maki Kataoka, a Tokyo-based spoke

woman.

Vehicle sales in Japan last month rose the most in 14 months, adding to signs of an improving outlook in the worlds third-largest economy. The Bank of Japan last week refrained from adding to unprecedented monetary stimulus after business confdence surged and Abe decided the economy was strong enough to weather a sales-tax increase.

This new euphoria, that you can feel staying in Tokyo, related to Abenomics, pushed up sales, Cattaneo said. We have a goperformance in 2013 compared to 2012.Ferrari sales in Japan increased 28 percent in the first six months, Cattaneo said.
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10/25


10. Regular readers will note that we have swing traded natural gas with some success over the past year, catching a few 2

moves on both the short and long side (see our most recent post here).taking a step back and looking at the sector fro

birds-eye view, our friends over at Ponderosa Advisors sent in their perspective on the market...Note that Ponderosa is a

search outfit focusing on oil and gas, crude refining, petchems, water rights , and the cattle market... when they write in,

listen...we have slimmed this down to a few pages but would advise anyone interested in the subject to click though and rthe post in its entirety...

PonderosaAdvisors For U.S. natural gas producers, if 2012 was the year of misery, 2013 may go down as the year of thetease. Averaging just $2.75 for the year, natural gas prices in 2012 were, in a word, miserable. However, in 4Q 2012 and ctinuing on through the first half of 2013 the price environment markedly improved, averaging $4.22 in April and $4.12 in MIn June, prices softened, and signs of the tease became apparent as prices fell to an average of $3.80. They have moved doward since.The early year price improvement bred optimism. Many analysts raised their forecasts on the expectation that the higher pr

were sustainable (i.e. above $4.00). Unfortunately, recent price activity suggests the expectations overshot the mark and prices will return to (and hold) in the $3.00-$4.00 level for a prolonged period of time. This article will review the fundamenthat underlay the current natural gas market and discuss their implications for the future.

The market environment created by the weak 2012 natural gas price entailed two distinct, fundamental phases. During the nine months of the year, prices averaged $2.67 and spent much of March and April sub-$2.00. The low prices reflectedenormous supply overhang that arose from the previous winter, which was never sufficiently cold to drive normal demand. S$3.00 gas prices encouraged power generators to switch from coal to natural gas. The resulting demand increase slowly drprices up and brought on the second market phase. Driven by increased power demand, prices rose and eventually offset thefects of low winter residential/commercial demand. By years end, total demand was up for a third straight year and prices wfirmly back over $3.50, prompting market optimists to believe they would strengthen further in 2013. During 1Q and 2Q2013, prices did, in fact, strengthen, which further reinforced forecasts that called for higher prices.Early on, the higher price outlook appeared correct. Three fundamental assumptions drove the higher price expectations:

The 2012-2013 winter would be colder than the 2011-2012 winter, thus, residential and commercial de-mand would be higher;

The 2012 demand growth, led by the power sector, would continue in 2013; and

The low price environment in 2012 resulted in a 53 percent decline in the number of active, natural gasdirected drilling rigs, which it was believed would inevitably lead to lower production.

Only the first assumption a colder winter- proved real. The other assumptions failed the test of time, suggesting a fundamemisreading of the market. Namely, they ignore the impact that oil and NGL production have on the natural gas market andto recognize that the current natural gas market is relatively balanced. There will inevitably be weather-induced price volatiHowever, only a structural increase in natural gas demand, new or modified regulation that inhibits exploration or a dramdrop in oil prices will perturb the balance enough to significantly increase averages prices beyond the volatility caused by treme weather conditions.

Oil and Gas RelinkOne of the most significant changes in the natural gas industry over the past five years has been its reconnection with the oil

dustry. [1] As recently as June of 2013, 8.5 out of ten drilling rigs were exploring either for oil or wet natural gas (i.e. natur

gas that contains significant NGLs: quantities of ethane, propane, butane, iso-butane and natural gasoline). In many parts of t

U.S., for example the Permian and the Eagle Ford regions of Texas, the Denver-Julesburg and the Bakken, over 95 percent oftotal revenue produced from a new well is derived from one or more of these liquid commodities, while natural gas accounts fonly 5 percent. When such a small portion of a wells total revenue stream is tied to natural gas, the current price of natural gprovides little motivation in the decision of whether or not a well should be drilled. Rather, the exploration company is con-cerned about theprice of oilas it will directly determine the return on investment in the case of an oil producing well, or indirly, if the well produces NGLs.

Cont.
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11/25


Recent natural gas production trends strikingly illustrate the de-

pendence of natural gas production on oil and NGLs. Figure 1

shows production from dry gas wells (defined as wells producingnatural gas with less than 1.15 gallons of liquids per Mcf

(GPM)), natural gas production from associated gas wells (i.e.

wells that produce oil or NGLs along with natural gas) and total

U.S. production of natural gas. While natural gas production

from dry gas wells (red bars) has fallen 4 percent since January

2011, natural gas production from associated gas wells (blue

bars) has increased by 22 percent. More than offsetting the dry

gas decline, this has been enough to generate a 9 percent overall

increase in total U.S. natural gas production (black line).

The active rig count reflects the shift toward oil and wet gas pro-

duction. Figure 2 shows the active rig count since January 2011.

Natural gas rigs are denoted by the red line, oil and oil /gas rigs in

orange and the blue bars the total rig count. Since the start of

2011, gas directed rigs have declined drastically: the count is

down 375 rigs (58 percent). However, the total rig count has in-

creased by 1 percent, as oil and oil/gas rigs have increased by

almost 400 rigs.

The natural gas directed rig count is no longer useful as a means of predicting natural gas production. The logic that the natu

gas directed rig count can predict production is grounded in history and a misunderstanding of the basic data. When produfill out their drilling permits, they are asked to designate the well type. Options vary by state, but generally include O

Natural Gas, Oil and Gas, and Coal Bed Methane. When producers check the box, they are only designating the expe

outcome based on intent and historical well performance in the area. The point is that the designation is arbitrary; rigid stand

as to what constitutes a gas rig versus other designations do not exist. When the well is drilled it produces whatever the p

sure from beneath forces to the surface. Ten years ago when drilling was active in predominantly dry gas areas, the distinc

was less relevant. Today, as the production data shown in Figure 1 demonstrates, producers target oil and liquid-rich areas,

the wells generally produce a mixture of commodities. The fact that the number of active natural gas drilling rigs is down

longer predictive of how much natural gas will be produced because so much of it comes from non-natural gas wells.

Technological change further distorts the relationship between rig count and production. The bottom line: wells drilled in than a third of the time, produce over twice as much gas. [Natural Gas companies] now deploys rigs that on average, prod

nearly nine times as much incremental gas in a year as they did in 2007.

Accordingly, [companies] can grow production with fewer and fewer rigs. [In a recent analysis of a natural gas company

nearly 30 percent reduction in rig count only generated a 4 percent reduction in incrementalproduction. Slower growth is

growth. Technological and operational innovations are major reasons production has increased so significantly in recent ye

even in the face of declining rig counts.

Cont.
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12/25


The Outlook

The current slow natural gas production growth and range -bound prices will persist until we see at least one of three chan

regulatory restrictions, a structural increase in gas demand or falling oil prices.

Regulatory fiat that restricts production is the least likely to occur despite the recent debates about the perceived dangers of

draulic fracing and other evils associated with oil and gas exploration and consumption. Alternatives to oil as a transporta

fuel are not economic and show little promise of becoming economic in the immediate future. Furthermore, even politicians

derstand that the economy needs oil and gas development, and will continue to do so for the foreseeable future. While regula

changes may nibble at the economic margin, they will not significantly impede natural gas or oil production.

A structural increase in natural gas demand is also unlikely in the short-term. . In 2012, natural gas demand increased becau

power utilities switched to very low-priced natural gas from coal. At prices well below $2.75, many utilities had an economic

incentive to burn natural gas in place of coal. However, so far in 2013, the high price of natural gas relative to coal, coupled

with utilities ability to hedge their power sales and use lower priced Northern Appalachian and Illinois Basin supplies have

combined to discourage similar switching.

Falling oil and NGL prices are the most likely cause of a major shift in the natural gas supply/demand balance. Oil and Nprices may fall for several reasons. A major global recession and the resulting demand destruction would cause such an oil p

collapse. In 2008 the economic collapse saw oil prices fall from a high in $133 per barrel in June and July to a low of $41

barrel in December, then to $39 per barrel in February of 2009. NGL prices showed similar trends.

Perhaps the most likely scenario is a gradual fall off in oil prices as the world sees reduced political tensions in the Mideas

slightly lower demand for oil due economic slowdown in Europe and elsewhere. Ponderosa Advisors production econom

models suggest that as long as prices remain above individual producers break-even rates, which can range from less than $4

$90/barrel (depending on the specific producers positions in specific areas), exploration for oil will continue without a dram

decline As a result, producers will continue to drill for oil and produce natural gas.

In conclusion, expect the natural gas market to be relatively stable until late in the decade. Natural gas exploration is now dri

by oil prices, and oil price fundamentals look reasonably strong (again, barring a deep global recession) and stable for the nex

few years. For significant volatility to return to the natural gas market, supply and demand must tighten. Demand must grow

meaningfully and within a reasonable timeframe because as long as oil prices remain strong, exploration and the resulting ass

ated gas production will continue to edge slowly upward. Until demand picks up significantly, dont expect gas prices to trav

up or down very far.

Comments: Ponderosas view that we are in a range-bound market suggests swing trading is the flavor of the month...hit a

run trading versus our preference for trends...
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13/25


11. Last issue we talked tongue in cheek about the coming boom in chicken wings due to McDonalds involvement...one of

readers took this one step further and graciously sent in ad-

ditional info regarding the boom in chicken (thx A.B.)...

CityWireIn the five years through 2013, revenue for Chi-nas poultry farming industry has grown at an average annu-alized rate of 7.7% to $75.3 billion and two U.S. meat giantsare in the thick of it. Tyson Foods and Cargill each want theirshare of this burgeoning market expected to produce 20 mil-lion tons of chicken this year with revenue growth of nearly10%, according to IBIS World.The research firm anticipates over the next five years this in-dustry transitioning to vertical integration will mature withrevenue of $105.8 billion as Chinas 1.3 billion consumers eatmore chicken. In vertical integration the poultry companycontrols the chicken from the egg though processing and con-

tracts with growers who house the birds during their matura-tion phase which is typically 47 to 50 days.

Springdale-based Tyson Foods has worked toward complete vertical integration of its China operations for more than a year. a move the company said will improve food safety standards in China while also helping grow topline sales.In China, Tyson processes chicken sold wholesale into food service for clients such as Yum Brands! and McDonalds as wellfresh chicken sold in retail groceries like Wal-Mart and Sams, extending those longtime U.S. relationships abroad.

Comments: Chicken consumption is boom-

ing (see green line on above chart) due to

China and the emergence of a middle class

and meat based diet...no futures market but

several chicken plays are out there (see Ty-son chart right)...we seem to be uncharacter-

istically late to this party, but does this trend

still have wings??

On a similar note, China was recently awarded permission to start importing processed chicken into the US.given how w

they did with milk, etc etc this development has us a bit concerned...WNDChinese-processed chicken will soon become a reality in America, courtesy of the U.S. Department of Agriculture, un

less the American people are willing to make a move right now to stop it!

The USDA has given permission to four chicken processing plants in China to import U.S. chicken, process it, and then expor

back to America to your favorite grocery store.

And no country-of-origin labels will be required, so American consumers will have no idea if the chicken theyre buying was

sent to China and back first or safely stayed only in America.

And since absolutely no on-site monitoring is mandated in China, Americans will have no way of knowing for sure if China i

sneaking in shipments of their own homegrown chicken destined for our sovereign shores.

Cont.

0

10

20

30

40

50

60

70

80

90

100

1965

1969

1973

1977

1981

1985

1989

1993

1997

2001

2005

2009

2013

PORK

TOTAL CHICKEN

TURKEY

COMMERCIAL F

AND SHELLFISH

BEEF
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14/25


12. Not to worry though, capitalists look to exploit consumer demand wherever possible...our future menu will be serving yourchoice of tainted Chinese processed chicken or meat-less plant-based chicken substitute ...

FORTUNE-- Most people consume protein in what vegetarians call "the secondhand form," that is, after it has been digested and co

verted into meat by chickens, cows, and pigs. This is inefficient, as Winston Churchill noted In "Fifty Years Hence," an essay pub-lished in 1931. Churchill wrote: "We shall escape the absurdity of growing a whole chicken in order to eat the breast or wing, by gring these parts separately under a suitable medium. Synthetic food will ... from the outset be practically indistinguishable from natuproducts, and any changes will be so gradual as to escape observation."Then again, predictions are hard -- especially about the future. Food scientists and entrepreneurs have tried to reinvent meat for decades, with little to show for it. Last summer, Dr. Mark Post, a Dutch scientist and medical doctor, unveiled a five-ounce hamburger was grown in a laboratory from cow muscle, at a cost of $325,000. (Google (GOOG) founder Sergey Brin picked up the tab.) Closehome, mock meats from companies like Kellogg (K) and Kraft (KRFT) can be found in supermarket freezers, branded as "Chik'n Ngets," an "All-American Flame Grilled Meatless Burger," and "Classic Meatless Meatballs." Soy-based, mushy, and more expensivthan the real thing, they remain niche products.

And yet, the need for alternatives to meat has never been greater. Global demand for meat has tripled in the last 40 years, den by population growth and a doubling of per-capita meat consumption, according to the Worldwatch Insitute. That has intensified

pressures on land, water, feed, fertilizer, and fuel. Meat is a climate change problem, too: Animal agriculture is said to be responsibfor about 14.5% of human-induced greenhouse gas emissions, more than the transportation sector.

This presents a big opportunity for someone who can devise a tasty and affordable plant-based substitute for meat. Tis exactly what Ethan Brown, the founder and chief executive of a California-based startup called Beyond Meat, aims to do, and he persuaded some smart people to put their money behind him. Beyond Meat makes vegan "chicken-free" strips that it says are better people's health (low-fat, no cholesterol), better for the environment (requiring less land and water), and better for animals (obviouslthan real chicken; most important, if all goes according to plan, they will cost less to produce than chicken.Fortune has learned thatBill Gates is an investor; he sampled the product and said he couldn't tell the difference between Beyond Meat and real chicken. "Thmeat market is ripe for invention," Gates wrote in a blog post about the future of food. Kleiner Perkins, the Silicon Valley venture ctal firm, made Beyond Meat its first investment in a food startup. "KP is looking for big ideas, and this qualifies as a big idea," saysAmol Deshpande, a former Cargill executive and a partner at the venture firm. "The single biggest inefficiency in agriculture is howget our protein." Other investors include Evan Williams and Biz Stone, the founders of Twitter; Morgan Creek Capital Managemen

and the Humane Society of the United States, an animal-

welfare group.

Comments: All kidding aside, meat substitutes are growing into big business and a trend worth watching...big money, i.e. Gates,Morgan Creek, et al. are all circling...no play here but an area we will keep a close eye on.

And while on the topic of meat, well keep an eye on S. Dakota as weather has obliterated their cattle herd...cattle and red meat hbeen in a massive trend for decades as more people enter middle class and put upward pressure on meat and ags, and supply constraints such as these only worsen the situation...

GlobalGazetteA record-breaking storm that dumped 4 feet of snow in parts of western South Dakota left ranchers dealing withheavy losses, in some cases perhaps up to half their herds, as they assess how many of their cattle died during the unseasonably earlblizzard.

Gary Cammack, who ranches on the prairie near Union Center about 40 miles northeast of the Black Hills, said he lost abou

70 cows and some calves, about 15 percent of his herd. A calf would normally sell for$1,000 while a mature cow would bring $1,500 or more, he said."It's bad. It's really bad. I'm the eternal optimist and this is really bad," Cammacksaid. "The livestock loss is just catastrophic. ... It's pretty unbelievable.""It's the worst early season snowstorm I've seen in my lifetime," said Cammack, 60.Early estimates suggest western South Dakota lost at least 5 percent of its cattle, saidSilvia Christen, executive director of the South Dakota Stockgrowers Association.Some individual ranchers reported losses of 20 percent to 50 percent of their live-stock, Christen said.

"This is, from an economic standpoint, something we're going to feel for acouple of years," Christen said.
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15/25


13. Over the past year we have touched on the problems mounting in the system for disability payments...LBK follows up w

their current views...

LibertyBlitzKrieg Meet the Disability-Industrial-Complex: Up to 45% on Disability Insurance are Frauds

If the American public knew what was going on in our system, half would be outraged and theother half would apply for benefits.

-Marilyn Zahm, one of the 1,500 disability judges operating in the U.S.

Ive known about the disability scam for many years now, but I had never read a report that details the racket until I checkeout the following from CBS 60 Minutes. As usual, the real money being made in the whole scheme is not centered around thepeople collecting the checks, but rather attorneys, doctors and even judges who grease the wheels of the $135 billion disabiliindustrial-complex.For example, in the economically depressed border area of Kentucky and West Virginia we find 10%-15% of the population odisability, or three times the national average. The regional disability racket is essentially run by attorneyEric Conn, whos clents for disability enjoy a 100% success rate thanks to Mr. Conns relationship with doctors and a local judge namedDavidDaugherty.

Senator Tom Coburn explains to CBS 60 Minutes that:Coburn says the report to be released tomorrow will show that Conn collected more than $13 million in legal fees from

federal government over the past six years and that he paid five doctors roughly $2 million to regularly sign off on bogus medcal forms that had been manufactured and filled out ahead of time by Conns staff.Just another scam from a scam economy. More from 60 minutes:The hearing involves the Federal Disability Insurance Program, which could become the first government benefits program trun out of money. When it began back in the 1950s it was envisioned as a small program to assist people who were unable towork because of illness or injury.Today, it serves nearly 12 million people up 20 percent in the last six years and has a budget of $135 billion. Thats mor

than the government spent last year on the Department of Homeland Security, the Justice Department, and the Labor Depart-ment combined. Its been called a secret welfare system with its own disability industrial complex, a system ravaged bywaste and fraud. A lot of people want to know whats going on. Especially Sen. Tom Coburn of Oklahoma.

Tom Coburn: Go read the statute. If theres any job in the economy you can perform, you are not eligible for disability. Thatpretty clear. So, whered all those disabled people come from?The Social Security Administration, which runs the disability program says the explosive surge is due to aging baby boomers the lingering effects of a bad economy. But Sen. Tom Coburn of Oklahoma,the ranking Republican on the Senate Subcommittee for Investigations

whos also a physician says its more complicated than that. Last year,his staff randomly selected hundreds of disability files and found that 25 per-

cent of them should never have been approved another 20 percent, hesaid, were highly questionable.Sen. Coburn says disability payments are now propping up the economy in

some of the poorest regions in the country. Which is why he sent his investi-gators to the border area of Kentucky and West Virginia.

More than a quarter of a million people in this area are on disability 10to 15 percent of the population about three times the national average.

Jennifer Griffith and Sarah Carver processed disability claims at the SocialSecurity regional office in Huntington, West Virginia.

Comments: Fraud or not, I like Eric Conns marketing plan (see picture)...
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14. We have touched on sugar countless times in the past 3 months and have subsequently been rewarded with a 2 month

20% rally since our call...given our attention to sugar, a reader sent in this slew of info on the boom of land for sugar fa

ing and its effectssugar=the new gold...

SucDen Considerable expansion took place until 1980, when world sugar consumption reached nearly 90 million tonnes, ian annual growth rate of 3.1%.After going through a sluggish growth in the 1990s, which hardly exceeded 2,2% per annum, sugar consumption has grown athealthy rate since the early 2000s, notably in Asia (+4,9% p.a.), the Middle-East (+4,6% p.a.) and Africa (+4,1% p.a.).Today, a world population of 7 billion people, of which 4,0 billion are concentrated in Asia, consumes roughly 165 milliontonnes of sugar, that is 23 kg per capita on average, with the lowest level seen in Bangladesh (8 kg) and the highest in Israel, w66 kg. The 10 largest sugar consuming nations represent roughly two-thirds of total world consumption.

QuartzBy 2020, the world will consume 25% more sugar than it doesnow. Where will it come from? At the moment, the biggest exporters of sug-ar are Brazil, Thailand, Australia and Guatemala. But thats changing. Sugarcane uses more land than almost any other major agricultural commodity,

which is fueling demand for more land. Of the 31 million hectaresaboutthe size of Italycurrently used to produce sugar,around 15%(pdf, p.4)involves land purchased in 100 major deals inked since 2000, says Oxfam, anon-governmental organization. Often, these land sales are to foreign inves-tors...With land growing scarcer in big sugar-producing countries, agriculturalcompanies are increasingly looking to poor countries with a lot of land andflimsy property laws, notes Oxfams Chris Jochnick.As pressure on the land is growing, inevitably youre going to have mocompetition for the land and more land grabs, he says, referring to large-scale land sales that ignore the claims of its residentand take place without their consultation, violate human rights, or occur without assessment of their environmental impact.

ToTheTick At one time it was the Gold Rush that obsessed everyone as there were screams and shouts to be heard of ther

gold in them there hills. Now, its sugar that is creating the buzz in the investment world. Sugar is the new gold and gold isyesterday anyhow. Its the acquisition of sugar that are fuelling todays rush for land acquisition in the world. While there arcompanies that are lining their pockets to make a few more bucks for the shareholders, its the families and the small-scale locproducers that are being left with the after-effects of a high-sugar-content rush on their lands. The Sugar Rush is on!According to information published that contains the largest database of land deals struck in the world since 2000, approxima5% of land in Africa has been bought up since that date. Not only have countries in the West exploited African countries for dades, but now they are buying the country up in lucrative deals to exploit the fertile land. The only saving grace is that it is maginally better than colonialist times of possession grabbing of whatever was wanted there. They are paying for it now, but haranything worth talking about. The lands are being snapped up at ridiculous prices in a speculative ideal of making even moremoney for the shareholders of companies around the world.Up until the Land Matrix report was published, there was little information about who was buying up the land and it was considered to be a closed culture. Nobody wanted to admit that they were actually exploiting African countries yet further in this

way. Very few would actually care that the landis being exploited just as long as the money getsinto the Wests banks. But, the increase in con-sumption of sugar is down to the food manufac-turers that are ladling it into the food that peopleare eating as if it were going out of fashion. Thatin itself should be enough to condemn the manu-facturers that are buying up the land since itmeans that we are being affected health-wisewhile they are raking it in.
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15. In June we noted an entry into Spanish equities and thought they were bottoming...since then we have caught a significant 20% rally in the index (see chart right)...Asias richest billionaire must be reading LAL as he is finally following our vice

QuartzLi Ka-Shing, the octogenarian billionaire known asSuperman for his business savvy, is offloading assets in China to buymore in Europe in a characteristically super-sized fashion.Hes plan-ning to sell or take public various companies and investments in HongKong and mainland China that could raise about $20 billion, giving himthe financial firepower to buy telecommunications and real estate assetsin Europe.These include taking Hong Kong-based drug and beauty products con-glomerateA.S. Watsons Grouppublic to raise about $10 billion, the South China Morning Post reported today. Li is also planning to list up to 70% of Hong Kong Electric, part of Power Assets Group, which could raise as much as $5 billion, Bloomberreported last week.

Li, the 8th richest man in the world according to Forbes, put Hong Kong supermarket ParknShopup for sale this summer in a

deal expected to

fetch up to $4 billion. In September, two of Lis biggest companies, Hutchison Whampoa and Cheung KongHoldings,sold their stakes in a large shopping mall in Guangzhou for $390 million. Other commercial buildings in Shanghai aShenzen worth more than $1 billion are also for sale, according to reports in mainland Chinese press.

Li has decided to make a slew of asset disposals in Hong Kong and on the mainland, to give him the financial ammunition tdo deals in Europe, according to the South China Morning Post. Analysts say that he is transferring funds out of maturing busnesses in China, where economic growth is slowing and the Hong Kong real estate business is under pressure, in order to scooup undervalued European assets.

Comments: While we have been long China for a couple months (see chart lower right), when the smart money starts bailing, our ears perk up...

Speaking of pressure in the Chinese real estate market...China is forcing its economy to transition into a consumer based

economy but how many malls do they really need???

SCMPHow many shopping malls does China need? If someone has come up with a sound answer for the retail needs of theworld's most populous nation it may well have been drowned out by the construction noise from projects sweeping the mainla

Property experts point to market saturation in some cities, but some mall operators justify their expansion plans by touing marketing strategies built on initiatives such as a better mix of tenants under their roofs."Apparently, shopping mall bubbles have emerged in some mainland cities, although some other places still have space for nemalls," said Chu Hsiang-yun, senior director of national retail services at global property consulting firm CBRE.

More than half the malls to emerge from the 82 million square metres of projects under construction globally are in Cna. Of these, eight of the 10 biggest malls are also on the mainland, a CBRE report shows.Separate research by global real estate services firm Jones Lang LaSalle shows that 150 malls will open in 20 major mainland

cities this year, each with an average gross floor area of 80,000 square metres. That compares with 80 new malls opened lastyear. The area devoted to malls in Beijing, Shanghai, Guangzhou and Shenzhen will rise by 40 per cent by 2015, while space 16 smaller cities may even double by then, it said.

"Every property developer wants to have access to the domes-tic market's rising middle class by getting into the retail business. Lo-cal governments are also encouraging mall construction as they wantto increase tax revenue," said Steven McCord, associate research di-rector at Jones Lang LaSalle, citing the factors behind the construc-tion surge. The central government's measures to curb the residentialproperty market since 2010 have served to strengthen this trend,boosting the appeal of retail and office markets to developers, he said.
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16. One of our skills at LAL is finding thematic trends to play for the long-term...always trade with the wind at your

back...that being said AsiaConfidential penned an interesting piece with their views of the thematic trends of the futurea

interesting piece that we find hard to poke holes through...

AsiaConfidential Thematic investing, or investing based on emerging themes, is fraught with some danger. Many people invest in the latest hot theme andget burned soon enough. Others mindlessly put their money into a company based on a themewithout regard to valuation or quality of management another sure-fire way to end up in the red.And lets face it: the future is inherently uncertain. If picking futureinvestment themes was easy, everyone would be sipping pna coladas in Bora Bora. The best investors know this andplace theirbets according to probabilities. That is, they invest whenthe odds are in their favour and invest large amounts when those odds offer significant upside with minimal risk.The question then becomesthis:which investment themesmight give you the best odds of success over the next decade? Its tough question. If theres one thing for which I have a high degree of conviction, its that the world is currently drowning in dand that debt will need to be cut, one way or another. If thats right, youll want to avoid sectors which have benefited mostfromthe three decade long expansion in credit. The finance sector is an obvious one and the bear market here is likely to lastdecades. The tech sector is another think of all the tech start-ups and others which will evaporate when the silly venture cap

ists funding them dont have access to cheap and abundant money. There are many other sectors which will suffer too.In other words, youll probably want investment exposure to themes which may still thrive in a world of shrinking credit. The

wont be many of them butAsia Confidentialhas a few ideas.

Asia outbound tourismThe trend of increasing Chinese outbound tourism looks setto continue. In 2012, the Chinese outbound tourism marketbecame the worlds largest, moving ahead of the U.S. andGermany. The number of annual Chinese outbound touristsnow totals 83 million, upalmost 8x since 2000.

The great thing about this trend is that itappears to be in its

infancy. Think about howthe Japanese,

having

fully recov-

ered fromthe ravages of World War Two, took to the skiesfromthe 1970sand transformed tourism destinations suchasHawaii and AustraliasGold Coast.They al-sotransformedthe airlines, hotels, amusementparks, travelagents, restaurant chains, spa and beach resorts as well asduty free stores whichcatered to them.The same thing is likely to happen as China and other Asian countries catch the travelbug. The companies which bestfulfilltheir needs will bebig winners.

Privatisation of state-owned assetsEuropes problems havent goneaway. And the problems arent limited to Europe, as governments in the U.S., U.K, Japan an

China have similar issues.

Put simply, all of them have too much government debt. And one way or another,

that debt will neeto be cut back. Whether throughwrite-downs, austerity, inflation or a combination of all of them, the debt will be reduced.One way to cut debt is through theprivatisation of state-owned assets. I think that this will be one of the enduringinvestmentthemes of the next decade. Ironically, it seems probable that the paragon of communism, China, willbe thefirst to accelerate sale of government-owned assets inaneffort to reduce the influence of state-owned enterprises (SOEs) and encourage competion.
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Low to mid-end consumptionIn the West, excess debt and declining real wages have resulted in consumers cutting back on spending since 2008. Thats beebad for high-end retailers but good forbusinesses such as dollar stores.Its atrend which is likely to continue for many years come.

In Asia, the situation is very different. Consumer balance sheets are in great shape, barring South Korea. Savings are abundanwhile debt is minimal. Better yet, wages are growing rapidly, even in slowing economies such as China, India and Indonesia.Excess savings and rising wages augur well for future spending.Moreover, you have countries such as China which are encouraging people to spendmore.Its part of Chinas strategy to re-balanceits economy away from being over-reliant on investment for economic growth.As a consequence, low to mid-end consumer companies across the globe are likelyto do well going forward. In the devel-opedworld, consumers will continue to trade down. In thedeveloping world, you should have people spending more, albeitstillat the lowerendgiven most of the region, including China and India, remains poor.

GoldLong-time readers will know my preference for having gold in an investment portfolio. Gold has two things going for it. Firstyou think that debt contraction is probable in future as I do, that brings risks to the worlds financial system. After all, the stillthinly-capitalized banks own much of the debt which will need to be restructured/written down. Therefore, its be wise to own

assets which sit outside the financial system. Thats where gold comes into play.

Secondly, the current policies of the worlds central banks may be preventing the contraction in debt which needs to occur tocleanse the financial system. In my view, central bank moves to reflate the credit bubble are likely to lead to a larger credit budown the track. In many ways, gold is the anti-central bank. The less faith that you have in central banks, the more gold that yshould own.

AgricultureIf a prudent investment strategy involves holdingphysical assets outside of the financial system, then agriculture should also bconsidered. Unlikemany of thehard commodities, agriculture has a serious supply-demand imbalance which should result inprices remaining elevated for years to come.Agriculture inventories are at multi-decade lows. That means inventories are being drawn down as consumption exceeds prodtion. Global agricultural production has only increased by 2.1% per annum over the past decade and the OECD forecasts thatgrowth rate will decline to 1.5% over the next ten years.The principle reasons behind the lack of supply

are limited expansion of agricultural land, increasing environmental pressures

rising production costs and growing resource constraints.Meanwhile, demand continues to grow solidly primarily due to growing populations, higher incomes and changing diets (highcalorific intakes)in developing markets. On the latter, for example, its well known that meat consumption increases as a counbecomes wealthier. The OECD predicts that the developing world will account for 80% of the growth in meat consumption ovthe next decade.

InfrastructureIn the U.S., good argumentshave been made for an urgent upgrade of creaking in-frastructure. Increased spend on infrastructure could create jobs, improve securityat ports and electricity grids as well askeep the U.S. competitive with China - all ofwhich could befinancedat exceedingly low interest rates thanks to Mr Bernankes

quackery. But political gridlock means it probably wont happen.In the developingworld, the problem is not of repairing infrastructure, but building

it. Some countries such as Singapore and China are host to some of the worldsbest highways, airports and ports. Others such as India and Indonesia remain in thedark ages.For instance, Indonesia spends just 1.7% of GDP on infrastructure, comparedtoChinas 8%. More than 40% of Indonesias roads remain unpaved.The countryhasonly 11 miles of railway line per person, less than half that of Thailand, India orChina.Anyone whos been in a traffic jam in Jakarta can attest to the underspend. Aretraffic jams in Jakarta the worst of any capital city in the world, I wonder?
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17. Since we mentioned gold in our thematic trades, lets check in on the mining sector...

Mining It may be too early for private equity players to gobble up juniors or put together mega-deals, but mid

tier miners may have new investors knocking on their doors.

The $1 billion injection for former Xstrata chief executive Mick Davis' new venture X2 Resources may be jthe start of wave of new private equity investments in the mining industry.According to one estimate cash raised for investment funds dedicated to mining and oil has reached a decade high o$24 billion this year.

The 2013 year to date record haul brings the total close to $100 billion accumulated for resource investmentover the past six years.

Philip Heywood, director for transaction services at consultants PwC in Vancouver, says although there hasbeen that many big deals announced, interest in mining from private equity players is strong and picking up.

"There has always been a niche interest from private equity in mining, but now larger players are entering thmarket," says Heywood, adding that private equity players are seeing opportunity in the sector now that valuationshave come down, sellers expectations are diminished and competition for good assets are much less.

However, private equity firms like Apollo Global Management which has raised $1.3 billion for resource-

focused investment, TPG Capital which put up half of X2's funding and the large funds that are looking at deals sucas KKR and Blackstone all want the same thing: Companies that are late stage, low cost, low risk, producing or cloto production and with all permitting in place.

"There aren't too many of these around and everyone wants to do their first deal right and be highly regardedfor it. Down the line, once good quality, stable cash producing assets are acquired, private equity investors may looat higher growth, earlier stage companies to diversify their portfolios."

Heywood says he does not expect any blockbuster mining deals from private equity investors in the short tealthough it's not impossible for opportunistic mega-deals to emerge.Apollo's head of mining and metals recently told PwC that the sweet spot for deals are in the $150 million to $500million range.

Comments: When the vultures start circling, our ears perk up...although the gold downdraft may still be underway, we hav

some firepower behind this...

HUI15 yr weekly
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The Leather Apron Letter 10-11-2013

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