Wednesday, January 12, 2011

[RED DEMOCRATICA] The "Risk On" Trade...Brazilian Style

 

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More Sense In One Issue Than A Month of CNBC
The Daily Reckoning | Wednesday, January 12, 2011

  • Trends from New York to Lisbon to Shanghai and beyond,
  • How to send your money (and yourself) to a beachfront paradise,
  • Plus, Bill Bonner on negative sum activities, cotton-pickin' minutes and more...
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"Risk Off" Trades
Where Gold, Bonds and Emerging Markets Converge
Eric Fry
Eric Fry
Reporting from Laguna Beach, California...

Our narrative today begins with gold-buying in New York, then wanders past bond-selling in Lisbon and ends with some squiggles in Shanghai.

First, the gold-buying...

The precious metals rebounded yesterday - and are maintaining their elevated levels this morning. The reason, according to Bloomberg News, is that "Europe's debt crisis is spreading. Portuguese bond yields [are] rising to levels that may force the nation to follow Greece and Ireland in requesting a bailout from the European Union."

Nonsense! Says Portugal's Prime Minister, Jose Socrates. "Portugal won't request any financial help, for the simple reason that it doesn't need it," the proud Prime Minister insists. "The government is doing its job and is doing it well."

Hmmm... Portugal's soaring bond yields provide compelling testimony to the contrary. The Portuguese government may be doing part of its job well - like repairing cobblestone streets or boosting global cork sales - but it is clearly not doing a great job of managing the nation's finances. At last count, Portugal's budget deficit was brushing up against 10% of GDP.

The government is promising to reduce that shortfall to a somewhat less terrible number over the next couple of years. But so far, bond investors are skeptical.

Yield on Portuguese Government Debt

As recently as one year ago, Portugal's 10-year bonds paid a respectably low yield of 3.70%. But now that Portugal has joined the ranks of Europe's fiscally infirm nations, its bond yields are nearly twice as high.

Portugal managed to sell a little bit of its debt this morning, but only because it offered a "junk bond" yield of 6.72%. (Your California editor could have securitized and sold his personal credit card debt at a lower rate of interest). Even so, the financial news outlets were quick to hail the Portuguese bond sale as "a success."

But this "success" was more theatre than real life. The size of the auction - at a mere 599 million euros - was little more than a ribbon- cutting ceremony to show the world that Portugal is in okay shape after all. The auction was a success, only if one ignores the fact that the ECB has been aggressively buying Portuguese debt to suppress bond yields. Bear in mind also that this 599 million euro sale occurred in the context of chatter about Portugal receiving a 60 billion euro bailout from the ECB.

The Portuguese government's finances may not be in dire straights just yet, but they are hardly in tip-top shape.

Not surprisingly, Portuguese stocks have been slumping for the past few months (as have Spanish stocks). These lackluster stock market trends on the Iberian Peninsula are eerily similar to those of several major Emerging Markets.

The goings on in these peripheral markets may not mean anything at all. On the other hand, they may mean a little something. In recent years, Emerging Market stocks and bonds - as the quintessential "risk on" assets - have tended to lead the financial markets of the Developed World - either higher or lower...

Which brings us to those squiggles in Shanghai...

The Shanghai Composite Index bottomed out in early November of 2008 - four months before the S&P 500 reached its ultimate low. Most of the other major Emerging Markets bottomed out at the same time as the Shanghai Composite and had established clear uptrends, even as the S&P 500 was tumbling to lower lows. As such, the Emerging Markets clearly led the Developed Markets out of the 2008-9 bear market.

Shanghai Composite vs. S&P 500 During the 2008 Crisis

Today, a completely opposite phenomenon may be unfolding. Emerging Markets have been weakening for several months, even as the Developed Markets have continued to new post-recovery highs. This recent divergence may not portend doom and gloom, but neither does it inspire confidence.

Shanghai Composite vs. S&P 500 Over the Last 3 Months

Net-net, there may be no relevant connection between the recent gold- buying in New York, bond-selling in Lisbon and squiggles in Shanghai. But if there were a connection, it would probably be that investors are slowly embracing the "risk off" trade. They are backing away from assets like Portuguese bonds and Chinese stocks. And in place of these "risk on" investments, they are buying gold, silver and other hard assets.

But in the column below, our colleagues over at International Living, Ronan McMahon and Margaret Summerfield, offer an alternative "risk on" trade that is both a hard asset and an Emerging Market investment...

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The Daily Reckoning Presents
The "Risk On" Trade...Brazilian Style
by Ronan McMahon and Margaret Summerfield
The new middle class in Brazil is growing...and spending their newfound wealth. Brazil is booming. And Brazil's northeast is growing at a faster rate than the rest of the country.

The most exciting story to emerge from Brazil in recent years is the rise of the middle class. In the last eight years, Class C (Brazilians earning $650 to $2850 a month) grew quickly. Today, 94.5 million people fall into Class C. They are driving the Brazilian economy, buying cars, washing machines, vacations, and new homes.

Investors in stocks and shares are riding the wave of this newfound wealth, betting on Brazilian companies that target domestic consumption.

Drawn by hundreds of miles of beaches, it's to the northeast coast that Brazil's new, up-and-coming class comes to vacation and retire. This is good news for the rentals business here. Moreover, this is a great beach base for you if you're a globetrotter.

Now, imagine your ideal retirement getaway.

Maybe you see the surf of a turquoise sea gently lapping a beautiful sandy beach.

You may simply want to escape the cold winters back home...or perhaps you're in the market for a new full-time home. Maybe you imagine a life where you travel for six months and spend the other six at your overseas retreat.

Whatever you dream of, that life really can be yours - for much less than you'd imagine. In fact, your retirement escape could actually make you money. João Pessoa is a place where you can embrace this lifestyle without hurting your bank balance.

Coastline of Joao Pessoa

João Pessoa is the capital of the state of Paraíba. Surrounded by miles of beautiful beaches, this is where many Brazilians from southern cities come to retire, vacation and buy second homes. It's one of the safest capital cities in Brazil...with a healthy outdoors lifestyle, centered on the beach and boardwalk. The city is popular as a retirement destination for senior civil servants.

The city has 1,730 acres of forest, providing a green backdrop to almost 25 miles of beach. João Pessoa has some of the nicest city beaches you'll find anywhere. Moreover, beachfront properties are still affordable...and there's a line forming of potential renters for your condo, when you're not there.

While popular with tourists, João Pessoa doesn't offer much choice when it comes to hotels. The four-star Verde Green is the city's newest and nicest hotel. Not that it has a lot of competition...the other hotels are two- or three-star, and "tired."

Yet according to my sources on the ground, estimated occupancy rates average 86% year-round. Rack rates in the Verde Green are in the range of $113 to $226 a night. Quality short-term rentals are difficult to find and command $468 per week for a small one- or two-bed unit.

The best place to buy for rental is the prime residential area of Cabo Branco. Development is limited here by the city's 1,730 acres of protected forest to the back, and the boardwalk to the front. Cabo Branco sits between the ocean and the forest on a thin triangle of land.

You'll find uncrowded stretches of beach, and the city's nicest restaurants and boardwalk kiosks here. It's a favorite with holidaymakers, younger retirees and second-home owners.

Riacho Verde, for example, is a small project of 55 units located a block from the beach in Cabo Branco. Unit sizes here range from 592 square feet to 1,431 square feet. Prices start at $146,207. The rental demand for this type of condo is strong. The building will be constructed as a condo building but with hotel-type amenities.

Projects like this sell fast. They are in hot demand. For short-term rentals, the average daily rate could be $73. Based on a 70% occupancy rate, that means $18,650 annually.

Property management fees run around 25% - leaving almost $14,000. Enjoy a couple of months here yourself in the low season and you can still enjoy a healthy yield.

"I cannot stress enough how strong the rental demand is for units like these," John Curtis, a real estate agent in João Pessoa, told me recently. "We have a waiting list of companies and individuals looking for accommodation..."

About 700 kilometers up the coast from Joao Pessoa, the beachfront city of Fortaleza is also booming. Fortaleza is benefitting directly from the spending power of the new middle classes. It's the top tourism destination for Brazilians. Passenger traffic through Fortaleza airport in 2010 reached 4.16 million passengers by the end of October. That's an increase of 22.4% compared to the same period the previous year...and 2009 was a record year for passenger numbers.

Brazilians come to Fortaleza for the vibrant nightlife, excellent restaurants, and beautiful beaches. East and west of the city, white- sand beaches run for miles. On the east side, Brazilians tourists head to a giant water park (South America's largest), a cluster of little beachside bars, cafes and clubs at Praia Futuro, and some amazing colored cliffs at Morro Branco.

West of Fortaleza, the beaches roll to the horizon...silky, fringed with coconut palms, and luxuriously empty. Many foreign tourists come here to kite surf. Forbes reckons this sport is the new golf for Silicon Valley executives. The fresh ocean breezes west of Fortaleza provide the perfect environment for kite surfers. Little beach towns like Cumbuco offer chic lodgings, and kite surfing schools. For the rest of us, those ocean breezes keep us cool in our hammocks in the afternoons...

You can profit from Fortaleza's strong economic and tourism base. Mid- level executives relocating to the city, and tourists alike, face a shortage of hotel rooms, and suitable rental condos. That makes finding decent long-term and short-term accommodation difficult. But it means rental opportunities for property buyers.

So when you consider Emerging Market investments, don't forget to consider Emerging Market real estate.

Regards,

Ronan McMahon and Margaret Summerfield,
for The Daily Reckoning

Joel's Note: With decades of globetrotting experience under their belt, the International Living team recently launched Alpha Hunter, a service aimed at tapping the many and vast opportunities of investing in the emerging markets. For more information on how you get on their mailing list, check out this link.

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Global Wealth Shifts as Asians Stock Up On Bad Debt
Bill Bonner
Bill Bonner
Reckoning from Paris, France...

Yesterday, we promised a new idea. Alert readers may have noticed - we didn't deliver.

But when you have a new idea you don't just throw it out like small change. It requires a certain amount of preparation...a bit of fanfare...a drum roll and a countdown.

The subject yesterday was European debt. The bond vigilantes came ashore in Portugal, attacking Portuguese government bonds. They seemed to be heading for the Spanish border.

All over Europe, the cry went up: "Can anyone stop them?"

It was as if the Huns were at the doors of Vienna...or the Moors were massed at the walls of Poitiers. Where is Charles Martel when you need him?

The funny thing about yesterday's news was that Japan had come to Europe's aid. Following China's lead, Japan said it would lend the poor Europeans some money.

What are these strange benefactors up to? Why would Japan - with the highest debt load in the world...and barely able to finance its own deficits - lend to Europeans? But the Asian rescuers are just exchanging bad US-dollar debt for bad European debt. They must figure that they are up to their eyeballs in American paper...might as well diversify into some Euro trash as well.

The other thing it signals is more shift of wealth, from the West to the East. Asians are now creditors to Europeans and Americas. That's just the way it works. The old world goes into debt to the new world. America is part of the Old World now. The Asians will now be calling the shots.

Which brings us closer to our idea.

But hold on...one second, Dear Reader... Let's look at yesterday's financial news.

The Dow rose 34 points. Gold rose $10. Nothing much to talk about.

But check out these headlines from The Wall Street Journal:

"Job openings fall in tough market," says one.

"Downturn's ugly trademark," begins another. "Steep, lasting drop in US wages."

Now just hold on a cotton-pickin' minute. What happened to the recovery?

It did just as we said it would do - it vanished. The Great Correction began in 2007. It is now in its 5th year. But it's not over.

Case-Shiller, the real estate analysts, now report a that the "double- dip" in housing is here. Prices are falling again in many areas.

Prices at the consumer level are not exactly falling...but they're not rising much either. The official CPI is flat at barely 1% increase per year. This isn't much comfort to the average household - which has higher food and energy bills (not included in the core CPI reading) to pay. But the low figures show us that we're still in a Great Correction, not an inflationary recovery.

And, there were fewer job postings in November than the month before. And here's the bad news: if you lose your job, a pox will be on your house for generations. No kidding. According to a study by a Columbia economist, you are likely to earn less in your next job, if you get one. Not only that, fast forward to 2030 and you're likely to still be earning less than colleagues who weren't laid off.

But it gets worse. Your children are likely to earn less too...and heck, maybe even your grandchildren.

The article mentions a manufacturing manager with two masters degrees. He was earning good money until he lost his job. Now he's sweeping floors. He's a janitor earning $9 an hour.

What good are those two masters degrees? Apparently, no good at all.

Another of the people spotlighted by the WSJ hopes to beat unemployment by going back to school. More degrees will lead to better job prospects, she thinks.

She should read the article. It doesn't seem to work that way. More education may not pay off. Why?

Again, we return to our new theme...our new idea.

And now...more of our thoughts...

There are some activities that are positive sum activities. That is, they are productive. They increase the total of real wealth in a society.

There are other activities that are zero sum activities...or even negative sum activities. War, for example. Excess legal wrangling. Paperwork. Too much time spent in schools. Too much support for the unemployed, the malingerers and the loafers. These things decrease the total of real wealth in a society.

Sometimes people are bright, honest and hardworking. Sometimes they are lazy, shiftless and cunning. They always prefer to get wealth and status by the easiest means possible. In some societies, the best way is by working hard. In others, it is by being clever...becoming a lawyer...a banker...or a government hack.

A new society...or a fresh economy (such as one that has just been flattened by war or hyperinflation)...or a new model for an economy...is generally a wealth-creating society.

A free society is also generally a wealth creating society. People do what they want. If they want wealth, they are free to create it.

But as societies (or economies) age, they become decadent, arthritic, and backward-looking. They shift from wealth creating to wealth shuffling...and then to wealth destroying. They evolve into societies that are more concerned with redistributing wealth than with creating it...more focused on the appearance of wealth creation than with the real thing.

People shift with their societies. When hard work and creativity pays off...they become hardworking and creative. When connections and corruption pays, they are up to the job.

That is true in almost all aspects of the society. Education, for example. In a new or free society people turn to education because they want to learn useful skills...or for the pure love of learning and contemplation. In decadent societies they covet degrees and diplomas - often in such drivel as "communications" and "political science," not to mention "gender studies" - and count on the paper to get them a cushy job where they don't really have to do anything. Since everyone believes "education" is such a good thing, there is little resistance to further spending by government and parents - even though the threshold of declining marginal utility for this type of education may have been passed long ago.

This is also true of military spending. A little military spending may be a good thing - it protects the society from outside predators. But "defense" spending soon becomes totemic. Eventually, the decadent state is realizing a net negative return. The private entrepreneur switches from producing work boots at a 10% margin to furnishing the Pentagon with combat boots at a 20% margin. Not only is the productive economy squeezed to support the defense establishment, the over-financed military itself increases the odds of attack by foreign powers...and decreases the real defensive position of the society.

Then, of course, there is the government itself. As Jefferson pointed out, a little of it may be a "necessary evil," but a lot of it is unnecessary, expensive, and a nuisance. Government does not create wealth. Governments shuffle wealth and stymie it. So, the more government you have, the less wealth-creation you have.

Right now, America is beginning a transition. It is an old, decadent society...headed for bankruptcy...and trying to find a new model. One of the elements of that new model is lower wages. People who thought they should earn $100,000 a year because they have a masters degree are finding that their services are really only worth $9 an hour. More generally, people in the advanced, decadent societies - who are accustomed to earning 10 times as much as a person in China, India or Brazil - look over their shoulders and see the foreigners gaining on them. Americans' real wages, for example, are likely to be stagnant or falling for many years. Meanwhile wages in emerging markets are likely to double every 10 years or so.

The latest figures from the US show national income still increasing at about 1.5% per year. Nominally. Before inflation. Adjust for the increased cost of energy and food (both of which are moving up fast...some setting new record highs) and the real income of the typical family in the US is actually falling.

Tomorrow, we'll talk about the role of the Federal Reserve...the banks...and the financial industry...

Stay tuned.

Regards,

Bill Bonner
for The Daily Reckoning

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Here at The Daily Reckoning, we value your questions and comments. If you would like to send us a few thoughts of your own, please address them to your managing editor at joel@dailyreckoning.com
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The Benefits of Gold and Silver Not Lost on the Chinese
Looking ahead, the World Gold Council forecasts that China's "gold consumption may double in the next decade," which is an astonishing thing to say! The WGC is talking about doubling annual gold consumption in only ten years...

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Why Emerging Markets Love Gold
On the surface, our favorite yellow metal isn't doing much this week. The spot price has moved within a tight range around $1,380. But just below…we sense something lurking. Retail buyers in China can't get their hands on gold bars fast enough.

Public Opposes a Debt Ceiling Increase, Why Won't Congress?

Chinese Renminbi Extends Its Reach

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The Daily Reckoning: Now in its 11th year, The Daily Reckoning is the flagship e-letter of Baltimore-based financial research firm and publishing group Agora Financial, a subsidiary of Agora Inc. The Daily Reckoning provides over half a million subscribers with literary economic perspective, global market analysis, and contrarian investment ideas. Published daily in six countries and three languages, each issue delivers a feature-length article by a senior member of our team and a guest essay from one of many leading thinkers and nationally acclaimed columnists.
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