Tuesday, February 9, 2016

The Strange Case of 1MDB

Dear James,

I need to send a secure email to you on behalf of __________. I will not be using my usual email… To which email address should I send the message? You may have been informed that the government incarcerated me for six weeks…

More on that in my message.

Tq and God bless, __________.

The news came as a shock. My friend Jong Lee [not his real name] had been thrown in jail by the repressive Najib regime in Malaysia.

I quickly organized a separate encrypted communications channel so we could continue our dialogue. Of course, all message traffic is intercepted by U.S. and Malaysian intelligence services. But with the multiplicity of channels today, and military-grade encryption available to civilians, it is possible to maintain some privacy. One key is to switch channels frequently to stay “one step ahead” of intelligence intercepts.

Fortunately Jong Lee is safe for the moment, but his actions are under constant scrutiny by Najib’s henchmen. He could be arrested and interrogated again at any time.

I was in Kuala Lumpur, the capital of Malaysia during two separate visits in July and August 2015. While there I spent time with many of the most distinguished citizens of the country. They included former cabinet ministers, academics, central bankers and the billionaire heads of the leading firms in tin, rubber and palm oil — the leading resource exports of Malaysia. Those visits were my first acquaintance with Jong Lee.

The highlight of my first visit was a small group celebration for the 90th birthday of Tun Mahathir Mohamad, the prime minister of Malaysia from 1981–2003.

Mahathir is the single most important political figure in the history of Malaysia since its independence from the United Kingdom in 1957. Mahathir was in robust good health and cheerfully blew out the candles on his birthday cake.

Jong Lee had been with us at Mahathir’s birthday party. He was thrown in jail just weeks after I had last seen him. His crime? Peaceful, legal protest against one of the most corrupt regimes on earth led by the current prime minister, Najib Razak.

As late as 2013, Malaysia was regarded as a model democratic success story with robust growth, a stable currency, ample hard currency reserves and a steady flow of foreign investment.

Now, in 2016, Malaysia is a pariah. At least $2.4 billion of funds belonging to the people of Malaysia has been looted. The funds were looted from 1Malaysia Development Bhd. (or, “1MDB”), a Malaysian sovereign wealth fund. This looting was facilitated in part by Goldman Sachs, which raised some of the cash that was subsequently diverted.

The administration of Prime Minister Najib is the target of four separate criminal investigations. The focus of those investigations are 1MDB transactions being conducted by authorities in Singapore, Switzerland, Abu Dhabi and the United States. At least $700 million of looted funds were deposited directly in Najib’s personal bank account.

This story of corruption by the Najib regime in Malaysia is a cautionary tale for investors in emerging markets generally, and Malaysia in particular. While aspects of the global emerging markets growth story may seem appealing; greed, corruption and venality are never far from the surface.

Scandals can erupt at any time and quickly spillover into the larger political, economic and global arenas with unexpected consequences. Corruption risk is difficult to quantify — it’s like an unseen snowflake that starts an avalanche. Yet, a financial avalanche should surprise no one. There is always a potential avalanche waiting for a single snowflake to bring the whole mountainside crashing down.

The details of the Malaysian scandal have been widely reported by The Wall Street Journal, Bloomberg and local publications such as the Sarawak Report. Despite its mind-boggling complexity, the essential facts can be boiled down to a simple outline in plain English.

Sovereign wealth funds are special purpose vehicles set up by countries to manage their hard currency reserve positions. They differ from normal reserve management by central banks in that sovereign wealth funds are allowed to invest in stocks, bonds, real estate and other alternative investments.

Central banks are usually limited to short-term cash equivalents such as U.S. Treasury bills. Sovereign wealth funds exist all over the world and control trillions of dollars of investments.

Most sovereign wealth funds are fairly transparent, conservative and well-managed. 1MDB was set up as the Malaysian sovereign wealth fund in September 2009, shortly after Najib became prime minister in April 2009. Najib was not only prime minister, but also named himself finance minister. By doing so he controlled Malaysia’s politics and finances at the same time. The conflicts were obvious. Some protests were raised at the time, but no serious objections stood in Najib’s way.

In addition to Goldman Sachs, one of the facilitators of corruption at 1MDB is a shadowy figure called Jho Low. He is now in his mid-30s and originally from Malaysia. He went to school in London and attended Wharton before insinuating himself into the Najib inner circle in 2008.

With control of billions of dollars in 1MDB, and Jho Low at his side, Najib got down to the serious business of looting the Malaysian people.

In 2009, 1MDB invested $1 billion in a Saudi Arabian joint venture with PetroSaudi to launch energy projects. However, only $300 million was wired to the PetroSaudi account. The remaining $700 million was diverted to an offshore account controlled by Jho Low. 1MDB’s auditors, Ernst & Young, were later fired for raising questions about transactions at PetroSaudi.

In 2010, 1MDB sold its PetroSaudi stake for $2.32 billion and diverted the proceeds to a Cayman Islands fund. However, this and other PetroSaudi transactions consisted of paper transactions between affiliated entities designed to inflate profits while producing no cash. Meanwhile, the $700 million of actual cash from the original investment is still unaccounted for.

Najib next approached Goldman bankers at the Davos World Economic Forum in Switzerland in January 2013. He said he needed $3 billion in a hurry. Goldman underwrote a $3 billion bond issue for 1MDB in March 2013. It earned almost $300 million in fees, about 10% of the bond issue. That’s an extraordinarily large fee for a bond issue by a sovereign entity.

Just days after the bond issue was complete $681 million was wired directly into Najib’s personal bank account. The source of funds is unknown, although Najib claims it was a “gift” from an Arab friend.

Through the maze of transactions 1MDB managed to incur $11 billion in debts while losing money on many of its investments. It is unclear if the fund is even solvent today.

While discussing 1MDB with Mahathir, he asked if I had ever heard of a sovereign wealth fund borrowing money. I had done extensive research on sovereign wealth funds for the U.S. intelligence community over the years because of possible threats to U.S. national security.

My answer was categorical. I had never seen a case of a sovereign wealth fund borrowing any money. Borrowing is antithetical to the whole idea of a sovereign wealth fund, which is to manage assets, not incur liabilities.

The official corruption in Malaysia is pervasive. A former mistress of Najib was found murdered. The death was inflicted with military-grade explosives. The persistent rumor that I heard in Malaysia is that this murder was ordered by Najib’s wife, Rosmah Mansor.

If true, this presents the spectacle of the spouse of a prime minister intervening in the military chain-of-command to order the murder of an innocent civilian. Not since the days of Ferdinand and Imelda Marcos (and before them, Juan and Evita Peron), has husband-and-wife corruption run so deep.

Now the entire house of cards constructed by Najib and Jho Low is crumbling. Jho Low has disappeared (and is presumably in hiding). Many 1MDB and Najib-linked bank accounts have been frozen by authorities in Singapore, Switzerland and elsewhere.

But Najib’s response, rather than come clean, has been to double down with threats, firings and more cover ups. In rapid succession, Najib shut down local newspapers, fired his Deputy Prime Minister and replaced his Justice Minister.

Certain individuals with direct knowledge of relevant facts have gone missing and are feared dead. The independence of investigations has been compromised through firings and intimidation.

For now, there is little recourse for civil society in Malaysia. Najib remains firmly in control and struts around the world stage as host of ASEAN and other regional conferences in Kuala Lumpur.

Najib also reminds locals of his close personal relationship with President Obama (the two played golf in Hawaii last year). Malaysia got a boost from being one of the founding members of the Trans-Pacific Partnership (TPP), an important free trade zone including the U.S., Japan, Canada, Chile and a number of East Asian countries (pointedly excluding China).

TPP is the centerpiece of Obama’s free-trade legacy, and he has pursued cordial relations with Najib as part of his effort to secure the deal.

This entire turn of events is saddening. Malaysia is a potentially rich nation. In the short run, it is stuck in the so-called “middle-income trap” where per capita income has been lifted out of poverty, but seems stuck below the level of developed economies.

The everyday Malaysians I met are friendly and easygoing. They are well-aware of the corruption, but powerless to change government in the short run (the next elections are not until 2018).

Najib is not home free. The U.S. Federal Bureau of Investigation is pursuing the case from a money laundering perspective. The FBI has clear jurisdiction because of the U.S. presence of Goldman Sachs, and the use of the U.S. dollar payments system to effect the looting.

For investors, the lesson is clear. Malaysia is a “no go” zone for the foreseeable future. Huge investor losses were incurred there in 2015 not because the long-term fundamentals were bad (they aren’t), but because the short-run politics are corrupt.

Your worst enemy is not risk, which can be measured and managed, but uncertainty, which cannot. Political corruption and out-of-control greed emerging in an otherwise stable democracy make for a classic case of uncertainty. This uncertainty is not going away soon.

- Jim Rickards via the Daily Reckoning

Saturday, February 6, 2016

This IS Your S&P 500…On Inflation

Tangent Capital Senior Managing Director Jim Rickards discusses the S&P 500 priced in ounces of gold. He speaks with Adam Johnson on Bloomberg Television's "Street Smart."

Wednesday, February 3, 2016

The Case for Gold as the Fed ‘Tightens into Recession’

Saudi Arabia says it’s ready to cooperate on pulling back crude output and George Soros made some bearish comments on China. Ameera David weighs in. Then, Ameera is joined by Jim Rickards – author of “The New Case for Gold” – to talk about the Fed.

After the break, Bianca Facchinei takes a look at Sweden’s plan to deport at least 80,000 refugees. Afterwards, Ameera and RT correspondent Lindsay France talk about police surveillance. And in The Big Deal, Ameera and Edward Harrison discuss the latest in Brazil.

- Source, Russia Today

Thursday, January 14, 2016

Jim Rickards: Fed raised rates too late

Billionaire investor Sam Zell just joined a growing number of experts predicting a U.S. recession within the next 12 months, so Edward Harrison breaks down his reasoning for doing so. Then, Jim Rickards, editor of Strategic Intelligence and author of “The Death of Money,” offers his analysis of the IMF’s decision to classify Russia’s $3 billion loan to Ukraine as ‘intergovernmental,’ and why the Federal Reserve should have raised interest rates years ago instead of this week.

After the break, Danielle DiMartino Booth, chief market strategist at The Liscio Report, examines the housing markets impact on U.S. GDP numbers. George Howard, associated professor of music business at Berklee College of Music, then tells Ameera David why Taylor Swift is one of the few artists with the power to take on the growing might of the streaming music industry.

Monday, January 4, 2016

Rickards On Helicopter Money And Ariely On Confabulation

According to the latest World Oil Outlook from the Organization of the Petroleum Exporting Countries, the price of oil will only hit 95 dollars a barrel by 2040. And that’s because, there is a glut. It turns out there’s too much of it in the UK too -- so much so that oil tankers are being turned around mid-route. Ameera David reports. Then, to talk about the Fed, Jim Rickards is on the show. Jim is the editor of Strategic Intelligence and author of "The Death of Money.” Jim tells Boom Bust’s Edward Harrison about his belief that so-called “helicopter money” is coming as a policy response to a weak economy.

After the break, Edward talks to Dan Ariely, a professor of psychology and behavioral economics at Duke University and founder of the Center for Advanced Hindsight. Dan tells Edward about ways to prevent cognitive shortcuts from hindering our financial outlook and discusses his experience with the Internet platform Kickstarter. And in The Big Deal, Ameera and Edward discuss whether inversions are a legitimate way to go about reducing tax and whether tax breaks on the repatriation of overseas profits can boost the economy.

- Source, RT

Monday, December 7, 2015

Richards On China, SDR - "Next Panic Will Be Bigger Than The Central Banks"

Pfizer is now in advanced talks to buy Allergan, a rival drug maker, for as much as $150 billion and Petrobras is facing a $24 billion repayment over the next 24 months. Ameera David weighs in. Then, Ameera sits down with Jim Rickards – editor of Strategic Intelligence and author of “The Death of Money” – to talk about China.

After the break, Bianca Facchinei takes a look at how ISIS makes its millions. Afterwards, Ameera and RT correspondent Manuel Rapalo discuss how the American Medical Association wants to ban direct to consumer advertising of prescription drugs. And in The Big Deal, Ameera and Edward Harrison talk about risky IPO investments.

Thursday, December 3, 2015

The Time to Play the Oil Rebound is Now

The price of oil hit the Saudi target price of $60 per barrel by the end of 2014. But it kept going down. The price hit $45 per barrel in January 2015 and $40 per barrel by this past summer. That was due to normal market overshooting and momentum trading. It was also due to the fact that desperate frackers actually increased production to meet the interest payments on their debt even thought they were in the process of going broke.

The Saudis knew this was a temporary overshoot. The frackers could not get financing to drill new wells. Also, overpumping the existing wells would just make them disappear faster.

As soon as the price of oil crashed, another human bias began to creep into Wall Street analysis. The same prominent voices that earlier said oil would stay high were now saying it would keep dropping!

Some well-known analysts were calling for $30 per barrel oil; one analyst even set his target at $15 per barrel. These low-ball figures were just as much off base as the earlier expectations of $130 per barrel oil. In fact, the Saudis had things mostly under control.

Using our market intelligence, we could see that when oil hit the $60 per barrel level (as it did in early May), it would soon head down again. When oil got too low (as it did in late August at $38 per barrel), it would soon head up. This analytical frame based on our intelligence sources has proved to be a highly accurate short-term predictive tool.

Absent a geopolitical shock in the Persian Gulf, oil is not going to $100 per barrel, and it’s not going to $30 per barrel. It will remain in a range of $50-60 per barrel (with occasional overshoots for technical reasons) until 2017. That’s how long it will take to destroy the frackers.

After that, the Saudis can gradually increase the price without having to worry about lost market share.

This story has been bad news for frackers and even worse news for leveraged commodities traders such as Glencore. Are there any winners? The answer is yes, but it takes some detachment from the herd to see who they are.

The oil industry is permeated in gloom right now because of oversupply and weak demand. Small producers are going out of business and a wave of energy-related bond defaults is about to wash over the fixed-income markets.

Who wins in this scenario? The answer is that the major global oil producers win. They have the diversification, financial strength and hedging ability to weather the storm.

The majors can bide their time and pick up oil assets for pennies on the dollar once the frackers file for bankruptcy. They also have close relations with the Saudis (through Saudi Aramco, the state-owned energy company of Saudi Arabia). This means that they are insiders when it comes to strategies such as the plan to destroy the frackers.

Because of human biases and crowd behavior, the stock prices of the major oil companies have been beaten down along with the price of oil and the stock prices of smaller players.

But the oil majors are in a league of their own and are positioning themselves to benefit from the rebound of prices in late 2016 and early 2017.

The time to play this rebound is now, not when the crowd catches on.

All the best,

Jim Rickards

Monday, November 30, 2015

Oil, Defaults and Human Behavior

Economics has been greatly enriched by the spread of behavioral insights.

Until the 1990s, economic analysis was dominated by ideas such as “efficient markets” and “rational expectations.” These doctrines were based on the notion that people were robots and would act to maximize wealth in all aspects of their behavior.

It was assumed that if markets were declining, rational investors would enter the market to scoop up bargains. This behavior would tend to stabilize markets and reduce volatility.

It turns out that human behavior is far from “rational” (as economists define it). As the result of some ingenious social science experiments conducted by Daniel Kahneman and others in the 1970s and 1980s, it has been demonstrated that people act in accordance with all kinds of biases and irrational impulses.

If markets are crashing, most investors will panic and dump stocks rather than look around for so-called bargains. More often than not, human behavior tends to amplify extreme movements rather than calm them down.

These biases come in many forms. There is herding (the tendency to follow the crowd), anchoring (the tendency to give too much weight to a particular event) and confirmation (the tendency to embrace data that we agree with and ignore contrary data).

If the crowd tends to be irrational, is there a way for you to remain focused and exploit the irrationality to your advantage as an investor?

The answer is yes, but only if you can overcome the biases of human nature. You need to look for signals (what we call “indications and warnings”) that show you what is really going on.

There is no better example of the tug of war between human bias and market fundamentals than the oil market.

Remember $100 per barrel oil? It wasn’t that long ago. As recently as July 25, 2014, less than 15 months ago, oil was $102.09 per barrel.

What kind of behavior did this high price produce? Many oil producers assumed the $100 per barrel level was a permanently high plateau. This is a good example of the anchoring bias. Because oil was expensive, people assumed it would remain expensive.

The fracking industry assumed oil would remain in a range of $70-130 per barrel. Over $5 trillion was spent on exploration and development, much of it in Canada and the U.S. This led to a flood of new oil, which reduced the market share of OPEC producers. Saudi Arabia was losing ground both to OPEC competitors and the frackers.

In mid-2014, Saudi Arabia developed a plan to destroy the fracking industry and regain its lost market share. The exact details of the plan have never been acknowledged publicly but were revealed to your editor privately by a trusted source operating at the pinnacle of the global energy industry.

The Saudi plan involved a linear optimization program designed to calculate a price at which frackers would be destroyed. But the Saudi fiscal situation would not be impaired more than necessary to get the job done.

A $30 per barrel price would surely destroy frackers but would also destroy the Saudi budget. An $80 per barrel price would be comfortable from a Saudi budget perspective but would give too much breathing room to the frackers. What was the optimal price to accomplish both goals?

Such optimization programs involve many assumptions and are not an exact science. Yet they do produce useful answers to complex problems and are much more reliable than mere guesswork or gut feel.

It turned out that the optimal solution for the Saudi problem was $60 per barrel. A price in the range of $50-60 per barrel would suit the Saudis just fine. That was a price range that would eliminate frackers over time but would not unduly strain Saudi finances.

What makes Saudi Arabia unique among energy producers is that they actually can dictate the market price to some extent. Saudi Arabia has the world’s largest oil reserves and the world’s lowest average production costs. Saudi Arabia can make money on its oil production at prices as low as $10 per barrel.

This does not mean that the Saudis want a $10 per barrel price. It just means they have enormous flexibility when it comes to setting the price wherever they want. If the Saudis want a higher price, they pump less. If they want a lower price, they pump more. It’s that simple. No other producer can do this without depleting reserves or going broke.

- Source, Jim Rickards via Daily Reckoning

Wednesday, November 25, 2015

A Massive Wave of Defaults

Debt comes in many forms, including high-quality US Treasury debt, high-grade corporate debt and junk bonds. Debt is also issued by both US companies and foreign companies. Some of the foreign corporate debt is issued in local currencies and some in dollars. In discussing debt defaults, it’s necessary to keep all of these distinctions in mind.

The US companies sitting on hoards of cash, such as Apple, IBM and Google, are not the ones I’m concerned about; they will be fine. The defaults will be coming from three other sources.

The first wave of defaults will be from junk bonds issued by energy exploration and drilling companies, especially frackers. These bonds were issued with expectations of continued high energy prices. With oil prices at $60 per barrel or below, many of these bonds will default.

The second wave will be from structured products and special purpose vehicles used to finance auto loans. We are already seeing an increase in subprime auto loan defaults. That will get worse.

The third wave will come from foreign companies that issued US dollar debt but cannot get easy access to US dollars from their central banks or cannot afford the interest costs now that the US dollar is much stronger than when the debt was issued.

The combined total of all three waves — energy junk bonds, auto loans and foreign corporations — is in excess of $10 trillion, more than 10 times larger than the subprime mortgages outstanding before the last crisis, in 2007.

Not all of these loans will default, but even a 10% default rate would result in over $1 trillion of losses for investors, not counting any derivative side bets on the same debt. This debt will not default right away and not all at once, but look for a tsunami of bad debts beginning in late 2015 and into early 2016.


Jim Rickards

Friday, November 20, 2015

Jim Rickards Personal Portfolio

My personal portfolio is a blend of cash, fine art, gold, silver, land and private equity. I do not own any publicly traded stocks or bonds, partly due to restrictions under various regulatory requirements applicable to my role as a portfolio strategist and newsletter writer.

The mix in my portfolio changes from time to time based on valuations of the particular asset classes. My recommended mix is 10% precious metals, 10% fine art, 30% cash, 20% land and 30% alternatives such as hedge funds, private equity and venture capital.

Currently, my personal allocation is overweight land, fine art and private equity and underweight cash and precious metals. However, this will change, because the fine art fund is currently making profit distributions, which are being reallocated to gold, at what I consider to be a good entry point, and to cash.

All investors should be able to purchase precious metals and land and hold cash without difficulty. Alternatives such as hedge funds, private equity and venture capital are not open to all investors, because they are frequently traded as private funds limited to accredited investors with high minimum subscription amounts.

There are also publicly traded equities such as high-quality bond funds and companies holding hard assets in energy, transportation, natural resources and agriculture.

- Source, Daily Reckoning

Sunday, November 15, 2015

Jim Rickards: Oil Shocks & The Global Economy

Jim Rickards appears on Russia Today, where he discusses global growth and the ongoing slowdown in China. Is the Death of Money on the way?