Fear and Loathing on Wall Street

Ah, I love the smell of fear in the morning! Stocks around the globe are getting hammered. So the only thing selling faster than stocks these days is replacement underwear.

The usual suspects are at work again. Greece is about done. The yield on 1-year Greek bonds rose to 82%. Think about that. That’s the market saying a Greek default is inevitable. But the problems, of course, don’t stop with Greece, or this wouldn’t be worth reporting. All of Europe is under a cloud. The banking system is on the verge of collapse.

Europe has the same problem the US did in ’08, except that in the US, banks held mortgage debt that was going up in flames and opening up huge craters in bank balance sheets. In Europe, it’s sovereign debt. In other words, European banks hold Greek government paper, and Italian government paper and Spanish paper and the rest.

Josef Ackermann, the CEO of Deutsche Bank, summed it up: “It is obvious, not to say a truism, that many European banks would not cope with writing down the government bonds held in the banking book to market value.”

As the value of those bonds collapses, European banks become insolvent. Those bonds are earning assets for the banks. Against those assets, banks have large liabilities to depositors. So if the bonds go poof, the bank is left with liabilities it can’t meet.

This is why the European Central Bank (ECB) has been buying bonds from the banks. This way, the bank gets a clean asset (cash) and transfers the junk on the ECB.

Recently, global bank regulators unveiled something called a “liquidity coverage ratio.” The regulators wanted banks to hold enough easy-to-sell assets to withstand a 30-day run on the bank’s funding (or deposits). An inability to do this is what doomed Lehman Brothers in 2008.

JP Morgan found that only seven of the largest 28 European banks met this test. By their measure, European banks fall short by 493 billion euros (almost $700 billion).

This is the doom we are under. And the list doesn’t end there. The US still has hideous fiscal problems and a weak economy. Plus, the big emerging markets are slowing down too.

What’s going up? Gold rising to $1,900 and $2,000 seems a cinch.

I was at a party on Saturday night. A friend of mine, knowing of my enthusiasm for the yellow metal, told me that he heard “gold is in a bubble.” I don’t think so. Not with all this stuff going on.

Besides, the Chinese are buying gold hand-over-fist. In 2010, they imported five times as much gold as they did in 2009. In 2011, they will top those figures. In China, the government actively encourages its people to own gold as part of their personal savings plans. And I will never forget visiting the Cai Bai gold market in Beijing. That place was hopping, just packed with people buying gold: gold figures, gold bars, gold coins, gold jewelry.

Gold stocks still lag the metal and remain a compelling buy. Jim Slater, the old corporate raider and now private investor, wrote a column in The Financial Times making a case for gold stocks. Slater compared gold stocks to companies dependent on consumer spending.

“Gold mining companies are benefiting from the tail wind of the gold price that is massively increasing their revenue and future cash flow,” he writes. “In contrast, companies that rely on consumer spending are likely to run into a very strong head wind. I know where I would rather have my money.”

To be clear, I don’t have an apocalyptic view of the world. Yes, US stocks just finished the worst August in a decade. And yes, we’re off to the worst September ever. But the underlying values of good assets and businesses fluctuate much less than the stock market. So during times like this, you are more likely to find wide divergences between stock prices and real-world values.

I’ll tell you this: My watch list is starting to make me salivate. It’s times like this that make me wish I had more money.

I’ve been buying into this decline personally. I’ve been trying to pace myself and go slow because I know that I am usually early. In 2008, I bought stocks and had most of my chips in by December. Of course, a nasty drop remained before we finally hit bottom in March 2009.

But the timing didn’t really matter so much. In the end, stocks I bought in late 2008 repaid me with at least a double in 18 months. It can seem like an eternity when you are going through it. Day after mind-numbing day of watching stuff drop. It’s especially painful when you look at something you picked up only a few months ago fall by a third.

Still, you’ve got to have resolve and confidence in the value of what you own or markets like these will just chew down your net worth as you bail out. You’ll miss, too, the inevitable rebound.

I remember putting money in an oil & gas stock (ATP Oil & Gas) in November 2008 only to watch it get cut in half by March 2009. But by September of 2009, that stock had tripled from where I bought it, and I booked a huge gain.

I remember seeing lots of stocks hit big air pockets in 2008, only to bounce back strongly. Not everything bounces back, of course. Inevitably, some stocks will break. But by and large, I expect the companies I have recommended to my subscribers to hold together.

Typically, the companies I recommend have good balance sheets with excess capital and/or generate strong cash flow.

And even the speculative companies I recommend have enough cash to advance their corporate development to the next level or are already at self-sustaining levels. The upside is tremendous on many of these. That’s why falling prices are often terrific buying opportunities. Successful investors are usually owners, not traders.

I have along list of prospective buys now. A lot of the market is still a “sell,” even after this summer’s selloff. But if you can sit still and wait a year or two (or dip in and buy), I think you will be repaid for your courage and cool-headedness amid the fear and loathing on Wall Street.


Chris Mayer,
for The Daily Reckoning