Showing posts from November, 2008

Ever wonder why Jim Rogers prefers commodities rather than the commodity businesses... and why I'm bearish on commodities

This is very short-term and not indicative of any strong results but one just needs to look at the uranium market and see how the commodity has done well in the last few weeks while the stocks of uranium companies have not : The spot price for uranium has surged 25 per cent over the past five weeks, a performance unmatched by the stocks of companies in the uranium sector. From a basket of 56 stocks tracked by Haywood Securities, for example, 42 fell over the last week, three were unchanged, and just 11 saw gains. This example illustrates why Jim Rogers prefers owning the commodities themselves rather than the businsses. One just needs to look at the charts of various stocks in the referenced article to see how terrible the stocks have done. To make matters worse, I think some of those companies will likely go bankrupt or end up severely diluting shareholders even if uranium prices go up 50% or 100% from here. The painful feeling for uranium company shareholders must come from the f

Be careful with diversified bets on junk bonds

In one my posts from yesterday where I was expressing dissapointment at the inability to purchase select junk bonds at reasonable yields, the user BigBeluga suggests junk bond ETFs and shares of companies that deal in venture capital financing or distressed lenders (he suggests a company that I'm unfamiliar with: HTGC.) I thought this was an important issue for anyone looking at high yield bonds so thought I would write a post with my views. I don't like his first idea (junk bond ETFs) but his latter idea (shares of companies that deal in them) seems more attractive. Not A Fan of Junk Bond ETFs BigBeluga mentions the two popular junk bond ETFs: JNK and HYG. Both of them have posted horrible returns this year. For example, the iShares iBoxx $ liquid high yield index has an year-to-date return of -30.65% (not sure if this includes interest/dividends) versus -9.12% for the iBoxx $ liquid investment grade index; +11.7% for Lehman 3-7 yr Treasury index (HYG has average maturity o

How bad is the situation in China and are we witnessing another Smoot-Hawley-type disaster?

Regardless of your views of the causes of the Great Depression-- did the FedRes really cause it? --it is hard to argue against the notion that the Smoot-Hawley tariffs started the trade war that likely destroyed the US, and indeed the world, economies at that time. Some conservatives seem to feel that the incoming Democratic government of Barack Obama may pass a Smoot-Hawley-type legislation. Speaking as someone who is left-leaning but is not American, although there is strong support for tariffs from the left, I highly doubt the Democrat government would pass such legislation without being provoked. I'm concerned about some protectionism movement but I don't feel it is anything significant. However, there is some rising concern that the party that is in position to make the mistake is not the US. Rather it is China. This is a radical thought that hasn't entered the mainstream consensus. China may end up doing what the US did in 1930. Yves Smith of Naked Capitalism refer

Bond market: small investors not wanted

It looks like I'm going to have to dump my junk bond idea. A view I have held of the bond market was just reinforced. Namely, that it is not for small investors and is not efficient. I investigated whether I could buy some junk bonds through my broker and it is not worthwhile for me. It should be noted that I'm in Canada and trying to buy an illiquid bond. I requested some quotes from my discount broker, HSBC Invest Direct, for a couple of Sears Roebuck Acceptance Corporation bonds and their prices are horrible (quoted price includes commission.) The quoted a 6.7% bond maturing in 2012 at a price value of 68.84 while FINRA shows the latest price as 49.75. Another 7.5% is quoted at 85.74 while FINRA shows a transaction at 48.02. So, bonds that are yielding around 30% can only be purchased through my broker for yields of around 20%. That's a huge premium and it's simply not worth it for me. I'll see if Canadian bonds can be bought at attractive prices. If not, I

Amazing how poorly managed some commodity companies have been

We all know how executives at financial companies, who incidentally were paid gross sums, didn't know what they hell they were doing. Sadly many still don't know what they are doing. Well, at least they have some excuses such as being distracted by the beauty of the ski slopes or by the elegant meal at the finest restaurants while the lending and derivatives businesses they were overseeing were getting out of control ;) But it's amazing how some commodity business executives have poorly run their businesses. Mike Shedlock refers to a couple of cases of oil&gas companies seemingly facing cash flow problems. The two examples cited, Chesapeake (CHK) and Petrobras (PBR), are not some junior companies with weak balance sheets. Indeed they are not. What we have are two of the largest companies in their field--Petrobras is a supermajor; while Chesapeake is the largest natural gas producer in the US--being mismanaged and running out of cash, at least for the time being. Compa

Where is the wealth destruction concentrated?

It goes without saying that we are in a massive crash of nearly all assets, except US$, Yen, and US government bonds, but where are most of the losses concentrated? I'm going to speak from a US-centric point of view. The details differ across countries--for instance, the housing bubbles in China or Ireland have little in common with the subprime and Alt-A problem loans in the US--but the core problems started in USA, and since, contrary to de-coupling theory proponents, USA is the largest and most important country on earth, I don't think my views are too narrowly focused on USA. Some people mistakenly believe that this is a housing bubble. It is not! Yes, housing in many countries was a bubble waiting to implode. Yes, the Subprime Virus, especially the collapse of two Bear Stearns real estate hedge funds in June of 2007 , signalled the beginning of the crash. However, the subprime problem is, believe it or not, quite minor compared to the massive bubbles elsewhere. If sub

BCE deal collapses

It looks like the BCE deal has collapsed for an unexpected reason. The accounting firm KPMG claims that the BCE buyout does not meet solvency tests. Given the tight timing constraints (deal has to close by December 11th,) this probably seals the fate of the takeover. Shares of telecommunications giant BCE Inc. plunged 40 per cent at the opening bell Wednesday after the company warned that its massive planned privatization is in jeopardy because it failed a preliminary solvency test conducted for its would-be purchasers, led by the Ontario Teachers' Pension Plan Board. ... The rout followed a pre-opening announcement by the Montreal company that it has received a “preliminary view” from auditing firm KPMG that “based on current market conditions, its analysis to date and the amount of indebtedness involved,” it does not expect to be able to deliver an opinion on the closing date of Dec. 11 that BCE “would meet the solvency tests as defined in the definitive agreement.” Unless t

The death of muni bond insurance

Joe Mysak of Bloomberg thinks that the muni bond insurance market died with the onerous requirement placed by Moody's, as outlined in their report The Changing Business of Financial Guaranty Insurance (Nov 20 2008). Municipal bond insurance, which at one time covered more than 50 percent of the bonds sold by states and localities in the U.S., died last week at age 37. The death was confirmed by Moody’s Investors Service in a research report titled “The Changing Business of Financial Guaranty Insurance,” published on Nov. 20. Municipal bond insurance had been in failing health since March 2007, after short-seller William Ackman questioned the business practices at MBIA Inc., then the biggest insurer. “To achieve a stand-alone rating of Aaa, a municipal-only financial guarantor would need to demonstrate competitive advantages that allow it to generate consistently strong underwriting results, maintain its financial health and defend against encroachment upon its franchise,” M

My next great strategic idea: junk bonds

Last time I had a great idea, it ended up in a disaster. That idea was none other than Ambac, of course. It's still remarkable that Ambac still lingers on--barely--even with its massive exposure to subprime bonds. Someone that wants to make an extremely speculative bet on Ambac now has the option of betting on the mandatory convertible equity units (ABK-Z). It's thinly traded and extremely risky and it would be close to gambling but I just noticed that they were listed on NYSE. Anyway, I'm thinking of making junk bonds one of my big strategic holdings for the next few years. One similar tactical move I made about an year ago was to allocate a certain percentage to risk arbitrage, whose verdict is still out (depending on how some of the outstanding deals close.) Do recall that I'm a total newbie when it comes to bonds and the only bonds I have owned in my life are Canada Savings bonds :) and GM junk bonds. I am attracted to junk bonds for the following reasons: Can st

Jeremy Grantham no superbear anymore

We should always pay attention when a superbear morphs into a creature with some features resembling a bull. We should doubly pay attention when he is one of few who has actually been correct with some of the key elements of the stock market crash. I remember encountering Jeremy Grantham's writings and interviews a few years ago, and thought he was crazy. He was extremely bearish and it seemed hard to believe anything he said. I wasn't a bull (that's why I owned US Treasuries for a while--got out too early) and was familiar with the bearish views of Marc Faber and Stephen Roach (Morgan Stanley economist who was "demoted" and sent off to Asia for his bearish views it seems.) But Grantham was far more bearish and had arguments to back it up. He reminds of another person of similar calibre, albeit possibly an opponent of sorts (Grantham is "liberal"): Jim Grant*. Similar to how half of what Jim Grant says is extreme and hard to believe, Grantham was that s

The consequence of bailing out the worst run firms

Bailing out Citigroup was necessary given the path that the US government and others have taken over the decades (namely, excessive de-regulation with no oversight of the financial industry.) However, bailing out one of the worst run firms will have detrimental results as I mentioned in yesterday's post. I know the government is very reluctant to nationalize the failing banks for various reasons, including their inability to run these behemoths (if the private sector can't run, good luck getting the government to run them.) But they should penalize these firms heavily and change their failed strategies from the past. In the case of Citigroup, it means forcing it to break up and dump their past strategies. Instead we have the CFO proclaiming that they are sticking with their past plans : And Citigroup still has many problems. Vikram S. Pandit, the chief executive, is making some progress in controlling costs and managing its sprawling operations, but the environment is tough. E

Massive Citigroup bailout worth as much as $326 billion

The US government agreed to backstop Citigroup's assets in a bailout worth as much as $326 billion. The complex plan involves Citigroup limiting dividends to one cent per share for a few years and the government getting a say on future executive compensation. The government will also receive preferred shares and warrants with strike price about 5x above the stock price on Friday (unless the company can itself around the warrants will likely end up worthless.) This is the type of deal that is necessary when banks have grown too large for their own good. This move will help in the short to medium terms but will be detrimental to the economy in the long run. By backstopping poorly run firms with questionable assets and business decisions, the government is indirectly penalizing the well-run firms. I think Citigroup needs to give up on its megabank idea and start splitting up the company. Some people criticize the whole concept of the megabank idea but I think it can work. One just

How far can the FedRes go with its quantitative easing?

I just read a report from HSBC and it essentially says that the FedRes has shifted its focus to a quantitative easing strategy. You will recall that this has been the strategy followed by Japan in the past decade. (source: The Fed’s balance sheet expansion by Ian Morris. Flashnote, HSBC Global Research. November 21, 2008.) The week of 17 September is when for all intents and purposes the Fed unofficially shifted from interest rate strategy to quantitative easing, as it was from that time the Fed’s balance sheet exploded from USD900bn in early September to USD2.2trn now, or from 6% of GDP (which is about typical) to 15%. The catalyst for this strategy shift was the failure of Lehman Brothers and AIG. As evidence for the shift, it was also from mid-September that Fed funds began trading well below target on a sustained basis (the weighted average of daily trading has been about 0.3% recently). This is despite the Fed’s currently paying a 1% Fed funds rate of interest on reserves, whi

Time to revisit Graham?

I am nowhere near being an adherent of Benjamin Graham's investing techniques, but I am influenced by his insightful thoughts. The Globe & Mail's Globe Investor magazine has a nice article questioning the performance of Graham followers and value investing in general. Graham is widely acknowledged as the father of value investing—the school of thought that’s sober, numbers-based, and which aims to buy companies at hefty discounts to their intrinsic value, rather than according to the minute-by-minute mood swings of the investing public. So-called Mr. Market isn’t at all rational, showing up at your door every day and offering you a different price for your shares. Just take a look at the bipolar Dow this fall: down 777 points one day, up almost 1,000 a few days later. “Graham used to talk about Mr. Market being a manic, paranoid, schizophrenic individual who goes up and down for any reason at all, unrelated to the fundamentals,” says George Athanassakos, director of the

Snowball, Buffett's new biography

"The snowball just happens if you're in the right kind of snow, and that's what happened with me. I don't just mean compounding money either. It's in terms of understanding the world and what kinds of friends you accumulate. You get to select over time, and you've got to be the kind of person that the snow wants to attach itself to. You've got to be your own wet snow, in effect. You'd better be picking up snow as you go along, because you are not going to be getting back up to the top of the hill again. That's the way life works." -- Warren Buffett, on life I haven't read it yet but for those that missed it, Alice Schroeder recently released a biography of Warren Buffett, Snowball: Warren Buffett and the Business of Life . As the title implies, this book is supposed to be about Buffett's personal life rather than his investing. The Globe & Mail has a review of the book so check that out if you want to get a feel for the book. It

Recap of bond performance

Huge sell-off in the markets and there really isn't much for me to say. I have said in the last few weeks that the stock market was attractive but not exceptionally cheap. Right now, however, I think we may be hitting a cheap level. Anyway, I thought I would look at something different: bonds. The following table from WSJ Market Data Center summarizes how various bond indexes have done: Bond yields are hitting recessionary levels. I recall reading recently that junk bond yields just surpassed the 1990-1991 recession levels. Some say that bond yields are forecasting a depression but I don't really see that (except in some specific bonds or in the CDS market--but I don't trust CDS.) Anyway, I'm investigating whether it is better to invest in junk bonds or stocks right now. Junk bonds yield between 15% to 20% so the question is whether stocks can beat that. One also needs to be concerned with inflation when it comes to a typical bond but this isn't a big issue wi

Ambac commutes two CDO-squared and two CDO deals

Ambac shares have taken a beating lately (what else is new?) but it announced one positive move yesterday. It commuted two of their most riskiest CDO-squared deals : Ambac Financial Group, Inc. today announced that it has commuted two CDO of CDO of ABS (commonly referred to as CDO-squared) exposures and two high grade CDO of ABS exposures. The four transactions, with an aggregate of approximately $3.5 billion notional outstanding at September 30, 2008, were settled with counterparties in exchange for a total cash payment by Ambac Assurance Corporation (AAC) of $1.0 billion. The two CDO-squared transactions originally comprised collateral consisting of A-rated CDO of ABS tranches, and the two high grade CDO of ABS exposures originally comprised collateral consisting of asset-backed securitizations rated A- or higher. Most of the collateral had been downgraded to below investment grade since the inception of the transactions. All four of the transactions had been internally downgraded

Largest US Bankruptcy On Tap

It looks like the US government will not be bailing out GM . Republicans are strongly against any bailout and they have blocking power in the Senate. As for my opinion, I think a successful bailout is nearly impossible so any money spent directly on the automakers will be wasted. I would prefer if the government helped the workers with re-training, unemployment, welfare, and similar programs. My guess is that GM will declare bankruptcy and the other two will follow suit a bit afterwards. Chrysler is rumoured to be in the worst state (it's private so we don't have access to their financials) and should go down first but it likely won't. Since Chrysler is controlled by Cerberus, they would not want to lose their multi-billion dollar investment and will play hard against the bondholders, UAW, and others. Whereas GM probably doesn't care too much about its public shareholders right now. Ford will probably declare bankrupty in 6 months to 2 years from now. It looks to be ab

Sign of a recession is here: Berkshire Hathaway stock crashes

Berkshire Hathaway shares have a habit of collapsing during recessions and stock market crashes. Well, it looks like Berkshire Hathaway shares are ringing in the recession: Nearly all the insurers are getting hit hard this week so it's not a Berkshire-specific sell-off. However, some, such as Felix Salmon, suggest that the market is getting concerned with the possibility of Berkshire Hathaway losing its AAA rating . Felix is one of the best bloggers--too bad Portfolio is targeting a market that probably wouldn't buy magazines: high-end and oriented towards executives/wealthy--and makes some good points. But I doubt that Buffett and Munger would have written derivatives contracts that require collateral to be posted in the manner of AIG (or Ambac, MBIA, et al in their investment portfolios.) I am also not sure if Berkshire depends on AAA as much as someone like G.E. (except for their start-up monoline.) In any case, Berkshire stock does poorly during recessions and market co

Biggest US monthly price (CPI) decline since at least 1947

A lot of people bash the FedRes but Ben Bernanke has been right on one thing: inflation. His view, which was similar to mine, was that inflation will moderate as the economy slows. Recall that he was going against quite a few who thought that inflation was going to be high (this was when commodities were skyrocketing.) Inflation has certainly declined although I suspect no one expected it to drop this much: U.S. consumer prices plunged by the steepest amount since records were tabulated in 1947, the Labor Department reported Wednesday. Prices fell 1% in October on a seasonally adjusted basis, with energy prices plunging fully 8.6%. Both the overall and energy decreases were the biggest since the government began keeping such records. Data on the overall CPI date back to 1947, and the energy data go back to 1957. Meanwhile, food prices in October rose 0.3%, the smallest gain since May. Gasoline prices fell a record 14.2% last month. The data on gasoline date back to 1967. The c

Opinion: Almost impossible for the government to bailout GM

I think it will be impossible for the government to successfully bail out GM. It's too late and the situation does not seem to have any positive outcomes. The big problem is that, even if the government is willing to take a risk by putting up money, anything they do will end up nationalizing GM. For instance, GM's market cap is $1.77 billion right now, with its enterprise value being $31 billion. If the government injects, say, $25 billion, you would end up owning more than half the company. Now, does anyone want the government to own and hence run the company? Even many that are in favour of a bailout would likely not want the government running GM. On top of the difficulties of the government running it, it would open up a big can of worms and possibly lead to big trade disputes with other countries. From a shareholder point of view, it goes without saying that the stock is likely to get wiped out. Bondholders are also looking at a big haircut given that worker liabilities

Rupert Murdoch definitely not a "doom and gloomer" when it comes to the newspaper industry

Well, at least one person is sticking with his bullish views of newspapers. This newspaper contrarian happens to be none other than Rupert Murdoch. In a lecture titled The future of newspapers: moving beyond dead trees , Murdoch presents his views of the future of the industry. Here is a quick recap : Global media magnate Rupert Murdoch says doomsayers who are predicting the Internet will kill off newspapers are “misguided cynics” who fail to grasp that the online world is potentially a huge new market of information-hungry consumers. ... Mr. Murdoch, the Australian-born chairman and chief executive of News Corp., said in a speech broadcast Sunday titled “The Future of Newspapers: Moving Beyond Dead Trees” that the Internet offered opportunities as well as challenges and that newspapers would always be around in some form or other. “Too many journalists seem to take a perverse pleasure in ruminating on their pending demise,” Mr. Murdoch said in a speech, recorded in the United Sta

William Ackmans says AIG investment was a mistake

Reuters summarizes some of William Ackman's latest moves in this article . Essentially, it seems that the AIG investment was a mistake and Ackman sold out with minimal loss. He also sold out of positions in Sears Holdings, Canadian Tire, and several others due to controlling shareholders. William Ackman is an activist investor and he can't do anything when others have majority share ownership. It's still not clear to me if William Ackman is a great investor or a speculator that is sometimes lucky. A lot of his returns look really great but he uses derivatives (which inherently contain high leverage.) One needs to be skeptical of hedge fund managers using leverage.

Deflation a dagger to the heart of value investing?

I'm not in the deflationary camp--used to be but am neutral right now--but what if we face a deflationary bust? How would various investment styles work if we actually enter a deflationary period? It's not good to hear this but Seth Klarman supposedly thinks that deflation is a dagger to the heart of value investing. Let me quote a summary of Seth Klarman's book, Margin of Safety, by Ronald R. Redfield : Sure enough he discusses deflationary environments. He [Seth Klarman] explains how deflation is "a dagger to the heart of value investing." He explains that it is hardly fun for any type of investor. He explains that value investors should worry about declining business values. I don't consider myself a pure value investor but those that are, should pay attention to what he says. Klarman suggests the following items to keep in mind in a deflationary scenario: Yet, here is what he [Seth Klarman] said value investors should do in this environment. a. "

Articles and thoughts for the week ending November 14th

Some articles you may find interesting, along with my thoughts... Martin Whitman 4th quarter commentary (thanks to traderashish for original mention): I've not read it fully and if I get a chance, I'll make a separate post on this but quick items I noticed include his additioanl purchase of GMAC bonds and MBIA surplus notes, and sales of MBIA and Ambac common shares. He still seems to feel that the Asian property managers are trading at huge discounts. Bill Miller 3rd quarter commentary (thanks to for pointing it out): Bill Miller is having a terrible year and a lot of so-called "value investors" have written him off as a value pretender. I haven't read his commentary fully but he touches on some important points including the situation with Fannie and Freddie (Bill Miller was a big shareholder so he lost a lot.) I am in the minority camp that believes that the Bush administration, and Hery Paulson in particular, made a huge mistake in seizing F

Who says commodities cannot be in a bubble?

(Do not construe anything I say as an attempt to gloat; rather I make these posts to illustrate fallacies.) One of the arguments given by commodities bulls is that commodity businesses can never in a bubble like the dot-com bubble. The reasoning was that commodity businesses produce something "real" and there is always demand for that product, whether be it steel, or iron ore, or oil. I don't think too many are making that argument now but it was a common argument I heard over the last few years. Well, let's look at uranium, which wasn't a popular commodity like copper or oil but nevertheless rose substancially. The thinking was that uranium was going to be in heavy demand due to the numerous Chinese nuclear reactors that are being built. As far as I know, nothing has changed with the Chinese nuclear reactors (as a side note, this is another reason oil consumption in China, where diesel generators for backup power is popular, won't be as great as some imagi

M&A deal to watch: Centennial Communications (CYCL) buyout by AT&T

AT&T (T) announced last friday that it is buying Centennial Communications (CYCL). Haven't looked deeply at this deal but this probably has low financing and regulatory risk. I suspect that regulators will not have any issues given that Centennial is a small company. The majority shareholder, owning around 20% of the company has agreed to the deal. AT&T is paying a 100%+ premium so it is unlikely to be rejected (although I will note that this is an opportunistic offer given that the share price collapsed more than 50% within the last two months. There is high risk if the deal collapses. On top of the share price dropping 50%, this company has negative book value so I'm not sure of its condition. You can get the press release announcing the deal here . Buyout price: $8.50 cash Expected closing date: 2Q 2009 As for me, I'll do more research and wait. The deal is expected to close in 2Q2009 so no rush. You are looking at around 12% return, which is good but not spe

What to make of unintended consequences?

It's really difficult to do something right during a crisis. Opponents as well as those who speak in hindsight often come up with a million criticisms but it's a different matter at the instance a decision is made. Furthermore, the results are always debatable depending on one's econopolitical stance. A good example is how a lot of conservatives still claim FDR didn't help the economy during the Great Depression and some even claim that he made it worse, all speaking in hindsight of course, even though the reality of the situation was that GDP started growing almost as soon as he started his policies ( check out the real GDP chart cited by Krugman .) One of the problems faced by the Federal Reserve is what to do with the commercial paper market that has locked up. They decided to buy the highest quality commerical paper. Their actions related to, say, AIG or potentially GM/Ford/Chrysler, is nothing more than a bailout, but their actions in the commercial paper market i