Japan, Gold and the Euro Crisis

At last week’s Safety & Survival Summit, sponsored by Agora Financial, I discussed the great appeal of Japanese stocks. This next table below, from Symphony Financial Partners, which runs a Japan-focused fund, shows you the percentage of Japanese stocks that meet three tough valuation criteria:

 Three Criteria for Japanese Stocks

However, as the Symphony guys point out, “low valuations and cash-rich balance sheets are all chants we have heard before.” The common lament of an investor in Japanese stocks is that they are cheap and stay cheap, that the management teams do nothing to unlock the value in their companies, that they just sit on the cash or blow it on dumb projects.

So what’s different this time?

“The real change,” according to Symphony, “is the discernible increase in high premium M&A/MBO activity.” (MBO stands for “management buyout” and is when a management team buys out a company, taking it private.)

For the first nine months of 2011, there were more MBOs than in all of 2010. It looks like it will be a record year for MBOs in Japan. What’s interesting is the fat premiums they are paying to make those deals. On average, buyers are paying 50% above the stock market price!

In a September note, the Asian research firm CLSA, gave six reasons for the increase in mergers and acquisitions in Japan:

1. Japan is dirt-cheap.
2. The rules have been changed, with the specified aim of spurring M&A.
3. Companies have so much money it is burning holes in their pockets.
4. Even if companies don’t have the money themselves, banks are falling over themselves to lend them the money.
5. Corporate governance just overtook the US (40% of US companies have poison pills, 45% have staggered boards — which means it takes many years to fire the board — and 70% have golden parachutes. These are not problems Japanese investors have to handle.)
6. Rules on what constitutes a monopoly just got wildly more liberal — from the old, parochial domestic market view to taking a worldview of market share: Nippon Steel/SMI may have had a combined 40% share in Japan, but it had less than 3% global share.

Maybe, just maybe, a fire has been lit under Japanese shares…

Gold Stocks Still Lagging

A radio host asked me last week if I was a gold bug. I asked him what that meant. He said a gold bug was “someone who sticks with gold through thick and thin.” Based on that definition, my answer would be no.

I paid no attention to gold throughout the 1990s. It was a dead asset that seemed to only go down in price. I started to pay attention after the tech bubble burst and after then-Fed chairman Alan Greenspan began his loose money policies, driving interest rates lower and, thus, inflating an historic credit bubble. I was a definite gold bull by 2004. But I don’t plan to always be a gold bull. Gold is an asset like any other. It will go up… and it will go down. At some point, gold will be a sell again, but not yet.

I feel the same way about gold stocks. I don’t plan to always recommend them, but they are attractive now. In 2011, they have only gotten cheaper.

Year to date, the GDXJ, which is an index of small gold miners, is down 22%, even though the price of gold is up 18%! Clearly, small gold stocks are sucking wind. But at the current quotes, gold stock valuations are at lows we have not seen since the last great bottom in gold stocks in 1979.

Hang onto those gold stocks.

The EU Crisis

At the summit, someone asked me if I worried about the EU crisis now unfolding. I don’t remember the answer I gave exactly, but it wasn’t a good one. The problem with the EU crisis is that no one really knows much of anything. I think Pyrford International, a UK fund manager, hit the nail on the head in a September note:

“The euro — I think we’re now all heartily sick of reading about it. Everyone has a view, and everyone is profoundly ignorant at the same time. No one knows the answers — there is no template, no relevant past experience.”

I think that’s it. The EU crisis is extraordinarily complicated on a lot of levels. With 17 different countries that can’t seem to agree on much, it is hard to handicap an outcome. But the essence of the problem is that some of these governments — like Greece — borrowed money they cannot re-pay. So either the rest of the EU comes to its aid, or Greece defaults. A default means lots of losses for banks (and others) holding the defaulted debt.

There are several governments in trouble beyond just Greece. Portugal, Italy, Spain and others are in trouble, too. So do they all get bailouts? Or not? If the EU breaks up, then we’re talking huge losses and the probable disappearance of a number of banks. Just like in 2008 in the US.

What this means for US investors is not clear. It’s hard to imagine a prosperous US with the EU in such disarray. Surely, an EU meltdown would affect the US. How many skeletons do US banks have in the closet? Hard to say.

But I do think one thing happens inevitably: A whole lot of paper money gets printed to pay the bills, no matter what. Either the European Central Bank prints a lot of money to bail out everybody, or the individual European nations — abandoning the EU — start printing their own money again.

The Greek drachma, Italian lira, Portuguese escudo and Spanish peseta may return to the world’s monetary markets before the decade is out. Might this be good for hard assets of the shiny variety? Might the people of the EU buy gold and silver after watching their savings melt away? I think they will.

It’s another reason why gold isn’t a sell — and probably won’t be — for quite some time yet…


Chris Mayer,
for The Daily Reckoning

The Daily Reckoning