Saturday, July 31, 2010 0 comments ++[ CLICK TO COMMENT ]++

At least we still have some Euro bulls, albeit from some shady corner of the universe

From The Wall Street Journal:

Gangsters, drug dealers and money launderers appear to be playing their part in helping shore up the financial stability of the euro zone.

That's thanks to their demand, according to European authorities, for high-denomination euro bank notes, in particular the €200 and €500 bills. The European Central Bank issues these notes for a hefty profit that is welcome at a time when its response to the financial crisis has called its financial strength into question.

The high-value bills are increasingly "making the euro the currency of choice for underground and black economies, and for all those who value anonymity in their financial transactions and investments," wrote Willem Buiter, chief economist at Citigroup, in a recent research report. The business of issuing euro notes, produced at almost zero cost, is "wildly profitable" for the ECB, Mr. Buiter wrote.

When euro notes and coins went into circulation in January 2002, the value of €500 notes outstanding was €30.8 billion ($40 billion), according to the ECB.

Today some €285 billion worth of such euro notes are in existence, an annual growth rate of 32%. By value, 35% of euro notes in circulation are in the highest denomination, the €500 bill that few people ever see.

In 1998, then-U.S. Treasury official Gary Gensler worried publicly about the competition to the $100 bill, the biggest U.S. bank note, posed by the big euro notes and their likely use by criminals. He pointed out that $1 million in $100 bills weighs 22 pounds; in hypothetical $500 bills, it would weigh just 4.4 pounds.


That's where seigniorage comes in.

In recent years, the profits on its issue of new paper currency have been running at €50 billion. In 2008, the year of the Lehman Brothers crisis, it was €80 billion.

Even with conservative assumptions about future growth of currency in circulation—at, say, 4% a year, which is in line with the ECB's 2% inflation target plus a margin for economic growth—Mr. Buiter estimates future seigniorage profits for the central bank between €2 trillion and €6.9 trillion.

Thanks to seigniorage, he says, the ECB is "super solvent."

Sunday, July 25, 2010 4 comments ++[ CLICK TO COMMENT ]++

China Debate: Bull vs Bear

Not sure how many others already saw this but I just ran across it recently. It's a debate (appears to be conducted on May 4th of 2010) between a China bull (Stephen Roach) and China bear (Jim Chanos.) Nothing earth-shattering for China-followers but it is still good to get the viewpoints of both sides.

(BTW, does anyone know where I can find the full Jim Chanos interview with Bloomberg that I mentioned in a prior blog post. Apparently the video was supposed to come out on June 25th but I never saw it anywhere. Maybe only available to Bloomberg subscribers? If anyone knows where I can find it, please let me know.)

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Sunday Spectacle LXXX

Corporate America - Buy High, Sell Low?
(source: "It's all about managing for value" by Michael Mauboussin. LMCM, June 11, 2010)

Thursday, July 22, 2010 0 comments ++[ CLICK TO COMMENT ]++

Grantham shifts ever so slightly towards the deflation camp

Well, I, for one, am more or less willing to throw in the towel on behalf of Infl ation. For the near future at least, his adversary in the blue trunks, Deflation, has won on points. Even if we get intermittently rising commodity prices, which seems quite likely, the downward pressure on prices from weak wages and weak demand seems to me now to be much the larger factor. Even three months ago, I was studiously trying to stay neutral on the “fl ation” issue, as my colleague Ben Inker calls it. I, like many, was mesmerized by the potential for money supply to increase dramatically, given the fl oods of government debt used in the bailout. But now, better late than never, I am willing to take sides: with weak loan supply and fairly weak loan demand, the velocity of money has slowed, and infl ation seems a distant prospect. Suddenly (for me), it is fairly clear that a weak economy and declining or fl at prices are the prospect for the immediate future.
The above quote, by Jeremy Grantham, comes from his latest quarterly letter ("Summer Essays", GMO Quarterly Letter, July 2010.) This is a surprising and sudden move but I should note that Grantham is only taking a short-term stance. It appears he is still betting on inflation in the medium to long-term. GMO's 7-year forecast hasn't changed much, with expectation of high returns from US "high quality*" and emerging markets.


Hugh Hendry's all-time best "investment" book

Sticking with his outside-the-box thinking and contrarian persona, Hugh Hendry picks an obscure novel as the best investment book of all time... From The New York Times,

The inspiration for his investment approach comes from an unlikely source: “The Gap in the Curtain,” a 1932 novel by John Buchan. The plot centers on five people who are chosen by a scientist to take part in an experiment that will let them glimpse one year into the future. Two see their own obituaries in one year’s time.

Mr. Hendry calls the novel “the best investment book ever written” because it taught him to envision the future without neglecting what happened leading up to it, a mistake many investors make, he said.
Probably not helpful to investors who rely on fundamental analysis but I can see some merit for those who are more macro-oriented and rely on technical analysis. Can you pluck a security's value at a point in time and take it for what it is; or is it important to know what led it to the current value? How about the state of a country or an industry? Something to think about...

(Thanks to reader, Vlado, for pointing out this article to me.)

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Sunday, July 18, 2010 5 comments ++[ CLICK TO COMMENT ]++

After a long absence... Articles of interest

It's about time I did another list of articles... Haven't posted a list of insightful articles in a long time so this is to catch up on some stuff... As usual, not in any particular order...

  • The curse of being too successful: Can John Paulson handle bigger portfolios? (Fortune): John Paulson has been one of the most successful investors in the last few years; actually he was very good in the past too but it wasn't as bold or spectacular as his bet against subprime mortgages. Now that he is successful and has one of the biggest hedge funds in the world, can he adapt his strategies to handle all this capital? As an example, this Fortune article points out how he is unable to exit his AngloGold Ashanti (AU) position with apparently no takers for his stake.
  • IEA downgrades oil demand growth forecast (Financial Times; h/t Infectious Greed): I don't usually pay much attention to these analysts but this time it's worth noting. The interesting thing this time around is that they are forecasting oil demand to grow only 1.3mmbd in 2011 versus the 1.8mmbd in 2010 even though the world economy is expected to grow from 4.1% in 2010 to 4.3%. This indicates how the 'oil to da moon' view is likely to be turn out to be wrong. You just can't project high present growth far into the future. If this trend continues, where oil growth is below GDP growth, it may further solidify the bear market in oil (assuming oil hit a peak in 2008, which I suspect is a multi-decade peak.)
  • (Highly Recommended) Analyzing companies using Value Line data (The Rational Walk): Ravi Nagarajan provides an overview of the Value Line stock report, along with items that investors should be paying attention to. For those not familiar, Value Line reports are perhaps the best in the industry with 10+ years of summarized historical data. I don't subscribe to that service and instead rely on the freely-available Morningstar online reports (unfortunately, the 10-year reports are not free at Morningstar anymore :( although you still have 5 years.) GuruFocus also provides 10-year data so that's another source you can use. I highly recommend this article to newbies, even if you don't use Value Line.
  • Structural changes in China likely mean weaker corporate profits (Toro's Running of the Bulls): Although I don't share the consensus view, the vast majority of investors, politicians, economists, and others are starting to believe that major structural changes in China are unfolding. In particular, many believe the renminbi has been set loose, on a path towards it strengthening against the US$; and that Chinese labour is earning, through hard struggles, higher wages. I don't put much weight in either of these because I believe China has overcapacity in manufacturing/real estate/fixed assets and just don't see the consensus scenario unfold until those problems are worked out. In any case, one should always consider what happens if they are wrong so I'm giving some thought to what Toro is saying in this post. To cut to the point, to quote the author, Toro, "This cannot be overstated enough – if the cost structures of global corporations are rising, as accelerating wages in China and a higher RMB implies, there will be headwinds for corporate profitability growth, and gains to the owners of capital will be lower." The next question I would ask is: who are the big losers? You might want to run through your portfolio and consider various scenarios. For instance, I think a company like Wal-mart would be hurt more than ExxonMobil. Of course, some companies will adapt and maybe even shift their business to cheaper areas within China or elsewhere; but some won't be able to.
  • (Highly Recommended) Analyzing restaurants (The Street Capitalist): Tariq Ali writes an excellent article on his method for analyzing restaurants. I haven't read the whole article yet but it's well-written and covers a lot of issues fundamental investors can use for other industries.
  • Odd-lot tender offer for Fidelity National Information Services (Value Uncovered): Adam does a good job in uncovering an opportunity for small investors. If you just started out investing and your portfolio is tiny, you may want to investigate this deal. Generally you can use multiple brokerage accounts with these tender offers (but don't rely on me and you should do your own homework.) So if you have 2 or 3 different accounts, you may be able to generate a somewhat reasonable profit. I may take a position in this, although the potential return is a bit too small for my liking (would prefer the max potential to be closer to 20% than the current 10%.) One also needs to spend some time thinking about the downside here, especially if the stock price collapses over the next few weeks.
  • (Recommended) Geoff Gannon Value Investor Questions Podcast #14 - What are the 4 most important numbers to know about a stock? (Value Investor Questions podcast by Geoff Gannon): Geoff Gannon has been releasing some interesting (audio) podcasts and this one deals with 4 numbers that he considers as very important. Investors are all different so you may consider other metrics as being more important but it's still worth hearing Gannon's thinking. I like how he, in this podcast, uses the analogy of a murder investigation to illustrate how the investigation can be tainted depending on the initial decisions you make.
  • (Recommended) Geoff Gannon Value Investor Questions Podcast #17 - Should You Put a Discount on a Stock With a Seasonal Business? (Value Investor Questions podcast by Geoff Gannon):  This podcast covers the issue of whether one should be discounting a seasonable business.
  • Parallels between John Law's Mississippi bubble and the present (Buttonwood): I think Buttonwood is too extreme in suggesting that the pro-stimulus crowd is behaving similarly to John Law. Nevertheless, I think some of the parallels that he/she brings up is kind of scary. It does seem, in some superflous sense, that policymakers took some steps during the crisis that were similar to John Law's actions.
  • Behind the scenes look at IKEA (Report on Business magazine): Always interesting to see how businesses are run.
  • Infographic of Canada's mining industry (Report on Business magazine): A quick look at the mining industry in Canada
  • "The Time We Have Is Growing Short" (Paul Volker for The New York Review of Books): Paul Volker, considered by some to be the greatest American central banker, laments the lack of interest in fixing the serious problems by policymakers. It's kind of too bad that governments did very little during the crisis to fix the problems. Barack Obama, in particular, had a clean slate and could have taken bold actions like FDR did. Instead, we end up with half-attempts at fixing problems. I have a really bad feeling that we haven't seen the final chapter, and we may see another financial crisis unfold.
  • "The Crisis & the Euro" (George Soros for The New York Review of Books): The man who broke the Bank of England definitely knows a thing or two about  the global economy. In this essay, George Soros presents his view on what is happening with the Euro and why governments are making a mistake.
  • (Recommended for those not familiar with the financial crisis) Review of Michael Lewis' book, Big Short (The New York Review of Books): Haven't read the book and probably won't get around to it for a long time, so this review provides enough meat for the time being. Big Short covers the story behind the short-sellers who profitted from the real estate bust.
  • (Recommended for those macro-oriented) Review of various economic sources - This Time Is Different: Eight Centuries of Financial Folly by Carmen M. Reinhart and Kenneth S. Rogoff; World Economic Outlook, April 2009: Crisis and Recovery by the International Monetary Fund; World Economic Outlook, October 2009: Sustaining the Recovery by the International Monetary Fund (Paul Krugman and Robin Wells for The New York Review of Books): Paul Krugman and Robin Wells try to predict the economy in the near-future based on their interpretation of various economic publications. Needless to say, it's very difficult to have any confidence in how the economy will play out.
  • (not investing-related) Can science explain religion? Review of Evolution of God (The New York Review of Books): Likely controversial in the eyes of theists, this article reviews a book by Robert Wright that tries to map out how religion has evolved over time. The author of the book tries to explain religion through evolutionary psychology and game theory.

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Sunday Spectacle LXXIX

Baltic Dry Index & Dr. Copper

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Saturday, July 17, 2010 0 comments ++[ CLICK TO COMMENT ]++

CALPERS - An example of the situation facing many pension funds

As if we didn't have enough problems as is, an additional big problem to worry about over the next few decades are the pension funds and their poor performance of late. Fortune has a nice recap of what happened to CALPERS, the largest pension fund in USA, that I belive is representative of the problems faced by other funds. Here are some of the key points that were brought up:

Before clocking a $100 billion loss in early 2009, the California Public Employees' Retirement System, known as Calpers, had the swagger of a hedge fund and the certainty of a saint. Other pension funds followed its lead, loading up on leverage, investing in unrated CDOs, shoving money into high-priced private equity deals and barreling into commodities and real estate.

The question now is whether a loss of nearly 40% of its market value -- the worst loss in the system's 77-year history -- has brought Calpers sufficiently back down to earth to avoid another such debacle, and whether other chastened pension systems have followed suit.


Most of Calpers investment losses came from its largely passive investments in baskets of equities, which still account for about half of the system's assets. But the retirement system also got into trouble by adding leverage, reducing oversight and by chasing other hot markets.

After maintaining a low-risk real estate strategy for decades, studies commissioned by Calpers show that it switched gears in 2002, embracing higher levels of risk even as the real estate market began to top out in 2005. By mid-2009, Calpers had a one-year loss of 48.8% in its real estate portfolio and was reporting among the lowest returns of any large pension funds in the country.

In early 2006, it said it would invest $6 billion in commodities, particularly through index futures, news that caused Grants' Interest Rate Observer to respond: "On the timing of this demarche, we hand Calpers the gold medal for Being Late."

Calpers showed even worse timing in the mortgage market. Just before the market tanked, it invested approximately $140 million in unrated collateralized debt obligations (CDOs) and $1.3 billion in complex buckets of loans and debts called structured investment vehicles (SIV). A Calpers lawsuit puts the SIV losses at "perhaps more than $1 billion."

Sunday, July 11, 2010 2 comments ++[ CLICK TO COMMENT ]++

Sunday Spectacle LXXVIII

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Saturday, July 10, 2010 3 comments ++[ CLICK TO COMMENT ]++

Google Insights analysis of Nokia and competitors

I have been researching Nokia (NOK) lately and while I wait for the annual reports to be mailed, I have been thinking about their competition. Anyone that has looked at history knows that new industries start off with many competitors and within 10 years, many of them fall off the earth, including some of the early pioneers. I suspect that is what is happening in the mobile phone industry.

Mobile Phone Industry

It's hard to correctly interpret the shift in the market that is unfolding in the background, let alone try to predict the future. Nevertheless, if one is considering investments in companies like Nokia, I think it's important to think about the industry (this incidentally is one reason Graham-oriented value investors stick to stable industries.) My guess at this point in time is that the losers are Palm and Motorola. These two companies were pioneers in the mobile phone industry—in fact, I may be wrong but I believe Motorola invented the modern wireless networking technology and architecture (of course everything has advanced since then)—but I have a feeling their castles have been over-run—the moat just wasn't strong enough.

The question for anyone looking at Nokia is whether it's the next one to fall. Investors have been selling off Nokia recently due to the fear that it is on the way to joining Palm and Motorola as a has-been. I find it surprising that the market has re-priced Nokia so quickly. As you can see from the following chart, it lost around $50 billion in market cap within 3 months with little news other than a profit warning:

You may want to recall how BP lost around $100 billion in market cap due to the Macando oil well disaster, which will likely end up being the worst man-made environmental catastrophe in American history. Nokia has seen a similar sell-off so the market is clearly fearing some bad things for Nokia.

Admittedly, Nokia has a higher beta and is more sensitive to earnings but even then, the markdown is very large. Companies don't lose $50 billion in market cap very easily. Typically you need some big disaster to cause that much wealth destruction.

So I decided to take a quick look at Google Insights, a free tool that lets you evaluate the popularity of various keywords (there is another similar one called Google Trends.)


Super-bear Robert Prechter calls for monumental stock market crash

Some of you may have heard him say it before—there is a reason Robert Prechter is considered by some to be a perma-bear—but his opinion seems more apocalyptic than before. The New York Times catches up with Robert Prechter and gets his latest take on things:

WITH the stock market lurching again, plenty of investors are nervous, and some are downright bearish. Then there’s Robert Prechter, the market forecaster and social theorist, who is in another league entirely.

Mr. Prechter is convinced that we have entered a market decline of staggering proportions — perhaps the biggest of the last 300 years.


His advice: individual investors should move completely out of the market and hold cash and cash equivalents, like Treasury bills, for years to come. (For traders with a fair amount of skill and willingness to embrace risk, he suggests other alternatives, like shorting the market or making bets on volatility.) But ultimately, “the decline will lead to one of the best investment opportunities ever,” he said.

Buy-and-hold stock investors will be devastated in a crash much worse than the declines of 2008 and early 2009 or the worst years of the Great Depression or the Panic of 1873, he predicted.

For a rough parallel, he said, go all the way back to England and the collapse of the South Sea Bubble in 1720, a crash that deterred people “from buying stocks for 100 years,” he said. This time, he said, “If I’m right, it will be such a shock that people will be telling their grandkids many years from now, ‘Don’t touch stocks.’ ”

The Dow, which now stands at 9,686.48, is likely to fall well below 1,000 over perhaps five or six years as a grand market cycle comes to an end, he said. That unraveling, combined with a depression and deflation, will make anyone holding cash “extremely grateful for their prudence.”

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Sunday Spectacle LXXVII

Thursday, July 1, 2010 2 comments ++[ CLICK TO COMMENT ]++

Are we seeing a change in retail sales behaviour in America?

As the so-called Great Recession—I prefer to call it the Long Recession, since I liken it more to the Long Depression in the late 1800's than the Great Depression in the 1930's—was unfolding, one of the big uncertainties was over the structure of the US economy. Since the US consumer was the over-leveraged party going into the credit bust, the big change is likely to lie with the consumer.

One of the big question marks for me, and to many others as well, has to do with the type of products consumers will purchase in the future. To put it bluntly, will American consumers pay up for higher-end products or will they trade down? By higher-end, I am referring to products that have a premium attached to it relative to similar products from competitors. This differs slightly from the definition used by some, where higher-end refers to luxury goods. For instance, I would consider, say, Colgate toothpaste to be a higher-end product within its market.

I ran across a Bloomberg article about various clothing retailers in America and thought it was worth contemplating the behaviour of shoppers in the last year. The following data from Bloomberg is interesting: