bmo transcript sep2010

8/10/2019 BMO Transcript Sep2010

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Don CoxeSTRATEGY ADVISOR,

BMO CAPITAL MARKETS

CONFERENCE CALL TRANSCRIPT

Don CoxeChairmanCOXE ADVISORS LLP.Chicago, IL(312) 461-5365email: [email protected]

September 3, 2010

The Call: Don Coxes Weekly Conference Callconducted exclusively for clientsand employees of BMO CapitalMarkets and BMO Nesbitt Burns

Now! Trade FX for Fun and Profit!! Levered a Hundred to One!!!

Thank you all for tuning in to The Call, which comes to you from Chicago.

The chart that we sent out was the DXY, (the US Dollar Index) and the

tagline is, Now! Trade Foreign Exchange for Fun and Profit Levered a

Hundred to One.

Forex Fascination

I want to discuss what is the latest appearance of what is equivalent of the

Pajamahadeen, (which is the traders from home in the speculative market)

and looking at whats happening in the forex market.

We havent talked much about that, and weve had big stories this week

from reports from the BIS and from various regulators about the sheer

extent of the explosion in currency trading, so I think thats worth

commentary.

US Dollar Index (DXY)September 1, 2009 to September 1, 2010

72

76

80

84

88

92

Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10

82.47

Source: Reuters


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Don Coxe Conference Call Transcript: September 3, 2010

Page 2COXE ADVISORS LLP.

Exceeding expectations

I knew we were going to have the payroll number, and not having any idea

really, as to which way the market was going to take it or what the data

would be, we could hardly feature that.

I will comment that obviously I am pleased that weve got this bullishness

in the market now on numbers that you never know until they come out,

what it was that the market either feared most or hoped for most, because

the numbers didnt look all that encouraging.

The unemployment rate edged up a tad and we werent adding jobs, but it

was not as bad as the worst fears were, so we got a nice bounce in the S&P

and in the BKX and the KRE and we got a big sell-off in gold and a rise in US

Treasury yields, so for the moment at least we are going into the Labor Day

long weekend with much more optimism about the US economy than we

had a few days ago, and thats a good thing.

Ill leave it to the economists to parse through the data and the comparisons

and the updates of the previous ones thats not our game, so Ill talk about

a few themes that I think are relevant to most of the investors who follow

these calls faithfully.

Newest bait

Beginning with the story on foreign exchange, Ive been watching

(unscientifically) that on financial websites in recent months, there were

more and more offerings of currency trading done by various banks and by

online brokers, with all sorts of technical vehicles that you could use for

profitable trading.

In recent weeks Ive seen (unscientifically because I am not much of a TV

watcher) more television ads about how you can trade foreign exchange 24

hours a day, 7 days a week, and that this is the way that you can make a lot

of money very fast.

Around the rulesagain

And for the retail traders it turns out that leverage of 50 to 100 1 was

freely available, so that meant that on a 100 1 leverage you had a 1% risein your direction, you doubled your money and these are on spot trades,

not futures (not the ones that show in the commodity indices) and therefore

they are not subject to leverage rules.


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They are apparently going to put the upper limit on that to 50 1, but there

had been talk it would have been 10 1, which the banks reacted to with

horror because you can bet the banks are making a lot of money by being on

the other sides of these trades.

Why is this of significance to serious investors?

Grand scale greed

Well, what you can bet is that once you get a whole bunch of new players

coming in using systems that were not in use in the foreign exchange

markets previously, that there will be irregularities developing and bad

signals.

In particular, we find out now that the algo-traders, (the algorithm traders)

the people, who gave you the flash crash and other such wonderful things

in the conventional markets, are rated as being behind the surge in dealing(which is at $4 trillion a day now) in the currency markets.

These traders are apparently making great bundles of money using their

algorithms, and all that we know about markets where the algo-players

eventually start to dominate it is that something big (and probably bad) is

going to happen in that market.

The algo-traders, (the ones who gave us the collapse of Long Term Capital

Management) that were a big factor in the buildup of liabilities in the

banking system, and theyve been a big factor in the wildly erratic behavior

of the stock market with big moves in each direction occurring far too

regularly, even on light volume as a matter of fact when you get lighter

volume, it means that their impact is even greater.

The reason its of importance to the kinds of companies that we follow is

that foreign exchange is a big, big item in the profitability of commodity

companies and they use various hedging devices, but when markets

become frenetic like this, then those kinds of hedges become more

expensive and more things can go wrong.

Woody Brock (who is an unconventional but absolutely brilliant economist,

who has seen things that other missed) a few years ago did a paper on

technical analysis in investing, and he analyzed its use in various asset

classes and concluded that there was only one asset class where it worked,

and that was in currency trading, and that currency traders lived and died

off their technical analysis.


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The evidence is that those who were good at it actually could make profits

more or less consistently, whereas he said of technical analysis, he was

skeptical of any sustained alpha from technical analysis in other asset

classes, whether you were trading bond futures or stocks.

Hook, line and sinker

We assume therefore that that fact that technical analysis was working

for so long in this, that thats one of the things that sucked people into it

for these even more sophisticated bits of technical analysis for the new

Pajamahadeen.

I only hope that for all those people that got wiped out in the tech crash and

got back into trading before the last crash, that they manage to exit from

their 50 to 100 1 trades before they get blasted.

Unintended consequences

My fear is that you add together these algo-traders and these

Pajamahadeens and something is going to happen where some sustained

news goes badly and were what we get therefore is really wild and erratic

foreign currency markets which put central banks in trouble in other

words that there is a feed-back effect when currencies behave badly.

Weve seen that in the desperate attempts of the Swiss bank to head-

off the rise of the Swiss franc against the euro the amount of money

that the Swiss bank has lost to date on this is huge relative to the GDP of

Switzerland.

A ticking time bomb

This is not all just theory or some market thats out there that doesnt

have an economic impact, and therefore a part of the system which up

until now has worked reasonably well, and provided a form of stability

and a mechanism for business people and commodity producers to hedge

their exposures, that this might be a market that actually becomes wildly

disorderly, that there are bankruptcies and then once again well find that

some bank got into trouble by having extended credit to people in other

words its the next accident waiting to happen.

I am certainly not going to tell people on the call that they shouldnt be

engaged in foreign exchange trading thats not the point, but it should be

related I believe to your views about the way the fundamentals are evolving,

as opposed to the short-term tergiversations that are going on in these

markets, when you now know that these markets are collectively dominated

by people trading off formulas and (or) technical analysis, something will

go wrong.


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With that caution, and hoping that those who are trading and who are on

the call have been making lots of money on it will continue to do so, Id like

to get on to the other big stories that we have.

History repeats?

In getting ready for the call about the topics of the week, because the

calls tend to deal with Page One stories, whereas inBasic Points(which

we are writing now and will be out next week) we try to deal more with

Page Sixteen stories or longer-term themes, I was struck by the fact that

by changing a few words here and there that a Tom Lehrer classic from by

boyhood is relevant.

With a few words added it begins,

Theyre rioting in Africa,

Theyre hurting in Spain,

Theres hurricanes in Florida,

And Russia needs rain

The whole world is festering with unhappy jerks,

The French pols hate the Germans,

The Germans hate the Turks.

Pelosi hates Tea Partiers,

South Africans hate the Dutch,

And I dont like anybody very much

Eurozone unrest returns

All of these are sub-stories that are going on in the markets right now, and

the story about whats happening in Germany about the new studies and

reports and so forth where a major banker who has completely challenged

the position of the Turkish minority in Germany and said Something has to

be done about it its just a whiff of racism coming out of a country which

can ill-afford to have even a whiff.

The French situation relative to the Germans is related to the question of

the succession to the leadership of the European Central Bank.

This is an important story because Jean Claude Trichet will be stepping

down next year and Mr. Weber of the Bundesbank is due to take over, but heis known to be a hard money man, so the fear is that if he gets in there (since

he has been generally a negative vote for the various bailouts that theyve

done) that whats going to happen is that a new euro-crisis will develop,

and that will be the fault of the Germans.


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Food fight

The rioting in Africa is part of the new problems that are developing in food,

and the lack of rain in Russia led to a story this week where Putin has more

or less announced Russia is not going to be a grain exporter through 2011s

crop, so what was a short-term (or a few week or a few month) embargo onRussian grain exports could last a long time, and the reason the rains are so

important is because they need dry soil for planting the winter wheat crops,

(which are crucial in the southern parts of Russia and those bordering the

Black Sea) and the lack of rains there has meant that too much of the soil is

dusty and could not sustain planting.

Thats been reinforcing the run-up in wheat, which has spread across to

the other grains and thats why the best-performing equity group lately has

been the agricultural sector.

The FAO has said that there is no new global food crisis like 2007, but aswe see, their own food index which back a year ago was 152 and 179.5 is

the most recent reading, and wheat which was 141 back then (the way they

measure it in euros per ton) is 231.

Inflationary impact

All of this is going to be a big effect on food prices, and we are seeing that

this comes at a time where weve also had strong meat prices.

Ordinarily if you have grain prices rising, you have meat prices falling

because most of the cost of producing a hog or a steer is the grains that feed

that beast, but looking at the prices although lean hog prices are down from

$86 in April, (where theyd rallied to) they are still up from $65 at year-end;

feeder cattle are at $115, up from $96 at year-end.

This is not a crisis or anything, but put these factors together and what we

are going to see is that global inflation numbers are going to be rising in

relationship (roughly) to what percentage of the consumer price index in

each country is food.

In other words as you go from the richest to the poorest, what you are

going to see is that whereas the rich countries are focused almost entirely

and maniacally on deflation, thats certainly not going to be the case in the

poorer countries and the Emerging Economies that includes the Chinas

and Indias of this world.


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Supply squeeze

This relates to the basic theme that weve talked about for years, as to

why we think that commodity equities deserve a very high place in equity

portfolios, because what they are based on is a scarcity concept, and

therefore that commodities should tend to have pricing power (relative toother sectors of the commodity indices) simply because there are so many

limits on increasing production of commodities, and so many things that

can go wrong.

The whole world versus my world...

You can say lots of things can go right (and thats true) but they are traded

globally, they are priced globally and therefore developments globally affect

them, whereas when we are talking about the deflation in the United States

and in Europe, the deflation is homegrown, and its driven at the margins

by their imports of low-cost goods from the Emerging Economies, but also

by their insipid economies, high levels of unemployment, and increasing

governments share of GDP.

Therefore its not a surprise that weve had this powerful rally in the

Treasury bond market (and getting yields down to where they were in the

Depression in the United States) at a time that countries that collectively

have billions of the worlds population are showing rising CPIs.

This is another example of the bifurcation in the world.

Rain is a four-letter word

Although we have a global economy, the rain falleth on the just and the

unjust alike, and if its not falling in the regions that are crucial for the

production of grains, then those who are most at risk get hurt, or if in the

case of Pakistan it falls too heavily, you have a true disaster.

This is a big country in terms of population its also big in terms of cotton,

so we have a 15-year high in cotton.

Fat profits for farmers

When you put all this together, you have to say that the Midwest of theUnited States, (whats between the mountain ranges) the cash crop farmers

in this region are having an amazing year an absolutely amazing year.


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With corn at $4.46, soybeans at $10.15, wheat at $7.21 (thats soft wheat

traded at Chicago) and $7.38, which is basically world wheat (the hard

wheat) these are big, profitable prices, and then when youve got cotton

at .89, up from .74 as recently as July, we are talking about a situation

where depending how much hedging the farmers did, (and all large-scale

farmers do a lot of hedging) their returns from their crops are going to be

spectacular.

So no surprise that everybody thats a supplier of inputs to farmers, the

producers of fertilizers, agricultural equipment, logistics, that these stocks

are on a tear, and obviously we did not predict the weather in Eastern

Europe and Russia, or the floods in Pakistan, we simply said that you need

to have exposure to this because it really has to be a situation where things

are close to good in most of the major grain producing regions of the world,

to drive grain prices down.

Two blocks from here at the Board of Trade (CBOT) where they first started

trading grains that was the pioneers in this its true, the old adage that

if its raining in Chicago, the price of corn will go down.

Thats an old maxim but its less true now that we have more global free

trade in grain than we used to have, so therefore what happens in Argentina

and Brazil and Russia has a huge impact here in Chicago.

Extraordinary influences abate

Whether its a coincidence or not, naturally as we are advisors to the Coxe

Commodity Strategy Fund (COX.UN) we were interested to see that thefund (which is moving up day after day) now was trading at where it was

just before Lehman crashed.

It took a long way to work its way back up there, but you remember that

the Lehman crash hit commodities worse than it did other financial assets,

because of $65 billion of assets that were frozen in the bankruptcy in

London where JP Morgan was the hypothecator on this, and they simply

unloaded commodity stocks and commodities and smashed the prices

down, and bankrupted some hedge funds and all of that, so that the

commodity stocks and commodities got hit worse than other financial assets

initially from the Lehman crash.


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Scarcity and surpluses

So that was the darkest of nights for us and for those who are commodity

enthusiasts coming back has been (as I say) a long road, and who knows,

some bad news may come to send us back down, but I think if we stick to

the scarcity concept, that there is just no way that we are going to havemassive oversupplies of the key commodities the way we have in industrial

goods and in services, where the combination of technology and slowing

consumer spending growth means that you have downward pressure from

above.

Today weve had this big sell-off in gold, which we should expect, but

its still not back to where it was at the end of August, this despite what is

considered the most bullish number that weve had in two months on the

employment side.

In the case of copper, (which is so strong at $3.50 here) its not so much thedemand side because the statistics from China indicated that China had

done a lot of its buying ahead, so weve had the sell-off when people were

coming out with estimates of GDP growth as low as 6% in China.

Conflict of calculations

Whats happening here is something that people who are not familiar

with commodity stock investing dont think about, which is that the Street

tends to add together the production capacity of the big mining companies

and then show what the supplies are going to be in a given year, then they

estimate what the growth or reduction in demand will be, and come upwith a price for the commodity going forward, which helps to explain why

it is that so many people on the Street always show much lower long-term

prices (that is after two years) than they show now.

On the basis of the way these are calculated, our theory, which is you invest

on the basis of unhedged reserves in the ground, you wouldnt buy any of

these stocks, because on the basis of the value of what these are supposed to

be worth a few years from now, they wouldnt be economic.

Mine management 101

The big four copper producers that are listed, (BHP, Xstrata, Freeport and

Rio Tinto) their production is down 12% this year, (as against the first half

of last year) and a whole variety of factors come into this, but the biggest

factor is reduced grades.


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Part of that is definitely done by the companies themselves weve talked

about this before, which is that when prices of a commodity are strong it is

good management to go to a lower grade parts of your ore body, because you

thereby extend the life of the mine.

This would apply to all the big companies, and since coppers productionis much more concentrated now than it was 20 years ago, then the good

mining management techniques of the mining engineers at the big firms

would say, We are making lots of money at $3 copper, we are getting lots of

evidence that China may be slowing down and weve got even more of the

economists predicting total collapse in China, so its prudent to be drawing

on lower grade sections of the ore body, but a lot of that is due to things that

also just are part of the business you get minor cave-ins or transportation

glitches anyway, thats a huge drop in production, and from the ones that

are most important in the world.

Switching sides

Therefore it was a supply-side driven rise in the price of copper rather than

demand side, which was the story from 2002 through to 2008.

Thats one of the reasons why the earnings forecasts for these companies

are always suspect because they are brilliantly done by the analysts these

people really know their business, but they use what they should use,

(which is the number of pounds being produced and what new ore bodies

are being brought on) and what you get is something where (as a result of

that) very few people predicted $3.50 copper in September, earlier this year.

Commodities: an endangered species?

Putting it together, the commodity story is a scarcity story in a world that is

far more productive in most other things (and therefore produces surpluses)

and when things go wrong with something where supply and demand are

closely in balance, the price moves can be big, therefore we believe there is

less endogenous risk.

In a world where the big industrial countries have excess supplies of labor,

industrial production rates are way below levels of high profitability for a

lot of the established industries this is the clearest-cut story of companiesthat should be able to continue generating high profits and paying down

debt, or as in the case of BHP, making a gigantic bid on the biggest supplies

of potash in the world, at a time that the duration of their other things that

they produce is tiny in relation to the duration of potash.


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Thank you all for tuning in Well talk to you next week.

The not-so-hidden value of reserves

We like to own the companies who have the reserves in the ground that

suggesting that if the stock market wont want to buy them, somebody

else will somebody thats got deep pockets or absolutely needs

the commodity, and that process continues as we see more and moreacquisitions by the Chinese of production facilities of commodities in

various parts of the world who knows, it could become a part of the

Potash story, but there s still perhaps a couple of chapters to be written in

that book.

Amber lights still flashing

We havent changed our views except that we are, despite this rally, more

concerned about the outlook for the US economy, because the problems

now (fiscally) have spread from Washington to the States, so its hard to

come up with an optimistic view for next year for the US GDP that would

justify the S&P at nearly 1,100.


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Page 12

THE CALL

The Call: Don Coxes weekly conference call conducted exclusively for employees and clients of BMO Capital Markets and

BMO Nesbitt Burns.

Published by: COXE ADVISORS LLP.

4th Floor 190 South LaSalle Street

Chicago, Illinois 60603

Web: www.CoxeAdvisors.comContact: Angela Trudeau, Editor

email: AT @CoxeAdvisors.com

Coxe Advisors LLP. Disclosure Statement

Coxe Advisors LLP. 2010. All rights reserved. Unauthorized reproduction, distribution, transmission or publication without the

prior express written consent of Coxe Advisors LLP. (Coxe) is strictly prohibited. Coxe is an investment adviser registered with the

U.S. Securities and Exchange Commission. Nothing herein implies that the firm is recommended or approved by the United States

government or any regulatory agency.

Information, opinions, estimates, projections and other materials (referred to collectively herein as, Information) contained hereinare provided as of the date hereof and are subject to change without notice. From time to time, Coxe publications may contain In-

formation with regard to securities, commodities, derivatives or other investment assets (each referred to herein as an Investment,

or collectively, the Investments), or investment strategies. Due to staggered publication dates, any Information contained herein

may differ from Information contained in prior or subsequent publications. Information discussed herein may have been obtained

from various unaffiliated third party sources believed to be reliable, but has not been independently verified by Coxe. Coxe makes no

representation or warranty, express or implied, in respect thereof, takes no responsibility for any errors and omissions which may be

contained herein, and accepts no liability whatsoever for any loss arising from any use of or reliance on such third party Information,

whether relied upon by the recipient or user, or any other third party (including, without limitation, any customer of the recipient or

user). Foreign currency denominated Investments are subject to fluctuations in exchange rates that could have a positive or adverse

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No Information included herein constitutes a recommendation that any particular Investment or investment strategy is suitable for any

specific person. Coxe publications are not intended as, and Coxe does not provide, investment advice tailored to the particular circum-

stances, investment objectives, and risk tolerances of any entity or individual. Coxe does not continuously follow any Investments or

their issuers even if mentioned in a Coxe publication. Accordingly, users must regard each Coxe publication as providing stand-aloneanalysis as of the date of publication and should not expect continuing analysis or additional reports related to such Investments or

their issuers. The Information contained herein is not to be construed as a solicitation for or an offer to buy or sell any referenced

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or as a recommendation to enter into any transaction.

Coxe and any officer, employee or independent contractor of Coxe, may from time to time have long or short positions in any Invest-

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publication, are restricted from entering into any transaction concerning any Investments discussed therein for the five days before and

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Coxe may enter into distribution agreements with various unaffiliated third parties to redistribute its publications. To the extent that

any publication is reproduced, redistributed, or retransmitted, Coxe is not privy to, and makes no representations regarding, such unaf-

filiated third parties positions in any Investments discussed therein. Any distributor authorized by agreement with Coxe to redistribute

this publication is not affiliated with Coxe. Third parties having permission to reproduce, redistribute, or retransmit Coxe publications

may offer to effect transactions in some or all discussed Investments. Coxe makes no recommendation with respect to the use of any

particular brokers or agents, and no such recommendation should be inferred by virtue of any distribution agreements that Coxe may

enter into with third parties.

bmo transcript sep2010

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