Our view on global investment markets:

August 2012 The Flounder

Keith Dicker, CFA
Chief Investment Officer
keithdicker@IceCapAssetManagement.com
www.IceCapAssetManagement.com

August 2012

The Flounder

Flippin and floppin

The King
The Flounder is the true king of the sea. Its graceful movements and
ability to blend with rocky bottoms ensures many peaceful days in
the wild blue yonder.
Patience is yet another exemplary trait it can go about its way for
days bothering no one while being unbothered itself. The flounders
life is slow, abundant and peaceful - until it isnt.
The moment the flounder is disturbed from its idyllic life, its only
defense mechanism is some serious flippin and floppin. While this
flurry of activity provides initial relief the end is inevitable. It was
nice while it lasted, but the flounder suddenly is no more.
Since man first learned to walk upright, there have been many
villages and then towns and then countries that have all floundered
at some point. Certainly those toppled by war and disease deserve
our empathy. Today however, its the good old fashion money
problems that is turning once vibrant countries into floundering
states.
Considering the Worlds largest economies are printing money with
reckless abandon, its important to know which ones are floundering
and which ones are resting quietly under the sea.
The Flounder Meter
While every business and industry implicitly believes in its

meaningless acronyms and language, nothing compares to the

financial services sector. This industry, the one who gifted us APR,
ISM, RSP as well as Core CPI calculated to the 3rd decimal point, is the
unchallenged king of senseless terms only a risk manager would love.
In response to these unnecessary complications, IceCap is
introducing a necessary yet simplified tool for measuring the state of
the Worlds leading economies The Flounder Meter.
This new metric considers the combination of money printing, bank
bailouts, debt levels, government spending and borrowing costs for a
given country. The Flounder Meter will finally allow everyone to see
through the smoke and mirrors and decide for themselves whether a
country is in good financial health.
The inaugural results are shown on the next page. Unsurprisingly,
Europe is the biggest flounder in the sea. Yet, the only difference
between Europe and other indebted countries is the cost they pay to
borrow. Should long-term interest rates rise, America, Japan and
Britain will be joining Europe at the top of the Flounder Meter.
Europe 4.5 Flounders
In the economic fantasy land called Europe - the amount of money
borrowed vastly exceeds the amount available to repay. At the same
time, economic growth and tax revenues are no where close enough
to service this debt. Europe remains a financial basket case, and a

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August 2012

The Flounder

Chart 1: The IceCap Flounder Meter

Country /
Region

Money
Printing

Bailing Out
Banks

Too Much
Debt

Too Much
Spending

Too
Expensive
to Borrow

Europe
Britain
USA
Japan
China
Canada
Source: IceCap Asset Management Limited

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August 2012

The Flounder

Tapas, Rioja & Zurich

very dangerous one at that. We believe that when the Greek dam
finally breaks, investors will be surprised of the financial reaction.
And this is only Greece.
Whereas Ireland, Portugal, Greece, and Cypress have already
floundered for everyone to see, Spain is just getting started. And
because this isnt just a bad dream, we must consider the numbers
involved.
The combined total of bailouts required for the aforementioned
countries is over EUR 260 billion. Spain meanwhile has nearly EUR
900 billion in liabilities outstanding. Better still, what money Spain is
able to currently borrow costs them 5% and more. For comparison,
USA, Britain, Germany, Japan and Canada all borrow for less than 2%.
Yes, Europe has agreed in principle to lend Spain EUR 100 billion to
shore up their banks. But what most dont realize is that this simply
replaces the amount of deposits that has fled the Spanish banking
system. The Spanish people and companies can see the writing on
the wall and it is telling them to get their money out of Spain.
Simply transferring your money to another bank in Spain isnt enough
the risk of having your money converted to the old Spanish Peseta
is causing people to stock up on tapas and rioja and take the short
journey to safety in Zurich.
Unfortunately (and ironically for that matter), what happens in

Switzerland doesnt always stay in Switzerland. As soon as the

Spanish, Italians and others deposit their money in Paradeplatz
Square, the Swiss National Bank quickly turns around and uses this
new money to buy the equivalent in Euro.
In effect, the Swiss are arguably the biggest buyers of Euro in the
World today. Just as Frankfurt tries to demolish financial
mathematics, so do the Swiss. As a result, those seeking safety in
Swiss Francs may actually be taking on significantly more risk than
they originally intended.
Meanwhile, Spanish property values continue their descent, the
economy is in deep recession, and the autonomous communities
are in desperate need of cash. Yet the federal government has no
cash available. In other words, Europe lending Spanish banks EUR 100
billion is the same as sticking your finger in one leaky hole only to
soon see another sprout up. Considering the Europeans have already
used most of their fingers and toes to plug holes in Ireland, Portugal,
Greece and Cypress its only a matter of time before they run out of
digits.
The Spanish Spiral has already started and there are only bad
choices available to stop it. The first bad choice is for Spain to begin
running massive trade surpluses it has to sell more to other
countries than what it is buying. Presently, this impossible task can
only be achieved if Spains labour costs were cut dramatically. Lower
input costs will make Spanish goods cheaper on the World market.

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August 2012

The Flounder

Watch out for Italy

Unfortunately, politics alone guarantees this path to economic
freedom will not be chosen. Now of course, even if Spanish workers
were prepared to accept the draconian wage cuts necessary there is
no certainty that other countries will allow Spain to gain significant
market share. In short, this option is dead in the water.
In our opinion, the other option is much more likely to happen. Yet,
the short-term pain involved means no politician will be endorsing it
anytime soon either. Spain needs to leave the Euro-zone and
reinstate its former currency the Peseta.
To date, Spain is the biggest flounder in Europe. It is already flippin
and floppin around, yet due to this being the slow summer month of
August, no one really cares yet. Over the next few months, the
World is going to start caring a whole lot.
And then there was Italy. Wine, food, espresso and afternoon naps
certainly supports the case for Italians being crowned lifestyle kings
of the World. Come to think of it, if you allowed me to accumulate
close to EUR 1.7 trillion in debt, Im pretty sure I would have enjoyed
life as well.
Unfortunately for Italy and its Goldman Sachs lead government, their
easy lifestyle is about to flounder.
Italy has the 3rd largest debt in the World. Yet, its economy is only
the 10th largest. When you consider that the only thing growing in the

Italian economy is the amount of money it borrows you just know a

financial catastrophe is lying straight ahead.
Money printing, too much debt, too much spending, bailing out
banks, and excessive interest rates for the southern European
countries helps Europe to almost push the Flounder Meter off the
charts.
Chart 2 on page 5 shows current growth rates across Europe. Nothing
is getting better, in fact the best that can be hoped for at this point is
stagnation.
Our view on Europe hasnt changed. Europe simply refuses to allow
any country to default on its debt. Europe believes money printing
and other monetary gimmicks will save the day. Mathematically and
economically this cannot work.
In the end, the ECB will eventually print trillions of Euros believing it
will save the day. Regardless if Europes mountains of debt is held by
investors or the ECB, the debt remains and it cannot be paid in full.
The only question that remains is whether the ECB launches their
massive money printing scheme before or after the European system
reaches its pinnacle. The end result is inevitable, how it plays out is
not.

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August 2012

The Flounder

Chart 2: Growth is floundering in Europe & Britain

5.00%

Italy GDP

4.00%
3.00%

4.00%

0.00%

2.00%

-2.00%

1.00%

-4.00%

0.00%

-6.00%

-1.00%

-8.00%

-2.00%
-3.00%

-10.00%

-4.00%

-12.00%

2.00%

Spain GDP

1.50%
1.00%

Britain GDP

2.0%

0.0%

0.00%
-0.50%

-1.0%

-1.00%
-2.00%

3.0%

1.0%

0.50%

-1.50%

Greece GDP

2.00%

Source: OECD

-2.0%
-3.0%
2010 2010
Q1
Q2

2010
Q3

2010
Q4

2011 2011
Q1
Q2

2011
Q3

2011
Q4

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2012
Q1

2012
Q2

August 2012

The Flounder

Financial point of no return

Britain, USA and Japan 4 flounders
The British, Americans and Japanese are cemented into no growth
economies backed by increasing debt, increasing deficits, and
increasing money printing to keep political and financial life afloat.

situation against the Japanese Ministry of Finance. At some point

very soon, Japan will become reliant upon foreign investors and we
have feeling that these investors will not at all be happy earning < 1%
on long-term loans.

The only significant difference between these guys and Europe is

their cost of borrowing. Mathematically speaking, as long as you are
able to borrow money at interest rates lower than your sustainable
rate of growth life should work out just fine. However, the
moment your borrowing costs rise you have a problem.

As the Japanese government currently allocates almost 50% of their

tax revenues to interest payments on their debt, the financial impact
of Japans cost of borrowing rising from 1% to 2% will be devastating.
And if you thought the European debt crisis has become all too
consuming, just wait until Japan elbows their way on stage it wont
be pretty.

Now, this problem is manageable over short time periods. However,

the real crisis begins as soon as you reach the point where others
refuse to lend you more money. This also happens to be the point
where the amount of money you must devote to interest payments
alone begins to overwhelm your entire financial position.
Presently, neither Britain, America nor Japan are in this boat.
However, unless the global economy rebounds both quickly and
strongly, Japan is clearly heading towards the financial point of no
return.
As a percentage of GDP, Japans 230% debt load would make even
the Greeks blush. Unlike Greece however, Japan has been able to
borrow money at very low rates directly from its citizens.
Unfortunately, demographics are not aligned and the number of
Japanese entering retirement is just beginning to tip this favourable

China 2.5 Flounders

For years, Chinas economic model has been the envy of the World.
The Chinese actually did nothing special except recognise a great
opportunity. While the Western World feasted on the American lead
doomed monetary policy China simply opened a few factories to
build the much sought after LCD TVs, Ipods and everything sold at
Wal-Mart.
Soon enough this cash bonanza forced Chinas government to loosen
its own purse strings and to begin building new roads, bridges, power
stations and entire cities to satisfy all the new workers. This capital
spending spree made the Western World giddy with excitement, and
justifiably so there was money to be made.
Today however, viewing the Chinese economy as a stand alone

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August 2012

The Flounder

Imbalanced = Balanced
miracle is incorrect. The global economy is just that global. The
unquestioned slowdown in the US and Europe is also causing the
Chinese factories to slow which inevitably causes Chinas capital
investment machine to slow as well.
Unfortunately, the slowing of Chinas capital investment programs
stops the real estate and construction industries in their tracks. The
infamous Chinese ghost cities were not free. They absorbed billions
in capital investment and now Chinese investors, including banks are
sitting on a growing pile of non-performing assets.

eventually reaches a point where each additional road, building and

city adds no economic value and in fact begins to produce negative
returns for investors.
Chinas standing in the Flounder Meter shows it as being in better
financial shape than most others. Yet, the point we make is that the
debt problems in Europe and America will affect China, and more
importantly just as America has an imbalanced economy, so too does
China.

At this point, the Chinese government is unsure how to react. Its a

fact that their banks have suddenly become zombie-like, making the
prospect for additional capital investment less and less likely. And
just as Germany has figured out, its difficult to export your way to
prosperity when the rest of the World is not in any mood to import.

Canada 1.5 Flounders

Since the 2008 financial crisis, Canadians have been very fortunate.
Due to then Finance Minister Paul Martins decision in the mid 1990s
not to allow the Canadian banks to merge, Canadian banks avoided a
lot of the nasty American real estate schemes and have collectively
held up very well and shine on todays World banking stage.

Meanwhile, the real crux of the Chinese economic problem is their

savings rate. Whereas the American vision of saving is simply to use
Groupon, the Chinese do it the old fashion way they simply dont
spend much of their money.

The 1990s was also Canadas chance to shine on the Worlds austerity
stage. At that time, Canada finally fessed-up to its money problems
and dutifully raised taxes, cut spending and systematically pared
down its debt over time.

While the Western World would love to have this problem, saving too
much money is just as bad as saving too little money. It creates an
imbalanced economy where in Chinas case, growth has been
primarily supported by capital investment in roads, buildings and the
like. While initially good, this intensive capital spending spree

Then as the millennium finally arrived, so too did the beginning of a

glorious run for commodities this was really the icing on the cake
and propelled Canada from the bottom of most G7 financial metrics
straight to the top.

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August 2012

The Flounder

Minting fresh loonies

While today Canada ranks very well relative to other Western World
countries, it still runs a deficit. Except for the commodity
powerhouses, most provincial finances are not improving. At the
same time, conversations about Canadas near-mythical real estate
markets are turning more worrisome.
Whether you believe it to be cyclical or structural, Canadas slowing
economy is negatively effecting its debt load. And, on a more sinister
basis, should Canadas long-term interest rates increase by even 1%
both residential and commercial real estate will decline.
What has us most concerned these days however is the Bank of
Canada. Just last month we wrote about Mark Carneys
acknowledging his dislike for socializing private sector losses onto tax
payers. Yet, what really concerned us was his admiration for the
Worlds other central bankers and his pride for belonging to the
central banking brethren.
At this point in time, Canada is the only G7 country not to print
money. And justifiably so - Canadas financial conditions certainly do
not warrant such draconian measures as schemed by the famed
central bank brethren.
However, on August 20, 2012 all innocence of the Bank of Canadas
monetary policies has been lost for ever. The Globe & Mails front
page story As strong loonie pinches manufacturing, Carney faces
auto workers opens the money printing can and openly questions if

the Bank of Canada should begin minting loonies to devalue the

Canadian Dollar.
At this point in time we can only hope that Mr. Carmichaels article is
his own perspective. If however, Mr. Carmichael has suddenly
morphed into the Jon Hilsenrath of the North and has in fact become
the unofficial spokesperson for the Bank of Canada, then Canadas
innocence and financial respect is about to be lost.
Not to despair, this loss will be a gain a gain of an IceCap Flounder
and a rise in this unfavourable ranking index.
Not seeing the big picture
Remarkably, what is lost upon most people is that the enormous debt
loads accumulated over years enabled us to live beyond our means.
Today, the financial stress created by this borrowing binge has
created huge fissures in the global financial system.
These fissures are the result of money that has been borrowed but
cannot be repaid. In the financial World, we refer to this as
deflationary, meaning the bad debt acts like an anchor on the
economy and results in low to negative growth for all economies
involved. This deflationary process cannot be stopped. Billions in
debt simply will not be paid and investors will have to take losses.
Policy makers however, are trying their darndest to stop it. They
believe the way to stop this deflationary force is to print money. The

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August 2012

The Flounder

Deflating or Reflating
hope is that by printing money, the bad debt will be paid back over
time and the global economy will not decline. This process is referred
to as inflating or reflating the financial system.

aura of German financial magic, even this disciplined financial nation

isnt strong enough to stop the deflationary wave from engulfing
Europe.

In effect, we have two giant forces coming head to head. We have

the man-made deflationary force coming in one direction and the
man-made inflationary response coming from the other direction.

Now, we fully admit that the entire deflation versus inflation concept
sells few newspapers and advertisements, yet this is the single most
important issue facing the financial World today.

There can only be two outcomes, and neither one is pleasant. Should
the deflationary wave prove too powerful, the global economy is
headed for a very deep and prolonged recession.

Of course, considering that the majority of investment professionals

today all earned and learned their stripes during the mega 1982-1999
secular bull market, it really isnt a surprise this all important dynamic
isnt reaching clients and their kitchen tables.

Should the inflationary wave overcome, one should expect the global
economy to produce low real growth but with hyper inflation.
At this point in the game, deflationary forces are overwhelming
reflationary efforts. In other words, the total losses from the ongoing
financial crisis continue to be greater than the total amount of money
printed. Considering we have had over $5 trillion in stimulus, this is
no laughing matter.
One thing is for certain, the central banks and governments of the
World are dead-set on reflating the global economy. As they are
presently behind the ball and losing the game, one must fully expect
to see plenty more money printing from the Americans, the
Japanese, the British and especially the Europeans. Europe is hanging
by a single financial thread called Germany. Ironically, despite the

Meanwhile, an entire generation of new hires over the last 5 years

have learned to analyse markets based upon how much money will
be printed by central banks money printing is accepted as normal to
these young bucks.
To offset this industry imbalance, you simply need to ask yourself why
is there so much effort going into money printing and other bailout
policies?
Crime does pay
The prestigious award for being the only person in the entire World
who would never ever be offered a job by a major bank goes to
Sonny Curtis.

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August 2012

The Flounder

Sonny Curtis
While Mr. Curtis is 75 years old, it certainly isnt his age that is
preventing him from travelling in private jets, drinking Bollinger and
dreaming up the latest elevator stories. Rather, it was one solitary act
from 1958 that has landed him on the never hire list. At the time,
he had no idea that writing the hit song I Fought the Law would
come back to haunt him.
While the lyrics make perfect sense, especially if you break the law
the latest bank scandal to create no moral outrage will certainly see
bankers everywhere rewrite Sonnys lyrics.
When it comes to banking, every bank in the World knows it is
illegal to launder money money printing is ok, but money
laundering is a no no. And, if you include the axis of evil (Iran, North
Korea and Libya) in the mix, well lets just say you are looking for
trouble.
Yet, none of this stopped British bank, Standard Chartered from
helping Iran launder over $250 billion between 2001 and 2007.
Naturally, this charade eventually came to light and one would think
that helping Americas enemy launder billions of dollars would bring
the wrath of the SEC, CIA, FBI, and the President. Nope, that would
be wrong.
In the end, there was no loss of their banking license, no one-way
tickets to Cuba, and no forced push-ups in Times Square. Instead,
Standard Chartered agreed to pay a $340 million fine. For most

people, $340 million is a lot of money. Yet, this amount is equal to

exactly 0.14% of the money laundered. Peanuts. Their service fees
alone would have covered this minor inconvenience.
For comparison, everyones favourite kitchen queen Martha Stewart
traded on insider information. She did illegally avoid a $45,673 loss
on her venture, which earned her 5 months in prison, and a nice little
electronic anklet as a souvenir. Her financial penalty was $225,081 or
493% of her crime.
Yet, she didnt launder any money for Iran, nor as far as we know did
she launder any napkins, table clothes or doilies for them either. In
the end Martha did indeed fight the law and unlike Standard
Chartered she didnt win.
The lesson here if you are going to commit a financial crime, be
sure to become a bank first. Otherwise, you better learn the lyrics to
Sonny Curtis classic youll need something to waste away your idle
time while in jail.
Our Strategy
While Americas favourite pastime lingers smack in the middle of the
dog days of summer, the same cannot be said for the stock market.
After all, summer is the time to relax, spend time with the family and
certainly not frown over financial and economic despair this is
something for September and October.

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August 2012

The Flounder

The gloves are coming off

The recent stock market rally is a faceless one at that. While the
average investor sees a higher market, professional money managers
see a market with no leadership and no volume not exactly the
prerequisites for a blast-off to the moon rally.

This is clearly an unhealthy environment for risk takers and continues

to create an asymmetrical dynamic between upside return and
downside risk. In short, upside returns remain limited while
downside loss remains significant.

During a sustainable stock market rally, one normally sees cyclical

sectors such as industrials, mining, technology and discretionary
stocks soaring past their boring cousins. In addition, trading volume is
usually increasing exponentially by the day. None of this is happening
today which should make growth investors somewhat nervous as we
head into post labour day trading.

IceCap portfolios are positioned to preserve capital while providing

liquidity for significant opportunities which we believe will occur in
the near future. We favour cash, bonds and gold, with strategic
positions in stocks and commodities.

September will bring us several significant events including the

German high courts decision on the legality of the ESM (European
Stability Mechanism), possible money printing by the ECB (European
Central Bank, more money thrown down the Greek rabbit hole, as
well as new debt issuance by Spain.
And thats only Europe. America will decide whether to print more
money themselves while Mr. Obama and Mr. Romney will take off
their gloves and really kick start their negative campaigning.
As a reminder, none of these events remotely touch economic or
profit growth both which are normal drivers of financial markets.
Instead, the financial World continues to hang on every thread and
syllable uttered by central banks and governments.

As always, wed be pleased to speak with anyone about our

investment management capabilities. As well, we encourage you to
share our global market outlook with those who you think may find it
of interest.
Please feel free to contact:
John Corney at johncorney@IceCapAssetManagement.com or
Keith Dicker at keithdicker@IceCapAssetManagement.com.
Thank you for sharing your time with us.

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