Saturday, September 29, 2007 1 comments

Added to Watch List: Pulte Homes Exchange Traded Bond (PHA)


In a prior post I mentioned low-quality bonds that were beaten-down in the last few months. My contrarian impulses have made me to look at homebuilder bonds (I also thought about bonds of Abitibi Consolidated--a stock I'm thinking of investing in). There are a lot of bonds one can invest in but I am limiting myself to exchange-traded bonds. For those not familiar, these are bonds that trade on an exchange, whereas the vast majority of bonds do not trade on an exchange (this is also what makes bonds unattractive to small investors). With an exchange traded bond, you will buy/sell as if it were an ETF or stock. I have previously held one of the exchange-traded bonds of General Motors (symbol: GMS).

The one that caught my eye is the Pulte Homes 7.375% Senior Notes due 6/1/2046 (symbol: HMA). You can get more information from the best free bond investing site on the planet: Quantum Online (if you are interested in bonds, you should bookmark this site. You need the free registration for the detailed stuff). These bonds are trading around 20% below par so you have a capital gains potential of around 20%. The yield is around 9% right now. Before I invest, I would want to check to see the financial condition of Pulte Homes to make sure it is not going to go bankrupt or default on the bonds. I took a quick glance and it seems like Pulte can pay the bonds (I ruled out Abitibi because there is a small possibility of them defaulting, and when I owned GMS, GM had a high chance of going bankrupt or defaulting (GM's debt to equity was a scary number ;) )).

So one is looking at around 9% yield plus a 20% capital gains potential. In the worst case, that capital gains will be spread out over 40 years :)If one thinks that Pulte can rebound in 3 years, then you will likely earn around 5% per year in the capital gains to generate a total of 14% per year for three years.

Returns on junk bonds

One of the hardest things for a newbie investor like me is that I'm still not sure what is an appropriate return on an investment. I used to think that I should be aiming for 20%/year but after being influenced by Warren Buffett, Charlie Munger, and others, I'm not really sure. I am totally and utterly confused. Given that the stock market returns 10% per year in the long run, is 12% per year a good return? I don't know if investments like these (if I decide to go for it) will hurt my portfolio or help it.

Is it worth pursuing a junk bond or go for the underlying stock? It's a hard decision. In the case of GM, I went with the bond because I felt there was a small risk of the company going bankrupt (although you will take losses on the bonds, bondholders will likely have been issued new shares post-bankruptcy and they typically do ok) and I thought GM would post big losses if the economy slowed down (whereas bondholders would have been paid the interest (yield was something like 11% on those bonds when I bought)). In the case of the Pulte Homes, I do not see bankruptcy on the horizon and the stock looks way more attractive than the bonds.

One attractive feature of junk bonds is that they have low correlation to the broad markets. Since I am bearish on the markets (due to my expectation of an economic slowdown), junk bonds are attractive. However, I should note that companies issuing junk bonds generally run into financial difficulties when the economy slows, so these bonds will only be attractive if you do not think the company will default. This default scenario doesn't apply to me because, although I would consider that in determining risk and return before purchase, I would clearly not buy a bond if I thought there was a chance of default.

An investor should also consider the tax implications. These bonds can be quite unattractive from a tax point of view. I'm a small investor and taxes aren't that big of a deal yet (eg. commissions and bid-ask spread is a bigger problem for me) so I don't pay as much attention to them.

In any case, I am still not sure I like this idea but if the price drops, I will look at it. I would like to see the bonds trading at around 60% of par value to make them really attractive. Right now they are around 80% of par value.

UPDATE: I noticed that PHA is rated Baa3 by Moody's with a potential ratings downgrade since August 22, 2007 (S&P rates it as BBB-). Both of these are just above the non-investment-grade level so a downgrade by Moody's will put that rating into the non-investment-grade (i.e. junk bond) territory. Should this happen (likely given how badly the housing situation is deteriorating) then some funds that cannot hold junk bonds may be forced to sell. I think PHA is worth investing during such time.

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Japan Post Privatization

Japan is set to privatize its mammoth postal service, Japan Post, on Monday. For those not familiar with Japan or Japan Post, this may seem innocuous and just another step towards privatization of government branches. But Japan Post is a bit different from any other government entity that has been privatized by any government elsewhere. Japan Post isn't a postal service; it's a massive bank. In fact, after privatization, it will become the largest bank by deposits:

The entity privatized on Monday [with $3.03 trillion] will eclipse Citigroup, with assets of $2.22 trillion, as the world's largest commercial bank. Third will be Japan's Mitsubishi UFJ Financial Group, with $1.67 trillion.

The privatization will be kind of slow with the final spin-off not occurring for 10 years:

Under the 10-year privatization plan, Japan Post will on Monday be broken into four separate businesses, initially held under a government-controlled holding company: An insurance company, savings bank, mail courier and post office management company.

This privatization will probably have a bigger impact on the economics of Japan over the next 15 years than any other particular government policy. Due to the massive size of Japan Post, banks in Japan aren't as efficient as they can be. Furthermore, citizens have been misallocating their savings in my opinion.

But Koizumi [previous Prime Minister] argued that the government guarantee on postal savings had encouraged generations of Japanese to park their money in the low-interest accounts, creating a stagnant pool of savings and diverting funds away from more productive investments like stocks and mutual funds.

Experts have also said that postal funds have been used to finance pointless government-backed public works -- bridges to nowhere, redundant roads -- and to purchase government bonds, contributing to a public debt now over 160 percent of Japan's gross domestic product.

I think this privatization will be a huge positive for Japan going forward. It's not going to be a major sudden change, and, instead, it will be a gradual change in the background. Hopefully this results in greater transparency and minimization of government spending. As mentioned in the quote above, Japan's government debt is an astronomical 160% of GDP (US debt to GDP is around 60%).

Friday, September 28, 2007 2 comments

Purchase/Increase: TRB

Added more Tribune (TRB) today. As mentioned before (search for TRB or click on the TRB label for prior articles), this is a merger-"arbitrage" play. The risk is definitely quite high but I feel that the deal will close. The two big threats are:

  • FCC won't approve the waiver: Tribune owns a waiver that enables it to own TV channels in the same regions, which is normally not permitted in USA. This is the biggest risk but I believe the commission will vote for the waiver given that newspapers are struggling. Even if there are some issues, Tribune can spin off their TV stations or something.
  • Bankers can't raise the money through debt: This used to be a big threat a month ago but given that the bond market has calmed down somewhat, I think financing should be fine. Sam Zell is unlikely to walk away and Tribune has already taken on massive leverage as per the first part of the takeover deal, so it is unlikely for the bankers to walk and face lawsuits and damage to their reputation.

I added to an existing small position...

Average Purchase Price: $27.27
Investment Time Horizon: Short-term

(The fact that the Canadian dollar is at parity to the US dollar means that calculating purchase prices is much easier now :) )

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Takefuji Buying Back Shares

Takefuji (TSE: 8564) shares rallied recently after announcing that it is buying back stock. It will buy back at most 3 million shares, which represents 2% of the total outstanding. The amount of the buyback (2%) is small but I still like the idea of buying here given that the stock is trading near multi-year lows. Some companies announce buybacks without buying anything but hopefully this isn't the case here.

Assuming enough reserves have been set aside for the consumer loan liabilities (I think they have) then buying back shares is prudent right now. The shares are down more than 50% this year alone and the stock looks cheap. Takefuji is trading around 66% of book value and should post positive earnings next year. It's better than issuing dividends (Takefuji already has a dividend yield of around 5%). I'm usually in favour of buybacks over dividends.

The whole Japanese consumer lending sub-sector has been suffering lately, and I think buybacks is an attractive proposition for them. I think other companies should buy back their shares given the low prices they are trading at (as long as market value is below book value, I think this is a good strategy for most).

Wednesday, September 26, 2007 0 comments

Insights from GaveKal

In my opinion, the best articles to read are those that (i) challenge your view, or (ii) look at the world from a unique point of view. I am always impressed by the thoughts emanating from Louis-Vincent Gave, Charles Gave, and Anatole Kaletsky of GaveKal. The fact that these ex-European (whatever that means :) ) are located in Hong Kong gives us a fresh perspective to those of us in Canada or USA. Unfortunately for small investors like me, it's hard to get free information from outfits like GaveKal.

John Mauldin, who also writes interesting articles, has posted GaveKal's latest commmentary on his website (you can also subscribe to John's free commentary). This article, titled Do Not Forget About Changes in Velocity, is very timely and one of the most interesting I have read in the last few months.

GaveKal basically questions whether a credit contraction can still occur. Right now, the market is pricing things as if there is an inflationary boom in front of us. One just needs to look at sectors that benefit from inflation, such as commodities and gold, in the last few weeks. Gold, for instance, has been on a tear but are these investors right? GaveKal isn't predicting anything just yet but they point out that any decline in the velocity of money is non-inflationary even if central banks print money.

The article also goes on to talk about how the Federal Reserve has done a pretty good job in the last 30 years or so, how China is facing some big problems, and what can derail the oil bull scenario. I'll quote some things I found insightful.

(all edits (bold, italics, etc) are mine)

Velocity of Money May Decline

...let us offer up a mistake that we made in the past and which, we fear, a number of people are making again today: forgetting that the velocity of money is not a constant...

Following the recent central bank actions in the US, Europe and the UK, most commentators seem to expect a sharp acceleration of either inflation, economic activity, or asset prices (or all three). As a result, gold is making new highs, the US$ is plunging to new depths, etc.... But aren't the recent buyers of gold focusing solely on likely changes in the money supply (M), while forgetting why central banks are set to dump money into the system in the first place? Isn't the reason behind the loosening of monetary policies the fact that the velocity of money (V) has been plummeting?

The crux of the problem is essentialy whether the velocity of money will continuously decline? As GaveKal points out, this is what happened in 2001-2003.

As in 2001, the question investors should thus ask themselves is whether velocity is set to rebound? If it is, then investors are right to position themselves for an ample liquidity environment (long gold, long commodities, long deep cyclicals). But if it isn't, then the investment environment could start getting a lot trickier.

It's pretty obvious that cyclicals and commodities will do well if there is inflation. The commodity bulls are still going heavily into that area but I think there is massive risk right now. Unlike 2004, the so-called fundamental arguments are already priced into the securities in my opinion (practically everyone has heard that oil is in short supply, that few major gold discoveries have been made, etc). The main thing that is driving prices right now in my opinion is speculation. Right now the speculation rests mainly on the liquidity view. I think the Federal Reserve may have initiated an easing cycle so rates may keep declining. But as GaveKal points out, if velocity declines, you can still see asset price declines.

The Crux of China's Problem

If anyone wants to know why China is facing the problems it is, the following words pretty much sum them up:

As we never tire of pointing out, there are three things that a central bank can control: the growth rate of its money supply, its interest rate, or the value of its currency. Unfortunately, as the Chinese central bankers are now discovering, it cannot control all three at the same time.

I think China is going to be the next big economic power but it is going to face a whole hoard of issues in the near future. My belief is that there are bubbles in manufacturing, real estate, and stocks, in China. It is going to be difficult to prevent a massive deflationary collapse in some of these sectors.

And with the Fed now engaged in a new easing cycle, which the PBoC simply cannot afford to follow, it is rapidly becoming crunch time for the RMB. Either the RMB will have to rise a lot in the near future, or the Chinese authorities will have to find some clever way of exporting massive amounts of excess capital. Either way, it is pretty good news for our favourite market: Hong Kong.

GaveKal is very bullish on Hong Kong but I'm not confident that HK will do well if there are sell-offs elsewhere in the world. If you look at the chart of the HK, China, and S&P 500 ETFs during the correction in August, HK actually gave up nearly all its gains.

I think the same thing may happen regardless of what China does. I think a worldwide sell-off will reduce the capital flow into China. That alone should take some pressure off China, although they still won't be able to escape their monetary policy problems.

Interview With Louis-Vincent Gave

Here is a very good radio interview of Louis-Vincent Gave by Jim Puplava of (download the MP3 version and listen to it when you have some free time).

A lot of what is mentioned is different from conventional thinking. For example, Louis-Vincent Gave has been one of those who downplay the impact of the US current account deficit. He also points out how service industry is superior to the manufacturing industry, just like how manufacturing is superior to the agricultural industry. A lot of people criticize the fact that USA, Canada, and others, have been losing their manufacturing industries but these individuals rarely have any evidence to show that it is indeed the case. I don't have time to transcribe some of the key points so you'll have to check out the audio interview if these topics sound useful to you.

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Sunday, September 23, 2007 0 comments

New Template

I have changed the blogger template because the previous one was hard to read (the links on the left were hard to read, and the white background text was too plain for me). I edited two templates from to arrive at this one. The header is kind of messed up and doesn't line up but I'll try fixing that when I feel like--if I feel like it :)

Every time I edit the template, I keep losing the lists on the menubar on the left so I have to re-type them. Kind of annoying...

If you want some free templates, check out They have some good stuff there...

Sam Zell Lecture at Wharton

Forbes has a lengthy article on Sam Zell's recent lecture at Wharton. It is a very good article and I recommend it to anyone interested in real estate investing or contrarian strategies. Sam Zell, the Gravedancer (cool nickname; he also looks like one :) ), is a contrarian-type investor who made his fortune by buying real estate investments. He has owned large amounts of real estate but isn't a developer (refer to one of the quotes below to see why he isn't).

I never heard of Sam Zell until I looked into the Tribune merger. I have a position in TRB (wish I had more money to invest in that) and expect the deal to close. I think contrarians may want to read some of the stuff Sam Zell has done because he is a textbook example of a successful contrarian.

I am going to be heavily quoting the article because I find a lot of useful information in Zell's words and thoughts. I have bolded concepts that I find insightful.

...the Chicago-based investor said current markets are spooked by problems with U.S. subprime lending. However, they still have capital to deploy, unlike during other real estate busts, when financing could not be arranged at any price.

"We're not really in a 'credit crunch.' I think we're in a 'confidence crunch,'" said Zell, funder of the Samuel Zell and Robert Lurie Real Estate Center at Wharton. "I would argue the excess liquidity that existed eight weeks ago still exists today. It has a different risk premium on it, but the actual amount of liquidity has not changed."

Zell's view is different from the mainstream and is somewhat similar to mine. Zell seems to think that there isn't a credit crunch. I have felt the same way since this whole thing started unfolding. If this is indeed the case, I believe that the Federal Reserve did not cut rates due to the credit problems, but did so due to some economic problems (that we don't know about but their private data indicates).

According to Zell, private equity firms awash with capital benefitted from "preposterous" leverage and offered premium prices to publicly held real estate firms. Zell said he considered that type of deal a "Godfather offer"--because no publicly held company could responsibly refuse it.

Zell predicted markets will soon stabilize, although they will become more risk averse and less leveraged than in recent years. "Today, you would never be able to replicate the Blackstone deal."

In my opinion all this private equity boom is due to cheap debt financing. I think the LBO private equity boom is pretty much over. The market has re-priced some of the risky debt and is unlikely to offer cheaper debt in the near future.

Zell did not discuss that deal [Tribune buyout] directly, but pointed out his reputation as a contrarian investor. He recalled the first time he saw the market turn. In the early 1970s, the real estate industry was infused with optimism and expanding rapidly. Zell did not think there would be enough demand to fill the real estate space under development, so he stopped doing new deals and structured a company to focus on distressed real estate. "Everybody else said, 'Sam, you don't understand.' I have heard that my entire career. Even when I buy newspapers in 2007, everybody says, 'If you didn't understand before, now you really don't understand.'"

It can't get more contrarian than buying newspapers today. I hope the Tribune deal closes for my sake (I'm betting on a takeover) but it's worth thinking about the the business of newspapers.

Sam Zell has crafted an amazing deal with the Tribune takeover. I don't recall the numbers but he is basically risking (only!) around $400 million for a potential return of $3+ billion. It's an amazing deal for Zell but he can still lose it all if the newspaper business can't be turned around.

John C. Dvorak often has "weird" off-the-wall views on things (he mostly writes about technology) but his latest column is excellent and parallels my views (BTW, I highly recommend this article to anyone interested in the newspaper area). My personal feeling, similar to Dvorak, is that small papers will dissapear while large ones with original content dominate. I expect more and more people to flock to papers like The New York Times, Washington Post, Wall Street Journal, and in Canada papers like The Toronto Star, The Globe & Mail, while the smaller rural papers simply die off. Sam Zell is going to have his work cut out. Papers like the Chicago Tribune and Los Angeles Times, among others, can do well but not so sure about other holdings. Real estate is largely cyclical so you can just buy and hold, but the newspaper declines seem to be some secular long-term downtrend.

"I would tell you whatever business I've been in--real estate, barges, rail cars--it's all about supply and demand."

The most important lesson from Sam Zell! I'm becoming more and more of a contrarian investor with a value tilt. I am starting to realize that supply & demand plays a huge role in this type of investing. In contrast to other types of investing, such as momentum investing or sector rotation, I think a contrarian that is value-oriented needs to nail the supply & demand proposition. I am seriously looking at Owens Corning (OC; OCWAZ) and supply & demand is something I think about a lot.

Following a market crash in 1973, Zell spent three years acquiring $3 billion in real estate assets, much of it for $1 down. He built his portfolio by approaching lenders and offering to take future operating losses off their hands in return for equity. Zell was able to carry the properties long enough for them to return to--and exceed--prior valuations.

You can see how Zell became a billionaire. Classic value investing... Buy something really cheap... Hold until it reaches more attractive valuation...

When Linneman asked Zell why he had never become a developer, the bearded, gravel-voiced mogul replied that development is too risky for his taste. "In that business, it helps to have an 'edifice complex,'" said Zell. "At least half of your rate of return comes from the psychological benefit you get from seeing the building go up. I never suffered from that particular affliction."

Zell never went into property development. For those of you interested in real estate and think property development is the only way to riches, Zell presents a case for doing it without development.

Zell and Lurie spent much of the 1980s diversifying their holdings into other businesses. Their strategy was the same as it had been in real estate--to look for opportunities in places where others were ignoring the rules of supply and demand.

The lesson to be learned: supply & demand...

While real estate professionals have excellent transactional skills, he added, they often lack the foresight to plot strategy. "When it comes to delegating the negotiation of a transaction, I would always pick a real estate guy over a corporate guy," said Zell. On the other hand, real estate people lack the ability to "look around the corner. To them, the tree is always growing to the sky. Therefore, we have enormous and very volatile cycles that continue to this day."

His thought about real estate professionals...

When it comes to real estate, Zell said he is focusing on development in emerging markets through a company called Equity Group International.

In 1999, Zell decided the REIT concept that had worked so well in the United States could be replicated in other parts of the world. He now controls major home builders in Mexico and Brazil, and is also branching out to India, China and Egypt.

He said the Guadalajara office of the Mexican company, Homex, is open 24 hours a day, seven days a week, to meet the needs of Mexican home buyers. "The beauty of all these places is there is unlimited demand," said Zell. "If you go back to Econ. 101, these countries have huge backlogs of housing demand. The population is increasing and housing has not."

Marc Faber is also bullish on real estate in developing countries. I have looked at real estate in emerging markets but I'm not sure how to invest there. They also look very risky right now given the huge run-up in almost everything in those countries (for example, real estate in some parts of India are ridiculous and worse than USA). If emerging markets correct--and I think they will if the US economy slows down--then foreign real estate will be a place to look. Real estate is probably a simpler bet in emerging markets than trying to invest in consumer goods, manufacturing, or technology, in those countries.

Zell acknowledged he does not always get it right. He told the story of how he acquired the Carter Hawley Hale stores in California in 1992...In 1995, he decided to bail out and sell the chain to its competitor, Federated Department Stores. The price? Even though he lost money on the deal, Zell finds comfort that his firm calculated the downside correctly... "The investment was a failure, but the process was a success. We identified the risk we were prepared to take, and we took it."

Good analytics can mitigate risk even when things turn against you. Too bad that such analysis is very difficult for newbie investors like myself.

"He who dances closest to the graves, always has to be careful he doesn't fall in."

A wise quote to add to the dangers of contrarian investing. The problem for newbie investors like myself is that I'm not sure how to mitigate the downside risk. A lot of contrarian opportunties have massive downside (basically bankruptcy or some such disastrous outcome) so I'm always scared.

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Saturday, September 22, 2007 0 comments

Criticism of the High Inflation Supporters

I recently posted a response on the Crow Bar rebutting those who think inflation is much higher than the officially reported number. I'll paraphrase that comment here.

To give some background, some people out there (mainly the goldbugs) believe that inflation is far higher than the reported number. Many actually think that inflation is way beyond 5% (officially full inflation is around 3% with core inflation around 2% (depends on period)). An argument for inflation being higher makes no sense whatsoever. My key arguments against such view are:

  1. The market, which is smarter and more nimble than any individual, central bank, or government, has not priced in such a high inflation.
  2. Depending on the number you pick, a high inflation number implies negative economic growth (i.e. contraction). There is zero real evidence of economic contraction.

We all believe in the free market (I hope). Given that, why hasn't the market, which is smarter than anyone including central banks, priced in high inflation if inflation was actually high? Stocks will get discounted more and even less people will be investing in bonds. Very few would find interest-sensitive assets like REITs attractive. But this hasn't happened. If those claiming that inflation is much higher than 3% (or whatever it is; 2% is the core) over the last 10 years were right, the market would have discounted all these assets. Yet, that isn't the case.

Furthermore, if inflation is much higher than what is reported, (real) GDP growth would be much lower. Depending on the number you pick, the implication would also be that (real) GDP growth may be negative (because real GDP is after discounting by inflation (PCE deflator)). For example, given that GDP growth has been around 3%, if you thought inflation was more than 3% higher than the reported number, you are basically saying the US economy has been contracting for years. Yet nothing is further from the truth. You don't need to listen to the government published numbers. Go and talk to anyone running a business. Talk to people looking for work. Look at capital spending by US corporations. Talk to lower class people who will feel economic contraction first. And so on. You will find that everyone would say that the economy has been expanding and doing well (except recently--we may actually go into a recession).

You can argue the economy is driven by debt, too much borrowing, and so on, but regardless of how the economy is being driven, a higher inflation number means real GDP growth is lower. Anyone that thinks inflation is higher than around 6% should realize that they are basically implying that the real GDP was contracting all these years. There is zero evidence of that (except in the last few months and maybe in the near future).

(Having said all that, I will admit that the recent Federal Reserve rate cut will put pressure on inflation if the cuts were unnecessary (i.e. cuts happened without the economy weakening). It looks like I sold out my gold (HMY) just before the massive rally recently but I'm still unsure that the inflationists are right. If the economy slows, it should be deflationary and the stock market rally in the last few weeks should falter. In any case, my comment is about the past, where people have been saying inflation is much higher than reported for years.)


New York Times free (WSJ likely as well)

Last week, The New York Times changed their policy and made everything on their website, including archives back to 1987, free. This makes a cheap guy like me happy :) Finally, we can not only read opinions and editorials for free, but we can also link to their full articles and research past historical articles. If the New York Times is as good as I think it is, this should increase its readership.

The Wall Street Journal website may also become free. Rupert Murdoch (as much as I disagree with this conservative views, he is a one savvy businessman--with a trophy wife to boot ;) ) has indicated that he has thought about making WSJ free. This probably won't impact the business crowd or wealthier investors who would have paid anyway, but small investors or the general public will be tempted to use WSJ for their primary business news in the future.

Since I am a liberal-libertarian, I love NYT for their stories on life, arts, politics, and so forth. I don't generally agree with the conservative-oriented WSJ views, although I agree with their economic views most of the time, but WSJ is arguably the top business news source. Since I was never a subscriber I have always felt that I was missing out on some news that could help my investing.

I'm happy with these changes...

Thursday, September 20, 2007 0 comments

Market Performance After Federal Reserve Rate Cut

Businessweek has an article looking at performance of S&P 500 components after the first rate cut. You can read the full article here.

(source: The Fed's Move: Cause for Joy—or Worry? by Ben Steverman, BusinessWeek. URL referenced above)

As is the case with most stock market analysis of inflection points, statistically the sample size is way too small to draw any meaningful conclusion. Nevertheless, we find that the market has gone up on average after 6 months after the first rate cut. However, in the last 20 years, the market actually declined in 1982, 1991, and 2001--these were recessions as you will recall. So the way I look at it, the market will likely decline if there is a recession. In other words, the most important thing now is, not what the Federal Reserve does next, but whether we have a recession on our hands or not.

(On an unrelated note, the long bonds sold off very sharply today. This is one of the few instances where the bonds sold off big time while the broad markets also declined. The sell-off is likely due to US$ decline but bonds have been doing terribly in the last few days.)

Wednesday, September 19, 2007 0 comments

Alan Greenspan Unplugged

Well, now that Alan Greenspan does not work for the government, he has been freely disclosing some interesting thoughts. His just-published book The Age of Turbulence: Adventures in a New World is supposedly worth reading if you are interested in Alan Greenspan's views, central banking, or economics in general. I'm too cheap to buy the book ;) and have a million other books on the list (I'm a newbie so I still have a million classics to catch up on). I'm going to list two interesting views of his. I agree with both of them.

Oil is a Big Factor in War

Alan Greenspan managed to say what warmongers and war profiteers the world over never say. Namely, that oil was one of the major--but not the only--reason for the Iraqi war, not to mention US foreign intervention in the Middle East.

I'll quote Robert Weissman's remark regarding this situation:

Greenspan's remarks, appearing first in his just-published memoirs, are eyebrow-raising for their directness:

"Whatever their publicized angst over Saddam Hussein's 'weapons of mass destruction,' American and British authorities were also concerned about violence in the area that harbors a resource indispensable for the functioning of the world economy. I am saddened that it is politically inconvenient to acknowledge what everyone knows: the Iraq war is largely about oil."

His follow-up remarks have been even more direct. "I thought the issue of weapons of mass destruction as the excuse was utterly beside the point," he told the Guardian.

Greenspan also tells the Washington Post's Bob Woodward that he actively lobbied the White House to remove Saddam Hussein for the express purpose of protecting Western control over global oil supplies.

"I'm saying taking Saddam out was essential," Greenspan said. But, writes Woodward, Greenspan "added that he was not implying that the war was an oil grab."

"No, no, no," he said. Getting rid of Hussein achieved the purpose of "making certain that the existing system [of oil markets] continues to work, frankly, until we find other [energy supplies], which ultimately we will."

(source: From Greenspan to Kissinger - Oil Warriors By ROBERT WEISSMAN; September 19, 2007; URL:

This is a tough position to take, especially when the "blind patriots" attack anyone who stands against any bogus war (for what it's worth, Greenspan was in favour of the war and was indeed promoting an attack on Iraq). I think the Iraqi war was completely unnecessary and immoral.

The Best Thing About America: Freedoms

Marcus Gee of The Globe & Mail has written an article elaborating Greenspan's views of China. Alan Greenspan is impressed with China but is concerned with something that parallels my view. A lot of people fail to realize that USA is the best country, for investing as well as living*, because of its freedoms. The so-called American Founding Fathers were extremely intelligent in creating a Constitution (and Bill of Rights) that was--and still is--far ahead of the rest of the world. If I moved to Titan and started a colony ;) I would base it primarily on the American Bill of Rights (but I would use British-style parliamentary system instead--USA/French-style system will lead to a two party or one party state IMO). Speaking a liberal-libertarian, I think this is the best thing about America. It is also what will make it an attractive country for centuries, until other countries catch up.

Greenspan points out that China, being a totalitarian country, is going to have problems in the future. I personally think that China will have to switch its econopolitical system at some point in the future (likely will be a messy scenario but better for the long run).

One reason, he argues, is that the United States has a secret economic weapon: the Constitution. "I do not believe most Americans are aware of how critical the Constitution of the United States has been, and will continue to be, to the prosperity of our nation," he writes. "To have had, for more than two centuries, unrivalled protection of individual rights, for all the participants in our economy, both native-born and immigrant, is a profoundly important contributor to our adventuresomeness and prosperity."

With their property protected from arbitrary confiscation, he argues, Americans have had the confidence to take the risks that make a capitalist economy thrive.

How many countries can say that property cannot be easily** seized by the government? Who is going to work hard if the government can grab what you have?

For one thing, foreign investors sometimes find that the technology they bring to their joint-venture factories in China mysteriously shows up in the Chinese-owned factories next door. With shaky property rights and dubious courts, there's not much they can do.

For the Chinese, the effects are much more serious. Mr. Greenspan notes that despite three decades of reform, Chinese farmers still do not own the land they till. They can lease it and take their produce to market, a huge improvement over the days of Mao-era collective farms, but they cannot buy or sell it or use it as collateral to secure a loan.

This handicap - a lack of access to capital - keeps hundreds of millions of peasants trapped in poverty on the farm while the urban middle-class thrives. "Granting legal title to peasant land could, with the stroke of the pen, substantially narrow the wealth gap between urban and rural residents," Mr. Greenspan writes. As it is, there are thousands of protests in China every year, many of them by peasants evicted from their land for urban expansion or factory construction.

Anyone watching China should pay attention to what happens to the farmers. The vast majority of the population are still in the rural areas and work as farmers. They are not sharing much in the wealth creation in China and this can lead to unrest (This is an even bigger problem in places like India but the system isn't totalitarian and property rights are better.)

(* Well, USA is the best country to live in on aggregate but there are several things that make it worse off than other countries. For instance, high discrepancy in wealth results in some people with immense wealth while many have very little. This creates all sorts of social problems including high violent crime and underemployment/waste of human resources. It's sad that the richest country in the world on GDP per capita terms (if you ignore little countries like Luxemberg) essentially has streets where some people are scared to walk on. You can literally go from one side of the street to another and the environment just deteriorates. All of this means that my country, Canada, is arguably better :) (no hate mail from you Americans please :) )).

(** Do note that USA is nowhere near perfect. Unfortunately ,the Constitution can be manipulated at times. For example, the government stripped assets of Japanese Americans in the 40's (this should have been impossible under the Constitution). On a non-economic issue, if I'm not mistaken, Abraham Lincoln held (executed?) Confederate soldiers/collaborators without trial (sounds eerily similar to George Bush and Guantanomo Bay). )

Tuesday, September 18, 2007 0 comments

Navigating the Takeover Propaganda

Saul Sterman recently wrote a good article about all the rumours, lies, exaggerations, truths, and propaganda that revolve around takeover deals. In his article he analyzes the Whole Foods Markets (WFMI) takeover of Wild Oats (OATS). He zeroes in on people that he terms deal breakers, who are opposed to the deal. A lot of words are typically uttered by these deal breakers regarding the feasibility of the deal but hardly any of it becomes true. Saul mentions 10 commandments that can be used to shed some light on the comments by deal breakers.

I think his article is a good framework for those, like me, looking at takeovers. As I have mentioned previously, I'm attempting to profit from the ABN and TRB takeovers. If the risk is ok with you, TRB still looks attractive to me.

Sunday, September 16, 2007 0 comments

Greenspan's Book: Inflation Likely Higher in the Distant Future

I ran across The Wall Street Journal's quick summary of some of Alan Greenspan's thoughts in his new book, The Age of Turbulence: Adventures in a New World. The part I found insightful is where he talks about his expectation for higher inflation and the need for far higher interest rates over the next 25 years. (I bolded some key words in the quote below)

In coming years, as the globalization process winds down, he predicts inflation will become harder to contain. Recent increases in the price of imports from China and a rise in long-term interest rates suggest "the turn may be upon us sooner rather than later."

Left alone, he said, the Fed's policy-making body, the Federal Open Market Committee, can keep inflation between 1% and 2%, but that could require forcing interest rates to double-digits, a level "not seen since the days of Paul Volcker," his predecessor as Fed chairman. "I fear that my successors on the FOMC, as they strive to maintain price stability in the coming quarter century, will run into populist resistance from Congress, if not from the White House," he writes.

If the Fed succumbs to that pressure, inflation could rise from a little over 2% at present to an average of 4% to 5% by the year 2030, he writes. Ten-year Treasury yields, now below 5%, will rise to "at least 8%" with the potential to go "significantly higher for brief periods." This, he says, will lead to stagnant returns on stocks and bonds and much smaller gains in housing prices.

(source: Greenspan Book Criticizes Bush And Republicans, Greg Ip and Emily Steel, Page A1, September 15, 2007, The Wall Street Journal Online; URL:

This isn't really anything new but I found it surprising that he thinks that you need 10%+ interest rates in the future. A rise in interest rates over the long term was almost inevitable given that the rates are low by super-long-term historical numbers (people in the 80's and 90's have been spoiled by the decline of interest rates to low single digits). Needless to say, higher interest rates will depress asset prices (since future cash flow from assets are discounted to the present using a given interest rate).

I don't agree entirely with Alan Greenspan's view. I do think interest rates will go up to combat inflation but there will still be deflationary pressures to keep them down. A key criteria for Greenspan's view is his expectation of Globalization winding down (bolded in the quote above) but I don't see that happening for a long time. Since I believe free markets are the ideal system, there are still a lot of countries that are not part of so-called Globalization. Many Latin American countries that are not commodity exporters, some African countries, and some protectionist Asian countries have not participated. The process will continue as these countries switch their econopolitical systems. Even for the big countries that have opened up their markets, they are still a long way from exerting inflation on the rest of the world. For example, if you look at some country like India, the vast majority of its economy is still quite primitive (agricultural, inefficient retail, etc) so there will be defltionary pressures exerted by workers in those areas changing jobs, or the development of new technology to satisfy the changes.

Having said all that, we can be sure about one thing: returns on stocks (at least for developed countries) will be lower in the future than they were in the last 25 years. If this is the case, I suspect passive indexing will underperform active investing--this is another reason I'm more keen to develop some skills in value investing, stock picking, and so forth.

Saturday, September 15, 2007 1 comments

Dissenting Opinion of Peak Oil

Someone posted a reference to a news story mentioning potential catastrophic effects of Peak Oil on the Morningstar message board that I post on. I thought I would post my response to Peak Oil.

As someone who doesn't subscribe to the theory of Peak Oil, let me offer my dissenting views.

First of all, it is possible for oil prices to go up even without Peak Oil if the US$ declines substantially (I don't think it will happen but some are expecting the US$ to decline a lot more). For the sake of argument, let's assume these people are predicting $200 oil based on present value and not based on substantial US$ decline. Anyway...

As I have been saying for a while now. a lot of the Peak Oil theory is based on high growth rates in developing countries, along with pretty good growth in developed countries. This rarely lasts for long. Investors, economists, and policymakers love to project the present far into the future but it never turns out that way. It wasn't too long ago, 1997 in fact, when the Asian Tigers (South Korea, Taiwan, Malaysia, Singapore, Indonesia) that were supposed to be the next big thing and continue to grow rapidly ran into big problems. Oil, if you recall, hit its bottom (in nominal terms) in 1998 with the fall of the Asian Tigers.

Right now, people are projecting 8%+ growth rates in China and India, along with fairly high growth rates in other developing countries, like Brazil, Vietnam, and so forth. I am pretty sure these rates are going to end up being completely wrong. Already China is running into massive pollution problems, not to mention bubbles in stocks, real estate, and manufacturing. If these growth rates end up being lower than forecast, the Peak Oil dates will be delayed. The dates can be delayed by decades even.

Secondly, most Peak Oil theorists ignore basic economics. Namely, demand should go down as prices rise due to scarcity. This is almost a law in economics and I'm not sure why Peak Oil theorists seem to ignore it. So far demand hasn't dropped with rising oil prices because it is not significant enough to impact profitability margins, and hence slow down the economy. It is highly improbable in my opinion to have developing countries, whose businesses tend to have razor-thin profit margins and are highly vulnerable to raw material costs, grow at a high rate if oil prices rise substantially. For instance, many Chinese factories have very thin margins and will go bankrupt or curb production if oil prices are high. The increase in prices will also impact consumers. Right now the higher classes (upper middle-class and higher) still buy fuel-hungry cars such as trucks, SUVs, large cars, and so on. I will guarantee you that if oil prices go up quite a bit, very few will buy those cars. Lower classes will revert to greater use of public transportation if oil prices go up a lot higher.

Lastly, as prices rise, technologies and materials that are competitive to oil will emerge. Similar to how railroads have all of a sudden become cost-competitive with trucking due to high oil prices, I suspect many alternative energy sources will take off. This can range from hybrid automobiles (autos are a big user of oil) to increased use of insulation (insulation can save 40% of a building's energy loss (most are already insulated so the savings will be lower but there will be greater incentive to improve what is already there)).

Friday, September 14, 2007 0 comments

US Long Bonds Moving Along With the Yen

Although this isn't anything dramatic, I have noticed the high correlation between US long bonds and the Japanese Yen lately. The following chart of Yen and TLT, the 20 yr US Treasury bond ETF, illustrates this point perfectly.


For all of 2007, but especially in the last few months, the US long bonds have behaved similarly as the Yen. I am not sure if this is a coincidence that won't going to last, or if this is a pattern that may develop further, but I'll be keeping a close eye on it. This could simply be capital flight (both Yen and US Treasuries are safe havens in terms of valuations) so it may be a coincidence.

Since I am long TLT, and think the Yen carry-trade may unwind soon, it may not make sense to sell TLT until the Yen finishes its move.

Tuesday, September 11, 2007 0 comments

Junk bond defaults likely to rise

Moody's is warning that junk bond default rates may go up:

Defaults among companies with speculative-grade credit are likely to more than double over the next year, Moody's Investors Service said Tuesday.
Many of the defaults and bankruptcies in the coming year may be triggered by companies simply running out of cash to sustain business, because most used strong markets in the past few years to relax financial covenants on their bank credit facilities, Gates said.

Well this is no surprise and I have been expecting it for a while now. Mortgage debt has been in the process of repricing over the last few months; now it looks like junk bonds (quite popular in LBOs over the last few years). I am predicting that the next thing will be emerging market bonds. Some EM bulls think that emerging markets are not risky anymore but the fact of the matter is that hardly any of them have ever repaid their debt in full. The current commodities boom is making some countries look good on paper but I suspect that they will default when the boom ends.

Friday, September 7, 2007 0 comments

Testing New Blog Themes

I'm in the process of testing out new themes for this blog so bear with me for a few days. Things may be messed up for the time being.

Wednesday, September 5, 2007 0 comments

Sold: Harmony (HMY)

Not sure if this is a dumb idea or not (I have a habit of missing gold rallies) but I sold my gold holding, Harmony (HMY). Ended up with practically zero gain, after taxes and commissions. Although gold can break out here, I'm not confident enough yet with it. Furthermore, I think Tribune looks way more attractive, albeit with big risk of the deal not closing, so I have decided to either add to that or hold cash.

For what it's worth, I still like Harmony and I would look at if someone wants a high-risk miner with high-leverage (due to high costs). But the macro environment is very questionable for gold right now. Although gold should rally with all housing problems and a switch to an easis bias by the Federal Reserve, it hasn't been as impressive as I would have liked it. It is still tracking too closely to the broad market for my liking. Since I'm bearish on the broad market, I don't like it.

HMY Sale price: $9.41

ROI: 3.29% (excl taxes and commissions)

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Sunday, September 2, 2007 0 comments

To Watch: Low-quality Bond Funds

Given the credit problems and the widening of the junk bond spread (over Treasury bonds), I think a good contrarian area to watch are credit investments. Aaron Pressman's BusinessWeek blog postings (here and here) talks about potential opportunities in low-quality debt instruments. It's illuminating to read the older blog entry and see how much things have fallen since then. Anyone who thought these instruments were attractive in July has lost quite a bit in one month.

To refresh your memory, the amount of extra yield over Treasury bonds that junk investors demanded leaped from a record low of less than 2.5 percentage points in early June to over 4.5 points in recent days

I personally think that this spread will widen even further. All this widening is occurring without any material slowdown in the economy. If corporate profit growth, which I view as near a peak, starts slowing down then low-quality corporate bonds will correct even further. Some of the corporations that issued junk bonds may have difficulties paying. That is the ideal time to buy! Right now, only the mortgage-related bonds have corrected to any meaningful degree.

The funds mentioned in the blog entries that interest me are:
  • Regions Morgan Keegan Strategic Income Fund (RSF)
  • RMK Multi-sector High Income Fund (RHY)
  • iShares iBoxx High Yield Corporate Bond exchange-traded fund (HYG)

The first two hold CDOs and mortgage bonds, which are precisely the ones that are suffering these days. The following NAV chart of RSF shows how it has dropped off a cliff lately.


Interestingly, even with a big correction, the RSF is trading at a premium to NAV. I think something like this is worth checking out in a few months. I suspect that it will keep dropping further as the mortgage debt issues, in addition to a possibly declining stock market, re-price these funds.

There are a whole hoard of other CEFs that one should investigate if they are interested. The advantage of CEFs is that they can possibly be bought at discounts. One can never be sure if the discounts will dissapear (thus profitting someone who bought with a discount) but in the long run it isn't a bad bet. One thing to note with CEFs is that they may have high MERs (management expense ratio). I haven't looked into any of these in detail (since we are nowhere near a bottom) but if MER is 2.5% and, say, the yield is 8%, then you are paying 30% of the income in costs--a huge cost. In such cases, I will only find the funds attractive if capital gains potential is much larger (or the yield is way beyond 10%).

Of course, the ideal solution, with the highest payoff (and also the highest risk) is to directly buy the corporate bonds or CDOs instead of using one of these funds. You avoid all the fund expenses but have to pick the right one. Since I'm in Canada and I have a small portfolio, this isn't easy for me. However I will consider exchange traded bonds on NYSE.

So to sum up, I'll watch the situation and consider investing in the future (maybe 5 or 6 months from now). I think a good time to consider junk bonds are when the economy troughs, and the yields are more than 15% (or yields of around 10% with a sizeable capital gains potential).

UPDATE: I think emerging market bond funds are also worth looking into. Unlike the Street, I think EM debt is still too expensive. The market is not pricing in the risk of default. If, and when, the market discounts the EM debt, it may be attractive. An example of an EM CEF is the recently launched Morgan Stanley Emerging Markets Domestic Debt Fund (EDD). Before diving into these, one needs to check to see how currency fluctuations will impact these bonds. I will consider EM debt funds in 6 months or so (or if the market sells off EM debt).

UPDATE: A few more CEFs with subprime exposure to consider in the future (courtesy some poster on the M* CEF message board): RMH, RMA, FHI, FHY, FHO


Let's Look at Labour During the Labour Day Holiday

National Holidays

Here's a graphic from the New York Times pointing out national holidays in select countries:

(source: More Days Off? Better Move to Colombia , Sept 2, 2007, New York Times)

For reference, Canada has 10 national holidays (my province also has one extra holiday (Civic Day)).

What I find interesting is that Japan has 50% more holidays than USA (15 vs 10). I should also note that some countries may have a low number of national holidays while employers provide more vacation time. European countries typically provide longer paid vacation.

American Productivity Leads

Productivity is arguably the most important measure for an economy when looking at labour. According to this story from BusinessWeek, USA had the highest productivity. The way some of these things are measured are too simplistic IMO but, nevertheless, they provide some rough indication.

The average U.S. worker produces $63,885 of wealth per year, more than their counterparts in all other countries, the International Labor Organization said in its report. Ireland comes in second at $55,986, followed by Luxembourg at $55,641, Belgium at $55,235 and France at $54,609.

The productivity figure is found by dividing the country's gross domestic product by the number of people employed.

Wealth per hour of work has also significantly improved for USA in the last 7 years, with USA overtaking France.

The U.S., according to the report, also beats all 27 nations in the European Union, Japan and Switzerland in the amount of wealth created per hour of work -- a second key measure of productivity.

Norway, which is not an EU member, generates the most output per working hour, $37.99, a figure inflated by the country's billions of dollars in oil exports and high prices for goods at home. The U.S. is second at $35.63, about a half dollar ahead of third-place France.

As has been the case in the last hundread years or so, technology and science play a critical role in boosting productivity.

America's increased productivity "has to do with the ICT (information and communication technologies) revolution, with the way the U.S. organizes companies, with the high level of competition in the country, with the extension of trade and investment abroad," said Jose Manuel Salazar, the ILO's head of employment.

Other countries are catching up to some degree...

China and other East Asian countries are catching up quickest with Western countries. Productivity in the region has doubled in the past decade and is accelerating faster than anywhere else, the report said.
But they still have a long way to go: Workers in East Asia are still only about one-fifth as productive as laborers in industrialized countries.

So, all you American workers, pat yourself on the back. Good job :) The only concern I have is that there is too much use of debt in USA (and Canada). Other than that, things are looking good IMO...

Saturday, September 1, 2007 0 comments

Jean-Marie Eveillard Interview with FA Magazine

Thanks to Dah Hui Lau's blog (aka David) for the following reference to a Jean-Marie Eveillard interview in the August edition of Financial Advisor magazine. Jean-Marie Eveillard is a respected value manager who runs First Eagle Funds. It's worth reading about his thoughts on diverse topics, many of which are quite pertinent right now. I'll list some of the items I found insightful below (for some reason I can't seem to copy the text from that PDF document).

  • He isn't so worried about the current boom except for the fact that it is a credit boom. He says credit booms end with credit busts.
  • As is the case with most value managers, he says private equity competes with him and makes it harder to find opportunities. Warren Buffett has remarked on this quite often.
  • Although this might be a bit biased given that he is a mutual fund manager, he says that hedge funds are basically money-making schemes for the managers. He wonders what's the difference between a hedge fund and an investor leveraging a mutual fund. I think he is being simplistic here since hedge funds undertake strategies that mutual funds don't, but his point about compensation is true. I think hedge funds don't impact most investors directly since most of us aren't wealthy enough to be eligible to use them. However, many pension funds and other institutional funds will suffer with hedge funds.
  • He has held gold or gold stocks for years but is starting to question whether they have hit a peak. This is something I also wonder about. I profitted from gold a couple of years ago, and I took a new position in Harmony (HMY) recently, but I wonder if the US$700ish peak in 2006 was a long-term peak or not. Unlike the past, the big risk is that gold will go down with the broad equity markets.
  • Two contrarian areas he likes are US newspapers (like New York Times (NYT)) and Japanese Industrials. I have been tracking NYT and I like it as a contrarian bet. Jean-Marie says it is a high quality asset that will last a long time, and has room for operating margin improvement. I personally dn't see a big upside so I'm not investing in NYT for the time being. As far as Japan is concerned, I like that whole space.
  • He also mentions a Swiss holding company that he likes: Pargesa. I'm not sure if this is a good buy now or not. Often some holdings by managers were obtained at lower valuations and it may not be appropriate for new investors to buy (for example, Coca-Cola or Washington Post, which is owned by Buffett, were great when Buffett bought it years ago but probably aren't great right now.)
  • Supposedly Graham-style discounts are present in Japan and South Korea right now. He prefers to use these countries to play the China boom because he doesn't trust the Chinese accounting--a view I also share. I am bullish on Japan and think it is a perfect contrarian opportunity right now. Japan is not easy because valuations look high (highest P/E in the world), and it's hard to get much news (big Japanese companies have english websites but newspaper stories are hard to find unless you pay quite a bit).
  • A Japanese company that he likes is a sensor maker called Keyence (TSE: 6861) . Keyence makes sensors for factory automation. He thinks it is worth Yen 34,000. The stock trades at Y25,690 today so you are looking at a 30% upside. According to, trailing P/E is 22 and forward P/Es are: FY08: 20.39, FY09: 18.59. Price-to-book is around 3. The stock has gone up quite a bit since 2002 and is starting to come down. I have to read up on the company but my concern is whether this company is sensitive to a slowdown. If it is, a P/E of 20 is going to get cut down. Most analysts have a HOLD rating (good from a contrarian point of view :) ). (BTW, is a good site for Japanese stock quote info. Use ".t" as the Tokyo Stock Exchange suffix (eg. 6861.t)).
  • He also likes the Japanese pneumatic maker, SMC. I have seen SMC equipment but never even knew it was Japanese. He says this may be near a cyclical peak so one needs to be careful. I'm going to skip this company for now since I'm bearish on the markets and the US economy, which will spill over to the rest of the world IMO.

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