Market Commentary First Quarter 2008 Panic utte is a gritty city on the continental divide in “The richest hill B western Montana. Amidst on earth.” the beauty of the Rockies, the town is surrounded by strip mines, and while not exactly im- poverished, there is nothing about Butte that hints at the enormous wealth buried in its mountains. The hill for which the city is named has been called the richest hill on earth, and it just might be: $48 billion of minerals have been extracted from it over the past century and a half. Gold and silver abound (the state motto is Oro y Plata), but the true source of land grant from the government to build a wealth in that hill is copper. railroad in British Columbia. When the Cana- dian Pacific Railroad learned of this threat to In its heyday 100 years ago, 300 mil- their monopoly, they bought him out for $1.2 lion pounds of copper were moved through million. Flush with cash, Heinze returned to Butte’s 600 miles of tunnels annually, mostly Butte and bought an unproductive mine. A under the watch of two men, William Clark month later, he found the richest vein of cop- and his rival Marcus Daly, who controlled per in the hill. Anaconda Copper, the largest mining company in the world. Anaconda, in turn, was part of The apex law was an obscure piece the Amalgamated Copper Company, the mo- of the mining code that allowed the owner of nopolistic trust run out of New York by Henry a vein near the surface to follow that vein Rogers and William Rockefeller of Standard underground, even if it crossed into other Oil and J. Pierpont Morgan. properties. Heinze found that a surveying error left a small parcel on Butte Hill, only 75 On a spring day in 1889, a Brooklyn- x 10 feet, unclaimed, which he promptly se- “The story of F. born son of German immigrants by the name cured, and then invoked the apex clause to Augustus of Fritz Augustus Heinze arrived in Butte to claim further mineral rights under the proper- Heinze would seek his fortune prospecting. He made a deal ties of the Amalgamated Copper Company. be amazing with an important mine owner to prospect his Before doing so, Heinze made sure that all of enough were we land in return for paying royalties on the ore the judges in the county were in his pay. After to stop here.” extracted above a certain grade. But Heinze 133 lawsuits between Heinze and the Amalga- was clever: he mixed in enough low-grade with mated, in which Heinze consistently prevailed high-grade ore to avoid paying royalties, and in local courts, he decided to settle, and in earned a fair amount of money before he was 1906, he sold all his claims to the Amalga- run out of town by the displeased mine owner. mated for more than $10 million. Heinze went to Canada, where he wangled a 429 Santa Monica Blvd., Ste 500 • Santa Monica • California • 90401 • p (310) 393-6300 • f (310) 393-6200 • www.angelesadvisors.com Market Commentary First Quarter 2008 The story of F. Augustus Heinze graphic themes to note. The best market was would be amazing enough were we to stop Morocco, up 34% in the first three months, here: the son of immigrants moving west, tak- but Turkey was off 39%. Much of Asia was ing on one of the largest corporations in the crushed, with China and India down about world controlled by the most powerful busi- 25% and Vietnam (they have a stock market?) nessmen in the world, and walking away with down 44%, but Taiwan and Pakistan each over $10 million (real money in 1906!). But F. added about 10%. Augustus Heinze was destined not only to ac- The best performing asset class last crue one of the great fortunes in American history, he was also to be the catalyst for one quarter was commodities. Coal rose 52%, plati- of the greatest financial disasters of the cen- num gained more than a third, copper, alumi- tury. That disaster has eerie similarities to our num and silver all added about 25%. Cocoa current financial mess, and its subsequent re- jumped 20%, but breakfast might be cheaper, “The Irish ran percussions may presage the changes we can as coffee fell 3% and pork bellies dropped out of luck, as expect in our future. that market fell 17%. “It11% was ina rockythe t was a rocky start for most financial as- ommodities have certainly soared the quarterstart.” and was sets in the first quarter of 2008. The US off 20% for the stock market lost nearly 10%, its worst past few years (see Chart 2), more year, the worst I broad-based, more persistent and of a quarter since the great bear market in 2002, C among world greater magnitude than previous booms. A equity markets.” and most developed equity markets saw similar declines. Volatility spiked higher, as prices “confluence of mutually reinforcing demand moved more than 1% on one out of every and supply factors,” as the IMF puts it, has three days last quarter. There were no geo- fueled this move. On the demand side, rapid 1 Capital Market Performance 40.0% 30.0% 23.3% 21.4% 20.0% 12.1% 7.7% 10.0% 4.6% 2.2% 0.0% -2.7% -5.6% -6.1% -10.0% -9.5% -8.9% -20.0% -17.3% -30.0% 1Q08 1-Year 5-Years US Equities Int'l. Equities US Bonds Global REITS 429 Santa Monica Blvd., Ste 500 • Santa Monica • California • 90401 • p (310) 393-6300 • f (310) 393-6200 • www.angelesadvisors.com Page 2 economic expansion in emerging economies re- quires raw materials for industrial production growth and to meet greater energy needs, while higher incomes lead to the consumption of more (and less-calorie efficient) foods. Supply is not especially elastic to meet changing demands, as it takes years to bring to market new sources of oil and minerals, and agricultural goods are often subject to exogenous factors such as weather. In addition to demand and supply forces, there have been increasing linkages among markets, for example, the rising price of food coinciding with the higher price of energy via the promotion of biofuels programs. Thus pressures in one market bleed over to another. Financial conditions, especially a weak US dollar and low real interest rates, have also been sup- portive of higher commodity prices. Previous commodity booms saw similar conditions; for example, there was strong global growth and a weak dollar in the early 1970s. But in the current period all these factors have been mutually rein- forcing for longer and to a greater extent than we have seen before. The early 1970s is an instructive period. In addition to strong global growth and a weak- ening dollar, there was the collapse of an estab- lished monetary system (known as Bretton Woods) and a huge accumulation of foreign re- serves by Japan and Western Europe. Then, cen- tral banks turned rising wages and commodity prices into general inflation by adopting loose monetary policies. A similar picture may be play- ing out in much of the developing world today. Many emerging countries have chosen to peg their currencies to the dollar, thereby adopting the Fed’s monetary stimulus in the face of rising wages and commodity prices. It is no surprise then that inflation is rising rapidly in these economies (see Chart 3), translating into higher import prices for us (rising 14.8% from a year ago, a record pace—see Chart 4). Bretton Woods established the global monetary regime following World War Two. The dollar replaced the British pound sterling as the gold-backed currency to which all others were linked. By the late 1960s, with the rise of export- led economies in Japan and Germany, large dol- Commodity Price Indexes 429 Santa Monica Blvd., Ste 500 • Santa Monica • California • 90401 • p (310) 393-6300 • f (310) 393-6200 • www.angelesadvisor (January 2003=100) Source: World Bank Jan 2000 2 Jan 2001 Jan 2002 Market Commentary Jan 2003 First Quarter 2008 Headline Inflation Jan 2004 Source: IMF WEO April 2008 Jan 2005 3 Jan 2006 Import Price Index, 12-month Pct. Change Jan 2007 12 Months Percent Change Source Courtesy: BLS 1985 1987 1989 1991 4 “The Irish ran out of luck, as that market fell quarter“In and the wascurrent 11% in the off 20%period for all the these year, the worst 1993 been mutuallyfactors have equity markets.” reinforcingamong forworld longer and to a 1995 1997 1999 2001 2003 2005 2007 greater extent Year than we have seen before.” s.com Page 3 Market Commentary First Quarter 2008 6 lar reserves were being accumulated over- Food Prices seas which were recycled back into dollars to maintain the currency peg. At the same time, US inflation began rising, as a costly war and Great Society welfare programs demanded more dollars. The regime fell apart under pressure, the dollar collapsed and inflation soared. Today there are grumblings from export-led emerging economies about the efficacy of the dollar-based system. The Kuwaiti finance minister last month talked openly about the Gulf states de-linking from the dollar, and the growing sovereign wealth funds are more quietly, but almost certainly, moving away from the dollar. “, and Congress The dollar has already declined sharply Source: UN FAO is about to direct against the major currencies, but much the federal less so versus many of our trading partners mortgage“For much agencies of 7 tothe play world, a larger it with pegged currencies (see Chart 5).