London Irvine Report June 20, 2007

Rescue or Crash?

Blair Freedom Day -7.

Earth provides enough to satisfy every man’s need, but not every man’s greed.

Mahatma Gandhi

Things are getting ugly in US real estate. Even with the latest fall in housing starts, they’re still way above current demand, and now everyone’s talking higher interest rates, which can only depress housing demand further. Despite all the higher rate talk, I think US rates will soon be forced lower as all the toxic mortgage derivatives junk continues to implode over the summer, but for now the Street still pretends that can’t happen. But first this. One final, last, last, last-chance to salvage something from the stalled global trade talks is underway. Up till now, the EU and USA have basically stiffed the developing world. Though Potsdam is well worth the visit, and will massage their egos no end, so weak are western leaders now, I doubt they can force through any agreement that might matter.

Key WTO players meet in Potsdam to break Doha Round deadlock

POTSDAM, Germany, June 19 (Xinhua) — Top trade officials from the United States, the European Union, Brazil and India launched crucial talks in Potsdam on Tuesday to try to break the deadlock over the Doha Round global trade talks.

Meeting behind closed doors at the Cecilienh of palace in Potsdam outside Berlin, senior officials including U.S. Trade Representative Susan Schwab, EU Trade Commissioner Peter Mandelson, Indian Commerce Minister Kamal Nath and Brazilian Foreign Minister Celso Amorim, will try in next five days to resolve differences mainly on farm subsidies and tariffs that have plagued the Doha Round of multilateral trade talks since its launch five years ago in the capital of Qatar.

Developing countries and rich nations are mainly at odds over the degree of state support for agricultural sectors particularly in the EU and the United States.

Below, MarketWatch covers yesterday’s episode of the slow motion US real estate crash.

Housing starts fall 2.1% to 1.47 million pace

May’s building permits up 3% on strength in multifamily dwellings

By Rex Nutting, MarketWatch

Last Update: 4:49 PM ET Jun 19, 2007

WASHINGTON (MarketWatch) — Starts of new homes in the United States dropped by 2.1% to a seasonally adjusted annual pace of 1.47 million in May, the softest pace of groundbreaking since January, the Commerce Department estimated Tuesday.

Meanwhile, building permits rose 3% to a 1.50 million pace as authorizations for new apartment buildings and condo projects surged.

Permits for single-family homes dropped to a 10-year low.

Economists said the mixed data showed that the nation’s housing market has a ways to go yet in wringing out its excesses.

——“The housing starts data are a sideshow to the main event, which is the demand side of the equation,” wrote Stephen Stanley, chief economist for RBS Greenwich Capital.

Larger declines in new construction are necessary amid high inventory levels, wrote Steven Wieting, an economist for Citigroup Global Markets.

Slower construction will continue to be a drag on growth, said Gary Schlossberg, an economist for Wells Capital Management.

—-“The housing starts data are a sideshow to the main event, which is the demand side of the equation,” wrote Stephen Stanley, chief economist for RBS Greenwich Capital.

Larger declines in new construction are necessary amid high inventory levels, wrote Steven Wieting, an economist for Citigroup Global Markets.

Slower construction will continue to be a drag on growth, said Gary Schlossberg, an economist for Wells Capital Management.

The highest profile “victim” of the toxin so far, has been the unfortunate Bear Sterns, or rather their hapless investors. With the sky falling, and creditors like Merrill seizing collateral, the Bear has started to blink. Below, BS offers a ray of hope. I suspect it will live up to its acronym. I suspect, we haven’t seen anything yet.

Bear Stearns to rescue ailing property fund

By Ambrose Evans-Pritchard Last Updated: 1:25am BST 20/06/2007

Bear Stearns has proposed a $1.5bn (£755m) rescue package for one of its asset management funds facing imminent collapse after betting heavily on US sub-prime mortgage debt.

The bank has been in emergency talks with creditors and the private equity group Blackstone in hope of saving the fund, which was forced to liquidate $4bn of mortgage securities last week

“They’re looking for a lock-down with creditors that would mean no more margin calls for 12 months,” said a banking source familiar with the deal.

“They had a lot of redemptions when things started going wrong, and that meant they had the rug pulled from underneath them,” he said.

The fund has a $600m base capital from clients but is understood to have taken on at least $6bn in debts to play the markets, including large loans from Barclays. It lost 23pc of its value in the first four months of the year, triggering the crisis.

Under the proposed deal, Bear Stearns will back the distressed fund provided Merrill Lynch, JP Morgan and other creditors put up $500m in fresh money.

Traders were watching closely to see whether the sudden downward spiral as margin calls hit over the past month is an isolated case or the beginning of a broader crisis among investors in the $2,000bn sub-prime sector.

—–The emergency talks came as the price of low-grade mortgage bonds issued in 2006 and listed on the closely watched ABX index crashed to all-time lows of 60.4 yesterday, down from near par at 97 in January.

The most vulnerable are so-called second lien loans, where creditors are last in line in cases of default.

Moody’s rating agency last week downgraded 131 bonds backing sub-prime mortgages, and placed 247 on negative watch, noting that the default rate had been higher than expected.

“They had a lot of redemptions when things started going wrong, and that meant they had the rug pulled from underneath them,” he said.

Well no. No one pulled the rug from underneath anyone. Greed made the managers over leverage, and complacency and greed made the investors over confident in BS. With ratings agencies slow to downgrade mortgage paper that they had implied was top drawer, the $6 billion dollar bailout looks like being just the start and probably off by a factor of 100. The race for cash is just starting. According to the latest BIS figures, global derivatives gambling stood at 533 trillion dollars as at March 31. Now the latest from the WSJ suggests the race is turning into a panic.

Two Big Funds
At Bear Stearns
Face Shutdown

As Rescue Plan Falters
Amid Subprime Woes,
Merrill Asserts Claims

June 20, 2007; Page A1

Two big hedge funds at Bear Stearns Cos. were close to being shut down last night as a rescue plan developed over several days fell apart in a drama that could have wide-ranging consequences for Wall Street and investors.

Merrill Lynch & Co., one of the hedge funds’ lenders, said it would move to seize collateral — much of it mortgage-backed debt — from the two funds and sell it, according to documents reviewed by The Wall Street Journal. At the same time, the funds’ managers worked with a handful of other key lenders, including Goldman Sachs Group Inc. and Bank of America Corp., to pay off the funds’ $9 billion in loans, according to a person familiar with the matter.

As of a few weeks ago, the two Bear Stearns hedge funds held more than $20 billion of investments, mostly in complex securities made up of bonds backed by subprime mortgages — the relatively risky home loans made to borrowers with troubled credit histories.

The Bear Stearns hedge funds’ problems are emblematic of the widening fallout from the nation’s housing downturn, which just a few weeks ago seemed to be stabilizing. During the housing boom in the first half of the decade, lenders issued record volumes of mortgages, often on very generous terms, then packaged those mortgages into bonds and sold them off, reducing their exposure to any loans that went bad.

Since 2000, Wall Street has created more than $1.8 trillion of securities backed by subprime mortgages, according to industry newsletter Inside Mortgage Finance.

—-Last month, Enhanced Leverage reported that its value fell 6.75% in April after the fund’s bets on the mortgage market went wrong. Two weeks later, it put the loss at 18%, spooking already-nervous investors and creditors and sending many of them running for the exits.

The huge revision at least in part reflected conversations Bear Stearns hedge-fund managers had with bond dealers, three of which told them in late April that some of the funds’ assets were worth less than the values stated on the funds’ books, according to a person familiar with the matter.

So far the turmoil doesn’t seem to be significantly hurting the broader bond markets. But as the Bear Stearns funds unwind positions, investors and traders could reassess the value of other debt securities. As a result, investors far beyond the reach of the funds could find their holdings of similar debt worth less than they thought.

In UK news, signs that the UK is following the US in suffering consumer burn-out. Below, the UK’s largest retailer unexpectedly misses the target.

Tesco slowdown sparks warning over rate rises

By Richard Fletcher and Edmund Conway Last Updated: 1:25am BST 20/06/2007

Tesco, the UK’s largest retailer, reported a slowdown in sales growth and gave warning that four interest rate rises in less than a year have hit consumer confidence.

“It appears that higher UK interest rates might finally be starting to bite,” said Sam Hart, retail analyst at Charles Stanley.

The slowdown comes amid growing evidence that households are creaking under the weight of a record debt burden, a rising tax imposition and major increases in the cost of living.

Group sales at Tesco increased 10pc in the 13 weeks to May 26 – boosted by a strong performance in Asia – but in the UK like-for-like sales growth slowed to 4.7pc, down from 5.8pc in the previous quarter.

City analysts had expected Tesco to report a 5.2pc increase in UK like-for-like sales.
—-Earlier this month, the British Retail Consortium, urged the Bank of England to refrain from further interest rate rises after reporting a 1.8pc increase in like-for-like sales – the lowest rate since November 2006. The Office for National Statistics has also reported a slow down in retail growth in recent months.

The Bank of England’s Monetary Policy Committee has raised interest rates from 4.5pc to 5.5pc since last August in an effort to wrestle control of inflation and cool the housing market.

Currency traders expect a further two increases in borrowing costs, suggesting that even leaner times could be ahead for Britain’s retailers.

In more UK news, “only the little people pay taxes” here too. With apologies to the Queen of Mean, Leona Helmsley. I suspect that at today’s televised select committee grilling, Mamon’s high priests of private equity, are likely to make poor old Leona look generous. With seven days to go until the UK gets the “psychologically flawed” scots “Stalin” taking up duties as new Prime Minister, with apologies to the leakers on the departing Prime Minister’s team, the high priests of greed couldn’t have picked a less appropriate time to come to the public’s attention. Will any have the sense to take off their Rolex.

Extra tax break for buy-out partners

By Martin Arnold, Private Equity Correspondent

Published: June 19 2007 23:16 | Last updated: June 19 2007 23:16

Private equity partners pay almost no tax on the large share of profits they receive from investments, thanks to a little-known law that has applied to buy-out firms for 20 years, say legal and accounting experts.

By offsetting part of the cost of funds’ investments against profits from the sale of those assets, buy-out partners can reduce the tax they pay on carried interest – a share of their funds’ profits – to well below 10 per cent.

News of this extra tax break for some of Britain’s wealthiest businessmen is likely to outrage trades unions and members of the Treasury select committee who will grill five buy-out executives in a televised session on Wednesday June 20.

Critics were already calling for a change in the capital gains tax rules that allow private equity partners to “pay less tax than a cleaning lady”, as revealed this month by Nicholas Ferguson, chairman of SVG Capital.

—-Private equity partners pay income tax on their salary and bonuses but not on carried interest, often the lion’s share of their income. Taper relief cuts the tax on carried interest from 40 to 10 per cent on investments held for two years. Further relief comes via a “base cost shift” law that has been applied to carried interest since a 1987 Revenue memorandum on private equity. The law allows fund partners to offset 20 per cent of the initial price paid for the assets they buy.

Many buy-out partners are “non-domiciled”, so pay no UK tax on carried interest. But the fact that even UK-domiciled partners pay almost no tax on carried interest is likely to “put the cat among the pigeons”, one tax lawyer said on Tuesday.

buy-out executives stressed that they were breaking no law by using a rule available to all partnerships. “This allows any partnership to pay less tax – and private equity is particularly well placed to take advantage of it,” said one buy-out firm chief.

In China news, China moved yesterday to try to head off US and EU tariffs. Below, the FT reports on what’s probably too little, too late, if adjusting or dropping tariffs on 2,831 products qualifies as too little.

China cuts tax rebates to curb exports

By Richard McGregor in Beijing, Andy Bounds in Strasbourg and Eoin Callan in Washington

Published: June 19 2007 19:01

China has cut and in some cases abolished export tax rebates for some of its largest export categories in the latest attempt by Beijing to rein in its bulging trade surplus and ease trade friction with the US and Europe.

The new measures announced on Tuesday appeared to be the most sweeping changes announced so far to the tax rebate system, which has already been trimmed for a number of products over the past year.

The rebate, which can be as high as 17.5 per cent, the level of China’s value-added tax, has been abolished for some leather products, fertiliser and some wood exports.

The finance ministry said the cuts were aimed at energy-intensive industries.

“The aim is to curb excessive growth of exports, rationalise export structure, ease trade friction and slow down sales of products that consume a lot of energy,” the ministry said.

The current account surplus is on track to reach about $400bn this year, more than 10 per cent of gross domestic product.

Mark Williams of Capital Economics said in a research note that the changes would have “little immediate impact” on the surplus.

“Chinese producers are continuing to enjoy bumper profit growth, which suggests they can absorb higher costs into their margins,” he said. “And in sectors where Chinese producers do not face much foreign competition, higher prices may simply be passed on to consumers.”

In other China news, China has the real estate market the US can only dream about. Below, Xinhua reports on the latest bubble. But a bubble in China can be like any other. 1.3 billion people have a 100 years of development to catch up on.

China’s property investment grows 27.5% in 1st 5 months

BEIJING, June 19 (Xinhua) — A report by China’s National Bureau of Statistics (NBS) shows investment in the country’s property sector reached 721.4 billion yuan in the first five months, an increase of 27.5 percent from the same period last year.

Of the total, 504.2 billion yuan was poured into residential property, up 29.5 percent, of which 20.8 billion yuan was injected into low-cost home construction, up 39.4 percent.

In the first five months, China’s developers registered 1.21 trillion yuan of investment capital, up 26.2 percent from the same period last year, of which foreign investment reached 22.2 billion yuan, up 89.9 percent, the NBS said without elaborating.

The area of land under development reached 97.75 million squaremeters, up 11.2 percent, while the floor space of buildings under construction reached 1.56 billion square meters, up 21.9 percent.

By the end of May, the floor space of commercial property unsold or unused totaled 127 million square meters, up 4.7 percent,of which 68.25 million square meters was residential, up 1.4 percent.

At the Comex silver depositories a net 5.09 Moz left Registered at HSBC and Brinks. Another net 2.6 Moz was added to Eligible mostly at Scotia Mocatta. Final figures were Registered 71.95 Moz, Eligible 58.24 Moz, Total 130.19 Moz. Stay long precious metals.

Ted Butler’s excellent latest silver update is available at the link below.

The NYSE WIN system is short. The NASDAQ system is flat.

Since playing a black box system in the current geo-pol/economic climate, isn’t the wisest thing to do, we will adjust long positions to carry an offsetting deep-out-of-the-money matching option position to provide an automatic fail safe stop in the event another 1987 like event occurs before the PPT can step in.

More details on the WIN system are available at link below.

The monthly Coppock Indicators finished May:

DJIA: 175 up. NASDAQ: 108 up. SP500: 149 up.

All three have confirmed the long trend as up.

This week’s featured link:
Longview Capital Partners. TSX-V: LV

Longview Capital Partners is a global resource group. The current portfolio of companies we have founded, developed and invested in now enjoys a combined market capitalization of over $900 million.

Our model is to selectively invest in private or undervalued assets, augment management teams with our expertise and assist in the going public process. Once public, Longview Capital Partners continues to invest and brings an awareness of the opportunity to our network of retail and institutional investors.

A Personal Disclosure.

Over the last few months, many of the stocks we’ve linked to have made some interesting moves. Possibly because of the LIR link, more likely because of the underlying company and good management. Going forwards, I expect the commodities demand cycle to last another couple of decades due the economic rise of Asia. I expect the pace of interest in natural resource stocks to quicken. I also expect many junior resource stocks will become takeover or consolidation targets. I expect NAFTA based resource stocks to be especially prominent.

Where I hold a position prior to a company being featured as a link, this will be disclosed. Where I will be investing during the week of linking, this too will be disclosed.

In no event should my investing or not investing substitute for doing your own due diligence, if you are considering an investment in the stock.

My circumstances and resources are probably very different to other potential investors. All stocks linked in LIR, I consider to merit the link, whether or not I invest in the company. As before, neither LIR, Global Profiles nor myself get paid for featuring a link. Lastly, because I invest in a stock it does not necessarily turn it into a sure thing winner. Happily though, neither will my investing turn it into an automatic loser.

Below is the list of natural resource stocks I hold an interest in. In no particular order, they are:

Birch Mountain Resources Ltd. BMD.

Canadian Royalties Inc CZZ.

MacMillan Gold MMG.

Quaterra Resources Inc QTA.

MBMI Resources Inc MBR.

Candax Energy Inc CAX.

Derek Oil & Gas Corp DRK.

Consolidated Spire Ventures CZS.

Cornerstone Capital Resources Inc

Pacific Asia China Energy

If you have a junior resource company you think has merit and don’t mind sharing it with others, feel free to send it along. If space permits and they have no objections, we’ll try to put up a link.

Junior resource companies are not suitable for everyone, but for those who are interested in that sector, we aim to provide companies of merit. As the new century unfolds and natural resource demand soars, I think, that there will be big money to be made from prudent investment in the sector. As always, it’s important to do one’s own due diligence if thinking about making an investment. No one has more at risk in an investment than you do yourself.

If you like this report, feel free to share it with others. It is not copyrighted but open sourced. If you have comments, witty remarks, or information to share, please send them along as well. If permission is granted, we may use them in this report.

Sometimes the daily LIR gets “bounced” out of the receiver’s server. When this happens it sometimes bounces you out of the LIR database as well. If you suddenly stop receiving the daily update but didn’t actually want a break from my daily insanity, just email me at the link below to get back onto the daily list.

Graeme Irvine

Global Profiles LLC


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