Pension Funds in Hot Water, A Commodity to Short, Gene Patents, Capital Controls and More!

by Addison Wiggin & Ian Mathias

  • State and autoworker pensions horrifically underfunded… how you might end up paying for both
  • Sugar prices get too sweet… Chris Mayer bets on a “reversion to the mean”
  • Patrick Cox on a gaming-changing court settlement for biotech investors
  • Plus, a closer look at the new capital controls in America

  Which is the bigger story: That an independent study just discovered California’s public pension systems are short half a trillion dollars… or that no one cares?

A study commissioned by Arnold Schwarzenegger announced yesterday that just the three largest CA pension funds, which will “benefit” over 2.6 million public employees, are underfunded by $425 billion. CalPERS, the public employee fund, makes up $239 billion of that unfunded debt by itself — way, way more than the fund’s own projection in 2008, which suggested CalPERS was short just $38 billion. (Turns out the market doesn’t return 7.75% every year for eternity.)

The researchers, mostly from Stanford, say California will need to inject $360 billion into its public benefit systems — right now — in order to have an 80% chance of meeting 80% of obligations over the next 16 years.

This is the same state, mind you, that can’t close its $20 billion budget gap.

  And yet… who cares? This story made a brief appearance on the Drudge Report yesterday. Then Schwarzenegger made his little speech. There were a few gasps. Then… poof. Gone. Onto bigger and better things, like Dancing With the Stars… and the final season of Lost.

No doubt, California employees will head back to work today and keep on contributing to a fund that is all but guaranteed to collapse. But it won’t implode today… it won’t mess with their monthly payments… so why worry?

  Pension plans at GM and Chrysler are also underwater, said a separate report yesterday. Just to meet minimum funding levels, GM will have to inject $12 billion into its fund within the next five years. Chrysler will owe $2.6 billion. In the grand scheme of things, that’s not a lot. But since neither company is actually making money, it’s a big deal. Just this morning, GM announced a $4.3 billion loss for the second half of 2009.

The federal government is still the majority owner of GM and a large shareholder of Chrysler. According to The New York Times, if the bill comes due while Uncle Sam is still in charge, the American taxpayer becomes “liable for paying benefits to hundreds of thousands of retirees.”

Heh. That’ll be a big hit.

  Yet another reason for the Fed to keep rates “exceptionally low,” for an “extended period.” The latest FOMC minutes, released yesterday, said all that you’d expect… which is not much. Inflation expectations are “reasonably anchored” and all signs point to the Fed keeping the free money flowing for some time. Party on, Garth.

  “History shows that when governments grow desperate to finance deficits, they get creative,” writes Dan Amoss. Dan just got back from a CFA Society meeting at which Russell Napier, a prominent stock market historian, shared his latest thoughts.

“During World War II, the U.S. government needed investors to buy an unprecedented amount of Treasury bonds. Commercial banks loaded up on Treasuries, which limited the amount of credit that could be granted to the private sector. It may have been the patriotic thing to do, but the real returns from war bonds were very poor. Napier said, ‘That’s the type of society [the U.S. and the U.K.] had to run to sustain our government debt. And I’m suggesting to you that these are exactly the sorts of things we have to look out for in our future.’

“Financial suppression is the process of forcing private sector savings into public sector debt. Most investors will tell you that this is impossible. But Napier ticked off two potential tools the government could use to strong-arm investors into Treasuries:

  • Capital controls: An example of this comes from the U.K. in the 1970s. For most of this decade, the yield on U.K. government bonds was below inflation. The government wouldn’t let investors take money out of the country.
  • The ‘Buffett tax’: Political leaders would say, ‘We love capitalism. It is the best thing America has ever had. And we would really, really like to promote it. And the best way we can promote capitalism is to get all you capitalists to invest with a long-term holding period.’ The idea would involve a 4% ‘transaction tax.’ This effectively forces shareholders to engage more deeply with corporate executives, rather than trading shares aggressively. The authorities would say, ‘This is a wonderful thing because Warren Buffett does it. And if Buffett does it, it has to be good. So as of tomorrow, we’ll have a 4% “Buffett” tax for the trading of all financial instruments except for government debt.’

“Napier says the government can’t get away with inflating away its debt in a free market. If it were attempted in an aggressive fashion, yields would soar, making the process self-defeating. So the government will make the Treasury market a ‘less free’ market. In other words, it will stack the deck in favor of Treasuries, to the detriment of all other financial assets.”

  Mssrs. Amoss and Napier are two more investors we trust getting nervous about capital controls. We mentioned a few yesterday… and got a mouthful from readers in today’s reader mail. Below.

Capital controls are, apparently, a touchy subject. “Jingoistic Americans naturally, but stupidly, see taking money out of the country as being unpatriotic,” comments Doug Casey on the subject. “They don’t understand that it’s mainly those prudent people who will be able to supply the capital to rebuild a devastated economy later. Besides, getting money abroad is, obviously, something that only rich people would do… and of course, it’s time to eat the rich, as well. For those two reasons, there won’t be much resistance to controls. And the government gets to appear to be ‘doing something.’”

One way to take your money out of the country… is to do it personally. Bring your wallet to Vancouver on July 20-23, 2010. Join us for a lively tete-a-tete with the world’s most aggressive and avant-garde investment personalities. As we mentioned yesterday, Doug will be there. Marc Faber, Bill Bonner and David Walker too. You can find a complete list of those speakers who’ve confirmed thus far, here.

  In the absence of the Fed’s quantitative easing (QE) program, mortgage rates have risen like a 12-year-old sucking a helium balloon. Yields on the 10-year T-bond are up to 4% since the Fed supposedly exited the market on April Fools’ Day. Thus, the national average rate on a 30-year fixed mortgage is up to 5.3%, says, up about 25-30bps over the last month and its highest since August.

  Mortgage applications plunged 11% last week, to the lowest level since June, the Mortgage Bankers Association reports.

  Office vacancy rates in the U.S. hit the highest level in 16 years in the first quarter of 2010, says research firm Reis Inc. 17.2% of office space currently sits vacant.

  All this good news sets the stage for a nice dollar rally, eh? Naturally. The dollar index is up about 0.7 points this week, to 81.6

  Gold, however, is rising too. In fact, the yellow metal is downright rallying in the face of dollar strength. The spot price is up to $1,147 as we write, up about $20 this week.

  “We’re betting on a simple reversion to the mean in the sugar markets,” Chris Mayer told his Special Situations readers yesterday. “Recently, the gap between U.S. and global sugar prices widened to a point not seen in a decade. In the U.S., sugar prices hit 35 cents a pound. Yet the rest of world paid less than 20 cents for the same sugar. How can that be?

“The U.S. government artificially inflates the price of sugar with import restrictions designed to benefit U.S. farmers. But the wide gap has created pressure to increase the import limits put on sugar. After all, U.S. farmers aren’t the only ones who have a dog in this fight. U.S. sugar processors, confectioners and food producers would prefer the price of sugar to be lower…

“A wholesale dismantling of the quota system is not likely. It has been in place since the 1970s. However, I do think we can expect some give on import restrictions. General Mills, Kraft and Hershey — all part of the American Sugar Alliance — are among those pressing Congress to ease up. Lawrence Graham, the chairman of the alliance, wrote that the current price is ‘almost unheard of, even under this protectionist policy.’

“If they don’t raise the quotas, there is a real danger of a sugar shortage, odd as that may sound.”

So how will Chris’ readers play this seemingly inevitable reversion? Only subscribers to Mayer’s Special Situations will be privileged enough to find out. Should you wish to join them, you can do so here.

  A judge in New York shook up the genetics world yesterday. In short, Myriad Genetics, a company that had a patent on the gene that predisposes breast cancer, was stripped of its monopoly on breast cancer gene testing. Ipso facto, there is now legal precedent that a company cannot hold a patent on identifying gene code.

Over 20% of the human genome is already patented… so a lot of people stand to gain or lose a lot of money. “This throws all gene patents into question,” notes our tech adviser Patrick Cox. “The ruling could affect several of our Breakthrough Technology Alert stocks.

“But the ruling should not apply beyond specific gene patents. Speculation that it will apply to other naturally occurring substances is unwarranted. It also stands a good chance of being overturned in appeal. We won’t know how things will shake out until the final ruling, which could take place in the Supreme Court many years from now.

“My opinion about the ruling, incidentally, is irrelevant. I’m increasingly skeptical of the value of both patents and copyrights in these exponentially accelerating times. Nevertheless, what is relevant is the possible impact of the ruling on the biotechs in our portfolio. Though it may lead me to recommend selling one of the companies in our portfolio, my guess is that it would be a net benefit.”

  “That article is a bit misleading,” a reader writes of the Zero Hedge bit we cited yesterday, which highlighted the paranoia-inducing new capital controls in place here in the U.S.

“It makes it sound like the foreign bank has to withhold. That’s not the case. The legislation (not effective until Jan. 1, 2013) is an ‘information’ grab, and it works like this:


“If you send money from a U.S. bank to a foreign bank, the foreign bank has to be a ‘good bank’ in the U.S.’ eyes, which means it has agreed to disclose all U.S. customers to the U.S. Treasury. If the foreign bank has not so agreed, then the U.S. bank must withhold 30% of the payment and hand it over to the U.S. Treasury prior to sending the rest of the money to the foreign bank FROM the U.S. bank. Then the person’s whose money is withheld has to file papers to the U.S. government to get a ‘refund’ and must show it was not a taxable matter.


“The intent of the legislation was to apply to dividends (which typically are taxable events) to prevent people from shifting taxable money offshore. “

The 5: We told you we were paranoid. (This reader, by the way, also happens to be our attorney, around whom we’re always paranoid. Thanks, Matt.)

  “Based on Zero Hedge’s — or should I say Absolute Negative Hedge’s — statement about the future of investing for us poor ‘captive’ Americans,” another writes, “I guess investing will be a whole lot simpler. And I can discontinue all of my investment advisory subscriptions, since I won’t be able to invest in stocks, bonds or options — just U.S. government securities. All I can say is that this rubbish was not worth the time to read it.”

The 5: Well, thanks for giving it a shot anyway.


Addison Wiggin

The 5 Min. Forecast

P.S. One of the companies Patrick Cox is looking into is rapidly approaching the FDA’s most lucrative “loophole.” We described the details last week. “This is a true first in the history of my research advisory,” writes Patrick. “Accordingly, we expect response to this particular special offer to cause a flood of new members,” but it closes tomorrow.

If you’re interested in the finest research on groundbreaking small caps in the tech world, Breakthrough Technology Report is it. Patrick’s work is inspired, passionate, detailed… and profitable. Why not take the deal while it’s at its best? You’ll find all the details, here.

P.P.S. If, on the other hand, it’s adrenaline-packed trades you’re after, we’ve worked out the details on the reader-requested Trading Reserve. This one-time fee for all our high-end trading services is so new we don’t even have an online order device set up yet. Still, you can get all the details and learn which discounts apply to your account by calling John Wilkinson at (866)361-7662. Give it a shot. John’s a nice guy.

P.P.P.S. Our favorite bartender here in Baltimore made the cover of B magazine. You should be very proud.


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