An article in the English-language of the German der Spiegel newspaper reported that the billion-dollar Sovereign Wealth Funds (SWFs) have lost up to 25% of their value – depriving the markets of a major cash source.

For those of you unfamiliar with SWFs, they are state-owned investment houses whose charter is to protect any budget surplus with prudent investments. The commodity boom of the past few years has filled the coffers of SWFs rich in raw materials such as oil, natural gas and metals.

Thought to be impervious to market swings, SWFs were held up as secretive groups with an uncanny knack for finding the best investments. That reputation blew up, however, when SWFs started to prop up Merrill Lynch, Citigroup and other big investment banks that ultimately lost a bundle.

These once-infallible mega-investors are now liquidating as they try to save their butts. In the process, money that they would have allocated to major investment projects such as commercial real estate, banking, oil exploration and other cash-intensive endeavors is simply going away.

The implications for both emerging and industrialized markets are profound, fueling speculation that the economic malaise could last longer than previously anticipated.

The article in der Spiegel reports that Norway’s $300 billion Government Pension Fund-Global, was down 7.7 percent in the September quarter. It was the worst performance in the 18-year history of the fund, which invests Norway’s oil revenues.

All told, SWFs have lost 18% to 25% this year alone, according to der Spiegel story. That could mean some $700 billion in cash has been taken out of the global investment pool.

The Abu Dhabi Investment Authority, perhaps the world’s biggest SWF, may have lost up to one-third of its $900 value, the German newspaper said. Things were bad in other Mid-East SWFs as well.

The Kuwait Investment Authority lost about 30% of its $250 billion reserve, although $50 billion of those losses may have been recouped with a new infusion of oil money. The Qatar Investment Authority is thought to be down 20% in 2008.

As the recession continues, where will new money come from? Well, it seems that taxpayers are picking up where the oil sheiks left off with bailout campaigns going on all over the world.

Freddie and Fannie are huge government-chartered mortgage lenders. In 18th century France, speculators bet on the riches of Louisiana, through the government-chartered Louisiana Company. In the 19th century, they wagered their money on the riches of India, through the government-chartered Eastn India Company. And in the 20th century, they gambled on rising housing prices through Fannie and Freddie.

The immediate problem is that the mortgage lenders are running out of money. They need to raise $75 billion. A few years ago, that would have been no problem.

Everybody was ready to put money into America’s go-go, securitized housing market. But then, housing went.

Yesterday’s news tells us that housing prices are falling in 23 out of 25 U.S. metropolitan areas. That, according to Case/Shiller. Foreclosures are still rising at a faster and faster pace. Etc. Etc.

(We’re sparing you the details…we don’t want to upset you too much, dear investor.)

So now, Freddie and Fannie have a problem. They need to raise money – a lot of it. And now it has become “very difficult,” say the experts, to raise that kind of dough. Investors are slowly putting two and three together. The pair of mortgage lenders needs more cash. Their industry is in full flight. Their capital is disappearing.

Their collateral gets marked down every month: “Hey, maybe we should sell the stock!” The result of these deliberations was a bad day on Wall Street for the twins, bringing total losses into the billions for remaining stockholders, who were too slow or too dull to sell their shares.

And for the faithful and/or delirious masses who continue to cling to their Fannie and Freddie shares, the bad news has not yet abated. The giant mortgage lenders must still raise even more capital to cover their mounting piles of defaulting mortgage debts. Freddie and Fannie still need to raise money…lots more money. And if a report leaked from Bridgewater Associates turns out to be correct, so will a lot of other businesses…and governments. Bridgewater’s confidential memo – which got out to the Swiss press and then made its way to Ambrose Evans-Pritchard at The Telegraph in London – says that losses from the credit crunch could go as high as $1.6 trillion…four times as high as official estimates from the IMF.

And it only gets worse…

One trillion, six hundred billion dollars is a lot of money. If Bridgewater is right, the whole financial sector will be gutted. You’ll remember, dear investor, after manufacturing pulled out of America, the financial industry was left. And retail. Housing. Services. And not much else. The center of economic power shifted from Detroit and Trenton – where they made things – to Manhattan, where they financed them. Mothers ceased wanting their babies to grow up to be CEO of General Motors; they wanted them to go to Wall Street. That’s where the real money was. Finance was the key not only to huge profits itself, but also to the growth of the retail and housing sectors. People bought durable goods and consumer goods on credit. No credit; no purchases. No purchases; no consumer economy.

Well, now GM has lost 75% of its value…and the financial industry is not far behind.

Well, Bridgewater goes on to say that a $1.6 trillion loss in the financial industry will mean a loss of $12 trillion in credit to the economy as a whole. When the lenders don’t have capital, they can’t lend it out. Typically, they lend $10 for every dollar of capital. So if a dollar of capital is wiped off their balance sheets, as much as $10 of credit is erased from the economy.

Here in Europe, we’re used to high prices. One billion? Heck, we spend that much on lunch. But $12 trillion begins to sound like real money. And $12 trillion taken out of the U.S. consumer economy begins to sound like the Great Depression. Like Japan, 1990-2006…only worse. Collapsing asset prices. Rising unemployment. Bankruptcies. Defaults.

Of course, no central bank or government will go into that good night without a fight. The Fed will cut rates…and lower reserve requirements…and probably intervene directly in markets. Banks will be effectively nationalized…The federal government will increase borrowing and spending to try to offset the money disappearing from the markets and the economy.

What about the foreigners? What about Sovereign Wealth Funds? They’ve got a lot of money. Couldn’t they help recapitalize the credit system? Alas, the SWFs have only $3 trillion currently. And the foreigners? Our guess is that when they realize what is happening they will be desperate to get rid of dollars and U.S. paper of all sorts.

Instead, they’ll want real resources, factories, brands, concrete and land. And they will have a great opportunity. As asset prices fall, they will be able to buy more valuable properties in America at bargain prices. Already, Abu Dhabi bought the Empire State Building. A Belgian brewery, run by Brazilians, is buying Budweiser.
More to come…

How’s our “Trade of the Decade” doing? Eight years ago we suggested you sell stocks and buy gold. The bull market on Wall Street was over, we thought. A bull market in gold was just beginning.

As far as we can tell, we were right.

The S&P is down about 20% from its high…which puts U.S. stocks barely lower than they were in 2000. But adjusted for inflation, the loss has been spectacular. Remember, oil has gone from around $10 a barrel to around $140 a barrel. Everything else has gone up too. Even by official CPI numbers, the year 2000 buck is worth only about 80 cents. And the dollar against the euro is down about 40%.

Real bear markets typically last 10-15 years. This one has another few years to go. These should be the most interesting ones. Commentators are already looking for a bottom in the stock market. They may have to wait a long time.

An ounce of gold would buy the whole Dow in 1926…again in the 1930s…and once again in 1980. If gold stays where it is, the Dow would have to drop below 1,000 for the gold/Dow ratio to return to one. More likely, the Dow will drop and gold will rise to meet it. In 1999, gold bottomed out at around $260 an ounce. Since then it is up nearly 5 times. The U.S. money supply, however, has gone up 11 times. So, our guess is that there’s plenty of upside left for the stuff they make dental fillings out of. If it were to equal the increase in M3, its price could rise to $2,700 or so.

This is all guesswork, of course. But the Trade of the Decade still looks good to us. Gold and the Dow will probably come together somewhere north of 3,000….

Source: The Woes of Fannie and Freddie

It seems that Russia has tens of billions in free cash on hand, an amount that could become hundreds of billions in the next few years. It was only a decade or so ago that Russia had defaulted on its debt, looking like a financial basket case to all the world. But now, thanks to a gusher of oil and gas money, the Bear is rich — filthy rich.

It’s a great problem to have, but it still counts as a problem: What to do with all that dough? Like other cash-rich sovereign wealth funds, or SWFs for short, Russia plans to invest its massive pile in high-quality foreign stocks around the globe.

In case you haven’t noticed, the truly exciting growth these days is no longer confined to the U.S. and Europe. Instead it’s found in countries like China, India, Brazil, Malaysia, Taiwan, Turkey, South Africa and so on. Emerging market economies are growing by leaps and bounds.

In this 21st-century world that looks so very different from the 20th, the best combination of safety and growth can be found in strong international companies… the same type of companies that Russia will be plowing its cash into.

Justice Litle

Editorial Director, Taipan Publishing Group

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MAXJet, Eos and Silverjet set up as specialist business class operators. MAXjet began in 2003 and went bust in 2007. Eos, the name of a Greek god of the dawn, set up in 2004 and went bust last Sunday. In Greek mythology, Eos opened the gates of heaven every day. Sadly, its modern day equivalent just passed through them.

The UK’s AIM-listed Silverjet is the last one standing. For how long we wonder? It began operations in 2006 and Air crew website Cabin Managers strikes a cautious note. It is warning against applying for work there until the “financial picture improves”. Two proxies presumably serve to monitor the situation. The oil price and the share price. Oil is $117 and the shares, from a high of over £2 last March, now trade at 14.5p.

It’s shopping time for the world’s most celebrated investor and it certainly isn’t airlines. Indeed, a capitalist present at the inaugural flight of the Wright brothers would have shot them out of the sky, Warren Buffett once quipped.

But for the world’s greatest investor prices have come down, and it’s the moment to be greedy when others are fearful… especially when you’re sitting on a $40bn cash pile.

Buffett likes simple businesses he can understand. He likes globally recognised brands with staying power and significant ‘economic moats’ too. And he certainly didn’t become the business world’s equivalent of Croesus without recognising a good price when he sees one. Mars and Wrigley have ticked all the right boxes

Buffett has chipped in $4.4bn to Mars’s (think Mars bars, Snickers, Twix, M&M and more) efforts to buy chewing gum maker Wrigleys (think Spearmint, Jiucyfruit, Orbit, Hubba Bubba and more).

Mars is offering $23bn all told. Buffett will secure a 19% stake in Wrigley for a “discounted” $2.1bn reports The Times today. The combined Mars/Wrigley group will overtake Cadbury’s to become the largest sweet maker in the world with over 14% of the market from $27bn sales.

The spotlight now falls on the prospect of consolidation for other Charlies running chocolate factories. The UK’s Cadbury Schweppes is shortly to be demerged into chocolate business London-listed Cadbury plc and US-listed soft drinks maker Dr Pepper Snapple. Speculation is increasing that a deal between the newly demerged Cadbury and Hershey could finally happen following talks that came to nothing last year. Interesting to note that, from a quick scan of the numbers, Wrigley managed to make almost three times Hersheys’ net income last year on sales only 8% higher.

So in Mr Market’s eyes Hershey is worth slightly more than a third of Wrigley, yet in 2005 and 2006, we find the a rather different comparative performance. Hershey’s sales exceeded Wrigleys, and in 2006 it made more money

The Times describes Warren Buffett as the world’s richest man, with a fortune of $62bn. Though he’s not the richest in terms of family wealth, according to the latest Sunday Times rich list last week-end. India’s Mukesh and Anil Ambani (who?) sit atop an $86bn petrochemicals fortune. Top of Britain’s rich list today is another Indian family – the Mittals, with an estimated £27.7bn fortune from steel. Ten years ago the Sainsbury family topped it with a £3.3bn retailing empire. In a decade or so no doubt we’ll gawping at the world’s first trillionaire. Or maybe less given the accelerated rate at which petrodollar wealth is being amassed.

And petrodollar wealth is showing up in state managed wealth too. The world’s Sovereign Wealth funds – in good part recycled petrodollars – could exceed the US economy (est. $13.8trn) in seven years time reports the Guardian. In 2007, their collective value rose 24% to $3.5trn from an estimated $0.5trn in 1990, according to the IMF. In fact, they have been growing at 24% a year for the past three years. Says Jan Randolph, head of sovereign risk at Global Insight:

“Armed with such large amounts of debt-free cash, sovereign wealth funds are the new financial power brokers, replacing the combined financial muscle of hedge funds and private equity, and usurping central banks as the international capital providers of last resort.”

So move aside Bernanke, Trichet, King and co and here comes the new muscle with a bulging wallet.

More than 20 countries have established SWFs says the International Monetary Fund, but they sound relaxed about their growth. In the greater scheme of things, $3.5trn isn’t such a huge sum when set against the estimated value of US securities at $50trn, or the global value of traded securities at $165trn.

Regards,

Rob Mackrill
The Daily Reckoning

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