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*** Don Coxe Conference call (6-03-05) ***

With many thanks to TheSlowLane from SI's "The Woodshed" board for the transcript. (Link below)

(Link to audio version of CC located below text)


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Nesbitt Burns Institutional Client Conference Call for June 3, 2005

Don Coxe
Chicago, IL


http://stockcharts.com/def/servlet/SC.web?c=$usd,uu[w,a]daclyyay[pc100!c200][vc60][iUb14!La12,26,9]&....
Chart: US Dollar Index

Comment: “How far will this intermediate term rally in the Dollar go?”

Thank you for all tuning in to the call, which comes to you from Chicago. The chart we faxed out was the US Dollar index and the comment was “How far will this intermediate term rally in the Dollar go?”

I’d like to get to that, we’ve obviously had a big news item this morning with the employment report coming in a full 100,000 under estimates and that’s created problems for the stock market, but it’s given new strength to the resurgent bond market and I’ll deal with that a little later. But it also is all part of the story on the Dollar.

I think that we’ve had so much news on the Dollar that this still has to be the top story of the week. The combination of the negative vote in France and then the powerfully negative vote in Holland is an indication that the Euro-elites have really lost control of the agenda over there. That’s a good news/bad news story.

It’s good news for the Dollar of course, because in terms of the Forex trading, the Euro and the Yen are the only two free market heavyweight currencies and the Yen is a dubious free market currency because of the manipulation of the government for the support of Treasuries. So, take the Euro as a pure play against the Dollar and what’s happened here is that we’ve had this significant sell-off this year in the Euro and this of course has accelerated in light of the developments last week.

So, if you take a look at the Euro on a year-to-date basis, where we’re at now, which is I think the best way to look at this because it takes in all the news. The Euro is down 9.55% and that’s a huge boost to the Dollar.

This is in the face of just unremitting bad news from Europe and generally good news in the US because, despite that terrible unemployment number today, the Euro has failed to rally. It rallied briefly but it’s given up those gains.

Whereas the Dollar’s move for the last nine years has been primarily the story of the Dollar itself as opposed to the situation of competitor currencies, what’s happened here has been that these are such dramatic developments in the Eurozone, with even talk from central bank officials over there that the Euro itself may fall apart – which I don’t see as a possibility, or at least such a remote possibility that I wouldn’t factor it in – this is a situation where it’s a torrent of bad news for the Euro and this comes at a time of extremely bad news for key Eurozone economies.

Well, this is a good news/bad news story because the help it’s giving the Dollar is just on the basis that somebody else is looking sicker. On the basis of the outlook on the global economy it is not good news that the Eurozone, that has been struggling anyway, is going to have further problems. Euroangst is back big time. And that’s only good news on a Schadenfreude basis. Saying “Well, take that Chirac” and “Take that, Schroeder”, but that’s an immature response.

What the financial markets want and what the global economy wants is vibrancy in the Eurozone and so the only good news out of this would be if maybe there’s some shock therapy here, which would help the people who want to “liberalize” the European economy like Commission leader Barrosso, Tony Blair, and then the new members of the Eurozone and of course they’ve been contemptuously dismissed by Chirac.

But the good news in that sense is that the French/German partnership, which was the engine for Europe has now become, as a Finnish official said, as a brake. Because look what they’ve done. They were key authors of the growth stability pact at Maastricht, which was to control deficits, and they’ve both contemptuously dismissed any effect of the growth stability pact and Chirac this week has announced that they’re planning to increase social spending without any regard to the growth stability pact.

What we’re seeing is now, if anybody ever doubted it, the sheer arrogance of these leaders who are supposedly true Europeans, which is, anything they find inconvenient they will thrust aside but they expect the unimportant partners in the EU to go along with the rules that are laid out. Well that’s just not on offer. So therefore, we have a situation where it’s really doubtful that anybody can understand what the direction will be of policymaking within the Eurozone.

Tony Blair takes over as President this month and he’s got the wind at his back now. He’s been re-elected, yes, he took a bit of a sell-off, as it were, related to Iraq. But his prime enemy, Chirac, has taken such a humiliating beating. And Schroeder also, in North Rhein Westphalia took such a terrible beating that’s he’s hurrying up the election for the Reichstag to the fall, to try to get this out of the way. So that has to be good for Tony Blair’s prestige and he’s got lots of allies across the Eurozone – the so-called Atlanticists, the ones who do not wake up each morning with a sneer on their face for the USA and for Anglo-Saxon economies.

So, in that sense, maybe we’re going to get some progress out of that zone. But it’s hard to see, given how decision-making works. France and Germany may not be able to provide positive leadership anymore but they can certainly prevent anything constructive from being done. And that seems to be what they’re all about here.

Well, if it’s that bad, then why isn’t the US Dollar even stronger, if its main rival in the OECD economy is struggling. Well it’s not just the unemployment number.

What we’ve got is a situation where the only truly vibrant sector of the US economy, apart from state and local governments and healthcare is the homebuilding industry. And of course this is getting additional help now as a result of this powerful rally in the 10-year note.

At 3.90 yield for the 10-year note, we’re close to the level at which massive re-financing can be done. That means that those people who are buying second, third, fourth and fifth homes as investments will be able to continue to lay on interest-only loans and lever up. And if you lever up with house prices rising at something like 12 ½% or some kind of statistic and of course those statistics are always dubious because you’re putting together the areas of maximum bubbling effects, which is in the coastal regions with more moderate increases such as we’re experiencing here in the Midwest.

But, even the way you balance these things out, there’s no question that any doubts we had about a housing bubble have been resolved. And so therefore, from Greenspan’s situation, it’s really a bad, bad situation. He has faced the fact that he’s due to retire and he cannot help but remember that he came into the job and raised rates to defend the Dollar and the crash followed immediately and he doesn’t want to exit with a housing crash. Because the last time we had a housing crash it took years of Fed stimulus with a steep yield curve to restore health to the financial system from all the real estate losses they had on mortgages back then.

So this is a situation where the area of strongest domestic growth is also the area of greatest potential weakness with any time horizon longer than a few months. And of course some of these house flippers would regard a few months even as a long-term time horizon.

Well, that’s the bad news. The good news is that we’ve got a tremendous restoration of liquidity in the US, which means that the problems we were experiencing in our financial market here, which were starting to become acute in March, which is when I lowered my equity exposure to a near minimum level and we had lots of signals coming. We had an occasional spikes in the TED spread, jumps in the VIX…these kinds of things.

Then we had the highly publicized problems with some of the hedge funds. We had the General Motors and Ford flaps. And yet now, if you look at the technicals, the TED and the VIX, we’re back down to levels indicating that the financial system is strong.

So, as one who was giving you alerts and warnings and concerns on these calls, that maybe we were going to pay the price of these financial excesses here, that’s been pushed off and in a funny kind of way we can think Chirac for that. It’s perhaps not too big an exaggeration to say that Chirac and his friends have given the US the biggest gift since the days of Lafayette.

But it’s a gift that’s designed to stimulate the area of the US economy that doesn’t need stimulation, while doing nothing for the sub-sectors of the economy that do need stimulation as shown in the job report. More losses of manufacturing jobs and a situation where we’re just not creating the kind of jobs that are needed to provide overall fiscal solvency for the United States. Which is, high-end, blue collar jobs and medium white collar jobs. The kind of people that do contribute fully into Social Security, into Medicare and who have health insurance. So, the chance of remedying that by getting the Dollar down has been pushed off.

Now if we go back to what happened after the crash in 87, and look at how the Dollar plummeted after that, I mean the Dollar back then, fell by nearly a third before it bottomed out and that was the basis of the fabulous performance of the US economy in the 90s; that plus the appearance on the scene of the miracle new industries. But even they wouldn’t have been able to show that kind of performance had it not been for the Dollar falling to such low levels.

Now, with the Dollar at these levels, if there is a big revival coming in tech stocks, tech companies, it’s not going to create huge employment within the US. It’s going to create employment elsewhere in the world. And that has also, as a result of the overvaluation that has occurred has also stimulated growth in competition that didn’t exist back then.

I invite you to read Tom Friedman’s column in today’s New York Times, very powerful piece of work, written from India, about the absurdity of the Eurozone economy, which is insisting on thirty-five hour weeks as he puts it. Whereas in India they’re trying to see how their people can work thirty-five hour days.

That competition has now reached a critical mass of self-sustained growth. So, therefore, the Dollar falling this time is going to have to fall a very, very long way before we’re going to have the growth of the good kind of domestic jobs.

So, for those people who are saying, “Well, the Dollar has fallen so far so therefore it’s entitled to rally”, yes, it’s having a rally. But this is a rally within a major long-term bear market and the longer we put off the adjustment to what the real trade value of the Dollar is, then the worse the adjustment will be, when it comes. And from the financial markets concern, the worse it can be in terms of creating some kind of crisis within the Eurodollar market.

Now what happened with those votes in Europe was a flood of money into Eurodollars, which produced a narrowing of the spread and tremendous performance by Eurodollar futures. So, that’s a liquidity measure that doesn’t get shown up in any of the monetary aggregates and I can’t demonstrate it to you with absolute charts and proof because nobody knows how many Eurodollars there are. All I can do is look at the performance of Eurodollar futures themselves. And they’re on a roll.

Therefore we have better liquidity, and of course hedge funds use Eurodollars as their source of funding because they’re based in the Caribbean. So we’ve got a re-liquification of those parts of our American financial system which are under stress in March, April and early May. Though there will not be, based on the indicators we have now, any major near-term risks to the market, notwithstanding the excesses that are somewhere out there in the system, as discussed in the current issue of Basic Points which I hope most of you had a chance to read.

The good news from the standpoint of a lot of you faithful listeners out here, is that we’ve had a tremendous rally in the mining stocks. Top performing group in the week ended Thursday, according to Steve Leuthold’s work on this. And we’ve had a huge move in copper. So the position that we were taking in Basic Points was that these stocks were dramatically underperforming the metal prices themselves, which meant that this was an emotional sell-off by those who didn’t know what they owned.

At least in the near-term, that call has been vindicated by the sustained move in copper – which is the king of the base metals – and now following through to the stocks. We’ve got Phelps Dodge today up 2.80 and this has been happening day after day as these stocks come back. Because so many of them were being used in the various strategies of the hedge funds where they were taking a bet against the US economy or taking a bet for the US economy.

In other words, they played around with these as against the 10-year note. And that was not a bad strategy because of this false belief that copper and the metals were indexed to the US economy.

So here today what we have is a breakout to an amazing high, this is back to the highest price copper has seen in 20 years. And this occurs at a time when we’ve had a bad US economic number. So, this is a pure Asia play. Undoubtedly there’s been some kind of short squeeze here. A four-cent move in one day in copper is a monster move, but it backs up our argument that there is no real correlation between the prices of the metals themselves and the performance of the US economy. It’s at the margins, driven by growth out of Asia, lead by China.

So, a sigh of relief for those who were wondering how long it was going to take to happen because of course last year was the big sell-off in these stocks. But at that time we were having somewhat weakening prices in the metals because of the extremely slow growth of China in the first quarter, which was achieved by ham-fisted methods which swiftly got reversed.

But a buck fifty-five copper is an absolute godsend for these companies and it means that the earnings forecasts are going to have to be revised upwards and the stocks are still sharply underperforming the metals themselves. In other words, they are getting more valuable in a real sense by the day.

On from there to the big commodity which is, of course, oil. What we’ve written about is this question about how you play these stocks. And we’ve drawn the distinction between the foxes and the hedgehogs. And the position that we’ve taken is that those of you who are believers in a good, long-term future for oil and natural gas should be investing on the basis of secure reserves in the ground.

Now for a couple of years all we did was talk of tbat on the calls on the basis of insecure reserves in places like Russia, Nigeria and Venezuela. But now we’ve got to take another component, which is, reserves that haven’t been sold forward at very low prices. For example, if you could go forward on the curve for crude oil, you’ll see that the December 09 crude is fifty-two bucks a barrel.

And as we’ve pointed out to indicate that the industry still doesn’t believe anything like Hubbard’s Peak and some elements of the industry still seem to be afflicted by Wall Street-itis, that this is driven by a near-term speculation about to collapse, we cited the surprise we had that PetroCanada – and they’re only just one of many – had sold forward half of its production out of the Buzzard Field in the North Sea, at twenty-six bucks a barrel for the late years of this decade. So they’ve sold that forward at half the price that the futures market is now showing for that period of time.

I don’t want to pick on them, they’re a wonderful company but it does indicate the problem that you have as investors in buying companies that share your viewpoint. So, you can’t put together a portfolio of oil and gas stocks purely on the foxes, the ones who are prepared to assume the risks and who have just moderate hedging designed to smooth their results. You’ve got to mix in some of those, but I really believe that you’ve got to emphasize those that have long-term reserves that are largely unhedged.

So that if our collective call – I’ll put it that way – that oil prices are going to stay strong for most of the time for years to come, primarily because of Hubbard’s Peak and because the kinds of reserves that can be brought on are within the OPEC region or Russia and that for a variety of reasons you shouldn’t count on those as being inevitable increases in production, then you want to have companies that can share in that price strength. And these stocks are not discounting oil prices as shown on the futures curve.

That is, frankly, a fairly rare situation. Because historically one of the ways that people did look at them was to impute the value as shown in the curve for what you’d get in earnings. So Wall Street, which used the futures curve as a justification for its extremely bearish forecasts for oil and gas in the past, when they were in backwardation, now chooses to ignore what those prices are on the forward curve now that we’re in contango.

So the only thing that doesn’t change, apparently, is the cautious forecasts from the Street, which have such powerful influence on so many of the oil companies, because when they’re doing their financing for acquisitions, they’ve got to do deals for financing by people who have this out-of-date perspective on the outlook.

Now…they’ve got good company. When you’re talking about the leaders of the industry, they’re still publicly on record as predicting oil prices falling and that will happen at some point, when we have a recession. But it takes some kind of really bearish outlook for the global economy to assume that we’re going to have a recession which is going to last for years.

Maybe it will happen, but if it does, I suggest you’ve got probably more to lose from owning stocks generally then you have from owning commodity stocks. Because the price/earnings ratio for the S&P – if you take out the commodity group – is not anywhere close to discounting a sustained global recession lasting for years.

Now you may say “Well, with the 10-year note at 3.90, that’s predicting a recession”. But you’ve to realize that this is so much driven by this big move of liquidity into the Treasuries, driven by the problems of the Eurozone and also driven by the reduced risk profile that was taken by hedgies, in particular, where they moved out of things like emerging market bonds into the Treasuries. And that, at such time as confidence is restored, that maybe what we’re going to see is a narrowing of the spreads on the lower-quality bonds. I’m not talking about the General Motors who have specific economic problems or financial problems that can be closely analyzed.

Well what should you do in a case like this where what we’ve had is this huge move in the greenback, not driven by US developments so much as by bad news abroad? Well, I think the logical thing to assume is that the Eurozone is actually going to putter along at its own slow pace, even though the leaders are proclaiming that this is a crisis and a disaster and so forth, because their advice has been wrong for so long.

They grossly overestimated what could be achieved simply by creating a common currency and they rejected the Lisbon Agreement, which was to improve Eurozone productivity because that would have meant dealing with their vested interest groups.

But underlying all of this is something that they’re not talking about which I think is a big factor driving those votes. Which is, the problem of the demographic makeup of the Eurozone, which is sort of fifteen to twenty years behind Japan.

And if you take a look at what happened in Japan’s triple waterfall crash, that was lead not by the stock market – yes the Nikkei was 92 times earnings which was ridiculous – but it was driven by a real estate crash which disemboweled the banking system which was tied in to the absurd speculation, that famous stage where the Emperor’s Garden in Tokyo were worth more than California. And what really did achieve this – if that’s the mot juste – was the recognition that there was no generation to take over these properties because of the demographic collapse in Japan.

Europe headed off that kind of thing by the import of millions of Muslims. So that the fact that their population, their birthrate was falling, not quite to Japanese levels but in the case of Italy, almost there. And so this was shielded because of the huge amount of immigration they’ve had. And the Dutch vote, in it’s own way was a more serious vote to look at than the French vote. Because the French can from time to time can be just cussed at their leadership. And as far as rejecting a new constitution, they’ve had so many of them in France that their attitude is “Well, we got rid of this one we can get another one pretty soon.”

The Dutch vote was fascinating because these are true Europeans, they are believers in building a strong economy. They are the most tolerant nation in the Eurozone and I think that a big factor there was the shock that’s occurred in Holland as a result of the recognition of the huge number of radical Islamists that they’ve got within their own country with no way of controlling them. And the slaughter of Theo Van Gogh really brought this home to the Dutch, plus they’ve got several of their very prominent figures who have to have twenty four hour police guard because there are fatwas out on their lives from indigenous Islamists.

To the Dutch who always believed if you treat people fairly and openly and give them lots of individual liberty, that they’re going to buy into the views of your own culture, that has been eroded substantially. And although when you do pollsters on this, people are very leery about suggesting of anything that could smack of racism.

This is not a question of racism, this is a question saying we want residents of our countries to buy into our values. We don’t care about their skin color or their religious belief but they’ve got to accept our way of life and our view of tolerance. And this is now called into sharp relief and I think that you may say, “Well that didn’t show up in any of the pundits that we’ve been reading about”, but they focused on obvious things like the sheer scale of the constitution and some of its various provisions.

But whenever you get a situation where there’s such a gigantic divergence between the elites and the people who vote, then you’ve got to say that a lot of that is driven by visceral emotions. And the Eurozone is no longer able, because of its deteriorating demography, to generate the kind of public goods required to sustain the thirty-five hour week and retirement at fifty-five and to protect all these high-cost industries.

They were able to do that because of the enormous productivity of their good companies and the work ethic of Germans, that kind of thing. But now demography is in the way of that and this is something that is producing a new kind of Euroangst. So, as Canadians…Canadians are familiar with the concept of revenge de berseau(?), which was the Quebecers way in the 19th century of offsetting the fact that they were part of an Anglo culture by having a much higher birth rate and thereby maintaining their population ratio within confederation.

What we’ve got now is la revenge de berseau vide(?) which is the empty cradles of Europe and this has been going on now for some decades. And so the Europeans are faced with the fact that they cannot reproduce themselves and the formula of making up that by bringing in Muslims has risks that they hadn’t anticipated.

Maybe they’ll find a way out of this and we can only hope that they will because all truly liberal people want to see that people can be treated as individual human beings. But Radical Islam doesn’t accept that kind of approach. Radical Islamists are a tiny minority, but as we’ve seen a tiny minority can do a tremendous amount of damage.

All of this is something that is going to be a longer-term problem for the Eurozone and therefore in a funny kind of sense, maybe it will support the Dollar.

If I sound pessimistic on this, it’s because I think that although we’ve talked about demography – I say we as a financial community – for the last twenty years, it’s quite obvious that there’s never been a willingness in the United States even to face up to that as shown by the failure to reform Social Security. And the Eurozone, similarly, no willingness to face up to the demographic challenge of the collapsing birth rate and the extension of life as a result of breakthroughs in medical science and healthcare.

So I suspect that in the years ahead that demography is going to become a bigger and bigger part of all kind of analysis and if demography is essentially a question of duration and replacement, I’ll pull it right back into how it is you invest in the commodity stocks. Duration of reserves, ability to replace production. And they are clear cut positive cases, whereas what we’ve got in terms of the industrialized world is a case that can become increasingly negative in the years ahead.

That shows you where you should emphasize your investing.

That’s it, any questions?


[Several minutes of Q&A follow. Discussion included the notion that given recent developments, the US Dollar and therefore the housing market and US economy could remain stronger than has been previously anticipated.]

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To listen to the audio presentation of the above CC (incl. Q&A session):

http://www.bmoharrisprivatebanking.com/webcast.asp