To bankrupt or not to bankrupt

The news is that Harrisburg has filed for bankruptcy.  While technically true that they have filed for bankruptcy, this may be shot down before it all begins.  The funniest part of this at the moment is that all the judges for this are in Tampa for a conference.  So hold your breath.

Remember, bankruptcy has not been far below the horizon here in the past.  The closest the city of Pittsburgh should have come to bankruptcy was in the early 1990’s just as Tom Murphy became mayor.  Yet the history is that the City of Bridgeport, CT had just before that time tried to file bankruptcy but was denied by a federal court to even enter bankruptcy.  Municipal (Chapter 9) bankruptcy is not like bankruptcy for you and me in lots of ways.  US constitutional issues prevent a judge from exerting many of the powers over a state entity the same way might happen in recievership for an individual or company.

In Bridgeport’s case the court ruled that the city was not really broke enough to file for bankruptcy, i.e that it had the fiscal capacity to tax or borrow its way to meet its obligations. Unlike other bankruptcies which really look at assets and liabilities, Chapter 9 is more about cash and the fiscal capacity to raise cash.  Most public assets are not going to be considered for sale or liquidation no matter, so there is no risk of the mayor’s chair being carted off to a flea market.

The thing is that while I believe the City of Pittsburgh was in a far worse shape than Bridgeport was at the time, that precedent was clearly the biggest thing on the mind of city lawyers who likely advised a bankruptcy filing would not go forward.  I personally bet they were wrong on that and that Pittsburgh was not in as good shape as Bridgeport was and well over the line of insolvency in a public sense.  There is even a school of thought that says if Bridgeport just waited another year before filing its fiscal condition would have been so bad that the court would have had no choice but to let the filing go forward.

Still I bet Bridgeport’s aborted bankruptcy is the only thing that kept the Murphy administration from filing for bankruptcy right as they took office when they were told the city was about to go cash zero. Prevented from bankruptcy all sorts of even worse things happened.  The result was that over the subsequent decade city in succession ’sold’ or liquidated the water department into the water authority (long story there), the city’s debt ballooned,  tax liens sold off to a third party without much concern for city of Pittsburgh development and no significant increase (Pension bonds were a wash I would say.. at best) in pension funding would leave us where we are today.   So today we have more debt, more pension liability, no direct control of the water system (think of all the problems that has caused) and had much of a decade of neighborhood economic development arrested because it was held hostage by a wall street company that couldnt spell in Latin.

Then there is this logic people say the Commonwealth of Pennsylvania must ‘approve’ any bankruptcy filing.  Also technically true in the legal sense.  In the real world sense it is not so important.  The lawyers might argue, but consider a few things.  In Pennsylvania the state approval for letting a federal bankruptcy filing go forward is mostly embedded in the Act 47 law and process.  There has been municipal bankruptcy in Pennsylvania, even one  recently in the case of Westfall Township.  Did Westfall get permmission to file for banktruptcy?   I would argue it didn’t in that an Act 47 process only began after they filed and had a bankruptcy proceeding move forward. The state went along, but it was kind of after the fact.  And in one of the stranger acts of jurisprudence.. some folks may remember the monster AHERF bankruptcy that still lives on in shaping the region’s state’s health care system.  AHERF, even though it was not a municipality, was a Chapter 9 bankruptcy.  Does not quite make sense to me, but I think it was just too big and too complex to really fit into a Chater 11.

In the bigger sense it does not matter if the state really approves a major bankruptcy or not.  If bills go unpaid, or say bond payments don’t go out.  Bad things happen and at some point someone would be forced to do something.  The state would have little choice to ‘approve’ a bankruptcy, or a judge would find some way to rule that a filing could go forward.

Also unmentioned in the article is the story of Vallejo, California and its bankruptcy that is just about to come out of.  That also is a case where I have argued the fundamental finances there are far better than they were (or are) here.   Go figure and again think about all the victory signs last month when the state accepted the while pension accounting scheme. Is Vallejo a model for what may happen in Harrisburg?   Probably not just yet.

So what happens now?  My guess is that when the judges get back from Tampa and have a hearing on any of this they are likely to push back and say no… no filing for you.   Sort of like the soup guy on Seinfeld.  Federal judges are not going to want to get into what is, on top of everything else, a political circus in the city of Harrisburg.   They will tell them they are not there to settle the city’s political problems, whether or not that is the verbiage of any actual ruling who knows.  So a bankruptcy may happen… but I bet it is not right now.

Still,  I am surprised the Commonwealth let this all get this far already.  There are consequences across the state for such financial miasma in any one municipality, let alone in the state capital.

This Does Not Bode Well

As can be easily seen from this chart (source), the money stock as measured by the Federal Reserve has grown by approximately 6.67% in the last five months! Since real GDP is projected to grow by only 1% (and will likely be revised downwards ex post), this means prices are going to rise fairly dramatically in a short period of time. And just in time for the holidays!

Anyway, there are a couple of ways this will play out, at least in the short-term. Either consumers will face higher prices or manufacturers, suppliers, and/or retailers will face lower profit margins (or some combo of these possibilities). I doubt that retail prices will rise much in the short term because most people can’t afford price hikes in lieu of relatively stagnant income over the past year. Instead, I think businesses will eat the increased costs in the short term, most likely through the holidays and the post-holidays stock liquidations.

After the new year begins, though, I think prices will begin to rise. And when that happens, it won’t be pretty. Thanks, Bernanke!

Edward Karr Sees Opportunities in Gold: Under the Mattress and in the Ground

Edward Karr According to Edward Karr, CEO of RAMPartners, the band is tuning up and the guests are just starting to arrive. Instead of selling before the party really gets going, he advises keeping a “decent percentage” of cash to take advantage of opportunities to buy both physical gold and junior mining stocks. His real bottom-line advice in this exclusive Gold Report interview? Tap into what makes you happy in life.

The Gold Report: RAMPartners is based in Geneva, Switzerland, a country that made economic news a month ago when the Swiss National Bank capped the Swiss franc at 1.20 francs per euro, slashed interest rates and flooded the market with Swiss francs. Did you agree with those moves and what impact do you think they had on the gold price?

Edward Karr: I emphatically disagree with the move by the Swiss National Bank. To me it makes no sense to peg the Swiss franc at 1.20 to the euro. Switzerland is, in effect, backstopping Greece and all of the other indebted countries in Europe. This is lunacy. Greece or anyone can just hit the Swiss National Bank’s bid at 1.20 and convert into Swiss francs, which it would probably rather have than its euro position.

Since this policy, we’ve seen a psychological shift in markets. People have been rethinking the Swiss franc as a safe-haven currency. The Norwegian kroner looks more like a safe-haven currency now than the Swiss franc. I’m just happy Switzerland is not part of the European Union and not part of the euro. I hope it will understand the foolishness of the 1.20 peg and get rid of it soon.

As to the current effect on the gold price, right around when this happened gold topped and started to sell off. I don’t think they are directly related, but I think it is psychological. If the Swiss franc holds at 1.20 to the euro, if a hedge fund or a corporation hits the Swiss National Bank with a billion euros, it is no big deal. But what about 10 billion, 100 billion, even a trillion? Then it starts becoming a big deal. At some point does Switzerland have to start selling its gold reserves to continue this lunacy? Switzerland now has 1,146 tons of gold. Maybe people are worried that if that gold starts to come out it could put downward pressure on the bullion price; hence, we have seen a little sell off in the overall market.

TGR: Just a few years ago, the Swiss Central Bank had more than 2,000 tons of gold in its reserves. What is your view on the sale of so much of its reserves?

EK: I think it was extremely shortsighted. Switzerland has a long history of fiscal stability and gold has been a very important part of that stability.

Right now, Switzerland has the world’s eighth largest gold reserve, which is quite impressive for such a small country. But, the 1,146 tons of gold it has at current market values is really only about $60 billion. That might seem like a big number, but it is minuscule in comparison to the trillions that global governments are going to have to print to combat this increasing financial crisis.

TRG: Gold has fallen steadily since reaching about $1,900/ounce (oz.) in August. It now sits at about $1,670/oz. Why has it fallen recently?

EK: I think the logical explanation for falling prices is that gold is a relatively liquid asset. Governments, hedge fund managers, bankers and individuals are all facing a severe cash crisis. In that environment you have forced liquidations. Governments are doing all they can to put a positive spin on a terrible environment. But, if you’re a global macro hedge fund manager who has heavy redemptions, you have to sell your liquid assets to raise cash.

Man Investments is one of the biggest hedge fund groups. Last month it announced record redemptions of $7 billion. The firm has to raise cash, so what is it going to do? There are no bids out there for Greek debt, no bids for mortgage-backed securities, no bids for countless other OTC financial derivatives. Gold is liquid; it is easily tradable and has been part of the massive global scramble to cash that we’ve seen in the last two to three months.

TRG: How low could gold go?

EK: That’s a great question. The only credible answer is that gold can go a lot lower than anyone expects. A lot of Johnny-come-latelies have bought into gold in the last few years. A big downdraft will shake out a lot of loose hands.

Europe is on the edge of a cliff. Dexia Bank might fall any day. UniCredit in Italy is right behind. I think we will see a severe domino effect that will make 2008 seem like a walk in the park. If Dexia or UniCredit or the European Central Bank itself had a big major gold position and it had forced liquidation, it will have to sell and the price could go down pretty dramatically.

TRG: Are you willing to be more specific on the price?

EK: It would not surprise me at all if I came in tomorrow and gold was at $1,000/oz., a 60% decline from the current levels. If gold were to fall that dramatically, to $900/oz. or $1,000/oz., it would represent an incredible buying opportunity. That’s when you would want to go all in and buy all you could, because it will snap back like a bungee jump.

When you buy gold, you want to buy it and take physical possession. Owning gold isn’t about the price paid. You shouldn’t look at the price every single day. By the time this crisis is over, it’s going to be about how many ounces you actually have in your possession—under your mattress, in your safe, not in your bank, I hope.

TRG: Your fund holds bullion and junior precious metal equities. How have you changed the way you manage the fund in the midst of this volatility?

EK: We have adjusted our portfolios and we are managing money a little differently. Volatility has certainly increased. In the last month, junior mining stocks are down 40%, 50%. When you get into these high volatility ranges, liquidity drives up as well, delivering a one-two punch. Selling 10,000 or 20,000 shares on a junior mining stock can take it down 25%.

You have to be nimble and you have to be able to stay the course. You don’t want to over-leverage. You want to keep a decent percentage of cash and have some dry gunpowder to take advantage of big sell-off opportunities.

TRG: When I look at my investment portfolio, which consists largely of junior gold explorers, I see nothing but red. I want to sell everything and wait for opportunities. Do you believe that is prudent or do you have better advice?

EK: The investment game is 99% psychological, and it is you against yourself. In my experience, when you feel it is the right time to sell it is exactly the wrong time to sell. I sincerely believe that investors who sell out now are going to miss out on one of the greatest rides of their lives.

Central banks around the world are going to have to put together trillions of dollars. Quantitative Easing (QE) 3 is going to make QE1 and QE2 seem like a little prelude. The Fed is going to have to team up with the European Central Bank and print an incredible amount of money to recapitalize the whole financial system. When they do that, it will set up a moon shot for precious metals and junior mining companies.

This party is just getting started. You can see the house, you can hear the music and see people, but you have not even walked in the front door. Wait for the party; don’t leave before it even begins!

TRG: What are some rules of thumb for investing in junior resource companies during uncertain times?

EK: I like to own good companies with solid management teams and great assets. And then, it all comes down to the timing. The current markets are fantastic for finding attractive entry points. As a general rule, when it feels the worst is usually the best time to buy.

When people get scared, markets and stock prices get way out of line. That is when you need to have the courage to really step in and accumulate. Worst case, if the banks collapse and the ATMs actually do stop working, those who own physical gold will be better off than 99% of the other people out there. But it is more likely that the markets will rebound quickly as QE3 comes in and the ECB and the Fed turbo charge the printing presses. Then, the junior mining stocks and bullion will be off to the races.

TRG: What are some names you have positions in?

EK: I’m quite bullish on Sagebrush Gold Ltd. (SAGE:OTCBB), which trades on over the counter in the U.S. I like the company because it recently acquired a former producing gold mine and mill in Nevada. Nevada is a great jurisdiction; it has rule of law, most of the mines are easily accessible and it has the geology. It is the second most prolific gold zone in the world after the Witwatersrand of South Africa. Sagebrush bought the Relief Canyon mine and its brand-new $30 million (M), state-of-the art facility. It should start production by mid-2012. Relief Canyon currently has a 155 thousand ounce (Koz.) resource and it has an aggressive exploration program on the property right now.

TRG: There are dozens of companies in Nevada. What makes this one different?

EK: A couple of things. Sagebrush has an asset ready to go into production tomorrow. With junior exploration companies that becomes really important. If you have a producing cash-flow asset, you are not as subject to overall market conditions, especially financing, that many junior companies get themselves into. Plus, Sagebrush has strong financial backers including Dr. Philip Frost as a significant shareholder. That gives me a lot of comfort the company will get into production quickly.

Let’s look at the economics of Sagebrush and assume gold holds at $1,500/oz. Sagebrush’s cash costs at Relief Canyon should be about $700/oz. With their 155 Koz. resource, that project could throw off $125M in cash flow over the next two to three years.

And the really exciting part of the Sagebrush story is its very high potential exploration package. The senior exploration geologist is Art Leger, an old hand who has been very successful. I believe he has found upward of 20 million ounces of gold on different crews and discoveries. He came to Sagebrush with a property called Red Rock; a friend who is a legendary natural resource investor told me he felt the Red Rock property was possibly the best exploration address he has ever seen.

Sagebrush’s Red Rock property is surrounded by some of the majors: Newmont Mining Corp. (NEM:NYSE), Barrick Gold Corp. (ABX:NYSE; ABX:TSX), Allied Nevada Gold Corp. (ANV:TSX; ANV:NYSE.A) and Paramount Gold and Silver Corp. (PZG:NYSE.A; PZG:TSX). This is prime exploration real estate and Leger thinks there are several world-class deposits on Red Rock. Sagebrush has a RC rig on property right now. It has done extensive geophysical work, defined drill targets and the drill program is underway.

TRG: Is Sagebrush looking to get listed on the TSX Venture or the TSX main board?

EK: I believe so. It is exploring both the TSX and the AMEX in the U.S. I would like to see the company listed on a more major exchange, where it will get increased visibility and liquidity, probably more research and publishing.

There is a further arbitrage opportunity here. Recently, Sagebrush acquired all of the assets of Continental Resources Group Inc. (CRGC:OTCBB). The deal was 0.8 shares of Sagebrush for every share of Continental. I believe the acquisition is still being worked out and the share swap will happen in the next few weeks. So the big opportunity is to buy the shares of Continental. Effectively, you are getting Sagebrush shares at around $0.31 with the current Continental price of $0.25. Sagebrush is in the $0.50 range, so this is like grabbing dollars for $0.60. Warren Buffet recently said he would buy Berkshire all day long for $0.90 on the dollar. By buying Continental, you get Sagebrush for $0.60 on the dollar. Plus Sagebrush acquired Continental’s portfolio of uranium exploration assets. Uranium is currently really beaten up post-Fukushima, but it is not going away longer term. I believe uranium prices will rally back when the cycle turns and patient investors will be well rewarded on this unique play.

TGR: One interesting note with Sagebrush is that it has Debra Struhsacker, an environmental consultant, as part of the management team. That’s unusual. Would you care to comment on that?

EK: Debra is a fantastic addition to the Sagebrush team. Having the foresight to have an environmental consultant in at this early stage of the company’s evolution really shows the management team is very serious and it is looking to move this project into production as fast as possible.

TGR: You talked about having some powder dry for when you’re ready to strike. What striking opportunities do you see in the market at this point?

EK: I like Nevada, as I mentioned. Another location that I really like is Colombia, which I think is setting itself up to be one of the hottest mining destinations of the future. Colombia is doing all of the right things from a political and economic standpoint. It has incredible undiscovered resources.

We’re a shareholder in a new gold exploration company there called Dicon Gold Inc. It is a Canadian company that is currently private. But I understand that it plans an IPO on the TSX in the next couple of months. Dicon has an incredible management team in place. I think this is really going to be one to watch.

TGR: Did you get in at the capital pool level or as a private placement?

EK: It was a private placement. I don’t think it is a capital pool; it is a straight IPO. We just recently participated in a private placement that was a very, very small round. We want to get involved in a much bigger way on the IPO.

TGR: Do you have one more name?

EK: Going back to Nevada, Yukon-Nevada Gold Corp. (TSX:YNG) is a real interesting opportunity. You’re looking at a stock that is $0.37 a share. I just had the management team in my office and I was very impressed with their presentation. The company has $80M in cash and a $300M market cap. It will re-enter production with one of the few roasting facilities in Nevada capable of producing 300 Koz. a year consistently. It has an autoclave in the recovery circuit.

Yukon-Nevada is an incredible buy. From what I understand, a couple of New York City hedge funds that had a substantial position had heavy redemptions. This stock has sold off from $0.80 down to $0.37 in the open market. We are not a shareholder yet, but we are looking to acquire at these levels.

TGR: Edward, can you leave our readers with some sage Karr wisdom that they can lean on in these unprecedented economic times?

EK: I truly believe that we are heading into a very, very challenging time for humanity in general. The ultimate goal in the financial markets is like the ultimate goal in life—to survive. But you also want to be happy and to prosper. You need to keep it all in perspective.

Your readers are in the top 1% of the global population. And if they own physical gold, they may be in the top one-tenth of the top 1%. A lot of people in the world live hand-to-mouth every day and they remain relatively happy.

I think it is really important to tap into that happiness. Take some time out to be grateful for all you have in life. Enjoy time with your friends and with your family. Spend time on what is important to you. Help people who are less fortunate than you are.

At the end of the day, we’re here for a good time, not for a long time. It is important to enjoy the journey each and every day. Don’t get so worried about the downdraft of your gold position or your junior mining stock. Keep it all in perspective.

TGR: Very wise words. Thank you for talking with us today, Edward.

Edward Karr is the founder of RAMPartners SA–an investment management and investment banking firm based in Geneva. Since 2005, RAMPartners has helped raise more than $100 million for small capitalization companies in fields such as natural resources, high technology, health care and clean energy. Prior to founding RAMPartners, Karr worked for a private Swiss asset management, investment banking and trading firm based in Geneva for six years. At the firm, he was responsible for all of the capital market transactions, investment and marketing activities. Prior to moving to Europe, Karr worked for Prudential Securities in the United States and has been in the financial services industry for 20 years. Before his entry into the financial services arena, Karr was affiliated with the United States Antarctic Program and spent 13 consecutive months working in the Antarctic, receiving the Antarctic Service Medal for his contributions of courage, sacrifice and devotion. Karr studied at Embry-Riddle Aeronautical University and Lansdowne College in London, England, and received a B.S. in economics/finance with Honors from Southern New Hampshire University. He is a licensed pilot and certified master scuba diver as well as a current board member and vice president of the American International Club of Geneva and co-chairman of Republican’s Abroad Switzerland.

Economic Events on October 19, 2011

The Mortgage Bankers’ Association purchase index will be released at 7:00 AM EDT, providing an update on the quantity of new mortgages and refinancings closed in the last week.

At 8:30 AM EDT, the Consumer Price Index report for September will be released.  The consensus is that CPI increased by 0.3% last month, and there was a 0.2% increase in CPI when food and energy are removed.

Also at 8:30 AM EDT, the Housing Starts report for September will be released.  The consensus is that construction on 590,000 new homes were started last month, which would be a increase of 19,000 from the previous month.

At 10:30 AM EDT, the weekly Energy Information Administration Petroleum Status Report will be released, giving investors an update on oil inventories in the United States.

At 2:00 PM EDT, the Beige Book report will be released, giving us more information about economic conditions in each Federal Reserve district in advance of the next Fed meeting.