Our view on global investment markets:

March 2013 Do you believe in miracles?

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

March 2013
U-S-A...U-S-A...

Do you believe in miracles?

Fortunately for USD Bulls Americas big currency neighbours are all looking a little shabby these days. In fact, in the 16 months since publishing Return of the Dollar, the Euro has declined -8%, the Japanese Yen has declined -24%, and the British Pound has declined 6%. The currency war is certainly in full swing, but the race to the bottom is far from over. Granted, this doesnt exactly produce solid votes of confidence for the global economy. And, believe it or not, this trend will only get stronger. In fact, investors should prepare to see the USD strengthen considerably against most currencies. The good news is that this allows investors from all walks of life to position themselves to either gain from USD strength, or to protect their capital against loss from EUR, GBP and Yen. Unfortunately, theres also some bad news. This upward surge in USD does not reflect a surging US economy or an improving fiscal condition. To see the canary in the American coal mine, look no further than Chart 1 on page 2. Ultimately, once the effects of money printing and the poor handling of debt levels has played itself out in Europe, Britain and Japan, the US too will bare the brunt of its similar strategies. For now however, the US is last in the long line of financial heart ache. To fully understand how the global debt crisis plays out however, investors must be willing to step outside of their own domestic economy and financial markets, and view the World from an www.IceCapAssetManagement.com 1

The odds of winning were slim and none. Avoiding embarrassment was the real objective, but then something happened. Momentum changed and the rag-tag bunch of American college hockey players shocked not only the Soviets and their 1980 Big Red Machine, but the entire sports World. When seemingly faced with the impossible, America always perseveres and finds a way to win. After winning the global economic game for the better part of 100 years, America is once again on the ropes and no one is giving her any hopes at winning, or even surviving for that matter. Americas debt levels are disastrous. It has no money to pay future pensions and healthcare. Economic growth is anemic. Meanwhile, more Americans than at any other time in history reply upon food stamps. And to make matters even more dire, it is only the decision to print trillions of new dollar bills that is holding everything together. Just as Americas rock is about to hit its American bottom, you must ask Do you believe in miracles? And, the short answer is yes. US Dollar Strength Way back in November 2011, our Global Outlook Return of the Dollar concluded when it comes to currencies it doesnt matter how you look in isolation its how you look when lined up next to your neighbour.

March 2013

Do you believe in miracles?

Chart 1: Canary in the US coal mine

USA - Nominal GDP vs Net Unfunded Liabilities
$70,000,000,000,000

$60,000,000,000,000

$60,000,000,000,000

$50,000,000,000,000

$40,000,000,000,000

$30,000,000,000,000

$ 45 trillion and growing

$20,000,000,000,000

$15,000,000,000,000

$10,000,000,000,000

$-

GDP
Source: IceCap Asset Management Limited, www.justfacts.com

Unfunded Liabilities

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March 2013
Honda vs Hyundai

Do you believe in miracles?

day to help create a few jobs, the Japanese have taken money printing to an entirely new level. Their program has one goal significantly decrease the value of the Japanese Yen. Think South Korea and other Asian exporting countries are happy with Japans attempt to drastically cut the value of the Yen? Not a chance. You can be certain that as the Yen continues to weaken, South Korea and others will also attempt to debase their currencies. And just to be clear, there is nothing like a good old currency crisis to help nudge money to safer areas. Understanding how these dynamics play out is the key to correctly forecasting the long-term direction of financial markets and why ultimately the US Dollar will strengthen relative to the Euro, Yen and British Pound. The worst is over Not one to be nostalgic, yet if it seems like it was only a few weeks ago we warned The Worst is Over, thats because it is true. Our February 2013 publication deftly explained why despite proclamations from Europes finest leaders that the worst is over, the debt crisis was in in fact still ongoing with no resolution in sight. Financially speaking, the only problem with Europe is that it refuses to allow debt markets to follow the normal course where good loans are repaid, and bad loans results in losses for those who made poor investment decisions. As you know by now of course, European

independent perspective. Unfortunately in financial analysis, all too often investors become one or two dimensional at best. To really up your investment game, you need to broaden your perspective and see through the daily grind of financial pomp and circumstance. Case in point inflation. Whereas our leading central banks report that their money printing ways are not creating inflation. Ask emerging market central banks, and theyll tell you a different story. While it is certainly true that American Quantitative Easing 1,2,3 and 4 is creating very little inflation in the US, the effect on emerging markets is a different story. All of this newly minted money has to go somewhere, and one thing is for certain it certainly isnt going into the US domestic economy. Instead, financial assets are pouring overseas to Asia and driving up inflation, currencies and local property markets. While we disagree with recent conjecture that central banks will one day soon put an end to their money printing ways, one thing is certain the effect on emerging markets will not be kind. While much discussion is focused on US domestic financial markets, the American withdrawal of liquidity will have a severe effect on emerging markets. To further expand your financial horizons, one must also be contemplating the effect of Japans newly embraced money printing programs. Whereas America has committed to printing $2.67 billion a

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March 2013
The Crisis in Cyprus

Do you believe in miracles?

of whack. As such it really was no different than its bailed out predecessors. The reason Cyprus suddenly became different, had nothing to do with its finances, but everything to do with the upcoming German election. The growing discontent towards the debt crisis within Europe is a phenomena that is no longer being taken lightly in Brussels and especially in Berlin. Prior to Cyprus, every Euro-zone government had a solid hold over their country. Yet, first in Italy, followed by France and Greece and then Spain support for ruling governments started to turn. Greece almost broke the Euro shackles and escaped, and this deeply worried Brussels. Yet this was nothing compared to the election nightmare in Italy where not only did Brussels preferred candidate not win, he didnt even come close to winning. Instead, the political future in Italy rests with a new political party whose Euro skeptic vision is sending shivers up and down the Troika. Meanwhile in France, the rock-star status enjoyed by the newly elected president Francois Hollande has completely vanished. In fact, over 67% of people disapprove of his handling of the economy, and this just 10 months into office. Considering the French economy is firmly entrenched in recession (see Chart 2, next page), exactly how Mr. Hollande plans to ignite a turn around remains unknown.

leaders have become very effective at ensuring everyone and everything not called a bank will take losses. Private companies you are out of luck, line up for your losses. Wealthy individuals go cry elsewhere, you are directed towards the higher taxes line up. And for everyone else sorry, nothing for you either. Except instead of losses on your investments and or higher taxes on your wealth, you are forced to accept ultra low returns and the pleasure of having 3-4 generations of your family living under one roof again. The question on everyones mind today is can it get any worse? For the answer, look no further than Cyprus. Cyprus is easy to dismiss. While your financial advisor is telling you Cyprus is a tiny country with a tiny economy, tiny banks and a tiny debt problem dont worry; the non-herd following investment managers of the World understand there is much more at stake. However, what isnt so tiny is the resulting geopolitical, economic, and monetary ramifications. In Europe, the crisis in Cyprus has proved to be THE most important showdown thus far. While the situations in Ireland, Portugal, Spain and Greece were all mostly the same and somewhat different Cyprus was simply a product of bad timing. From a fundamental perspective, the mighty little tax haven was no different than anyone else. The governments finances grew out of whack while simultaneously its banking system grew even more out

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March 2013

Do you believe in miracles?

Chart 2: France Composite Output Index

France is now in recession

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March 2013
Cypus: new template

Do you believe in miracles?

Banks deposits have always been considered hands-off. The fact that many depositors in Cyprus are being levied 30-40% of their savings is a major turning point in the global debt crisis. This critical turn will have unintended consequences. For starters, deposit holders in every Euro-zone country is presently thinking whether they should move their money somewhere, anywhere beyond the reaches of Brussels. Savers in Italy and especially Spain must be making alternative plans not to, is simply irrational and irresponsible. Those who believe that the probability of having their deposits taxed in Spain, or Italy are really missing the point. Whereas prior to Cyprus, the mere mention of losses for depositors drew laughter and justifiably so. After all, there was nothing to base this fear. However, now the precedent has been set. The reason the Spanish banking system required a EUR 100 billion bailout, was due to the combination of banks losing billions on a collapsing housing market AND people withdrawing their deposits. Since the Spanish economy continues to decline, new strains are developing on the government and banking system which increases the probability of additional bailouts. This of course means the Cyprus template has now re-opened the deposit can of worms and the risk of money fleeing the banking system has once again returned. As a result, the risk of Spanish banks losing deposits is certainly causing jitters in Brussels. www.IceCapAssetManagement.com 6

Which brings us to Germany. The September 22, 2013 federal election is rapidly approaching. Although Chancellor Merkels coalition currently enjoys a cushion, distaste for additional bailouts is growing and the sudden emergence of a new political party is causing consternation for Ms. Merkel. Its for this reason that a new bailout using German tax payer money was risky indeed. Throw in the nuance of bailout money going to help uber wealthy Russians, and it is easy to see why Cyprus didnt stand a chance. IceCap will not recite the facts and storyline of the Cyprus bailout this information is readily available. We believe the most important question is whether Cyprus is the new template for European (and eventually global) debt restructuring? Prior to Cyprus, the European bailout model resulted in buckets of new debt for the underlying country combined with crippling spending cuts and tax increases. Any investment losses occurred for stock holders of the banks and in some situations the bond holders. Bank deposits were never in play. The Cyprus template changed everything. Now everyday, average people who saved their entire lives and never participated in the world of global finance are being forced to cough up some money towards the bailout and losing a part of their bank deposit.

March 2013

Do you believe in miracles?

Worlds reserve currency. The bulk of international trade occurs in USD, and USD debt is the deepest debt market in the World. Presently there is no alternative the USD is the only game in town. As capital shifts to the USD, we expect all asset classes to benefit. US Treasury bonds will attract a lot of institutional money, while the corporate bond market will also draw attention. The same can be said for high earnings quality and high cash flow stocks. Meanwhile, real estate will also be an obvious benefactor, as will other alternative forms of investments season tickets to the San Francisco 49ers new stadium anyone? As demand for everything USD develops, its important to remember this movement isnt a vote FOR the US, rather it is a vote AGAINST other currencies and countries. Does this mean Americas debt and fiscal problems will be fixed? Definitely not dont start believing in miracles just yet. In fact, our view on a strong USD is anything but a vote of confidence for the long-term health of the American fiscal and monetary pie. The US will continue to run large deficits and accumulate even more debt. In short, Americas money problems will continue not to improve. While these shifts in global financial assets are occurring, we suggest you keep your eye (and hands) on gold bullion. Our view towards gold hasnt changed. There are times to own gold and times not to own gold. It just so happens that the current global financial environment

You can check out anytime you like, but you can never leave
Naturally, Brussels considers itself a master of game theory and whether to tax or not to tax the depositors in Cyprus. In the end, they concluded the risk of Merkel losing the German election outweighed the probability of the bank deposit runs spreading elsewhere in Europe. With Slovenia up next on the bailout chopping block, well get to see whether the Euro-zone really is a Hotel California. The burning question is whether depositors will once again be invited to contribute to the bailout. Our guess is that Brussels is desperate to show that Cyprus was a one-off event and that depositors elsewhere in the Euro-zone are not at risk. Slovenia deposits should be safe. But seriously, if you have money in a Slovenian bank were pretty sure you are on the cusp of a major withdrawal. Chart 3, next page shows the result of the European bailout strategy. Overall, new debt that can never be repaid is forced upon tax payers all while higher taxes and reduced spending produces long lasting recessions. As long as Brussels continues to treat the symptoms of the debt crisis, the odds of resolution are slim and none. Over time, increasingly more and more private capital will leave the Euro-zone and seek relative safety elsewhere. Considering Britain and Japan are also fully engaged in money printing, currency debasement and bank bailouts, expect the same in these countries as well. This is where the USD comes into play. We believe over time, private capital will move towards the US. For better or worse, the USD is the

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March 2013
500% 400% 300% 200% 100% 0% Ireland 30% 25% 20% 15% 10% 5% 0% Ireland 5% 14% 25% 117%

Do you believe in miracles?

* IceCap estimate

Chart 3: The cost of Europes bailout

Debt to GDP
176%

471% *

68%

120%

107%

162%

Portugal

Before Bailout

After Bailout

Greece 27%

Cyprus 24% *

Unemployment Rate
8%

17%

*
7% 4% Cyprus

Portugal
Before Bailout

Greece
After Bailout

Source: IceCap Asset Management Limited, Eurostat www.IceCapAssetManagement.com 8

March 2013
A confidence game

Do you believe in miracles?

Gold bullion continues to trade within a fairly wide range and remains sluggish. Long-term fundamentals and sentiment models remain extremely positive for gold, yet we remain concerned with the shortterm technical picture. Like every other asset class, well adjust our gold strategy if needed. 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.

continues to present a very favourable situation for gold bullion and other precious metals. During the transition towards stronger demand for USD, we expect gold to trade within long and volatile ranges. Due to technicalities, many investors (mostly institutional investors such as pension funds, bank assets etc) cannot invest in gold bullion. For this reason, gold will increase dramatically against non-USD currencies but trade inline with USD. However, a point will eventually be reached where, just as investors lost confidence in EUR, Yen and GBP, they too will lose confidence in USD and then you will see surging prices for gold bullion. Bottom line dont be surprised by further USD strength, it will happen. Our Strategy One thing about IceCap Asset Management is our ongoing focus on transparency. For better or worse, we share with clients, non clients and other managers our investment strategy and provide critique when warranted. Our recent decision to increase equities in early December followed by a quick reversal of the trade in the middle of February remains correct. Global equities have zigged and zagged but remain at the exact same level since we last traded. Our sentiment models continue to guide us towards caution, and well retain this stance until conditions change in either direction.

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