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May 2011 Investment Journal 
Bonds had a good month in May, with the Barclay's Aggregate Index rising .94%. Stocks were off, with the S&P declining by 1.35%. Gold slipped by 1.79%. The outlook changed over the month from a relatively bullish stance to a more guarded one, as stories of economic weakness became more prevalent. Especially noteworthy was the increased chatter about the upcoming "end" of the US Fed's policy of "quantitative easing" and how it might negatively impact the markets.

Investors were startled early in the month by a violent reversal in the prices of many commodities, especially silver, which lost 25% of its value over four trading sessions. We wrote last month about the "parabola" flavor of the April price moves, and were expecting some sort of sell-off. What is less known is the allegedly perilous state of JPM Morgan and/or its' clients, who had massively shorted silver below $35. As it hit $50, enormous damage was done to their net worth, to the point where it is believed the CFTC directed the CME to increase margin deposit requirements-four times in one week! The result was an engineered and immediate decline in silver designed to bail out distressed but systemically important players on the backs of speculators.
Oil also reversed hard, closing down 10% in one day, as those who had to post new margin collateral for silver had to scramble to sell other winning positions like oil which had not seen increased margin requirements. Sure enough, regulators then raised margin requirements for oil futures investors/traders, which sent oil even lower.

These actions all smack of forced liquidation, not a change in fundamentals in our view. With elections coming up, politicians need to break the back of rising gas prices and a sinking dollar. While near term damage has been done, the fundamentals of increased demand and reduced supply have not changed. The primary risk, however, is that regulators have decided to drive out speculators/investors from the hard assets arena and will impose any and all actions on a continuing basis to achieve their objectives. Watch especially for regular and successive increases in the margin requirements for all sorts of goods like oil, corn, wheat, copper, silver etc. for further clues to their stance.

The European bailout parade accepted its third participant on May 4, as Portugal agreed to terms of a $78 billion rescue package imposed by the IMF and EU, joining early adopters Greece and then Ireland.

Just a few days later, EU officials announced that the bail-out package announced last April for Greece would have to be re-worked due to their lack of reform and no progress in their economy, essentially shutting them out of the markets and rendering them unable to raise funds to pay off even a portion of their loans/bonds.  Most pundits predict that as much as 50% of the bonds par value will have to be written off, and an "extend and pretend" maneuver will accompany it (extend the original maturity and accrue the interest as if it were actually able to be repaid). Any decline in these bond prices hits the European Central Bank and various commercial banks especially hard, since they are the primary buyer of Greek debt.

This will all be politely referred to in the media soon as a "soft restructuring", or, even more creatively, "re-profiling". What you will not see is the deliberate use of these terms to avoid triggering payments required under "default insurance" provided by CDS (credit default swap) contracts. Similar to U.S. mono-line insurers like AMBAC and MBIA who guaranteed to "make-whole" mortgage investors if things went bad (they did), CDS are customized, over-the-counter contracts which investors purchase to protect against a decline in value -- clearly Greek bonds have declined haven't they? The only problem is that those who would have to fund these obligations are venerated state banks like Deutche Bank, Credit Agricole etc., who it is presumed have "laid off" their counter-party risk to others down the line. (This is the same line of reasoning that lead AIG down the rathole.) So the EU is creatively obfuscating and not permitting a technical default, while at the same time now calling for an outright ban on CDS (changing the rules in mid-stream). This is another example of the financial oligarchy which has hijacked national economies and markets to perpetuate the status quo. We don't think it will sit well with the good German burghers or average EU citizen.

The Irish, for example, are getting fed up. Renowned Trinity College Professor Morgan Kelly wrote an op-ed piece in the Irish Times on May 7 entitled "Ireland's Future Depends on Breaking Free From Bailout", urging Ireland to walk away from the EU/IMF bailout and for the government to immediately balance its budget. The article went viral and is a must read to get a sense of the end game that is coming in Europe (it is also a very well written and entertaining read):
In short, Kelly says that Irish taxpayers should not be made to pay for the cronyism and poor judgment exercised by politicians and certain segments of the privileged classes. It is time to repudiate the debt and create perhaps a new political party that will put Ireland first. Call it the new populism if you will.

This is the byline that will inexorably be played up by the Greeks, and the Portuguese, and perhaps even the USA eventually. Ordinary citizens are not going to hear of further "austerity" measures, which punish them for actions they have no control over, and which cripple their economies. (In Spain this month, as in Germany in April, voters handed the ruling Socialist party their worst electoral defeat in 30 years. The Socialists campaigned on a platform of (you guessed it) the need for further austerity measures!
Markets do not like uncertainty, and these battles for national sovereignty are going to heat up this summer. The future of the Euro is in serious doubt, and all eyes are now on Germany, which as the financial powerhouse of the EU, will have the final say about bailouts and restructuring. Keep the channel tuned to Radio Berlin!

We also want to point our readers to a wonderful piece of research produced by PIMCO entitled "Navigating the Multi-Speed World". It is a yearly "thought piece" that summarizes their thoughts on how the world should behave over the next 3 to 5 years, and can be read here:

Among other observations, they point out how advanced economies are punishing savers by keeping interest rates ultra-low, producing "negative real rates" of return (nominal rate minus inflation), which PIMCO calls "financial repression". They continue to advance the notion, which we have long subscribed to, that a changing world presents opportunities outside the USA and the typical "home bias" construction of most U.S. based portfolios. Or, as we say, the "global opportunity set" is in full on expansion mode.
Lastly, we can't help but note the enormous changes going on in the technology space with the concept of "cloud computing" and "software as a service". While Apple's iPad has made a huge splash, we think it is even more significant that they (and others) are moving with deliberate haste to create online, password accessible music storage vaults. This mirrors a trend that began in industry with the move to "paperless" offices. Soon the average user will not only be wireless and mobile, but won't need to store anything locally on their finite size hard drive. Goodbye iTunes, hello iCloud?

Thank you again for reading our Journal, and have a great month!
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