Seamens Capital Management: Europe Is Repeating US Mistakes Of 1930s

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SEAMENS CAPITAL MANAGEMENT, LLC is a $500million hedge fund based in Massachusetts. The firm has a long term fundamental approach to investing, and uses short term volatility to take advantage of selling and buying opportunities.

The firms’ Seamans Global Bond Fund was down 1.7% for both the fourth quarter of 2011 and the full year 2011.

The manager’s note that the US Federal Reserve was forced to monetize its debt after there was a sharp decline in purchases of US Government debt by foreign central banks. The fund also noted similar action by the ECB to secure financing for Portugal, Greece, Ireland and other European countries.

The fund is still confident in its holdings of high quality short term sovereign debt and precious metals as a hedge. Due to the reasons stated above, which increase the risk of higher interest rates and dollar and Euro devaluation, these assets should perform well.

Taking a closer look at the market dynamics in 2011, austerity measures, the accepted solution for the financial issues of the peripheral European countries, are provoking further weakness in economic demand. According to the International Monetary Fund, Italian GDP will contract 2.2% this year while Spanish GDP will shrink 1.7%. Germany, the strongest economy in the Eurozone, showed a 0.25% quarter-over-quarter contraction in the fourth quarter of 2011. Austerity measures have the potential to create a self-reinforcing negative feedback loop, a policy mistake that was made in the U.S. in the 1930’s. In 2012, Europe needs to finance about 1.1 trillion euros of country debt as well as about 1.1 trillion euros in European bank debt. European banks in general use a higher degree of leverage than U.S. banks and hold lower reserves against bad debts. Morgan Stanley has suggested that European banks may need to reduce their balance sheets by 1.5 to 2.5 trillion euros over the next 18 to 24 months. This deleveraging could equate to as much as 10% of eurozone bank assets.

One example provided is France: French banks secure much of their financing in lower-cost short-term commercial paper rather than in higher-cost long-term structured loans used by other European banks. This leaves the French banks susceptible to a liquidity crisis in the event that they are unable to access the short-term financial markets. The French bank exposure to peripheral European debt is more than 680 billion euros, or more than 25% of France’s GDP.

Seamens Capital Management: Europe Is Repeating US Mistakes Of 1930s

The euro recently celebrated its tenth anniversary as the sole currency for 17 countries. Initially, the euro benefitted the northern European manufacturing countries by broadening their markets, and it helped the southern European consuming countries who were able to finance their purchases and economic growth at lower interest rates. As a result, the euro rose from $0.89 at the end of 2001 to a peak of $1.60 in the middle of 2008. However, the euro suffers from a fundamental flaw because it offers only one monetary policy without any currency flexibility. While Germany flourished, the

peripheral European countries were unable to adjust their currencies to offset their diminished competitive positions.

Greece was the first euro-based country to face financial difficulties beginning in May 2010. Ireland and Portugal needed financial support from the ECB during 2011. Italy is currently the country of the greatest concern, with 1.9 trillion euros in total debt, an amount which exceeds the value of the debts of all the other peripheral European countries combined. While discussions continue, Germany has not shown any desire to underwrite or guarantee the debts of the other European countries. Although Greek debt holders agreed to take a 50% write down on their bonds in October 2011, it was not enough to allow Greece to regain its financial stability. More than 30% of the deposits of the Greek banking system have now left the country and it appears to be only a matter of time before Greece will find its euro membership politically untenable. Because the initial write down of the value of the Greek debt was not declared to be an event of default, the credit default swaps that banks held did not adequately protect them from a decline in the value of their Greek bond holdings. As a result, the European banks began reducing their exposures to other financially impaired countries which has led to rising interest rates on other peripheral European debt. Greek interest rates have now risen to such a level that the country is on the ECB’s financial life support system.

An increasing level of distrust between European banks has led to an increase in bank deposits with the ECB. The ECB created the Long-Term Refinancing Operation (LTRO) as the primary vehicle for financing the debts of the peripheral European countries, supporting the European banks who are the primary lenders. The LTRO issued more than 500 billion euros in 2011. These financings have caused the ECB’s balance sheet to balloon from less than 2 trillion euros to more than 2.7 trillion euros. While the value of the euro rose during the first half of 2011, it declined in the second half with the expectation of Europe’s LTRO quantitative easing program. For the year, the euro fell by 3%. The fund managers stated that they “would not be surprised to see the euro fall by an additional 10% to 20% over the short-term as the peripheral European countries devalue and adopt currencies which allow them to regain competitive positions (devaluation of the Euro is an idea which ValueWalk recently proposed).”

In regards to the dollar, the U.S. low interest rate policy has made the dollar the preferred lending currency for a number of years. The decline in the dollar’s value has increased its popularity by making loans less expensive to repay. As a result, international dollar-based loans worldwide rose to more than $10 trillion in 2011, up from $7 trillion in 2007. The decline in European economic growth has led to repayment of these U.S. dollar denominated debts. The rise in the value of outstanding derivatives including credit default swaps which are largely dollar based has led to further dollar purchases. These two factors are the primary driving forces behind the recent strength in the dollar. While the U.S. dollar is technically strong, it remains fundamentally weak. In 2011, Japan, China, Russia, India and Iran all entered into partial bilateral arrangements to conduct trade in their currencies. These countries represent a large segment of current global trading and include the countries with the most rapidly growing demands for energy and other commodity resources. The exclusive use of the petro dollar to settle world oil trade dating to 1974 has effectively come to an end. This process is likely to lead to further bilateral trading agreements and

a further decline in the value of the dollar as a world reserve currency. Over time, we expect the process will lead to a 30% to 50% decline in the value of the dollar.

Meanwhile, the challenges in Europe led to a decline in Chinese economic growth and lower values for both Asian and commodity based currencies in the second half of 2011. The Japanese yen which rose 5.5% and the Chinese yuan which rose 5% were the only major currencies to show gains for the year.

Global interest rates have diverged. The interest rates on long-term U.S. and German government bonds, which are considered safe investments, have been falling. Interest rates in the U.S. and Germany declined by about 40% in 2011 to reach lows which have not been seen since the 1940s. The interest rates on the peripheral European country debt which bottomed in 2005 have been rising. There has been a preference for bond over stock investments by U.S. mutual fund investors since the financial dislocations of 2008. Investors redeemed $149 billion worth of domestic stock assets in 2011 following redemptions of $95 billion in 2010. They increased their bond investments by $241 billion and $137 billion in 2010 and 2011 respectively. Although interest rates could decline further, particularly if there were another financial crisis, the risk is that interest rates on longer bonds may rise substantially. The fund expects that the quantitative easing in both the U.S. and Europe will ultimately lead to higher inflation and rising interest rates in the next few years. As a result, positions are held specifically in short term debt. The fund continues looking for opportunities to make investments in securities which benefit from changing currency values and rising interest rates.

Additionally as mentioned in the beginning, the fund has been using gold and silver as a hedge against the monetary debasement by the central banks since the fall of 2008. Since that time, the price of gold has roughly doubled to reach $1,563 per ounce at the end of 2011. The demand for gold by the central banks of the emerging markets countries such as China and Russia has supported the rise in the price of gold. They maintain their belief that the demands of the emerging markets countries for additional gold reserves to support their currencies will result in the price of gold rising to $3,000 to $5,000 over the next few years.

Gold is favorable compared to fiat currencies that are being issued to mitigate the financial obligations created by excessive debts. For this reason, gold is caught in a tug of war between the debtor developed countries who would like to see a lower price and the creditor developing countries that favor a higher price consistent with sound monetary practices. These two opposing positions manifested themselves in the volatility of the price of gold which traded in a range of between $1,308 and $1,923 during 2011. Gold did manage to finish the year 10% higher than the previous year despite a sharp sell-off in the final month of the year. The fund remains committed to precious metals as a hedge against the monetary debasement and believe that investors will be rewarded for their patience.

Given the financial issues facing the developed countries, the fund can anticipate that 2012 may also have its challenges. The fund managers believe that the Seamans Global Bond Fund QP, with its

commitment to high quality sovereign debt and a physical precious metals hedge, will offer stability and income to investors. Already there has been a significant rebound in the value of the Seamans Global Bond Fund QP in January.


Seamans Global Bond Fund had a great January due to their positions in precious metals and their emphasis on safe short term sovereign bonds to hedge against dollar and euro devaluation.

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