During a time of compressing commodity prices, Don Coxe, Chairman of Coxe Advisors LLP, was kind enough to share insight on the state of the market. He expects we may begin to see hoarding develop in select commodities, similar to 2008-2009, against a backdrop of capitalism “laying in its death bed”—a result of on-going monetary stimulus.
Here are notes from his conversation with Bull Market Thinking’s Tekoa Da Silva:
Tekoa Da Silva: Don, something fascinating you published back in 2012 in the final issue of Basic Points called “The Final Problem,” was you used the analogy of Western capitalism being on its deathbed and if one were to look at the long term chart of US Treasuries, one might prepare flowers for the widow.
With rates climbing higher here Don, is the patient of Western capitalism waking up out of its coma–or is it getting ready to keel back over again?
Don Coxe: Well, that’s really hard to tell because I don’t feel capitalism can revive as long as what we call the financial heroin is flowing, and the analogy I have used for three years is the experience of my father in World War Two as a battlefield surgeon. He did more battlefield anesthetics than any other Canadian doctor for which he was cited and the anesthetic for severely wounded soldiers was heroin which was legal.
He said it wasn’t much of a challenge about choosing who was put on the heroin. The skill came in taking them off, and putting them on morphine or a lesser anesthetic because the soldier would still be in great pain and they would scream and protest, but you had to take them off, otherwise they would become addicts—they would be useless as soldiers and they would be sent home. They would be unable to function in family life, and their lives would be destroyed.
When I used that analogy speaking onstage three years ago with former Bank of Canada governor, David Dodge, he said it was a great analogy and it was absolutely right—that central banks should not wait long to go back to normal monetary policies otherwise the patient will have become an addict.
So, what we saw [last month] was that one speech by Bernanke [caused] a breakdown in the Treasury bond market, a huge sell-off in the stock market, a sell-off in the commodities markets, and great screams of protest.
To me, this is a really bad sign because the whole key to how capitalism functions is the pricing of risk and if you take the risk out of the system by having a zero interest rate, that encourages all sorts of bad practices, and as [an example] for the last five years, junk bonds have outperformed Treasury bonds by a dramatic margin.
They out performed AAA, AA, and A-rated corporate bonds; and those are the bonds of the companies that actually build society. Furthermore, because of these low interest rates, the great technology corporations have been borrowing large amounts of money not to invest in their businesses but to pay dividends and buy back stock. In other words, this isn’t the stuff of growth. This is the stuff of complacency.
So my fear is that the longer we stay on these zero rates, the more flaccid and flabby and flatulent capitalism will be.
TD: Don, when we consider the pain of getting a couch-potato exercising again–what might be the sweat and tears the economy might experience? Skyrocketing interest rates or complete collapse of the equities markets?
DC: I don’t visualize anything so apocalyptic but…this is the first time where we’ve had the central banks uniting together to try to rob capitalism of its basic élan vital in the interest of protecting the losers in society and those that are hurt.
The hedge funds and the shadow banks have become all too powerful in the system. So charge them money for what they’re doing and that will help to let capitalism sort out its winners. To me, what we’re putting at risk is capitalism itself. This system has been around since Adam Smith’s time and his principles have been pretty much understood.
What we’re [also] doing is we’re adding to the number of people on disability which is full benefits for everything at a far faster rate than we’re growing the economy or reducing the number of unemployed. This is speaking of the USA.
So we’ve got to go through some pain just as the soldiers [did]. When the soldier was recovering, my father would take away the heroin and give them morphine. They would scream and protest but in a few days, they would be back up and walking around again.
So it can’t be done without some pain but the horrifying thing was that even the talk that it was going to be done some time in the future was enough to get all these people rushing about.
The analogy I’ve been using is Chekhov's gun. Chekhov said if there’s a gun on the wall or on the mantelpiece on the first act of the play, it will be used in a later act, probably the last act. When the gun is used, the position of all the characters, virtually all the characters in the play will be irrevocably transformed.
So Ben Bernanke made the first hint last fall that there was a gun on the wall and last month he took the gun down and polished it up. That’s all he did and he put it back.
But that’s enough to make people realize that the gun is going to be fired. As far as I’m concerned, they can’t fire it too soon. I don’t want this play to run as long as the Mahabharata.
TD: Don, you’ve also pointed to the epidemic of pensions investing in bonds with inadequate yield to meet their actuarial requirements. Are you hearing nervousness coming from those communities over the past couple weeks?
DC: Oh, absolutely. Absolutely. I speak at pension conferences quite frequently and they’re all feeling desperate. They say, “We cannot meet our liabilities,” and so right now, the major pension fund groups are making applications to, in this country, the Pension Benefit Guaranty Corporation, about trying to find ways to stretch out the application of the rules because the typical corporate pension plan assumes seven percent compounded returns.
But that’s extremely difficult to achieve. But as I was pointing out in the last [month], Ben Bernanke did a series of speeches at Princeton last year which have been printed up…and he was asked, “What about seniors who save through insured bank accounts, and the pension funds who can’t reach their liabilities?”
Bernanke said, “We have two mandates. One is we’ve got to fight inflation and number two, is we have to promote a reasonably strong economy. What you’re talking about is in effect collateral damage but those are the two mandates we have to meet. We are aware of the impact on those two groups.”
[So] they aren’t worried about inflation at all now. [If] they will keep interest rates at zero for another year, every day in my view capitalism dies a little bit when the pricing mechanism of risk doesn’t work properly.
Capitalism is such a powerful force that to draw on this life force of economic progress in order to prop up the weak – at some point, you got to say, “No, we’re not going to do it anymore.”
TD: Don, is it a smart idea to purchase the inflationary types of assets, the hard assets during times like these when there’s no fear of inflation—or is it better to wait until the signs of inflation start to kick back up again?
DC: It used to be that you had to pay money to buy an inflation hedge. Not anymore. So my attitude is that any portfolio should have good exposure to companies that could benefit from rising prices in the system. Hording [may] develop…if it becomes economically possible to horde more oil – in the past, what would happen is they would rent tankers and put oil into them against future price rises.
In the case of the grains, that’s exactly what we will see happen. People will fill up the granaries with it. So I think it’s a good time. Of course we’ve got gold now at the $1226 level, down $675 from where it was two years ago.
Deflation has grasped the world by the neck, and I feel that getting exposure to good gold mining companies now is a good investment, [but] you just don’t know how long it’s going to be to pay off.
But if the alternative is cash on which you’re paid zero, then you’re being ‘encouraged’ shall we say, to acquire some investments which will benefit from the economic recovery once it finally gets underway, whenever that is. It will happen. There has always been a recovery.
TD: Don, what are you seeing and hearing in the circles that you travel in, in terms of the gold mining companies?
DC: I talk to people who are in a state of shock. They’ve never thought there could be a [correction] on this scale that occurs so quickly and with no buying coming in. What you’re going to see then when the stocks start to recover…is some people who will say, “I was so terrified when they were going down before and now that I’m getting close to breaking even, I’m going to get out.”
TD: Don, what would you say investors should keep in mind during these times?
DC: Well, you’re best off investing in companies that don’t rely on concepts, but rely on being able to effectively produce goods and services or products that people want and that have honest managements that have some proof of what they’re doing.
You shouldn’t have unreasonable expectations from it because you don’t need it at the time of zero interest rates. The well-managed companies with strong balance sheets will have already done a lot of the financing because bond financing [has made] money so cheap.
We don’t know how much damage has been done to the core of capitalism during this period. So therefore in this sense, it’s the first time we’ve ever had to see this kind of challenge. It’s been too long with the anesthetic. So that’s going to be the big challenge when the recovery comes, [but] the stronger ones are going to survive. You’ve got to pick them out.
TD: Don Coxe, Chairman of Coxe Advisors LLP, thank you so much for sharing your comments.
DC: Thank you.
Don Coxe has 40 years of institutional investment experience in Canada and the US.
As a strategist and investor, he has been engaged at the senior level in global capital markets through every recession and boom since the onset of stagflation in 1972. He has worked on the buy side and the sell side in many capacities and has managed both bond and equity portfolios, and served as CEO, CIO and Research Director.
From his office in Chicago, Mr. Coxe leads the Global Commodity Strategy investment management team – a collaboration of Coxe Advisors and BMO Global Asset Management – to create and market commodity-oriented solutions for investors. He is advisor to the Coxe Commodity Strategy Fund and the Coxe Global Agribusiness Income Fund in Canada, and the Virtus Global Commodity Stock fund in the US, and the UCIT Global Commodities Fund.