Author: Sacha Peter

Bank of America / Berkshire Hathaway

The decision to purchase $5 billion of preferred shares (with an under-market value of a 6% coupon, albeit with bonus provisions) in conjunction with the 10-year warrants to purchase BAC shares for $7.142857 (7 and 1/7th for those that do not recognize the string of numbers after the decimal point) has been analyzed to death by others.

The warrants are the golden part of this agreement – it is essentially a binary bet on the bank – if Bank of America does not go belly-up, it should be able to produce sufficient cash after a ten year period to justify a stock valuation significantly higher than $7 1/7 per share. If the company does go belly-up, Berkshire should be able to retain some residual interest in the preferred shares while the common shareholders get wiped out.

There is about $150 billion in tangible equity on the balance sheet to clear through before this would occur, which is why I suspect that this deal is a very good one for Berkshire and Warren Buffett.

I generally do not like it when financial companies raise capital – this is no exception. It makes you wonder how well JP Morgan is doing in terms of their solvency and liquidity situation. Analyzing big banks such as BAC or JPM is essentially a leap of faith more than an informed investment decision.

Price of Gold

Being patient with the market is not all that stimulating to write about.

Looking at the price of gold over the past five days, it has been extremely volatile. The 5-day chart (for December gold delivery) is here:

As always, timing is everything. Although I believe gold is vastly overpriced, it is very difficult to compete against momentum and psychology, especially when the US government is still running deficits north of a trillion dollars – currency erosion (including that of most global currencies, not just including the US dollar) is playing a large part in the increase of the price of gold.

To get an idea of traditional valuation it is good to look at marginal cost of extraction in various gold mining companies. Of course, traditional commodity valuation methods only tend to be valid for a long term projection in terms of decades – the gyrations witnessed inbetween are gut-wrenching for most commodities.

An omnious market sign

The following headline graphic on CNNfn is something that you will not be finding at a market bottom:

VIX might be at 43%, but it seems that it could get even higher to flush out any bullish sentiment left in the marketplace.

This week and the next will continue to be dominated by noise while the key decision-makers have their portfolios on algorithmic autopilot. I believe after the labour day long weekend is when things will get interesting again. Most pension fund managers are probably scratching their head and wondering how they heck they can achieve their expected return on plan assets when their equity components have tanked.

Fixed rate mortgage rates will drop

Attached is a 1-year chart of the 5-year government benchmark bond yield:

5-Year Canadian Government Bond Yield

With a yield of 1.41%, this is the lowest the 5-year yield has been for decades. The lowest reached during the last economic crisis (January 14, 2009) was 1.54%.

The quick implication is that the 5-year fixed mortgage rate will likely drop. Although we are completely bathed in the midst of a European financial crisis (causing collateral damage domestically, just as the US economic crisis caused damage in Canada), banks are apparently solvent.

What will be an interesting question is whether this recent crush in the markets will cause a decrease in real estate prices or whether prices will continue to remain strong, especially in the Vancouver area. Real estate, gold, and government treasuries are three asset classes that have managed to hold value, while everything else has been dumped. If real estate prices are compressing then banks may tighten credit requirements (e.g. higher down payment, higher rate, etc.)