PIMCO, which manages the world's largest bond fund, made an $8.1 billion bet that we'll see inflation within the next 10 years. The firm disclosed it began writing contracts that would profit from rising inflation (known as 10-year inflation floors) this March. PIMCO said it wrote additional contracts in April. In total, 25 PIMCO funds entered into inflation floors... Bill Gross' Total Return fund accounts for $6.57 billion of the $8.1 billion.
Inflation floors are structured as options on the consumer price index (CPI). They're similar to other insurance vehicles, like credit default swaps. The buyer of the contract pays an upfront premium for the right to receive payment after 10 years should the CPI decline. The seller, PIMCO, receives the premium – in this case, $70.5 million.
What attracted PIMCO to these options? For one, the company doesn't expect prices to fall. Second, the premiums for inflation floors are soaring. Last October, inflation floors cost as little as 42 basis points of the face value. Today, the premium has nearly quadrupled to 146 basis points. As Mihir Worah, head of PIMCO's real return portfolio, said, "The options were priced at rich levels to the underlying risk."
This is a great bet by PIMCO. If we do see deflation over the next 10 years, the value of PIMCO's $1.1 trillion bond portfolio will soar. The $8.1 billion loss from inflation floors will be inconsequential. If we see inflation, PIMCO gets to keep the rich premiums. According to Bloomberg:
In PIMCO's case, a cumulative 10 percent decline in the price index over 10 years would require the funds to pay out a total of about $810 million, based on that formula. The funds would pay nothing to the counterparties and keep the premiums if prices in 2020 are equal to or higher than in December 2009 or January 2010, depending on the contracts.
PIMCO's bet is similar to the $36 billion of equity put options Warren Buffett's Berkshire Hathaway sold earlier this year. And PIMCO likely took the other side of Fairfax Financial's – the Canadian Berkshire Hathaway – huge bet on deflation.
Vulture investor Wilbur Ross bought a number of troubled U.S. banks during the crisis with a financial backstop from the U.S. government. In a CNBC interview today, Ross said he's shopping in Ireland...
The billionaire investor, along with private-equity firms Carlyle Group and Cardinal Group, bid for the Irish state-controlled Educational Savings Bank (which has around $15 billion in deposits). The Irish government will be his partner in the bank. Ireland used to be the economic jewel of Europe. It had a strong balance sheet and a fully funded pension. Then, it got caught in the real estate craze. At one point, real estate loans written by Irish banks totaled more than the country's entire GDP, Ross said. Now, Ireland is working hard to get its finances in order. It recently cut the entire civil service payroll by 14% (without backlash from citizens).
Ross thinks real estate will be tough in Ireland for years. Unlike in the States, if you're foreclosed upon in Ireland, the debt follows you. You can't just mail your keys to the bank. So Irish banks have billions of dollars of mortgages in arrears. Ross plans to use the knowledge he acquired from running his U.S. mortgage lender (American Home Mortgage) to fix the Irish banks' problems. He'll reduce borrowers' principal amounts to "make the bank function well."
Ross also said he's avoiding Greece and the other "Club Med" European countries.
After discussing his views on Europe, Ross changed topics to the expiring tax benefits. He pointed out that families making more than $250,000 a year comprise 40% of U.S. consumer spending. Considering consumer spending is 70% of our GDP, it's a bad idea to raise taxes on these folks.
We agree with Ross... Burdening your most productive citizens with higher taxes isn't the answer. As we've explained on many occasions, we have to cut spending in entitlement programs. And a pay cut for civil employees (like in Ireland) probably isn't a bad idea, either.
In his latest Retirement Millionaire issue, Doc Eifrig tells readers how to take advantage of a government loophole that is closing on December 31, 2010. Whether you want to have more money for your retirement or pass more money onto your heirs, Doc's latest issue will help. In short, he tells you how to receive tax-free income for life. This one issue of Retirement Millionaire could easily save you tens of thousands of dollars in taxes. To learn more, click here...
We know massive estate taxes are a major concern for our readers. That's why we're working with a top New York-based firm to show a select few readers how to not only avoid taxes on their retirement accounts, but double the amount of money their heirs will receive. Again, this strategy is not for everyone. For starters, it takes, at a minimum, a $250,000 retirement account. I can't divulge the full details (we're arranging a conference in New York so interested readers can learn more), but the numbers work like this...
Starting next year, if you have $1 million or more in a retirement account, the government will take half when you pass that money to your heirs. With the strategy this firm created, that same $1 million increases to $2.5 million. That's not a typo... You go from the government taking more than 50% of your portfolio to making an extra $1.5 million. Plus, you pay zero fees for the service. I know this sounds crazy, but it's legitimate and 100% legal. The firm has already handled many cases. If you meet the criteria above and you would like an invite to the New York conference, please send an e-mail to feedback@stansberryresearch.com with the subject line "RETIREMENT CONFERENCE" and your full name.
New highs: Eldorado Gold (EGO), Market Vectors Gold Miners (GDX), Sprott Resource Lending Corp. (SILU), Silver Wheaton (SLW), Anheuser-Busch InBev (BUD), DirecTV (DTV), iShares Silver (SLV), Philip Morris (PM).
Someone on our case for being bullish? Send your accusations to feedback@stansberryresearch.com.
"Wow. Did someone put something in the water? Or is something in the air? I thought this edition of the Digest was almost BULLISH. No mention of the impending end of the world monetary and financial system as we know it. Ferris talking about gold at $3,000 and the Fed raising interest rates to 'cool it down.' I've been in the Buffett camp of 'definitely no double dip' for some time now. Once sentiment turns, and the public stop piling into stupidly over-valued bond funds, and start buying stock funds again, this market is going to take off like a rocket. Of course, as it does, it'll be the time to start pruning one's stock holdings, selling them at inflated prices to the herd. Keep up your good work providing us with a roadmap." – Paid-up subscriber TS
Goldsmith comment: It's amazing what a trigger-happy government with a printing press can do to an investment thesis.
"I'm a new subscriber to your newsletter. My question is this: if we want to follow up on any of your recommendations do we go through you, or find a suitable brokerage firm?" – Paid-up subscriber Scot Sanford
Goldsmith comment: We don't facilitate any transactions. If you'd like to act on our recommendations, you should open a brokerage account with a reputable broker. We've received good feedback about the discount brokers TD Ameritrade, E*trade, and Fidelity. You can find lots of good options, some cheaper than others. It shouldn't take more than five minutes to open one of these accounts. Also, make sure to ask what incentives the companies offer for new accounts.
Regards,
Sean Goldsmith
Baltimore, Maryland
September 15, 2010