Tokyo based, expat Cape Bretoner. Learning to live in a de-leveraging world. Better suited to the crusades. CFA & FRM charter holder. Disclaimer: @Firehorsecaper reminds investors to always perform their own due diligence on any investment, and to consult their own financial adviser or representative when warranted. Any material provided is intended as general information only, and should not be considered or relied upon as a formal investment recommendation.
Joined Jun 23, 2015
86 Blog Posts


Most world Asia attention of late has been on China, for good reason. China is now the 2nd largest world economy after the US. India is the 9th largest economy in the world (GDP of $1.9tln, on par with Canada). China’s population is 1.38bln, India is 1.285bln (India per capita GDP US$1,500 or $6.00 per business day).

Trump’s advisors have chosen the “Idiot’s Guide to World Trade”  as their debate, if not pre-policy playbook and have equated imports to losing. Trump most recently expounded that  the US is losing $500bln a year to China. The USA’s net trade balance with China in 2015 was actually $366bln, made up of $482bln of losing (imports from China) and $116bln of export to China.


Mexico ended up in the Trump campaign’s managers crosshairs by “winning” too much as well, to the tune of $50bln + per annum. The USA exports a sizeable 236bln to Mexico but imports almost $300bln for a $58bln balance of net losing. Oreos and car manufacturing aside, many more absolute jobs are being lost by the US to China than Mexico.

India does not rate on the losing metric it would appear. The net losing is only 2.5X Trump’s reported (waiting on US Federal tax filing) net worth at 23.2bln. The USA exports $21.5bln of goods to India and imports $44.7bln. India has 450,000 illegal immigrants in the USA (4% of total, most visa over-stays), well in excess of the 300,000 Chinese. No walls are possible of course, but a dam via the revised H1-B visa program (limiting Indian IT sector uptake) is under construction.

The USA only net lose $15bln presently to Canada, one of its largest trading partners at > 1/2 tln per annum (2-way). The trade balance is often in fact a “push” which will likely delay the North Wall, at least until Trump figures out how to get the wildlings to pay for it.

Incredible India is the successful tourism slogan currently in use. Modi’s “Make in India” program is meant to re-invigorate onshore manufacturing (the majority of the gains expected to come at the cost of China). With the domestic infrastructure issues in India, nobody expected a straight autobahn shot to success, but we have seen some interesting speed bumps as recently as this month. As with Africa, most of India has leapfrogged the PC era and gone directly to smartphones.

Freedom 251:


Sometimes if it seems too good to be true, it likely is. This Make in India advertised Freedom 251 smartphone looks to be a hoax/scam. The sponsoring company is called Ringing Bells Pvt Ltd. The 251 hook is a reference to the price, Rs. 251 (US$3.65 at the current USD/INR exchange rate of 68.775 per US$1). Apparently over 700,000 eager Indian buyers have pre-ordered via paying the 251 Rupee to Ringing Bells. The alleged refurbished ADCOM handsets are made in China/Taiwan. The point of this post is not to highlight a $2.5mm phone scam, but rather to highlight that things are often not what they appear.

Even if China plays nice on the pace of RMB devaluation in 2016 and beyond, we are likely too see other forms of competitive devaluation via dumping of industrial goods (steel, etc.) via regional trade partners, facilitated by One Road, One Belt, aka the New Silk Road.


They say that those who do not study history are bound to repeat it.

A full 30% of world trade comes through the Strait of Malacca (running between Malaysia, Indonesia and Singapore), a passageway between  India and China, used extensively for commercial trade. A full 80% of China’s energy imports come through the Strait of Malacca. Geopolitically, more concern has been evident on the activity of North Korea in the region. China’s chest pounding via naval build up in the South China Sea, as a means to mark their territory and expanding sphere of influence, is 2nd only to Putin’s free range aspirations in Eastern Europe in terms of import.

They say even the “Made in China” label is often “Made in India” these days. Major trading partners might be better served by setting a T-account for net losing with India/China as a trading block. JCG



Note: Freedom 251 background: (India – local press):

NEW DELHI:  As the makers of world’s cheapest Rs. 251 (less than $4) smartphone went gaga over being part of Prime Minister Narendra Modi’s “Make in India” and “Digital India” initiatives in last few days, a top government official clarified on Thursday that the government has nothing to do with “Freedom 251” smartphone.
“This is not a government project. ‘Make in India’ team has nothing to do with this,” wrote Amitabh Kant, secretary of department of industrial policy and promotion (DIPP), in a Twitter post.
The tweet comes on the heel of the fact that the government is already keeping a close watch on “Freedom 251” and its Noida-based maker Ringing Bells Pvt. Ltd.
On February 23, Communications Minister Ravi Shankar Prasad said his department is keeping a close watch on Ringing Bells. The minister said the Department of Telecommunications has inquired whether the company can provide phones at such a low price, which works out to less than US$ 4.
“This was done to ensure that there are no discrepancies later. If there are any, we will take action as per the law. Our department is keeping a watch,” Mr Prasad said in New Delhi.
Earlier, informed sources told IANS that the telecom ministry has done an internal assessment on viability of the handset ‘Freedom 251’ and found such a device cannot be offered for not less than Rs. 2,300-2,400.
Ringing Bells has promised to deliver 25 lakh handsets by June 30.
In an earlier chat with IANS over phone, Ringing Bells president Ashok Chadha said the company will hand over 25 lakh “Freedom 251” phones to the people who have registered for it online.
“I am hopeful that we will be able to start delivery latest by April 10 and finish well before the June 30 deadline,” Mr Chadha told IANS.
According to Mr Chadha, the company is looking to set up two more units – one each in Noida and Uttarakhand. But how fast the company is going to start the manufacturing and churn out devices is a big question.
Mr Chadha said that while the manufacturing cost of the phone is high, it will be recovered through a series of measures like economies of scale, innovative marketing, reduction in duties and creating an e-commerce marketplace.
However, how well is the little-known firm placed to achieve this task is not yet clear.
Taking the world by surprise, the company launched “Freedom 251” smartphone last week that, it said, has been developed “with immense support” from the government.
There are, however, some apprehensions about its final appearance and performance.
The Indian Cellular Association has also written to the telecom ministry, urging the government to get to the bottom of the issue as selling a smartphone this cheap is not possible.


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North American investors are likely still perplexed about CoCos, given the negative buzz (deserved) out of Europe in recent weeks.


Note: Not good company to be keeping

Both the US and Canada banks issue preferred shares as their instrument of choice for AT1 (Additional Tier 1). In the case of Canada, rate reset preferred shares are the dominant instrument whereby the bonds carry a fixed rate for the initial 5 year period, then reset at a spread to the yield on the current Government of Canada 5 year bonds. These instruments have a non-viable contingent capital (NVCC) feature where they potentially get converted to equity. In the case of Canada, the bank regulator, the Office of the Superintendent of Financial Institutions (OSFI) is in the drivers seat. There are two triggers; i) a public statement by OSFI that the bank is or soon will be non-viable and ii) the acceptance of provincial or federal government support, without which OSFI would have declared the bank non-viable. This is an important distinction, NVCC securities convert at the point of non-viability (gone concern) whereas CoCos convert via set contractual triggers while the bank is still operating (going concern). At least some of the recent flow we have seen in European bank equity has likely been driven by CoCo hedging by institutional holders (the UK and others ban retail participation in CoCos). Canada’s aggregate bank issuer dominated preferred market is small at $57bln (versus a $1.4tln+ stock market), but dominated by retail, in part due to the preferable tax treatment (eligible Canadian dividends).

Under Basel 3 (B3), Tier 1 capital is split into 2 components; Common Equity Tier 1 (CET1) and Additional Tier 1 (AT1). Banks must maintain a minimum CET1 capital ratio of 4.5% and a minimum total Tier 1 capital requirement of 6%. The means by which AT1 is raised is not mandated. Banks could simply issue more CET1, but issuing AT1 securities in contingent form (CoCos) has been deemed more efficient from a capital perspective (cheaper than equity, and also counts toward regulatory capital buffers and leverage ratios).

European banks have issued $97bln of CoCos since 04/2013 through the end of 2015. Of the EUR40bln incremental targeted for 2016, zero has been issued thus far in 2016 given the overall funk the markets are in and the particular pain for financials (Europe down 24% versus 19% for US and 36% for Japan).


Contrarians looking to allocate fresh capital to this space should hunker down for some serious analysis. The legacy premium being offered for the “contingent convertible” feature was just too skinny in retrospect. The Canadian market has re-priced where relative value has emerged versus USD peer securities. Structurally there are differences in that US Bank prefs do not have explicit NVCC language. US prefs are issued at the holding company level, versus the operating company level for Canadian prefs, hence it is safe to surmise they are roughly comparable in terms of the potential for equity conversion in a tap out.

From a statistical modelling perspective we have had a negative 100 year event nearly every decade. This does not seem like an environment where you want to “sell the tails” too cheaply. Caveat Emptor. JCG

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Apple brought a $12 bln debt offering today in 9 parts. This was the 2nd largest debt deal of this year after AB InBev’s $46bln deal. Many scratch their heads at why a company with as much cash as Apple has issues so much debt. The biggest reason is that Apple’s cash is largely held offshore, and to repatriate it would be costly from a US taxation perspective. Another reason is the pricing of the debt, due to the fact they had $26bln in orders (order book) for $12bln of bonds, which allowed them to issue at a tighter spread;

$500mm 2 year fixed printed at +60 US Treasuries (UST) versus guidance of +60 and initial price talk (IPT) of +75

$1bln 3 year fixed printed +80 UST  vs matching guidance and +90 IPT.

$500mm 3 year FRN printed L+80 versus matching guidance.

$2.5bln 5 year fixed +105 UST, in from +115 IPT.

$500mm 5 year FRN L+113.

$1.5bln 7 year green bond, +135 UST vs +145 IPT.

$2bln 10 year fixed +150 UST vs +160 IPT.

$1.25 20 year fixed +190 UST versus +200 IPT.

$2.5bln 30 year fixed +205 UST versus +215 IPT.

There is strong demand for high grade debt with no tithe to the oil & gas or mining & metals sectors. Apple is rated Aa1 by Moody’s.


The following details the split between domestic and offshore of Apple’s cash hoard, quite striking:


Moody’s noted that at the current issuance trajectory, Apple could have $100bln of debt by the end of 2017. There has been a great deal of debate on the merit of a tax amnesty on foreign profit for US corporates. It has been done before (5.25% instead of typical 35%), but it is not politically correct to suggest an election year is the time to do it again. There are risks to delaying. Tax inversions should be easier for cash rich tech companies that already outsource critical components overseas. JCG

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A betting man would likely place at least even odds on a $20 oil pendulum swing before we hit $50 again, if for no other reason to  its’ proximity to spot prices in the low 30’s.


JP Morgan has issued some interesting research, modelling the asset divestitures (by asset class) likely seen from reserve managers and sovereign wealth funds (SWF) on a further downside trajectory in oil, to as low as $20 per barrel. Global FX reserves peaked at just over $12 trillion in August 2014. Reductions from that time have come primarily from China (approx. $700bln) and commodity levered economies. A decent current estimate is $11 trillion. SWF assets stand at $4.5 trillion, with 93% held by the top 10 funds, ranked by size. Half of the top 10 gained their girth via oil riches with the remainder plumped via long held general trade surpluses. If we were to see a $428bln divestiture in 2016 on a move to $20 oil by this approx $15 trillion war chest (2.9% of assets), I would characterize it as a “flesh wound”. Seems low. Check you VaR. Fat tail result observation likely (kurtotic distributions).


The stresses on oil dependent global economies had been well documented and as illustrated in the graph below,most need a snorkel if not a nitrox tank already. 4 of the “fiscally challenged” sovereigns below also have top 10 ranked SWF’s by size.

-Saudi Arabia. SAMA Foreign Holdings. Est. 1952. $762bln (14′), 100 of GDP, 2.6x expenditures, 65.0 x sovereign debt.

-UAE. Abu Dhabi Investment Authority. Est. 1976. $589bln (14′), 147% GDP, 4.8x expenditures, 5.3 x sovereign debt.

-Kuwait. Kuwait Investment Authority. Est. 1953. $548bln (14′), 321% GDP, 6.7X expenditures, 54.0 x sovereign debt.

-Qatar. Qatar Investment Authority. Est 2006. $304bln (14′), 144% GDP, 5.48X expenditures, 6.2X sovereign debt.

Source: Moody’s, IMF, SWFI

The most stressed nations at  current oil levels will be in straight jackets at $20bbl oil. As the dominoes of Venezuela, Nigeria and Libya wobble if not fall, it will likely make Arab Spring of 2011 look like a Tragically Hip concert.


Many market pundits point to the fact that lower is oil is positive and will result in an eventual  GDP lift for most countries. MSCI World (-6%)  has significantly underperformed MSCI EM (-1.8%) over the last 3-4 weeks.

As James Grant recently put it, more eloquently than I might, “Surely, no such thing as a separate and distinct U.S. economy can be said to exist. There is rather the single dollarized and financialized and leveraged worldwide economy. Like it or not, we are all in this together – the Chinese communists, the European socialists, the Japanese statists and we the people.”

The amount of Gas & Oil related debt that will need to be re-structured and that will eventually default clearly ramps at $20 oil. Current default rate estimates are at 7%+ and it is difficult to envision that default rates do not get to the low teens if oil prices languish to $20 bbl from here. The list of global survivors left to pick up the pieces dwindles as well, impacting recovery rates. The public debt markets have been the funding avenue of choice in the latest energy build out cycle and while the Banks will certainly not escape unscathed, there will be enough pain to share with estimated industry debt at $700bln+.

USD denominated debt (non-bank) outside the contiguous states stood at $9.2 tln as at 09/14, +$3tln since 01/10.

Cupped hands to make up for the reserve manager and SWFs asset divestitures are hard to find as the pension & endowment space revamp their asset allocation, largely away from the public markets in favour of private & specialty areas with higher alpha potential.


Liquidity is waning, and not likely to recover near term. Global regulations, regardless of intent, have had the effect of neutering the profit motive. The former commodity prop groups of the major global banks have largely been thrown to the winds with the most successful finding homes in the successful, albeit less stable trading houses (Mercuria, Vitol, Glencore, Trafigura, Noble, Gunvor, etc.).

Opportunities abound with so many cross currents, but the penalties for being wrong will be increasingly punitive. Asset redemptions, spikes is deficit spending/drawing down former surpluses, spikes in unfunded liabilities, credit downgrades (out of IG), increased civil unrest, increased protectionism and a ballooning global refugee crisis are all issues we will be dealing with in 2016 and beyond. JCG

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As a barometer for “risk off”, a rally in the Japanese Yen is spot on.

From the 121.70 USD/JPY euphoria level achieved post rate cut, we elevator shafted through 111 and even got into the 110’s before bouncing to the current 112.35. While 10 big figure moves in the world’s 3rd largest economy should be alarming to all, there is a good chance we get more. Barclay’s today forecast a further rally to 100 by the end of Q1 2016 and 95.00 by year end 2016 (prior YE 2016 estimate 120).


Central banks have officially run out of runway.


The Fed, EBC, BoJ, ECB, Riksbank (Sweden cut to -0.50 yesterday, submerged by 5bp more than the market expected and expanded QE purchases through reinvesting monies from maturities and coupon payments) & SNB’s goal of achieving 2.0% inflation in unison is not going to happen.


Gold has something different to infer from these moves it would appear. My modest allocation to gold miners will be tweaked (higher weighting) and DXJ (currency hedged Japan) jettisoned as wrong-footed folly. You have to trade what you see, not what you know (think you know).


Japan Topix financials were down 24% since the very recent rate cut in Japan (the market is further dissolving today as they return back from vacation). Mitsubishi UFJ entered the jaws of today’s market trading at 49% of tangible book, Mizuho 66%, Sumitomo Mitsui 52%. For reference Bank of America trades  at 80% of tangible book. What is the liquidation value of a Japanese bank? Where does that bid come from? Not even Citi could make a go of it and sold their Japan franchise for less than $1bln. Even Ford is packing up their Japan tent and going home.


The reasons for such apparent “distressed” bank valuations is clear, the lifeline of higher rates is further beyond the grasp of banks globally. Yellen, Gundlach, Bass, JP Morgan, etc. talk about and research negative rates as if it is a “normal” conversation to be having.

There is an ebb and flow to the relative valuation of financials, but historically the equity markets struggle without the participation of financials. Going forward, bank balance sheets will more fortress like, less levered, and more conservative in their make up. CoCos (Contingent Convertibles) will make up a bigger proportion of the capital structure as there will be no “put” to their respective governments. Credit ratings will be lower, as no “lift” from implicit government support should be implied or expected.

Coming back to the car analogy, gone are the days of the V8, 4 cylinders, hybrids and full on electric are in vogue. Adjust your return expectations accordingly. JCG

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I am very bullish of the Japanese equity market, largely on a currency hedged basis. DXJ is my preferred means of garnering exposure. On a valuation metric, Japanese equities are cheap. In terms of weighting, a market capitalization weighting for Japan would be 8.02%, “Japan Lite” would be 6.02% (75% mkt cap weighting) and GDP weighted would be 5.33%. As I am underweight EM until further notice (est. 2020), I have also put this weighting in my Japan bucket for a round 10% (fully hedged as to currency). Exposure to Japan gives you a lot of EM exposure by default and increasingly Japanese firms are outsourcing the intermediate stages of production in favor of final stage and highest value add onshore. At USD/JPY 135.00 (est. Q1 2017), I’d be inclined to pare the currency hedge back to 50%, the “no remorse” hedge ratio.

The Japanese equity market peaked at 38,000 in 1989. The low was 7,400 in 2009 (17,191 currently). The Nikkei’s absolute level is often dictated more by foreign investor flows than onshore with a low 6% retail participation rate in the stocked market. The comparable participation level for the USA is 33%. Many foreign asset managers have at least moved from underweight to equal weight on Japan in the last 2 years. Beyond nitrous stock boosting QE, another sizeable catalyst is the monumental asset re-allocation of GPIF (Government Pension Investment Fund), the $1.25 trillion behemoth pension fund for Japanese Public Sector Employees (3X CalPERS size and $200bln bigger than NBIM, Norway’s colossal oil funded sovereign wealth fund). The big shift is largely from bonds to stocks (both domestic and international) and while “taper” in not yet in the Japanese jisho (dictionary), GPIF and the BoJ are likely sharing the play book, if you know what I mean.

Bank of Japan (BoJ) Governor, Kuroda-san continues to deliver the QE goods and in addition to the spectre on negative rates, introduced for the first time on Bank reserves (-0.10% from 0.10% ) last week on potentially 250 trillion JPY of Bank reserves, new tools are being developed to achieve the BoJ’s price objectives (2.0% inflation or bust).


Having lived in Japan for 3 1/2 years (and visited on 25+ occasions since), I know what a perplexing market it can be. After 3 weeks of the ground one thinks they know, i) What is wrong with Japan and, ii) How to fix it. After 3 1/2  years all you can say is, I lived on Japan for 3 1/2 years. There is even a phrase for the folly of shorting JGB’s (Japanese Govt Bonds), the “widowmaker” for the number of traders that have been carried out employing the strategy over the years (definition of a Rates trader is someone who finds a trend and fights it). Even the doctrine of the time value of money has been exorcized by unconventional monetary policy (the Japanese curve is now negative to 8 years and 10’s have been in a 4-6 bp range this week, an all-time low yield for the 10 year maturity).


Years ago, one would have thought the downside on a short position in bonds would be bound at zero, yet we now stand with trillions of government debt (>22% of global GDP equiv.) trading at negative yields. Japan’s QE has been unique not just in terms of its scale (a full 75% of GDP) but in terms of the asset classes they purchase under their broad mandate. The bulk of the G10 have their balance sheets bloated with bonds exclusively. Japan gorges on bonds as well of course, owning approx. >70% of the market, but they also but corporate bonds, REIT’s and equity ETF’s (estimated to now own 50% of the o/s ETF market).


Fuji-san: A worthy “bucket list” climb. An active volcano, hence note the Japanese expression, “Only a fool climbs it more than once.”

Global sovereign debt now stands at $59.7 tln. The US is the obligor on 29%, Europe 26%, Japan 20%, China 6% and Rest of World 19%. Metrics like debt to GDP are important, but who owns the debt is just as important. Before the Global Financial Crisis foreign ownership of JGB’s was a paltry 7%. The number for UST was 56% held by foreigners, but with a Fed balance sheet exceeding $4.5 trillion the percentage is comfortably below 50%. If the Fed’s balance sheet were the same relative size at the BoJ’s it would be in excess of $14 tln.

Japanese corporations are very selective about how they deploy their liquidity. Cash & equivalents held by Japanese listed corporations total $1.4tln versus $1.8tln for US Corporations (the Japanese economy is approx. 1/3 the size of the US). Japan is a highly innovative country, holding a full 1/3 of all global patents. Japan is highly homogeneous with 99.38% of the populace Japanese (less than a million foreigners out of a 127mm population).

There is always a great deal of discussion on the poor demographics of Japan. In 1910 Japan has 50mm people versus the current 127mm and with the current birth rate (1mm per annum) and immigration policies they will round trip to 50mm by 2110. Underlying trends are changing though. People are getting married later. There are more women entering the work force and entering the real estate market on their own instead of waiting it out for Mr. Right at their parent place in the burbs. Japan real estate has been hot, up > 20% over the last 2 years. Rentals yields have come off the highs (8-9%) but are still very attractive for a developed market. Foreigners are competing as the bid increasingly (often Chinese but the palette is broadening) against the local Japanese, and with 35 year mortgage rates at 1.35% this week, their is a clear domestic advantage. Tokyo is a sprawling metropolis, with Tokyo-Yokohama holding the record as the world’s most populated urban area.


The 2020 Summer Olympics are yet another catalyst for a more inviting and worldly Japan. Versus their “stretch” plan for 20mm @ tourists by 2020, Japan had 19.73mm in 2015, up 47.3% in number and 71.5% in spend (3.48 tln JPY) over 2014. Again, the Chinese dominate the flow at 40%. Japan is making great effort to further press the momentum coming into the olympics with 10,000 English signs being installed and more subtle tweaks like allowing tattoo sporting guests to enjoy the sprawling network of natural hot springs peppered throughout the land. Most establishment have a long standing ban on ink as “unclean” but it has more to do with the fact that in the old days only the Yakusa (organized crime) had tattoos.

Japan has < 2% of the world’s population and yet has 15-20% of world wealth (even after a 26 year bear market). As noted, traditional analysis can be daunting. I like to look at Japan as a big insurance company that uses its own currency. The drive is there, the work ethic is there, but if they were forced to annuitize, they would still be much better off than most of planet Earth.

These are the key reasons I’m bullish on the Japanese equity market, but the currency hedging decision is a critical component. JCG

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As has been well chronicled on this web site, all is not well with the commodity complex. For a wealthy, developed nation Canada has a heavy reliance on primary industry. Canada is one of the few remaining AAA rated sovereigns credits. Canada is a 1st world country with a 3rd world currency. Much has to do with the high correlation with oil, it has always been high at 0.80, but has been running at 0.94 of late.

Combined, the Oil & Gas and Mining & Metals sectors make up 35% of the stock market in Canada, versus 16% in the US. Both Canada’s population and economy are about 1/10th of the US (34.75mm & $1.5tln respectively) and trade flows run predominantly North/South, 73% of exports and 63% of imports are with Uncle Sam.

“Just Like The States” is a compliment old timers still use for a job well done and approx. 85% of Canada’s 34.75mm people live within 100 miles (165 km for the bulk of the world on the metric system) of the US border. Canada’s unemployment rate stands at 7% (all US states are below 7% with the whole a low 5 handle) yet there is a high degree of regional disparity, with some in the double digits. There are only 4 cities in Canada with populations >1mm (Toronto, Vancouver, Calgary and Montreal).

Energy in the form of oil, primarily from Alberta (oil sands), Newfoundland (offshore), and Quebec (hydroelectric) along with metals, agricultural products, and forest products make up over 58% of exports. Autos, machinery and equipment make up 38%. Exports make up approx. 32% of GDP

The oil downdraft has had the largest effect on Alberta and the situation is not likely to improve in the near term. Much of the pipeline infrastructure focus has been on southbound KeyStone XL – Stage 4 which has been blocked by Obama (will Trump want naming rights to approve?). Part of the solution to the oil conundrum will be improving the mobility of trade across Provincial borders, with the added advantage of being able to settle in Canadian dollars. Justin Trudeau has arrived in the Prime Minister role (centerfold actually), bringing the Liberal party back to power with great fanfare and has promised spending of C$60bln over 10 years on infrastructure, with a front-end weighting. A portion of the infrastructure spend with likely be on critical intra-Canada linkages. While there are less viable road and rail options for this purpose, the Energy East pipeline and Trans Mountain pipeline twinning project are the two major proposed pipeline projects taking Alberta oil both East and West (in higher volume) respectively. New environmental hurdles have raised questions about the governments support for the pipelines, but in the end they make too much economic sense to not advance. This improved infrastructure would reduce and potentially eliminate the reliance on imported oil, which costs Canada > $20bln per annum. Venezuela and Nigeria are both on the watch list for major civil unrest in 2016, largely due to the swoon in oil prices. Canada also imports oil from the US (roughly 1/2 of the 630k bbl per day imported versus Canada’s 2.7mm bbl a day habit), Norway and the UK. Azerbaijan, requesting $4bln in aid this week is the canary in the oil well. Brazil and South Africa (who just hikes short rates by 50bp to 6.75% yesterday to put a finger in the ZAR dyke yesterday), are also markets to watch for 2106.

The structural decline of the auto segment in Canada is a much tougher nut and there is almost no degree of currency depreciation that can bring production back above the 49th parallel. The first wave of market share losses were dolled out by manufacturers establishing non-union plants in the Southern US States. More recently, Mexico has been growing significantly, no longer hampered by a perceived product quality gap. Canada’s unit automobile production (centred in Ontario) is down to 2.3mm unit per annum which is 24% below peak levels (99′).

No export discussion can leave out China. The Chinese Renminbi broke into the top 5 payment currencies in 2015, displacing the Canadian Dollar (CAD) to 6th rank. China had held the Yuan (CNY) steady in the face of significant easing by most of its trading partners up until August 2015 and still gained 3% world export share (to 13% from 10%). Read: China does not need a cheaper currency to be competitive. On the capital flight question, how much would China have to devalue the currency by to dissuade those so inclined  from moving? A lot is the answer, hence the worries of a 10-15% de-valuation by China is overblown. There will likely be modest depreciation versus the USD going forward (inside of 5%), and relatively sanguine fluctuations should be expected versus a basket of their trading partners (which is PBOC’s eventual intent). China runs a very large current account surplus (2%+ of GDP on a US$10tln+ economy) and there will likely be a spike going forward as the rate of domestic investment will fall at a much faster pace than the savings rate falls. Flooding the global markets with industrial goods when protectionism is on the rise is not a formula for getting along, but get along we must.

Canada has a vast advantage over the US in two key areas. Corporate taxes are a full 13% lower than in the US. Canada has the most educated population in the OECD with 51% of adults aged 25-64 having finished post secondary education (OECD avg. 31%). Canada heavily subsidises education and the world class ranking of the top schools attracts many foreign students.

As a developed market, birth rates are modest at 1.6 children per woman (2.1 required for a stable population base), but Canada has a long standing immigration policy that ensures, at least from a demographic perspective, that Canada keeps growing. Immigration to Canada is 260,000 per year (US is 1mm, 10x would be 2.6mm), 0.74% of the country’s population per annum (10% of those in the refugee category, 7% for the US). Life expectancy in Canada is 81.24 years versus 78.74 for the USA.

Canada is the 11th largest economy in the world, representing 2.9% of world GDP. Canada is home to 68 of the top 2000 companies in the world, for a tie for 5th with France.

Last week CAD and SGD, the Singapore Dollar traded at parity for the first time in 21 years, at 1.43 per USD. The commodity super cycle took CAD/SGD to near 1.60 over that 2 decade + period.  Singapore has none of the resource riches that Canada boasts, yet is has largely through will, minimizing graft and superior execution created the largest financial centre in South East Asia. The parallels to North America are strong, Hong Kong is like New York, Singapore is like Toronto. Singapore is one of the largest shipping centres in the world, depending on metric of throughput or value Singapore is often #1 (currently #2 to Shanghai). Singapore recently displaced Tokyo as the 3rd largest global fx trading centre after London and New York. Singapore boast > 30,000 multinationals that run their regional treasury centres for Asia (and in many cases broadened to include Europe and MENA) from a Singapore base.

Faced with the opportunity Canada has at hand, Singapore would have a crack team of government officials on tactical missions to entice multinational firms to relocate to Canada. Based on corporate taxation differentials alone (-13%), tax inversions make abundant sense. The grass is greener on the other side largely because it is fertilized with bull*hit, but in Canada’s case, the merits are largely beyond assail. The cash laden US tech sector in particular would be fertile with targets to entice to Canada’s Silicon Valley, Kitchener-Waterloo, Ontario. EDC, The Export Development Corporation of Canada, an Agent  of her Majesty in right of Canada (AAA/Aaa) stands at the ready to insure global trade.

Resident of Canada’s largest cities (Vancouver & Toronto) are admittedly over their skis with respect to residential property valuation at present (by 20% at Fitch’s latest tally), but even a modicum of success in leading a migration north of corporate America would make it look dirt cheap 3-5 year out.

Why did the Canadian cross the road? Answer: To get to the middle. Trade accordingly. JCG

Note: Author is a Singapore based Canadian, originally hailing from Cape Breton, Nova Scotia. Follow me on Twitter @firehorsecaper


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The stock market took off last Friday Jan. 22nd like Space X’s Falcon 9 rocket, yet Chesapeake’s equity was left on the launch pad in the end, closing at $3.51, down 22% ytd and 82% yoy. The initial exuberance (+17% intra-day) at CHK cutting their pref dividends ($172mm in annual interest savings) gave way to the grave realization that all is not well, and time is is running out. Suspending the dividend on their prefs has been seen as prudent (prefs get paid after debt holders but before equity holders in a wind up). Notably, some of the pref dividend savings will be earmarked to buy back their secondary debt in the open market. Most CHK senior unsecured bond issues are trading distressed, wrapped around $30’s in price. Looking at a specific issue, the CHK 7.25% 12/15/2018 (senior unsecured) traded up to $40.00 for a yield of 47.5% . The bonds are rated B3/CCC+ with a recovery rating of 6 (the lowest rating, implying a recovery in the 0-10% band). This bond was trading above par for the first half on 2015 and only broke par to the downside in July 2015. CHK equity was at $10 when CHK 7.25% 18′ broke par (coincident with the common dividend being cut) and now sits at $3.51. Typically, one would expect the equity to massively underperform bonds on drawdown of this magnitude.  Part of the reason for the poor recovery rating on the CHK senior unsecured is that there is a lot debt with priority ranking ahead of it. The CHK 8% 12/15/2022 (2nd Lien), a $2.5bln benchmark size issue, is rated B1/BB- and traded at $46.25 for a yield of 24.55%. The recovery rating on these bonds is a 1, implying a very high recovery rate (>90%).

The debt load being carried by the top 60 independent oil & gas groups stands at $206bln, up from $100bln in 2006. Chesapeake has $9.8bln of this indebtedness versus $2.3bln in equity market capitalization. A full 1/3rd of the 155 energy names covered by S&P are now rated B- or below with a barrage of fresh downgrades in the offing by Q2 2016 (175 discrete global energy names in the case of Moody’s).


Oil had a strong rally off the lows last week, but US E&P players are being Ubered by OPEC at these prices. One can imagine Saudi Arabia relishing the death throws of “unconventional oil”. The Saudi’s have not had a good run either, downgraded to A+ in Q4 15′ and running a deficit approaching >15% of GDP ($90bln), largely due to lower profits from oil exports. That said, Saudi Arabia’s marginal cost of production is $3/bbl, versus $15/bbl for Iran, $73 for US “Shale” oil ($57 Gulf of Mexico) and $90 in Canada.

Chesapeake expected their negative cash flow for 2015 to be -$2.5bln with oil at $50 per barrel and natural gas at $3.00 per MMBtu. Not privy to projected numbers yet for 2016, but the price side of the equation is not helping at $31.5bbl and $2.12 MMBtu. Part of the solution is curtailing both activity and capex, both of which CHK has undertaken, and efforts continue. In Q3 2015 there were 16 active CHK rigs and there are currently 9 operating. To meet commitments for 2016 Chesapeake might be able to get there with 4-6 rigs. Capex of $280mm is expected in 2016. Interest costs will be $660mm for 2016 and there is a $500mm debt maturity due in March 2016, (CHK 3.25% 03/15/2016 which trades at $96.50). Chesapeake had $1.8bln in cash at the end of Q3 15′. Chesapeake’s $4bln bank revolver was re-negotiated into a secured facility in Q4 15′. Secured facilities further diminish the likelihood of senior unsecured  bondholders getting any substantive recovery in a tap out. As Le Fly has noted, banks generally like providing umbrellas when it is sunny, in the current environment, not so much. Chesapeake results for calendar 2015 will be out Feb. 24, 2016 with an expected $5.5bln loss for the year.

Unit operating cost have spiked 60% in the last decade for the industry overall and while cost cutting has allowed this number to come down to 46% (tightening staff and procurement) meaningfully deeper savings will likely require a deeper dive and could be more costly to implement.

Investors should buckle up, it is going to be a rocky ride. Chesapeake has some high profile holders, including Carl Ichan who owns 10.98% of the equity (holding as at last reporting, but offside >$1bln). When Carl was an infant, in the mid 1930’s, Aladdin kerosene lamps were all the rage. If we ever needed a genie, it is now. JCG

Disclosure: No current exposure to CHK equity or debt. Vetting 1st lien debt of minority (30%) owned oil services/fracking holding, FTS International, FTSINT 06/15/2020, hedged via CHK equity short.



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2016: Year of the Fire Monkey

Chinese New Year, aka the Spring Festival, Chunyun to the Chinese, the Lunar New Year is almost upon us. Monday February 8th is the kick-off and festivities run until February 21st. The monkey is the 9th of the 12 animals in the Chinese zodiac. The Chinese also apply 5 elements (metal, water, wood, fire and earth) to the calendar. 1956 was the last Red Fire Monkey year (i.e. animal/element combination).

On an annual basis, the Spring Festival represents the largest human migration, with all that are able (health & budget) heading home to visit family (an urban to rural migration in most cases). This is like American Thanksgiving on steroids. A full 1/3 of Beijing 20mm residents are on the move. China has 14 cities of over 5mm with similar travel plans. 40mm + domestic flights and over 250k train trips across the country. The focus over the lunar new year is on home and family, rather than business affairs. Rituals include cleaning and giving gifts of money in red packets that are supposed to  bring  i) good luck and ii) long life to the family.


The PBoC have been busy. Short term liquidity facilities totalling 1.6tln Yuan (US$240bln) have been put in place. They have signalled a cut on the RRR is not likely before Chinese New Year, as many had expected. Much of the recent effort has been expended on stemming spec trade in offshore Yuan (CNH) which has brought it effectively in line with the onshore Yuan (CNY). Global market will get a much needed break from hanging on every sign of IBS from China. They will be both celebrating and praying for extra luck in this tricky monkey year ahead.

Don’t count out the Chinese due to a rocky 2016 start. Monkey contains metal and water. Metal is related to gold. Water is connected to wisdom and danger. The Chinese have a very healthy risk appetite. There is almost no limit to how much they will press. The biggest risk the Chinese face is that they get old before they get rich. I for one think they get rich. JCG

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Less than 1% of submitted US tax returns are subject to audit  (0.86% in 2014).

The bad news is the primary statute of limitations for US federal tax audit has been doubled to 6 years from 3 years. This increases compliance costs clearly and has an effect on the eventual all-in audit cost. Mistakes are often repeated over tax reporting periods and interest and penalties will of course be accruing over a much longer period. Congress passed the Choice Improvement Act of 2015 which effectively overruled a Supreme Court ruling that capped the scope of tax audit to 3 years. There were select tax circumstances where the audit period was already 6 years, such as if >25% of one’s income was “omitted”. No statute of limitations applies if you never filed a return (the practical limit in these cases is deemed to be 10 years).

FATCA implementation has effectively made American living abroad un-bankable with few investment management options. The number of US Green Card holders choosing to relinquish their status is under-reported and growing.

There is a lot of commentary on the earnings recession the US is in the midst of, which could lead to an economic recession. It may be time to re-think a corporate tax amnesty to prompt the repatriation of foreign profits that has left trillions parked in the world’s financial centres (everywhere but NY). The spike in corporate debt issuance has been driven by many factors, stock buybacks being a particular area of folly it appears, but part of it has been the US corporation do not have cash liquidity in the jurisdictions where it is required to run their businesses in an optimal fashion. Tax inversions have been all the rage for several years (US to Europe in many cases) and with the Canadian dollar at $0.68 expect to see some headed North in 2016 (Corporate taxes in Canada are a full 13% lower than the US).

Ted Cruz thinks the IRS should be abolished, which should fully open the debate on a simplified tax code, with a flat tax as the anchor. The municipal bond market will of course watch developments closely. One thing is near certain, the US is going to need a much bigger debt ceiling. JCG

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