Thursday, October 27, 2011

EU official: banks to take 50pct cut on Greek debt

A European Union official says the currency union's leaders have reached a deal with banks to take losses of 50 percent of their Greek bonds in a key move to solve the eurozone's debt crisis.

The official was speaking early Thursday morning on condition of anonymity pending an official statement.

A second official confirmed that there was a voluntary deal.


We just may have a deal:

  • EU official, who wished to remain anonymous, tells Bloomberg that euro-area leaders are set to approve accord for 50% writedown on Greek bonds

If true, this means that Portugal, Ireland, Spain and Italy will promptly commence sabotaging their economies (just like Greece) simply to get the same debt Blue Light special as Greece. It also means that, at least according to Barclays, we have a CDS credit event, although we are certain that Europe would never announce this deal unless ISDA (complete determinations committee list here) was onboard, and corrupt as always. In addition, Greece was unable to generate a 90% acceptance for a 21% haircut tender offer. And we are somehow supposed to believe they can do it with 50%? Lastly, as a reminder, on September 14, Moody's put SocGen, BNP and Credit Agricole on downgrade review. This will be the trigger

These 3 Companies are Spending BILLIONS on Stock Buybacks : INTC, BLL, AIC

After stocks slumped badly this summer, many questioned the wisdom of big stock buyback programs. After all, companies were spending huge amounts of cash on repurchases at formerly higher prices and would have been able to buy a lot more shares if they waited until stock prices really slumped. Yet just as individual investors can't time the market, neither can corporations. And with cash balances rising higher and higher, buybacks, along with dividends, are the most logical use of a company's money right now.

The real takeaway of buybacks is the real leverage it can provide to earnings per share (EPS) growth. Take toy maker Hasbro (NYSE: HAS) as an example. Net income is likely to fall roughly $25 million to $375 million this year, as the toy maker derives fewer benefits from the Transformers movie franchise than it did in 2010. Yet earnings per share are likely to be around $2.80 this year, up around 7% from a year ago. Goldman Sachs figures that ongoing stock buybacks will actually boost the company's 2011 results by around $0.20. Were it not for the shrinking share count, Hasbro would be suffering from negative year-over-year EPS comparisons.

For many companies in the midst of big buybacks, a shrinking share count can help propel moderate net income gains into more robust EPS gains. Here are three stocks that are clearly benefiting from a rapidly shrinking share count.

1. Intel (Nasdaq: INTC)
The fact that this chip giant delivered 24% net income growth (on a non-GAAP basis) in its third quarter is surely impressive, when much of the investment community had seemingly written off the desktop and laptop computer markets in the face of the tablet computer onslaught. But the fact that earnings per share rose by 33% should be even more attention-grabbing.

Intel is doing its best to appeal to dividend-focused investors, spending $1.1 billion in the most recent quarter in support of a payout that currently yields 3.6%. Yet another $4 billion was spent re-acquiring company stock, eliminating 186 million shares from the share count. In fact, Intel is so focused on shrinking the share count that it just announced plans to borrow $5 billion to increase its current share repurchase plan by another $10 billion to bring it up to $14 billion. ($4 billion remained on the previous plan.) If completed, that would reduce the share count by an additional 11%, which means net income growth could slow to just 5%-10% in 2012, but EPS growth would still stay in the more impressive 15%-20% range. Despite a 4% jump in Wednesday trading, shares still trade for less than 10 times likely (upwardly revised) 2012 profit forecasts.

2. Ball Corp. (NYSE: BLL)

A fast-rising Chinese middle class is the reason this company is boosting sales at a double-digit clip this year. Ball is the largest supplier of soda cans in the United States, the second-largest in Europe, and the largest in China. (The company also has strong market share in food cans.) It's a healthy business: Ball is expected to generate $400 million in free cash flow this year, and $500 million in free cash flow next year, according to analysts at Merrill Lynch.

You would think aluminum cans is a fairly boring and quite mature business. Yet at a recent analyst meeting, Ball's management ran through a series of new types of cans and bottles (such as its Alumi-Tek re-sealable bottles) that are driving growth. But management's top-line growth plans aren't really the story here. Instead, it's what all that free cash flow is doing to the share count. The number of shares outstanding has fallen for seven straight years to around 183.5 million by the end of 2010, but that figure may fall to 150 million by 2013, according to Merrill Lynch. The EPS impact: Merrill assumes after-tax income will rise almost 20% from $430 million in 2010 to $511 million by 2013. But a radical cut in the share count should boost EPS 42% during that time frame, from $2.29 to $3.25.

3. Assurant (NYSE: AIZ)

This specialty insurer has managed to shrink its share count every year since going public back in 2004. And while shares remain at a tangible discount to book value, management intends to keep buying back stock. The insurer bought back $533 million worth of stock in 2010, and analysts at Sterne Agee think Assurant will spend $500 million on buybacks in 2011, another $600 million in 2012 and $500 million more in 2013. This would reduce the year-end share count from 2011 to 2013 by 26%.

So even though the analysts foresee operating income rising 14% during that time frame (from $426 million to $489 million), they think EPS will rise from $4.41 in 2011 to $6.50 in 2013, a 47% jump. By the end of 2013, tangible book value per share should approach $55. That's far above the current $38 share price.

Risks to Consider: The biggest risk for these companies is a newly-weakened economy bringing down stock prices across the board, which would make these big buybacks look like an ill-timed, injudicious use of a company's capital base.

Action to Take -->
These companies are boosting per share profits at a fast clip, even as the economy remains in a funk. Shrinking share counts also set the stage for sharply higher profits when the next upswing in the economic cycle arrives. Any of these three stocks merit further research on your part, but from where I sit, they look pretty enticing.

Our Listeners Questions Answered – Week III

A Look At This Weeks Show:
- When and how do we know when to re-balance our Triangle Strategy?
- Does the gold market track with or opposite to the stock market? Is the short term movement indicative of the long term trend?
- Do countries with larger gold reserves (or other commodities) offer a safer currency risk than countries that are gold poor?

Martin Armstrong: The Entire Global Monetary System Needs to be Revised

Let’s talk about maybe one of the reasons why QE2 failed. In your view, will they announce another QE3 or QE4 as some on Wall Street anticipate if the economy weakens?

Well, unfortunately, they feel they have to do something. But in all honestly, as I think they do realize, they can’t stop it because we are in a global economy. I mean, you take the QE2 idea, then okay, you are going to buy 30-year bonds and you are going to take them in, and therefore, in theory there’ll be a shortage of long-term debt, so therefore they’ll lend more back to the mortgage market. Again, that shows the problem of this myopic view of the world. China said, well gee thank you very much, and they shortened their maturity by selling those 30-year bonds and moving down to two year notes or less.

So the problem we have is that there is no way to stimulate the economy because if they pump in cash, there is no guarantee it stays here. They export it overnight. We do not know who owns what. The only thing we do know is that 40% of the interest that is on our national debt goes out to foreigners. So, the old economic theories where you have a fixed exchange rate system and all these things after World War II, it just does not exist anymore. And we really have to sit down and revise the entire world monetary system because nobody knows what they are doing.

What are your views on Europe and how things will play out there?

What we are seeing in Europe and what the Europeans did not do properly is that they thought they were creating a single currency. What they didn’t do was they didn’t create a unified debt market. So, they left the national debts in each of the members. By doing that you are creating essentially a derivative where okay, fine the Deutsch Mark does not exist anymore, or the Greek Drachma; but if I short the Greek bond, it is effectively the same thing as if it were the currency. I can isolate just Greece and sell that.

Now what happens is that pressure has been pulling Europe apart. And they are not prepared to consolidate the debt to stop it, and they keep putting band-aids on to try and prevent it. But it’s not going to happen. I mean Europe is collapsing under this monetary idea that they had, and the way I can explain it in American terms is if you can imagine what chaos we would have if all 50 states were allowed to issue federal government debt. It would be an absolute free for all. And unfortunately in Europe, there is no single European bond. Every country issues its own, and then the banks use those independent states, they take their debt and they use that for their reserves to say that the banking system is secure. Now, when you start taking Greece down and people start attacking the bonds of Spain and Italy and so on, what happens is, now you are attacking the actual reserves of the bank. Now we have a banking crisis develop. So, I mean, Europe is just … the politicians won’t do the right thing, and therefore it is just turning into a real basket case. (more)

Greenspan: Why European Union Is Doomed to Fail

The European Union is doomed to fail because the divide between the northern and southern countries is just too great, former Fed Chairman Alan Greenspan told CNBC in a recent interview.

"At the outset of the creation of the euro in 1999, it was expected that the southern eurozone economies would behave like those in the north; the Italians would behave like Germans. They didn’t," Greenspan said. "Instead, northern Europe fell into subsidizing southern Europe’s excess consumption, that is, its current account deficits."

Greenspan predicts that as the south's fiscal crisis deepens, the flow of goods from the north will stop altogether and southern Europe's standard of living will go down.

"The effect of the divergent cultures in the eurozone has been grossly underestimated," he added. "The only way to have several currencies from divergent nations lumped together is if they are culturally close, such as Germany, the Netherlands and Austria. If they aren’t, it simply can’t continue to work."

Greenspan feels that, to a very large extent, what’s driving the United States at the moment is Europe. "Today, there is one single integrated global stock market," he said.

He also expects the European crisis, coupled with a failure to address the U.S. budget deficit, may be severe enough to cause a bond market crisis if the market suddenly decides the U.S. is more like Greece than not.

"It is very difficult to predict when a bond crisis could happen," he said. But getting an agreement on the U.S. budget will be difficult, he added, because Washington is the most polarized he's seen it in his career.

Greenspan would like to see Congress address the revenue side of the budget problem by eliminating government subsidies through tax breaks, like the deduction for mortgage interest payments.

"Much fiscal policy is implemented, not through spending increases, but through tax credits and other so-called 'tax expenditures,'" he said. "The markets should respond to them as they do spending cuts, with little contraction in economic activity. We thus could get a very large positive impact on the deficit from such reductions, with minimum negative impact on the economy."

It is no surprise, then, that Greenspan supports the Simpson-Bowles deficit-reduction proposal, which came out last year. Though the plan was met with strong resistance in Washington, Greenspan believes "the presumption we can rein in our budget deficits without inflicting some fiscal pain is utterly unrealistic."

If Simpson-Bowles isn't enacted, Greenspan favors letting the Bush tax cuts expire and restructuring the tax code, moves he says could fairly easily put ove­­r a trillion dollars back into Uncle Sam's pocket each year.

It's Time to Buy these 3 Commodities

When it comes to commodities, there are two factors that dictate prices. The first factor is the underlying demand for the commodity, which can exceed or lag relative supply. The second factor is the technical picture, which is in focus for global investment-bank desks, which simply respond to the direction of a price of a commodity while paying little attention to the fundamental forces in place.

Right now, it's the latter factor ruling the markets. Many commodities are being dragged down by technical factors as losing sessions beget more losing sessions. As a result, silver, platinum and copper have all been sucked down, each trading more than one standard deviation below their 50-day moving average. On a technical basis, this "oversold" condition usually is a considered a "buy" signal. Come to think of it, the fundamental picture also means it's also time to buy. Let's take a closer look...

These three metals sold off sharply in recent months on fears that the global economy -- led by a sputtering U.S. economy -- was headed for a slowdown that would crimp demand for these commodities, which have a range of industrial applications. Yet as we've seen in recent weeks, the potential systemic shock that some were anticipating in July and August is now less likely to happen: Recent U.S. economic data have been decent enough to likely deter a recession; Europe is belatedly tackling the Greek debt crisis, and the rest of the world is cooling to a more moderate but still-respectable rate of growth.

This means demand for these commodities is unlikely to slump sharply from current levels, and pricing should rebuild at least part of the way back. This isn't a call for a boom in the commodities sector, but a solid opportunity for a rebound snapback. If that's the case, then what's the best way to play for each metal?

Mining firm Couer D' Alene (NYSE: CDE) is always a solid play on silver when the metal is in an oversold state. I made a pair of suggested trades on this stock earlier this year. Back in January, I thought it looked undervalued at $22. But in April, I thought the stock had run too far too fast -- up to $35, and suggested profit-taking (or even possibly shorting the stock).

With the stock back at $23, it looks like the light is flashing green again.

This is because industry watchers have set their 2012 price targets for the underlying spot market for silver in 2012, and the outlook is good. A survey of 11 silver analysts by Bloomberg predicts silver will rebound to $42 an ounce in the first quarter of 2012, up from a current $32. The most bearish of the analysts surveyed sees silver falling from its current price around $30 to about $27, so the current price isn't far from that view.

Assume silver stays put at just $30 an ounce in 2012. In that event, UBS' analysts figure Couer D'Alene could offer up a solid dividend in 2012 -- yielding 7% at current prices, which assumes a 50% payout ratio). As I noted back in January, the miner has completed the most exhaustive phase of its capital spending program and will soon be generating robust free cash flow. In a recent note, UBS noted: "On their most recent conference call [Aug. 8], management indicated that the dividend policy is something the board will be evaluating as cash continues to accumulate. Management indicated they believe 'returning capital to shareholders is a 2012 event...'" In a more bullish scenario, the dividend math becomes more striking. Assuming silver rebounds back to $40 in 2012, a 50% payout equates to a 12.5% dividend yield, according to UBS.

Couer D'Alene will release quarterly results on Nov. 7. Pay close attention to management's commentary about potential dividend plans. This could wind up being a nice snapback AND dividend play.

There are several ways to play a rebound in copper, but miner Freeport McMoran (NYSE: FCX) is the most logical candidate, due to its heft and global exposure. Shares plunged from $55 to $30 late this summer and are now inching their way back to the $40 mark. The fall from those mid-summer highs is largely due to concerns that China, the biggest consumer of copper, was on the cusp of an economic slowdown. Yet on Monday morning, Oct. 24, a key manufacturing index showed that the sector expanded in September for the first time since June.

Analysts at Merrill Lynch predict copper prices will stay in the $3.40 to $3.80 per pound range from now through the end of 2013. (The current spot price is $3.40, down from $4.50 this past July). Based on this range Merrill Lynch's analysts think Freeport-McMoran's stock is quite undervalued. They figure the firm's mining assets are worth roughly $65 a share, and they have an overall price target of $57 a share (which is derived on a blended price-to-net-asset-value, price-to-cash-flow and price-to-earnings basis). That price is where the stock was earlier in the year, and reflects 45% upside from current levels.


The recent sharp drop in platinum, from $1,900 an ounce in mid-August to a recent $1,500 is a bit curious. Demand for the metal isn't really dependent on China, but instead is a key metal for the auto industry, which uses platinum in catalytic converters. Scarcity is the real driver here, as it is only mined in South Africa and Russia, and Russia has warned that its output will begin falling. Meanwhile, auto industry production is expected to rise the next few years.
If you're looking for a way to play the sector, then the ETFS Physical Platinum Fund (Nasdaq: PPLT) is now at its lowest level since it was introduced in early 2010.

Risks to Consider: These commodities could fall further if the European debt crisis fails to get resolved and the major world economies are roiled.

Action to Take -->
Commodities go through deep bull and bear cycles. Even within these cycles, you'll spot major moves. The current pullback looks simply to be a re-entry point in a longer-term bull market, especially as it increasingly appears that the U.S. and Chinese economies -- the greatest driver of these commodities -- will not slow to the extent some had feared just a few months ago. Any of the options I mentioned above are suitable for investors to play these snapbacks, but there are other options out there as well.

Why You Can't Buy Banks Yet: BAC, C, GS, KBE, SCGLY

Is a dollar not worth the paper it's printed on? The answer may be yes based on the value of cash on the books of some big banks, compared with their current stock price. Some investors consider the fact that banks are trading at a discount, to the cash they are holding, a reason to buy. It's really one more reason not to buy right now.

Upside Down Financials
Value investors like strong companies that are selling at a discount to intrinsic value. Increasingly, financials have been looked at as a potential value play because they have been sold so heavily in the aftermath of the financial crisis. Shares of Citigroup Inc. (NYSE:C), for example, are down over 93% since October 2007. Following a relatively stable 2010, big bank stocks have been hammered again this year. The SPDR KBW Bank (ARCA:KBE) is off about 25% year to date. There's been a whole laundry list of reasons for the recent downtrend, including slowing global growth expectations, European banking contagion and damaging litigation relating to housing securities.

As a result of the selling pressure on banks, stock prices are no longer aligned with asset value. Look at Bank of America Corp (NYSE:BAC), which has been one of the most heavily sold financials this year. At the same time, regulators have forced banks to aggressively recapitalize through new standards like Basel III. While restructuring its business lines, Bank of America has accumulated roughly $140 billion in cash. Tangible common equity (book value) stands at roughly $125 billion. Yet the market cap of this company is $67 billion. That's an upside down relationship. Normally, market cap is greater than book value, and book value is greater than cash on hand.

Logically speaking, Bank of America's stock price should rise to reflect the capital position, or the cash on the balance sheet at the very least. The fact that the market is not bidding up Bank of America, to reflect the capital on hand, suggests the cash does not cover all of the looming liabilities. Clearly, the market is stating that legal claims, particularly those related to the disastrous Countrywide Financial acquisition, will eat up all of the cash on the balance sheet. (For more on Contrywide and Bank of America, check out Can Bank Of America Dispose Of Countrywide?)

Citigroup is in the same position. Citigroup has about $186 billion in cash on the balance sheet, and another $170 billion in government backed securities. Yet, the market capitalization of the company is roughly $92 billion. The stock is selling at a steep discount to book value. Apparently, the cash that these banks hold is not worth the paper it is printed on.

The Bottom Line
The banking sector is an extremely risky play for retail investors, as I noted back on August 19 in this article concerning European banks. One of those Euro bank stocks, Societe Generale (OTCBB:SCGLY), is down a staggering 14% since then.

The American banking system is in a much better condition than Europe. Capital as a percentage of assets of American banks has never been higher, and liquidity positions are terrific. But, the market is reflecting a massive risk premium for these banks in the current operating environment. Even Goldman Sachs Group, Inc. (NYSE:GS), which is widely considered the gold standard of the financial services industry, posted a loss for just the second time in their history as a public company last quarter. Goldman lost $428 million as investment banking revenues fell, and private equity investments and fixed income trading securities were marked down sharply.

Banks are still working to move a ton of bad loans off their balance sheets, and litigation issues are keeping stock prices of Bank of America and Citigroup from reflecting cash or book value. These banks will continue to get a heavy risk and conglomerate discount. Retail investors should avoid these stocks for now.

Charlie Munger: Euro Leaders Behind the Curve on Crisis

European leaders, who have directed about $350 billion to aid Greece, Ireland and Portugal, need to do more to resolve the continent’s debt crisis, Berkshire Hathaway Inc. Vice Chairman Charles Munger said.

“They are way behind the curve,” Munger, 87, told Bloomberg Television’s Shivaune Field in an interview today in Los Angeles. “They have to stop shooting at this elephant with a pea shooter.”

Berkshire has cut its holdings of European sovereign debt and Chairman Warren Buffett said last month that his firm wasn’t prepared to invest in the continent’s banks. Munger, who advises Buffett on Berkshire’s investments, praised policy makers in the U.S. for the 2008 bank bailouts. European lenders must turn to investors as they face losses on bond holdings, with nations including Greece struggling to repay debts, Buffett said.

5 Coal Stocks To Watch : ACI, BTU, JRCC, KOL, PVR

Coal has gotten very cold very quickly. One of the hottest commodities only a year ago, it feels as though the bottom has fallen out of many of these stocks. If coal follows the common commodity pattern, the overshoot at the top of the market will be coupled by a dive and investors will have the opportunity to pick up some real bargains. Investors thinking that today is the day to buy, should remember that another global recession presents a major downside, even from today's prices, but there are many stocks approaching interesting price levels.

What's Gone Wrong?
A lot of the melt-up in coal was fueled by the economic recovery, as better business conditions promised better demand, both for thermal coal, used to produce electricity, and metallurgical, or met coal, used to produce steel. Since the spring of this year, though, investors have begun to not only accept the end of the recovery, but fear a potential slip back into recession. That has led to a great deal more caution at steel companies and lower orders at utilities. (For related reading, see Industries That Thrive On Recession.)

To that end, the market has been spooked recently by disappointing shipment guidance from the likes of Alpha Natural Resources (NYSE:ANR) and Walter Energy (NYSE:WLT). Though Canadian railroad Canadian National (NYSE:CNI) recently made some mildly encouraging comments about its coal traffic, the reality is that the parlous state of economies in North America, Europe, and Asia has investors very much on edge.

Names to Watch
Nevertheless, all is not lost for coal. The disaster in Japan earlier this year has put the expansion of nuclear power on ice, so coal is here to stay for a while longer, both as a source of electricity and a critical component of steel. Moreover, major coal companies have been on a consolidation binge, particularly for met coal, and are actively working to expand their global footprint. At the same time, the migration of most U.S. coal companies away from Appalachia and towards Powder River Basin deposits, which are as much as 80% cheaper to exploit, is still an important driver.

Which names should investors watch, then?

Alpha Natural Resources
Alpha has been an especially active acquirer of late, but may have gone too far in its deal for Massey. While Massey offers some geographic synergy, it was bought at the top of the cycle and the company needs to see met coal prices sustained at a much higher level than the traditional norm. Alpha is also dealing with the rapid cost inflation. Recent moves in the market have put the stock at interesting long-term levels, but the short-term still looks tricky.

Peabody Energy (NYSE:BTU) is not only the largest U.S. coal company, but increasingly a global player with interests in Australia, China, and Mongolia. Peabody has sold out of basins like Appalachia and Illinois, in favor of easier-to-mine PRB coal, but has been active in acquiring offshore met coal assets. Arguably the most respected name in coal, Peabody is a great operator, trading at an interesting price.

Arch Coal
Before buying some met coal assets, Arch Coal (NYSE:ACI) looked ready to surrender its position as the #2 U.S. player. Arch has typically been a savvy miner, though jumping back into Appalachian assets is a bold and contrarian play. Arch does not look as cheap or well-run as Peabody, but a recovery in coal prices could produce more relative earnings momentum here and a better stock outcome.

Walter Energy
Walter has significantly expanded its met coal assets, but by doing so, has worsened its margins and exposed itself to higher costs. There has been a surprising amount of management turmoil recently and big shareholders are restless. If Walter gets its house in order, or can induce a larger company like Peabody or Rio Tinto (NYSE:RIO) to make a bid, the appreciation potential here is considerable. The risk of further decline is also high, if the economy stalls and margins cannot be turned around.

Penn Virginia
Penn Virginia Resource Partners (NYSE:PVR) is an odd duck in many respects; it's a limited partnership, it doesn't operate mines, it leases them, and it has a sizable midstream gas business. It also has a better than 8% yield, a good management team and a solid legacy of prudent growth. With so many miners eager to leave Appalachia, PVR should have appealing asset acquisition prospects and the company pays a very solid distribution.

The Bottom Line
By no means is this an exhaustive list of coal investment prospects. Not only are there miners, like James River (Nasdaq:JRCC), to consider, but foreign entities like China Shenhua, equipment companies like Joy Global (Nasdaq:JOYG) and ETFs like Market Vectors Coal (NYSE:KOL).

Coal is starting to look cheap again, but investors should be cautious when reaching out to grab a falling knife. Buying at the bottom is often a byproduct of luck and excessive risk appetite and often not worth that risk. Still, coal is very much in demand around the world and these stocks look poised to do better, once investors feel a bit better about the economy.

Barrels, Bushels, and Bonds

CAMBRIDGE – The prices of hydrocarbons, minerals, and agricultural commodities have been on a veritable roller coaster. While commodity prices are always more variable than those for manufactured goods and services, commodity markets over the last five years have seen extraordinary, almost unprecedented, volatility.

Countries that specialize in the export of oil, copper, iron ore, wheat, coffee, or other commodities have been booming, but they are highly vulnerable. Dollar commodity prices could plunge at any time, as a result of a new recession, an increase in real interest rates in the United States, fluctuations in climate, or random sector-specific factors.

Countries that have outstanding debt in dollars or other foreign currencies are especially vulnerable. If their export revenues were to plunge relative to their debt-service obligations, the result could be crises reminiscent of Latin America’s in 1982 or the Asian and Russian currency crises of 1997-1998.

Many developing countries have made progress since the 1990’s in shifting from dollar-denominated debt toward foreign direct investment and other types of capital inflows, or in paying down their liabilities altogether. But some commodity exporters still seek ways to borrow that won’t expose them to excessive risk.

Commodity bonds may offer a neat way to circumvent these risks. Exporters of any particular commodity should issue debt that is denominated in terms of the price of that commodity, rather than in dollars or any other currency. Jamaica, for example, would issue aluminum bonds; Nigeria would issue oil bonds; Sierra Leone would issue iron-ore bonds; and Mongolia would issue copper bonds. Investors would be able to buy Guatemala’s coffee bonds, Côte d’Ivoire’s cocoa bonds, Liberia’s rubber bonds, Mali’s cotton bonds, and Ghana’s gold bonds.

The advantage of such bonds is that in the event of a decline in the world price of the underlying commodity, the debt-to-export ratio need not rise. The cost of debt service adjusts automatically, without the severe disruption that results from loss of confidence, crisis, debt restructuring, and so forth.

The idea is not new. So, why has it not been tried before? When one asks finance ministers in commodity-exporting debtor countries, they frequently reply that they fear insufficient demand for commodity bonds.

That is a surprising proposition, given that commodity bonds have an obvious latent market, rooted in real economic fundamentals. After all, steel companies have an inherent need to hedge against fluctuations in the price of iron ore, just as airlines and utilities have an inherent need to hedge against fluctuations in the price of oil.

Each of these commodities is an important input for major corporations. Surely there is at least as much natural demand for commodity bonds as there is for credit-default swaps and some of the bizarrely complicated derivatives that are currently traded!

It takes liquidity to make a market successful, and it can be difficult to get a new one started until it achieves a certain critical mass. The problem may be that there are not many investors who want to take a long position on oil and Nigerian credit risk simultaneously.

A multilateral agency such as the World Bank could play a critical role in launching a market in commodity bonds. The fit would be particularly good in those countries where the Bank is already lending money.

Here is how it would work. Instead of denominating a loan to Nigeria in terms of dollars, the Bank would denominate it in terms of the price of oil and lay off its exposure to the world oil price by issuing that same quantity of bonds denominated in oil. If the Bank lends to multiple oil-exporting countries, the market for oil bonds that it creates would be that much larger and more liquid. This pooling function would be particularly important in cases where there are different grades or varieties of the product (as with oil or coffee), and where prices can diverge enough to make an important difference to the exporters.

An alternative for some commodity exporters is to hedge their risk by selling on the futures market. But an important disadvantage of derivatives is their short maturity. A West African country with newly discovered oil reserves needs to finance exploration, drilling, and pipeline construction, which means that it needs to hedge at a time horizon of 10-20 years, not 90 days.

Another disadvantage of derivatives is that they require a high degree of sophistication –both technical and political. In the event of an increase in a commodity’s price, a finance minister who has done a perfect job of hedging export-price risk on the futures market will suddenly find himself accused of having gambled away the national patrimony. This principal-agent problem is much diminished in the case of commodity bonds.

If the international financial wizards can get together and act on this idea now, commodity exporters might be able to avoid calamity the next time the world price of their product takes a plunge. The World Bank should take up the cause.