|By Matein Khalid|“Few individuals alter the course of history. Fewer still change the map of the world. Hardly anyone creates a nation state. Mohammed Ali Jinnah did all three”. Dr. Stanley Wolpert’s words still give me goose pimples two decades after I first read his book. Mr. Jinnah founded Pakistan and was also my ancestral kinsman. I too was born in Karachi, the city by the sea, his city. I was raised in my grandfather’s house with vivid tales about his life in the cosmopolitan, secular world of 1940’s South Bombay where Nana, a Churchgate lawyer like Mr. Jinnah, lived through the surreal twilight of the British Raj and the trauma of Partition. They are all gone now, the Partition generation, the amazing men and women of that dramatic moment in Indian history yet I will never regret to my dying day, my human link to that lost world. In any case, December 25 was the 141st anniversary of Mr. Jinnah’s birth and a time to introspect for every citizen of Pakistan. James Joyce was so right. History is a nightmare from which we all struggle to awaken.
In 2015 and early 2016, I had written at least half a dozen columns strongly recommending UAE investors understand the macro ballast behind the spectacular bull market on the Karachi stock exchange. Pakistani equities were up 45% in 2016, the best performing emerging market in Asia. Pakistan is still not expensive at 10.4 times forward earnings, still a major valuation discount to Indonesia at 15X, India at 16X and the Philippines at 18X earnings. Ironically, foreign investors unnerved by the escalating conflict with India on the Line of Control in Kashmir, Nawaz Sharif’s political woes (political joke de jour is PML-N stands for Panama money laundering network LOL) and a sporadic privatization program have actually sold $250 million in Pakistani equities. Unlike Seoul, Tokyo, Mumbai or Jakarta, Pakistani equities do not soar only when they are in favour with global investors.
MSCI upgraded Pakistan to emerging markets from its former frontier netherworld last June. The elected government of Nawaz Sharif will complete its full term, only the second such government in Pakistani history to do so. Army Chief General Raheel Sharif won his war against the Taliban in Swat and South Waziristan – and resisted the calls of phony “democrats” who called on the GHQ to stage a coup d’état. The State Bank of Pakistan’s hard currency reserves have topped $20 billion. Budget deficits, inflation and policy interest rates has plunged to record lows. The $6.7 billion IMF structural adjustment program is on track, China has promised to invest $46 billion in its “economic corridor”. Pakistan has raised more than $3 billion in Eurobonds/sukuk in the international capital markets.
Pakistan equities have returned 28% per annum for US dollar investors since 2011. This makes President Asif Zardari the father of the most spectacular bull market in Asia despite his PPP’s ostensibly socialist, populist agenda. Pakistan is also weekly correlated to Wall Street or even the major emerging markets indices. I remember when a former American ambassador once told me that Pakistan was a “geopolitical too big to fail” state – to Washington, Beijing, Riyadh, Abu Dhabi and even to New Delhi. As late as December 2015, it was obvious to me that the world was grossly underweight Pakistan on the eve of a MSCI upgrade from frontier to emerging market that came in June 2016. Since the free float in Karachi is a mere 22%, I did not need to be Warren Buffett to figure out that at least a 40 – 80% move in Pakistani equities was imminent in 2016. After all, UAE shares more than doubled in value before and after their MSCI upgrade. This macro trade was, frankly, impossible to miss.
I believe it was a strategic mistake for Pakistan to sell 40% of its combined stock exchange to Chinese and not Western investors. Pakistan’s destiny is with the Western democracies, not as a satellite state of the Dragon Empire. There is no doubt that KSE 100 index can well rise to 6400, though I would immediately go to cash if any religious right coalition emerges in the 2018 general election.
I believe the Kashmir time bomb will not explode into war on the LOC, even if it poisons relations between Islamabad and New Delhi. War and peace, how Count Leo Tolstoy would have chronicled our tragic, utterly pointless, pitiless saga of hate and loss in the game of nations.
The easy money in Pakistani equities was made in 2016 though there is no shortage of 30 – 50% upside strategic plays in Karachi in 2017. Pakistan amply vindicates George Soros’s observation. The big money is made when things go from Godawful to just plain awful.
Commodities – Can gold fall but silver rise in 2017?
Gold has had a cruel 2016 and while this column caught the $280 an ounce rally from its winter lows near $1050, I completely misjudged and mistimed the outlook for the yellow metal in the second half of 2016. After all, back in July, just after Brexit, a free fall in sterling, on ominous rise in the implied volatility of the foreign exchange markets, it was easy to be long (and wrong!) gold, at $1340, up 25% for 2016. My strategic error was to accept that a Donald Trump win would mean chaos in the world financial markets and global safe haven demand for gold that could take the COMEX contract to $1500 and a near 50% rise in the post 2011 embattled asset class for the year. Sadly, the Scottish poet Robert Burns was so right. The best laid plans of mice and men (and dafto Dubai goldbugs, in my case) aft go astray and so they did with a vengeance. Gold is now $1150 an ounce, almost $200 an ounce below its Election Day high.
The scale of the outflows from gold exchange traded funds have been staggering, with $700 million in outflows in one week in December alone. The December FOMC, with its three projected interest rate hikes and explicit Yellen warning to Trump about her response to fiscal stimulus is gold bearish and US dollar bullish. Higher US dollar overnight borrowing rates in 2017 are Count Dracula’s cross of gold at dawn to the zero yield gold market.
While there has been a post-election uptick in inflation expectations and 25% rise in the price of crude oil after Saudi Arabia played OPEC swing producer in Vienna, this has not really helped gold find a credible bottom. Nor has the failure of Renzi’s Italian political reform referendum or the capital woes of the world’s oldest bank in Siena attracted any real demand to gold, in sharp contrast to its post-Lehman rally from $700 to $1900 an ounce in 2008-11. Trump’s election has led to a fall, not rise, in market volatility. US GDP growth in the third quarter has accelerated amid a surge in consumer/business confidence, not fallen off a cliff. If US economic growth rises to an above trend 3% and the Federal Reserve continues to hike interest rates thrice, it is possible that gold will lose another $200 an ounce in 2017 and reach the $950 a troy ounce level my Fibonacci obsessed elves tell me is its ultimate strategic technical target.
Stung badly by accepting the wisdom of crowds and market consensus on the eve of the election, my mind imagines scenarios where the next $200 an ounce move in gold is up, not down. This could happen if Trump is unable to pass his $1 trillion infrastructure spending package through the fiscal hawkish Republican establishment in Congress – and the Fed backs down on interest rate hikes or a major German bank, the ultimate German bank, faces a funding big chill in the global interbank markets. We do not need Nassim Taleb to remind us that we live in a world of black swans.
Silver has been the Pavlovian collateral damage to gold’s fall from grace since Trump’s election. Can silver fall below $15 in the first four months of 2017? Sure. The outflows from the silver index fund SLV and the options skew on the New York Merc/Comex all suggest the current downtrend will continue.
Yet it is also a fact that silver peaked at $21 an ounce in July, that silver is an industrial as well as a monetary metal, that automotive/medical/solar panel demand could be well above 50% of total demand in the silver bullion market in 2017 and silver mine output form gold/lead and zinc mines will decline in 2017. If silver sees a 200 million ounce deficit in 2017, almost double the supply deficit of 2015, I can easily see a short squeeze in the silver market. So the ghost of Nelson Bunker Hunt haunts me as I believe we are on the precipice of a major bullish move on silver, though only after short term pain down to a 14 handle. So this is the level where I will begin to accumulate silver longs for an $18 target, using Comex silver options and futures.
Stock Pick – Wall Street’s Blackstone Group
The most profitable trade after Donald Trump’s shock win was to buy American money center banks Goldman Sachs, Bank of America, Citigroup and J.P. Morgan, which all surged by 22-30% on a steeper Treasury yield curve, the potential rollback of Dodd Frank and the Volcker Rule, the selection of Steven Mnuchin, a second generation Goldman partner as Treasury Secretary and an unabashedly pro-Wall Street regime in the White House. True, banks drifted lower as pension fund rebalancing and US-Russian tensions led to fall in the ten year US Treasury note from 2.6% to 2.46%.
Will the Age of Trump be hunky dory for banks on day one? No. Is Italian banking not a systemic threat to global finance? No. Is far right fanatic Geert Wilders, who demonized both migrants and Brussels, lead in the Dutch polls not a threat to global banking? No. Could China’s currency crisis or Turkey’s financial meltdown on the Bosphorus escalate? Yes. Could Republican fiscal hawks create legislative risk for Trump’s economic policy agenda? Yes.
The balance of risks suggests it is not prudent to “bank” (awful pun, forgive me) the profits on my pre-election money center bank strategy ideas, notably – Citi, BankAm, Morgan Stanley, Goldman, Barclays and ING. Investors do not go broke booking profits, as a 3 – 5% S&P swoon in January could mean a 8% hit to financials. Yet I would be a buyer on “dips” (eg Citi at 52, Goldman at 200, BankAm at 19) as the yield curve will steepen, the fiscal stimulus will happen, the regulatory rollback will commence, merger mania will continue, US growth will accelerate and trading volumes, deal flow and market volatility will rise. The last seven weeks have been the most compelling argument I have seen to buy financials since Uncle Sam lost his AAA credit rating in September 2011. Now Uncle Sugar is the 45th President!
Blackstone Group is the world’s preeminent alternative asset manager, with $340 billion under management in hedge funds, property, private equity, emerging markets and energy funds plus a fabulously profitable deal advisory business. It is ironic that Blackstone trades at 27 ten years after its ill fated IPO at $32 in the summer of 2007, which I strongly advised against investing to the readers of this column and my friends in the Gulf’s buy side constellation. This public stance cost me an invitation to dinner with Steven Schwarzmann, Blackstone’s founding CEO and my boyhood hero when I last saw him on the Wharton campus.
The Blackstone IPO was a disaster as shares fell as low as $5 a share, wiping out some of the most powerful family offices in the Gulf who took Morgan Stanley’s “strong buy” recommendation at face value. As a former J.P. Morgan Chase alum in New York before I returned to Dubai, I knew all too well that investment banks work for issuers, not investors, in a high profile IPO. Investment bankers pocket 7% from gullible clients who have no clue that a IPO roadshow, like 007’s license to kill, is a license to fleece! The fleeced lambs are led to the slaughter by their own “relationship manager”, who is like a doctor who offers free consultation, but takes a cut every time he “prescribes” a pill to his patient.
Blackstone has fallen to 27 as 2016 ends. Can it fall to 25 if volatility spikes on Wall Street in early 2017. Sure. This is my target buy level. Why? One, Blackstone has raised $200 billion since 2011, more than KKR, Carlyle Group and TPG combined. Two, at 25, the distribution (dividend) yield is 6.4%. The economic income multiple is only twelve, due to carried interest angst. Three, higher interest rates are correlated with higher hedge fund returns, a boost for performance fees. Four, Blackstone plans to IPO its US residential housing portfolio, acquired in the aftermath of the 2009 recession and now the largest in the world. Five, Blackstone has built formidable franchises in credit and quantitative strategies. Six, unlike Kravis and Roberts at KKR or Dave Rubinstein at Carlyle, Blackstone has a deep management bench. Seven, 2017 will be the record year for realized gains as Trumpnomics electrifies the stock markets. As Schwarzmann showed the world in 2007 with his own IPO, he knows how to extract peak value from a deal! Seven, the bank syndicated loan market’s “animal spirits” are resurrected by Trump’s win, bullish for Blackstone’s colossal deal machine. Eight, US real estate is on a roll. My target price for BX? Thirty four and out the door!