Our view on global investment markets:

April 2013 Achtung Baby

Keith Dicker, CFA
Chief Investment Officer
keithdicker@IceCapAssetManagement.com
www.IceCapAssetManagement.com

April 2013

Achtung Baby

Its alright its alright its alright

Berlin (1990): Inspiration from the German reunification was not
inspiring. In fact nothing was going as planned. Ideas were not
flowing, lyrics were not working, and the music certainly wasnt
playing.
The days were so dire, that Bono pleaded that their music would
have to move people in mysterious ways, and be even better than the
real thing. Never to give up, the rock band dug themselves in and
declared they would keep trying to become one, until the end of the
world.
Berlin (2013): Inspiration from becoming the Worlds exporting
super power had long vanished. Throwing their hard earned money
at the Irish and Portuguese, staring down the Greeks while Athens
burned, and forcing the Italians, Spanish and Cypriots to accept their
way or the highway was reason for celebration. Everything was going
as planned - until now.
The September 22, 2013 German Federal Election is fast approaching
and what previously seemed like a cake walk of an election win, is no
longer. Euro skeptic parties are gaining traction across Europe and are
now knocking on Germanys door.
Chancellor Angela Merkel certainly has her work cut out for her. If
she can successfully lead her coalition to victory, the coast just might
be clear. Political failure on the other hand, could turn Europe into a
zoo station.

To Russia with love

While the debacle called Cyprus continues, many depositors who
should be angry, are not. In fact many are holding court over brandy,
vodka and macchiato describing how they pulled one over the never
watching eyes of the Troika and their friends at the European Union,
the International Monetary Fund and the European Central Bank.
Meanwhile, the Troika is slowly coming to the realization that
perhaps they are not the sharpest knives in the drawer after all. The
reason for this epiphany is the mysterious case of the disappearing
cash from Cypriot banks.
Despite erecting iron clad walls around all Cypriot banks, someone,
somewhere, somehow still managed to withdraw billions of Euros
from these supposedly closed banks. In what only can be described in
a Woody Allen-esque way, it seems the great leaders of Europe
simply forgot to close the back door to the banks. Apparently, while
the average Cypriot dutifully lined up at the ATM to withdraw his EUR
100 daily allowance, wealthy Russians and other Europeans simply
flew directly to Athens and London to withdraw all of their money
from the still-open bank branches.
And just think during this entire time, Germany thought they were
pulling one over on Russia. The sad part of the story however is that
Cyprus once again has a giant hole to fill in their banking system all
the while anti-Euro sentiment builds quietly across the continent.

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April 2013

Achtung Baby

Old is not new

Just like every other bailout in Europe, initial estimates of the money
required for Cyprus will be unsurprisingly low, as will the actual
economic growth rates thereafter. Whereas the gatekeepers in
Brussels initially estimated the Cyprus bailout package to be EUR 17
billion, the newest figure has jumped 35% to EUR 23 billion, and no
one should be surprised one year from now when this figure is
increased even further.
For those who still care, this shouldnt be the least bit shocking. After
all, the initial estimate for the Greek bailout was EUR 110 billion.
Sadly, here we are 3 years and EUR 325 billion later, and there is still
no end in sight.
Elsewhere in the bailout world, Portugal had to officially request a 7
year extension to its repayment scheme. Meanwhile, rumours of
Ireland once again heading to Brussels with cap in hand simmer as
well. Meanwhile, Spain and Italy - the 2 big daddies of the European
debt mess continue on a trajectory to nowhere, if thats possible.
Despite higher taxes, reduced government spending, and the slow
withdrawal of private capital, Spains fiscal position is not improving.
To top it off, stories of unpaid bills have become legendary especially
in the city of Madrid, which managed to increase its debt outstanding
by 18% in just one year.
At the same time, Italy is no closer to having anyone form a new
government. In fact, it took the warring parties 6 rounds of voting

just to agree upon the largely symbolic position of President. To make

the story even more entertaining, the new President is anything but
new. Somehow, 87 year old Giorgio Napolitano was arm twisted to
once again return to Romes Quirinal Palace for another 7 year term.
Of course, this resolves nothing in the Wonderful World of Italian
Politics except to provide the anti-Euro, anti-same-old-government
leader Beppe Grillo with even more comedic material for the next
election sometime this year.
Meanwhile, as Europe continues to churn nowhere, it seems that
leading government officials everywhere have suddenly become fixed
income experts. According to these financial wizards, declining yields
from Italy and Spain is vindication that (once again) the worst is over.
This is the point where we ask investors, government officials, and
media to read beyond both the headlines and the first paragraph of
investment reports.
Just as the declining US unemployment rate is attributed to more and
more people simply giving up hope (theres that word again) and
not an abundance of new jobs; the decline in sovereign bond yields is
the result of domestic banks and pension funds buying new bonds
from their respective governments not an increase in confidence
from international investors.
While strong domestic demand for a governments debt is usually a
good sign, forced demand is not. To fully appreciate the continuing
demand for Spanish sovereign debt, look no further than the
countrys social security pension fund which now proudly states
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April 2013

Achtung Baby

Epic
that over 97% of its assets are invested in Spanish Government
Bonds. Considering that in 2007 less than 50% of its assets were
invested this way, as well that 70% of purchases in 2012 occurred
during the last few months of the year, this all-in strategy need only
be described with one word epic.

Table 1: Capital contribution of ESM Member States

Of course, odds are this epic strategy will only end in disaster. First of
all, the high concentration of investment is embarrassing for
whomever is in charge of the fund. Fund managers, investment
committees, and trustees have a fiduciary duty to the owners of the
fund. Objective #1 for this group is to preserve capital and the
diversification of assets, neither of which is being achieved. Next, this
is really no different than directly raiding the pension fund assets.
This is a shameful act and ultimately someone will have to pay for
this Spanish mistake, which naturally leads us to Germany.
Germany
In simple terms, the generosity threshold of the average German is
pretty close to being breached. Recall that initially Germany was
required to only pay 21.72% towards any bailout. Granted this is a
lot to pay, and a lot to swallow, especially for many Germans who
believe they shouldnt have to pay anything for the poor money
management skills of other European countries.
Table 1 shows the exact bailout commitment for each Euro-zone
country. While this table hasnt been bantered around any research
reports for quite some, we believe it is worthwhile as it provides a

Source: European Stability Mechanism Fact Sheet

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April 2013

Achtung Baby

875 x leverage = AA+ credit rating

refresher on the magical World of European Mathematics. The
European Stability Mechanism (ESM) is armed with EUR 700 billion to
help the needy - what on earth could possibly go wrong? To begin
with, this convoluted bailout scheme is here to stay until it isnt. A
quick glance shows there are several reasons why the bailout fund
could snowball and itself need a bailout at some point.

absence of these contributors means someone else has to pick-up

the slack. The irony, and inherent weakness in the ESM, is that some
of the stronger countries are likely to become slackers themselves.
And with Italy and France becoming increasingly vulnerable (for
different reasons), this leaves Germany as the only real financial
superpower remaining to save the European day.

For starters, many people often ignore, or conveniently forget that

this EUR 700 billion fund is actually only supported by EUR 80 billion
of capital. The remaining EUR 620 billion will be you guessed it,
borrowed. To clarify, the bailout fund which was created to bailout
countries who had too much debt, is being created by using even
more debt. And mind you, its not even a little debt. If fully used, the
ESM will be leveraged 875x of original paid in capital. Granted, maybe
the ESM wont borrow any money and simply do new capital calls
from the Euro-zone countries. Yet, theres only one ironic concern
with this idea no euro country has the money available and they
too will have to borrow. Either way, the ESM is a levered bailout
machine.

German Federal Elections

Regardless the outcome, September 22, 2013 will be a big day for
current Chancellor Angela Merkel and her coalition. Since 2005, Ms.
Merkel has lead the Government and arguably has become the single
most important glob of glue holding the Euro-zone together.
Everyone, everywhere must understand that if Ms. Merkel is
defeated, so too is the Euro.

Next, look no further than Ireland, Portugal, Greece, Spain, Cyprus

(and soon enough Slovenia). Each of these countries are receiving
bailouts in one form or another yet according to the structure of
the ESM, each is also expected to contribute to the bailout fund.
Now, even Brussels admits its tricky when you have to contribute to
a fund to bailout yourself so they reluctantly decided that recipient
countries would not have to contribute after all. Of course, the

As of today, current seating in the German Bundestag is as follows:

Merkels
coalition

Source: bundestag.de

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April 2013

Achtung Baby

Fingers and toes

Noteworthy of course is Ms. Merkels CDU/CSU/FDP coalition
consisting of 330 seats. Like every country, German politics has its
own nuances, tides and waves that are beyond boring to most
outsiders, and at first glance Merkels coalition appears to have a
cushion to pull off another win.
Yet, what isnt appreciated by many but certainly known to Ms.
Merkel is the growing anti-Euro wave creeping across the Euro-zone
that has landed smack in the middle of Berlin. Up to now, all Euroskeptic parties originated in the European countries that were forced
to accept various forms of austerity.
It turns out excessive debt loads, higher and higher taxes, combined
with a transfer of political power to Brussels, is actually not popular
amongst some people. In fact, these policies have become so
unpopular that more and more people are starting to believe that
perhaps the Euro isnt such a good deal after all.
Currently, Merkel and her followers are crossing every finger and toe
hoping that there are no further crisiss prior to the September 22,
2013 election. Every time another bailout is required, or increased
systemic stress from distressed banks, or thousands of Greeks,
Spaniards, Portuguese, or Italians marching in protest, the popularity
of Euro-skeptic parties increases.
Unfortunately for the incumbents, Chart 1 (next page) shows the
economic slowdown enveloping the old World is about to swarm the

German economy as well. To really put the slowdown into

perspective, simply ponder the following release from the usually
balanced Markit Economics team:
While March saw severe and painful downturns persisting in Italy
and Spain, a stronger rate of decline was recorded in France and
growth almost stalled in Germany, which suggests that the only
source of bright light in an otherwise gloomy region has once again
begun to fade. Chris Williamson, Chief Economist.
In addition to having to explain away the upcoming recession, Merkel
and Brussels will also be doing their best to put out any smaller fires
before they spread out of control. To identify the heat on this map,
keep an eye on Italys political deadlock, Italys Monte Paschi Bank
scandal, Greek protestors, Spanish protestors, the Cyprus
government, anyone in Slovenia as well as 89 year old and former
Portuguese Prime Minister Mario Soares who announced The desire
to please chancellor Merkel is ruining the country. In short, if
something doesnt happen between now and September 22 we
would be wordless.
Naturally, this wave of economic and societal discontent leads to
political change. And what originally started as fringe parties, has
now evolved into the True Finns in Finland, Syriza in Greece, the Five
Star Movement in Italy and now the Alternative for Germany (AfD).
The AfD is new. So new, that theyve yet to officially register for the

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April 2013

Achtung Baby

Chart 1: Markit Eurozone Composite PMI

Sharp decline

21 months in recession

Starting to be dragged lower

Depressing

Source: Markit Economics, IceCap Asset Management Limited

www.IceCapAssetManagement.com

April 2013

Achtung Baby

Atlas might shrug

upcoming election. Yet, despite this non-official status, recent polls
have up to 24% of voters considering voting for the party. To achieve
this level of relevance in such a short time is nothing short of epic
(theres that word again).

happens. Yet, the swiftness of this sell-off in gold bullion was

particularly worrisome. To put the decline into perspective, it has
been calculated that the swiftness and volatility of such a move in
gold only occurs every 4,767 years a rare event indeed.

Even more troubling to Ms. Merkel is the composition of the AfD. No

comedians, no billionaire party animals and certainly no one wearing
a pirate hat. In fact, to the naked eye the AfD contains no one of
interest to the courts, People Magazine or Brussels. The founders are
a bunch of business people, academics and everyday average people.

From another perspective, in 2002 global equity markets declined 30%, but this was over a 10-month period. Painful, yes but there
were no jolting -15% declines over 2 days. Mathematically, the -30%
decline should have felt twice as bad when compared to a -15%
decline. However, when the decline is spread out over a longer
period, people become somewhat desensitized to the loss. As such
the psychological damage from the gold experience feels worse.
More importantly however, when financial markets experience
significant and rapid price changes, you know something is afoot.

In addition, practically all of their policies are similar to the current

main stream parties. Yet, the only real difference between the AfD
and Merkel, is that she wants to keep the Euro in order to save
Europe, while the AfD wants to get rid of the Euro to save Europe. No
ands, ifs or buts with this one.
We have no idea what will happen. We do know that should Europe
experience no further crisiss between now and the German election,
the election should be a non-event. However, should anything occur
to mix the pot, the odds of a Euro break-up increases significantly.
Every 4,767 years
During April 12-15, 2013 gold bullion declined from $1,559 to $1,328.
This $231 or 14.8% decline was significant for several reasons.
For starters, all financial markets experience significant declines it

In our opinion the primary reason for the sell-off is attributed to gold
being used in just about every hedge, carry, and pair trade known to
mankind. Its been no secret that since the central banks began
printing money, many investors have been LONG GOLD and SHORT
YEN/EUR/Treasuries/Oil to name a few. Considering gold was trading
in a weak technical range, for the fireworks to begin all it needed was
a single very large seller and off she went.
Also of significance was the impact of margins. When trading in any
type of commodity or currency, investors typically only need to pay
about 5% of the actual amount due. The other 95% is in effect
borrowed and when there are significant moves in the underlying

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April 2013

Achtung Baby

QE5?
investment, the buyer has to contribute more money to maintain
margin otherwise his margin is called and his position is forcefully
liquidated. And this is when the golden snowball really stated to roll.
The really important point to understand is that today global financial
markets are all interconnected. Commodities are connected to
stocks, stocks are connected to bonds, bonds are connected
currencies, currencies are connected to interest rates, interest rates
are connected to central bankers, central bankers are connected to
gold, and everything is connected to inflation and deflation.
Sadly, pretty well all investors today are ignoring the signals and
messages produced by the central banks and their money printing
ways. Most want to believe that the World has returned to the typical
business cycle and the reaction by stocks and bonds simply
represents a normal investment experience.
We know this message is falling on deaf ears, yet it is a message that
warrants repeating. It is fact, the major central banks are all trying to
out-print each other with the hope that their currency will fall,
business profits will rise, employment will rise and the glory days will
return. Yet, the overwhelming tide of sluggish economic growth is
telling in simple terms, the World is increasingly becoming caught in
a deflationary trap and the window to escape is getting smaller and
smaller.
Yet, although the global economy is caught in a deflationary trap,

most people everywhere in the World are experiencing a higher real

cost of living. Yes, prices of some goods and services such as
healthcare and education are rising, while other costs are rather
flattish. Yet, the impact of higher taxes and austerity is not included in
normal inflation calculations and this is a shame, because failure to
recognise the social and political risk resulting from this tax inflation
is sure to cause more socioeconomic and geopolitical stress as the
days pass along.
All of which brings us to the next big market surprise.
The Next Big Market Surprise
The next move by the US Federal Reserve will be to INCREASE their
money printing program. Yes, various members of the FED have
recently hinted that they are discussing the whens and hows of
reducing their addiction to their printing money schemes. However,
the deflationary wave enveloping the globe simply cannot be ignored.
The combination of the steady decline in commodities, developing
recessions in Britain, and Europe, as well as declining growth in
Australia, Brazil, Russia, Canada and Asia are economic cries for help.
Yes despite the central banks of the World printing trillions of Dollars,
Yen, Pounds, Euros and Swissies the much feared deflationary trap
continues.
Of course, maybe the central banks and governments could simply
admit defeat, and cleanse the World of the much maligned bad debt

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April 2013

Achtung Baby

Apologies to Marc Faber

that clogs the system. Yes there would be losses, especially for banks,
insurance companies and pension funds yet, just think about all of
the fresh, clean, crisp capital waiting on the financial sideline. Instead
of a very deep and long lasting depression as warned by current
leaders, the World and its economy would actually recovery a whole
lot quicker with no can left to kick down the road.
Alas, this ripping off the band-aid approach is extremely unlikely,
which therefore always leaves the default option more of the same.
But, will it really be the same?
While rumours of Ben Bernanke registering his 401K plan may induce
cheers from all Austrian economists, we caution that his replacement
could actually be even more liberal with the printing press. Now
apologies to our dear friend Marc Faber, but Janet Yellen actually has
the potential to print so much money that it would make Ben
Bernankes view on monetary expansion look closer to that of Marc
Fabers view. Yes, Ms. Yellen really has the potential to become a star
in the global quantitative easing league.
Meanwhile, British everywhere should be preparing for their re-entry
into the money printing twilight zone. You are now merely days away
from the arrival of Mark Carney and those thinking he will simply
continue with his unassuming, conservative Canadian-way should
think again. Mr. Carney wasnt hired to ramp up a moral suasion
strategy, instead one should expect a new and very aggressive Bank
of England. After all, UK growth has completely stalled and the rest of

the World has a head start in the latest round of currency devaluation
schemes.
As all markets and financial phenomena are interconnected, investors
should also consider what happens next with the Australian Dollar.
The AUD has skyrocketed 80% since the dark days of 2009, yet for the
past 2 years the currency has become the epitome of stability. Since
money never sleeps, expect a breakout move at some time soon.
Chart 2 (next page) shows the AUD is poised to break out of a
narrowing technical trend, and when you consider the recent
disconnect between commodity prices and AUD, the break in trend is
likely to be on the downside.
Our Strategy
Despite volatile, headline producing moves, global stock markets
continue to tread water and have traded flattish since the end of
January. During this time, we have waited patiently for sentiment and
technical measures to lead the way to a re-entry point. Yet, various
sentiment indicators still signal downside risk, while the combination
of fewer and fewer stocks making new highs, combined with
weakening emerging markets are signals for investors to remain
cautious.
As all financial markets have corrections the time between such
downturns vary. Yet, it is worrying that it has been 100 days since
American stocks have declined -5%, 382 days since a 10% correction
and 1,031 days since a market drop of over 20%. The message is loud

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April 2013

Achtung Baby

Chart 2: Aussie Dollar

AUD inflection
point approaching

It is unusual
for AUD to
disconnect
from
commodity
prices

Source: TheShortSideOfLong.blogspot.com

Copyright 2012 Ned Davis Research, Inc. Further distribution prohibited without prior
permission. All Rights Reserved. See NDR Disclaimer at
www.ndr.com/copyright.html. For data vendor disclaimers refer to
ww.ndr.com/vendorinfo/.

www.IceCapAssetManagement.com
Source: Markit Economics, IceCap Asset Management Limited

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April 2013

Achtung Baby

Dont forget the bond market

and clear a correction is due. However, unless a significant crisis
develops, the downturn should be with the -5% to -10% range.
Gold has recovered from the low on Monday, and is now down -7%
(vs -14%) from pre-crash levels. The bounce is welcomed, yet we
have to recognise that many support levels have been broken which
causes us to be concerned about the potential for more corrections.
We remain holders of gold, but we have reduced our holdings.
Whereas most personal investors and media pay little attention to
bond markets, it really has become the most fascinating market in
town. It has always been our view that longer-term rates will spike
up, but this will only occur within a country that is experiencing
financial stress. The global deflationary wave will remain supportive
of lower rates, at the same time, investors must also acknowledge
that the demand from private investors as well as that from money
printing programs, ensures current demand is enough to meet all
new supply of bonds coming to the market.

As always, wed be pleased to speak with anyone about our

investment management capabilities. As well, we encourage you to
share our global market outlook with those who you think may find it
of interest.
Please feel to contact:
John Corney at johncorney@IceCapAssetManagement.com or
Keith Dicker at keithdicker@IceCapAssetManagement.com.
Thank you for sharing your time with us.

Of course, should the German election really heat up, market

sentiment, technicals and fundamentals will become less and less
important. And to this we caution a very big achtung baby!

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