Sovereign debt, Gold and Hypothecation

"Capitalism without bankruptcy is like Christianity without hell" Borman

Over the last two days I've been watching some videos on Youtube showing interviews by Kyle Bass the founder of Hayman Capital. Bass is probably most famous for the gains he made by betting against the US housing market by hedging his positions through the purchase credit default swaps (CDS). These CDS acted as insurance against market price falls of the collateralized debt obligations (CDO) being widely marketed at that time.

When speaking in a 15/11/2011 BBC interview Bass was questioned on the morality of investors of making gains from the US subprime mortgage crisis. Basically the interviewer asked if it was right or wrong to profit from the misfortunes of people who over-borrowed and lost their homes in the US. He quite succinctly replied that the such events would occur regardless of his involvement and that he had a fiduciary duty to protect his client's funds. He gave the following quote: "Capitalism without bankruptcy is Christianity without hell." I must admit that it was the first time I had heard that quote before!

Currently I'm reading his latest letter to Hayman Capital shareholders where he is extremely certain of a Japanese sovereign debt default following the default of EU nations. He paints the following picture of the current situation:

"Imagine a team of mountain climbers all strapped together for safety as they ascend a treacherous peak. While they are all holding on to the mountain there is no additional strain placed on each other. Now consider what happens if one climber, let’s call him Stavros, slips and loses his grip. He places added strain on the remaining climbers. One climber might no make a difference, but as Seamus, Pablo and Jose each lose their grip they not only add extra total dead weight to the team but also increase the amount each other climber has to carry, until finally Francois, Luigi and Takehiro let go and poor Jurgen, and Uncle Sam are left trying to keep the whole team on the mountain."

In particular he is speaking about the unsustainable sovereign debts positions of Greece, Italy, Ireland, Iceland, Spain, Belgium, Japan, Portugal, France and Japan. To quote Bass again: "We believe the debts of the following nations, among others, are not sustainable in the current economic environment: Greece, Italy, Japan, Ireland, Iceland, Japan, Spain, Belgium, Japan, Portugal, France, and have we mentioned Japan?"

So where to for cautious investors - Cash, guns or gold? We all know the implications of holding cash with all the money 'printing' being done by the world's central banks. As for guns well known financial commentators such as Robert Kiyosaki have been frequently talking about the possibility of social upheaval and alluding to the insurance policy offered by buying a gun to protect one's assets from upcoming unemployed and desperate masses! Although I do believe Kiyosaki is a very successful investor he has been know to make repeated alarmist comments in his most recent posts on his site www.conspiracyoftherich.com

As for gold the question I want to discuss is between physical or paper? In my personal opinion investing a portion of ones fund in gold is always going to be a smart move. Throughout history regardless of country or upbringing man has always had used the metal as a store of wealth and hedge against fiat currency manipulation. Dylan Grice of Societe Generale has written about the timing of gold purchases and sales in Popular Delusions. Those interested in reading the full article can find it within the 2010 annual report from Platinum Asset Management (PTM) which is where I read it.

Those of you with Australian self-managed super funds (SMSF) looking to invest in gold would mostly likely be looking at exchange traded funds such as Betashares Gold Bullion ETF (ASX code QAU). However with the recent issues surrounding hypothecation I became slightly wary of gold ETFs when I read the following article on Zero Hedge: http://www.zerohedge.com/news/gold-rehypotecation-unwind-begins-hsbc-sues-mf-global-over-disputed-ownership-physical-gold The article talks about HSBC suing MF Global over disputed ownership of physical gold that was re-hypothecated. The underlying worry for investors is whether MF Global used re-hypothecated client gold to satisfy liabilities and whether there are other occurrences of this occurring at other financial institutions.

Closer to home in Australia I'm wondering whether the same thing could occur if I purhased Australian listed ETF backed by gold bullion? As central bankers continue printing more money to reduce imminent volatility they are only causing the eventual consequences to be worse. Read The Black Swan of Cairo by Taleb & Blyth for details. However if I expect to protect myself from their actions by buying gold the last thing I would want is to find out my gold has been used as collateral for another parties transactions!

If you have any comments or find any errors in my post please feel free to let me know.