Model Portfolio timbo56:SSOF1

When Lewis and Clark made contact with the Sioux in the Great Plains, they found amongst the Sioux an apparently unique society. A number of Sioux men had made a compact that no matter how great the danger, they would never turn back. This group was proud and held themselves apart from the other Sioux. But there is a price to be paid for great courage: Out of the thirty that had originally made the compact, only six were still alive at the time the American explorers arrived.

Also, consider the Israeli army, which used to have gender integrated units. But the men were embarrassed to show fear in front of the women, and vice versa. And sometimes, in war, it is best to throw dignity aside and plunge unseemly for the foxhole. Due to the reluctance to engage in this sort of behavior, the casualty rates were higher. So they stopped the practice.

Yes, fear helps one to survive. That is the reason for having an emotion like fear. And in September of 2008, it would have been very good to be afraid, to be very afraid, and to cash out your stock market chips and bail. But in March of 2009, when there was still lots to be afraid of, in many respects more to be afraid of then in September of 2008, it would have been very good to put those fear feelings aside and to act in a courageous manner, buying lots and lots of stock. If you had thrown caution to the wind, maxed out your credit cards, and put it all into Fifth Third Bank (FITB) shares or some other stock beaten down to an extreme low, that would have worked out really, really well. But if you had asked ten people if it was a good idea to do that, all ten of them would have told you not to. So how can you know when to be afraid, and when to be courageous? That really is one of the great riddles of human existence.

Of course, in the short term one cannot know. We all make our investment decisions in, to borrow from famed military analyst Carl von Clausewitz, the "fog of" investing. Data is indefinite, noisy, and subject to revision. One trend runs counter to another. Misinformation is deliberately disseminated. The great unknowables, such as the effect of the huge nominal value of credit default swaps, become more and more frightening as the bear analysts get proven right time and time again and the bulls huddle, chastened, in a quiet corner.

In the fog of investing we are reduced to a reliance on policy. One of my policies is to not panic. Sure, sometimes it would be good to be the first one bolting through the theatre exit. But, in general, it is foolish to succumb to panic, however much one might feel afraid. And I did feel very afraid at times, in midst of the panic. But I'm glad I held on.

It is important to remember that bear markets end when it appears that no end is in sight. Bear markets end when there is little reason for optimism and a lot of reason for pessimism. They end when bear analysts are parading in the full glory of their oft confirmed prescience, illuminated by the spotlight of media adulation. They end when the thought that government action could address economic problems appears to be a laughable exercise in naïveté.

We should also remember that bull markets form when there is extreme skepticism that a recent upswing could be anything more than a brief respite from a continuing plunge. Bull markets form on wobbly knees, appearing fragile, with little in the way of economic growth prospects backing up the positive market movement. At every stage there are a lot of skeptics, loudly calling out, "sucker's rally." How could it be different?? If it were not for the skeptics, the market would already be at a level that would make further progress actually unlikely. The market moves higher as skeptics are convinced and bears turn to bulls. So, when there are a lot of bears ambling about, it is ripe season for conversions.

Yes it is regrettable that my portfolio plunged in October and November of 2008, but I still believe that the better policy is to bet on growth, because that is the more usual pattern. The recent instance of market turmoil does not make it a common occurrence. We should take into account the possibility of a market disaster, but it should not overshadow our actions. We should invest for the more usual case of growth, bearing in mind that disaster is always a possibility.

The best policy is to reject panic. There may be instances in which outcomes would have benefited from panic, but there is no way to distinguish a brief swoon from the beginnings of a market plunge. So if we were to see the exact same pattern as in early September 2008, the eventual outcome could be completely different. Next time, it could prove to be the ideal buying opportunity, just as we can now see that March of 2009 was.

So Fear be not proud and Panic, hang your head. Fear may help us to survive and sometimes even Panic, too. But Courage, at the right moment, can pay off very handsome, and that is something Fear and Panic never do.

Posted by Timothy at 1:47 PM | Permalink | TrackBacks (0)

I try to base my investment decisions on what I see as the long-term trends. This is not because the short-term trends are unimportant, but because they are fundamentally unpredictable. If a person could predict a stock’s movement from minute to minute, that person could become rich within a few days, by selling just before the stock went down and buying before it went up. Everyone would like to be able to do this, but nobody can, because which way a stock moves over a few minutes is based on the unpredictable decisions of others, who are all trying to outsmart each other. Much the same can be said for day-to-day stock movement, and even, to a lesser degree, month-to-month movement.

My most basic belief about the stock market is that it is a chaotic manifestation of a chaotic world. In a sense it is chaos squared, because the actors are not little grains of sand being swept about in a tube of water, but are conscious and are making decisions for self-advantage, based on their observations of the chaos about them. Trying to predict the self interested decisions of others would be an exercise in futility, although behavioral analysis investing does this to some degree.

This is why it is important to stay humble when viewing the stock market and to refrain from imagining that it is possible to predict market movements in the short term. For every single stock in the stock market, the value of the stock at any moment is exactly what the consensus view of the most interested and moneyed investors believe it should be. There is no point, at least in the short term, trying to second guess this group, because they are smart and very knowledgeable about the stock.

So why invest?? First, if we have any money, then we must. Second, because even the smart and knowledgeable investors are smart and knowledgeable about what makes the most difference in the short term: The structure of a particular company, the immediate market environment for the products of that company, etc. They are not necessarily particularly knowledgeable about the world as a whole, and might not realize that forces brewing in some other part of the world will have a big effect on the company they know so well.

Having said all this, I was way too confident, back in September 2008 that the market would not go down to 7500 on the Dow. First off, I should have followed my own advice, realized that the short term is unpredictable and that therefore a severe market plunge was possible. Second, my model for government action was flawed. I always presume that the government will act to avert short term disaster, to support home-owners and to avoid wide-spread unemployment, because that is the way to woo voters and stay popular. Bush did not do these things and became extraordinarily unpopular in the bargain. Perhaps he just did not understand what it is that had to be done to achieve these goals. It is hard for me to understand, for example, why Bush did not move more aggressively to support the housing market. When Bush administration policy seemed to fly in the face of reason, such as supporting a strong dollar at just the time when export growth and import substitution was needed to pick up the slack from a lack of investment in housing, I figured that administration officials would soon see their errors and reverse course. That did not happen. Of course the most significant policy failure was the decision to let Lehman Brothers go under.

I still think that my model for government behavior is generally correct. I think that if Bush had realized how unpopular he would become and how he would cripple the Republican Party, he would have chosen policies that would have achieved his personal and political goals. I think that he just did not know how and did not know who to turn to, to help him out.

Posted by Timothy at 10:12 PM | Permalink | TrackBacks (0)

Mark Twain said, “There are three types of lies: lies, damned lies and statistics.” Chinese statistics might now be added as a particularly difficult group to decipher. The names of the statistics tend to be stated in contorted English, such as “Growth Rate of Value-Added of Industry.” I’m pretty sure that I know what is meant by that, but I would have said, “Growth Rate of Value-Added by Industry.” There is also: “Floor Spaces Sold and Sales Price Growth of Commercial Buildings,” but based on the column headings, I would have named this one, “Commercial Floor Space Sold, Given in Square Meters and Yuan Spent.” The average sales price could be calculated by dividing the Yuan Spent by the Square Meters Sold, so I guess it all works out.

In any event, depending on what statistic one looks at, it appears that China is quickly reacting to its downturn in export demand, by focusing on growth in domestic demand. In Shanghai, value added by industry was down 4.9% in April from a year earlier, but in Hunan province, in the interior, it is up by 18%. In April, investment completed in housing was down 32.9% in Fujian and in 12.7% in Guangdong. In Jilin (a province in Manchuria), however, the same figure was up 87.1%, and in Hunan it was up by 16%. So it appears that although the economies of some coastal provinces have been hit hard by the sudden decline in exports, growth has shifted to interior provinces, perhaps to satisfy growing internal demand and perhaps to some degree due to government intervention aimed at helping these traditionally poorer regions.

Viewing the “Output and Growth of Major Industrial Products” yields a similar impression. It used to be that there would be large increases pretty much across the board, but in the statistics for April, the production of small-sized tractors (lawn tractors), which must be primarily an export product, fell 10%, whereas the production of Medium sized tractors grew by 43%, perhaps because of the economic stimulus agricultural effort. Growth in production of products is now very much a checkerboard, apparently related to export intensity.

The real eye popper, however, is automobiles, up 17% to 1,181,200. That is an awful lot of trucks and cars to produce in a month, and if we multiply by only 11, to be conservative because April tends to be a fairly high production month, we get an annual production rate of about 13 million. China does export some cars, but most of these are for the domestic market, meaning that we can expect petroleum consumption to grow rapidly in China this year. This is born out by the figures for the production of gasoline, up 19.6%, to 1.4 million barrels per day. Diesel fuel, perhaps more closely related to overall economic activity is up a mere 0.7%.

Noting that so far, only slightly more than 5% of the stimulus funds have been spent, China appears to be doing reasonably well and should contribute to growth in demand for petroleum. My thought is that with Chinese consumption growing so rapidly, when the United States starts to rising employment, we will have rapidly increasing petroleum prices.

Posted by Timothy at 11:35 AM | Permalink | TrackBacks (0)

Thank goodness Las Vegas represents only slightly more than ½ of 1% of the U.S. economy, because it has been punched in the stomach and is about to get punched again. Las Vegas has a fundamental problem: It relies on inexpensive air faire to get travelers to those hotels and gaming tables. Now that the economy is very bad, Las Vegas is hurt by the bad economy. But if the economy recovers, oil prices will go up, and so will air faire. There will no longer be any way to get those masses of tourists in and out.

What’s worse, huge new developments are slated to open that will increase the number of hotel rooms in Las Vegas by about 15,000. Each time one of these huge developments is finished, an army of construction workers will find themselves out of a job with no relief in sight in Las Vegas. As they leave for greener pastures, the demand for housing will fall still further. Of course those new developments will have to hire clerks, maids and card dealers, but if the total number of visitors does not rise, that just means that somehow people doing these jobs at other places will be let go. Just because there are more hotel rooms does not mean that the ratio of hotel workers per visitor will change. I expect that several older hotel/casinos will close. So construction worker employment will decline and I don’t see anything to make up for that decline.

As the construction workers leave, employment of service providers will fall. Teachers, for the children of the construction workers, waitresses, for the restaurants that serve the construction workers and on and on and on, will lose their jobs. The population will fall still further. I don’t see a bottom for Las Vegas real estate. When there are more homes than people to live in them, competition can drive prices down and down to a very, very low point. Las Vegas real estate has dropped a lot already, but it certainly has room to be cut in half, again.

So it is worth avoiding stocks that have Las Vegas exposure as a significant percentage of their business. Wells Fargo (WFC) has Las Vegas exposure. In any analysis of Wells Fargo this must be taken into account. Needless to say, stay away from casino stocks, such as MGM Mirage (MGM), Las Vegas Sands (LVS) and Wynn Resorts (WYNN). I don’t currently have a short position in any of these stocks, because I am waiting for the market to rise a bit first. But if WYNN rises to 50, I will certainly short it.

I believe that there should be an effort at the federal level to save Las Vegas. It should begin now, because government action always takes time. Some federal functions should be switched at least partially from the D.C. area to the Las Vegas area. The developing disaster should be a concern to all right-thinking persons, because it stands to hurt a lot of innocent people.

Posted by Timothy at 11:33 PM | Permalink | TrackBacks (0)

I highly recommend www.gallup.com, which displays a marvelous compendium of information concerning beliefs about all sorts of things. The scope of the queries undertaken is truly remarkable, ranging from polls about how Moldovan’s feel about their electoral recount to how American’s feel about their own health and well being. If you visit this website, I guarantee that you will learn something.

One item that caught my eye was an item about Americans’ preferences for long term investments. Apparently, 34% of Americans now feel that savings accounts are the best form of long term investment, closely followed by real estate with 33%. Only 15% favored the stock market. This represents a big change from early 2007, when only 18% felt that savings accounts were best and 31% favored the stock market. Real estate was on top back then, with 37%. To me, these figures are very, very bullish for the stock market. Why??? Because it is changes in beliefs that drive prices, and a belief is more likely to increase in popularity from a point of great unpopularity. At a minimum it is easy to say that it becomes hard for a very unpopular belief to become even more unpopular. To do so would require convincing the last holdouts. Taking a different approach, if equal proportions of savings-believers and stock-believers switched places, for example 10% of each group changed belief, the stock-believers would have a net gain and the savings-believers a net loss.

Consider a thought experiment: What if there were two types of equally rare, equally useful metal, gold1 and gold2, and society began with gold1 being three times as expensive as gold2, because of greater hording of gold1. If 5% of gold1 value was exchanged for gold2 and 5% of gold2 value was exchanged for gold1, gold2 would rise in price because 3 times as many dollars would be flowing from gold1 to gold2 than in the other direction. This could well start a trend of rising gold2 prices that would feed on itself, with gold2 becoming increasingly valuable and increasingly popular due to that rise in value. Eventually, it is quite likely that this momentum would lead gold2 to exceed gold1 in value. It could become quite a bit more valuable as many people would have come to view gold1 as a very poor investment in comparison with gold2, which had the quality of tending to rise in value. Then one day, when gold2 was perhaps three times as valuable as gold1, a peculiar thing would happen. The price of gold1 would increase relative to gold2. Perhaps that day, a few gold2 holders had the thought that the price difference had become too great, and they changed belief. Well, this would of course cause the entire cycle to repeat itself, which it could continue to do forever, given peoples’ unwillingness to learn from history.

There is an element of this phenomenon with the stock market, today. As it went down, it had begun to appear to be a less and less inviting place to store one’s wealth. But at some low point, the trend reversed, and then (here is my most basic point) the trend becomes self-reinforcing, until it has gone too far. So, as we recover from the market’s low point, a self-reinforcing trend of stock market advances takes root, and this trend also helps the economy as whole. Fortunately, the trend is also reinforced by increasing government spending as the American Reinvestment and Recovery Act (ARRA) gets slowly into gear and more public works projects enter the construction phase. ARRA public works spending is still a trickle, but this month about 13 billion will be spent on a one-time $250 payment to social security and supplemental security income recipients. This should help the retail industry which has suffered from grievous layoffs, as of late. ARRA public works spending will increase significantly in June and by August turn from a stream into a river of spending and employment. I predict that by mid-2010 the stock market will have overtaken savings accounts in popularity as a long-term savings mechanism.

One interesting aspect of the Gallup survey is that precious metals were not even included in the question. It is my belief that precious metals will be eventually held by pension funds and insurance companies as a relatively stable form of maintaining and building wealth. Nothing else is as fungible, quantifiable, transportable and naturally supply-limited as precious metals. These are among the qualities that have caused gold to be one of the very best investments over the last 10 years. I have to believe that at some point this good performance will cause investors and institutions both to get over their aversion to “hoarding” and come to see that precious metals deserve a place in just about any portfolio. When that happens, watch out. The price of gold will soar. For right now, however, I believe the best bet is the stock market, until it recovers to a reasonable level of 1350 on the S&P 500.

Posted by Timothy at 4:40 PM | Permalink | TrackBacks (0)

When the price of oil moves, there are at least two phenomena that exacerbate the price move, whatever the direction. I call these kickers. When the price goes down, they kick it down further, when price goes up, they kick it up further.

The first is rigs in or rigs out. When the price goes down, rigs are pulled out of service. This has no immediate effect on oil production, because there is a lag between the time a rig starts to drill an oil well, and the time oil is struck, the well is finished and oil production begins. But it does have an effect on oil consumption, because every rig is a direct and indirect user of oil products. First there is the direct use. Power is needed to drill down and to pump mud through the incipient well. This power is typically provided by a 1,000 hp or greater diesel engine that is kept running around the clock. But this is not all, as the pipe and casing used in the drilling represents iron ore that was dug out of the ground, shipped to a steel mill, made into steel using coal that also had to be mined and shipped. Finally, when the steel pipe has been manufactured it must be trucked to the rig site. Of course the roughnecks have to get to the drill site, too. So, add it all together, it still may not be that much, but at a time when demand is falling for other reasons, it helps push it down that much further.

The other kicker is oil use by oil exporting countries. When the price of oil is high, these countries typically go through a boom time that drives up their own consumption. When the price goes down, the opposite may occur. I don’t know that the recent price plunge has kept prices low for long enough to have much of an effect on the consumption of the major producers, so I will focus on the oil used in drilling.

We are now at a point where the number of rigs has been cut by more than half. As the number of rigs started to decline, oil production went up because damage from the fall hurricanes was being repaired. But it has now peaked and is on the way down, with the four week moving average falling by 100,000 barrels per day between April 17th to May 1st. It is likely that there are other, seasonal factors, but it makes sense that the plunge in the number of rigs would show up in decreased production, eventually. That is how supply and demand are supposed to work. But now that prices have started to move up, we are likely to see a reverse phenomenon as more rigs are placed into service. Oil inventories have risen very dramatically over the last six months, but there is a good chance that as prices rise, the effects of rigs being placed back into service will play a role in driving up demand for oil, well before production from new wells starts to fully compensate for older wells drying up. This could help drive the price up sharply.

I predict that before the end of this year the price of oil will reach over $100/barrel, again.

Posted by Timothy at 4:01 PM | Permalink | TrackBacks (0)

It is indeed difficult to give advise counter to that of Dr. Roubini, because he has a great track record. I will direct my readers' attention, however, to the fact that he had a great track record under the Bush administration. If one argues that government intervention is likely to be ineffective, it helps immensely to have an administration in power that fails to take action, even when action is urgently required. The Bush administration repeatedly failed to act, and the resultant economic disaster is just what Dr. Roubini predicted. But the Obama administration has acted, and so I believe the result will be different. Bush failed to address the housing price crisis, which led to the banking crisis. The banking crisis led to the bankruptcy of Lehman Brothers, which the Bush administration failed to address. Then they came up with TARP, which was darn hard to get through Congress and which appears to have been poorly administered. The resultant freeze up in the credit markets led to plunging employment, which was left unaddressed with the obvious and entirely necessary palliative of fiscal stimulus.

So, I dare to disagree with the very impressive Dr. Roubini because the situation has changed, with the change in leadership. Any time stock is cheap, you will only buy counter to the recommendation of many leading experts. Dr. Roubini's Jeremiah predictions have a great deal to do with the market being so low, still. If he stated otherwise, this buying opportunity would not be here. The market would be a lot higher.

I respect Dr. Roubini, but I also think that he got a little lucky in predicting a financial collapse at a time when most did not realize just how bad our leadership was.

Another good thing about buying stock when a leading light such as Dr. Roubini is proclaiming us to be in a "suckers' rally, is that he can only change his mind from bearish to bullish. If he did so that would be a huge boost to the market.

Posted by Timothy at 4:30 PM | Permalink | TrackBacks (0)

A great deal of market movement is a battle between logic and recent experience. During the dot com boom, logic told us that things had gotten out of hand, but recent experience told us that the boom could go on forever. Eventually logic won, but not before recent experience had taught early logic adherents a painful lesson.

I believe that we are now seeing another battle between logic and recent experience. Logic tells us that we should soon see a pretty powerful bull market, but recent experience tells us not to hold our breath. Here are the points logic makes:

1. Except for the great depression, every serious market downturn has been followed by a big rally. Even the great depression was, eventually. It is just that we had a three year bear market, before things turned around. But since then, we have never had a bear market that lasted for much longer than a year.

2. A stimulus package appears to be coming.

3. Larry Summers and Tim Geithner- we've got the A-team in Washington, now.

4. Buy cheap is one half of "buy cheap, sell dear."

5. The market anticipates the economy, and causes changes in the economy. Therefore the market should improve months before the overall economy does.

Recent experience is now the gloomy one, so changed from the ecstatic figure of February, 2000. "All the bear analysts have been right" she says morosely, "And they are still quite bearish." Here are the bear points:

1. The bull analysts said, "Stand Pat" after the market dropped in late September and early October, and they were wrong, wrong, wrong.

2. It is naive to think that Government will get this right and fix things. They'll never get it together to do the right thing. They are just a bunch of loud mouths, out to help themselves.

3. It is naive to think that the banks are curable, and the people will refuse to help them out again. Without lending there is no way the economy will recover.

Yes, the bears have some scary stuff to talk about. But the government has both treasury and fed, and between the two, I believe they will have the resources to save the major banks. And Obama's tough talk on bonuses should give him some leeway. Plus, the stimulus package should slow down the rate of defaults, which is at the core of the banks' problems.

Posted by Timothy at 3:40 PM | Permalink | TrackBacks (0)

Was that really the face of the Virgin Mary on the billboard?? What an interesting thought, given that we would have no way of knowing what she looked like. But people see it there, because our brains work as pattern recognizers. That is how we make sense of the world, by looking for patterns. And we will find a pattern, whether or not there is an actual pattern to be found. And so we find commentators noting the shape of the curves of the S&P 500, comparing it with past shapes, and stating that we will "test the bottom" again. But studies have shown that there is no correlation between market moves over time. So this method of analysis, looking at the market movements and trying to glean significance in processes like bottom formation will work very well, unless it doesn't. And if it does not work, we will just forget all about, and we will try to perceive significance in the future patterns. It's enough to give market analysis a bad name.

So, should we not try?? Sure we should. But I say, let us broaden our view. Let us break from the pattern recognition mindset, and embrace a broader and more liberal view of reality. The market does not exist in a vacuum. It is a chaotic manifestation of a chaotic world.

I don't know if this exhibit still exists at the Exploratorium in San Francisco, but there was a wonderful, wonderful exhibit on chaos. The exhibit designers found marvelously clever ways to construct chaotic systems. One was a tube, about 4 feet long filled with water and sand and vertically rotatable. After the sand had settle at one end of the tube, it could be rotated so that the sand-filled end was higher, and the sand would spill through the water to the other end, forming a million small patterns on its way. The movement of the sand on its way down was completely unpredictable and chaotic, except for the fact that it would all reach the other end eventually. In many respects the stock market is the same way. The small day to day movements are entirely unpredictable, but in broad scope, there are forces that move the market. To understand those forces we must broaden our view, and not try to analyze and predict the stock market based on the stock market alone. The stock market is profoundly influenced by the political world. It is foolish to talk about bottom formation when there are huge political changes taking place. We should look at the broad picture, to include politics here and abroad. When we do, we see that there is a strong push to stimulate the economy. This will make a huge, huge difference. I don't think we will test that bottom. Based on the political scene, I think the bottom is made. I won't try to predict what will happen tomorrow. But I do believe that we are on an uptrend that could, at some point between now and March, take off in a pretty powerful rally.

Posted by Timothy at 10:40 PM | Permalink | TrackBacks (0)

Some believe that they can see far into the future in predicting the stock market, but I do not believe it. For example, October nosedive was not the result of any irresistible long term cycle, but rather the effect of recent government errors that were easily avoidable. These were: 1) failure to prevent a bankruptcy of Lehman Brothers; 2) the twenty day delay in the passage of the Emergency Economic Stabilization Act 3) Bush’s rejection of a stimulus package.

Weeks after Lehman Brothers declared bankruptcy; Fed Chair Bernanke and then Treasury Secretary Paulson stated that neither the Fed nor the administration had the authority to save Lehman Brothers. How strange, then, that both Bernanke and Paulson waited weeks to take this position, rather than stating this right at the time of the Lehman Brothers bankruptcy. So very strange that the government had been able to avoid a Bear Stearns bankruptcy before, and was able to save AIG a day later, but could not save Lehman Brothers. How very, very peculiar it is that neither Bernanke nor Paulson asked for expanded authorization from Congress, so that they could save Lehman Brothers. How weird that at the time Paulson stated that, "I never once considered that it was appropriate to put taxpayer money on the line in resolving Lehman Brothers." If he had not had the authorization to avoid a Lehman Brothers bankruptcy, why did Paulson announce his opinion as to appropriateness? If there had truly been no authorization, appropriateness would have been moot.

It was only after it became clear that the Lehman Brothers bankruptcy caused a chain reaction that resulted in devastating problems for the world economy that both Bernanke and Paulson took the position that they were not authorized to save Lehman Brothers. One must sadly, however, reach the conclusion that the Lehman Brothers bankruptcy resulted from a choice made, principally by Paulson. No other conclusion makes any sense.

The decision to let Lehman Brothers go bankrupt was bad enough, but then the delay in passing the Emergency Economic Stabilization Act (EESA) made a bad situation worse. With the investing community waiting on tenterhooks to see how the vote would go and tension mounting day after day, the economy paused and fell during this period. When the bill was passed, the situation had become so much worse that the EESA was unable to stop the downward momentum.

Finally, on November 6 Nancy Pelosi proposed $61 billion in stimulus spending and on November 7 Tony Fratto, Bush's press undersecretary, killed the idea. Never mind that liberal and conservative economists agree that this is what needed and needs to be done, we have been cursed with a president who does not listen to what the learned say. So we have been in a free fall.

It is also instructive to go back farther. For some reason the Office of Housing Enterprise Oversight did not promptly raise the limit on conforming loans, and when it did raise the limit, did so only tentatively and part way. A big increase in the limit for conforming loans could have done a great deal to buffer the fall in housing prices and to avoid the resultant fall in the value of mortgage backed securities. The accounting rules decision that banks would have to mark to market their mortgage backed securities also greatly damaged the solvency of the major investment banks.

The issue that I have with lauding and now crediting the early predictors of doom, such as Nouriel Roubini, is that things did not have to be this way, and the way things have developed is the result of terrible government decisions that were unpredictable. Perhaps I should have realized that with someone like Bush in the White House, someone who has never shown an appreciation for scholarship and expertise, that disaster was waiting to happen.

The good news is that in a mere 17 days Bush will be gone. We will have a new Administration that does respect scholarship and expertise. The National Economic Council will no longer be directed by Keith Hennessy, who does not have an economics degree, but will be directed by Larry Summers, who has a Ph.D. in Economics from Harvard and a world of experience in Academia and public service. I have nothing against Keith Hennessy (who does have a bachelors in math and poli. sci. from Stanford and a Masters in Public Policy from Harvard), but his appointment as director of the National Economic Council, when he does not have a degree in economics, showed that Bush does not value scholarship and expertise in economics.

The greater point is that Obama is assembling a great economics team, one from which we should expect great things. There are some things that I will not believe, and one of these is that we are the helpless victims of circumstance, unable to do anything to better our situation. This cannot be the case, especially when it comes to economics. The government can and should make a difference. Starting in 17 days, thank goodness, I believe that government will.

As the focus shifts to the Obama administration, with the new Congress being seated on January 6 and work beginning on a stimulus plan, I believe the market will tend to go higher. Of course, Bush can still create problems on his way out, so every day closer to the inauguration is another chance for trouble finally gone. History shows that recovery rallies take place before most investors expect. The stock market is still remarkably low, with great values abounding. If we wait until Obama has been in office for a few months, the opportunity is likely to be largely passed. Of course, that is the general rule: Things are only clear after the fact. Opportunity must always be taken when prospects are not clear.

Posted by Timothy at 4:23 PM | Permalink | TrackBacks (0)

It has been a very difficult and unpleasant two months. I have made an error in my analysis, that has caused huge losses in my portfolio. Ouch!! My error is that I have always believed that the government will choose the path of minimizing near term pain. And yet, our government, potentially informed by the wisest economists in the world, has inexplicable chosen the course of great near term pain. Why????????? Bush has opposed another stimulus package for reasons that sound idiotic. He wants to see if the first one is working. Well...... unemployment is skyrocketing, the stock market has tanked, big time, IT'S NOT WORKING. WE NEED MUCH, MUCH MORE FEDERAL SPENDING. Listening to Bush and other Republicans, it is as if Keynes had never lived and had never written his masterwork. It is as if the lessons of the great depression have not been noted and widely recognized and discussed. It is as if we are being led by the ignorant, by people who are not interested in economics and rather than wishing to learn, in order to lead us out of the mess they have created, simply fall back on blind instinct in times of crisis.

Without greatly increased federal spending over the next year, we would certainly find ourselves with rising double digit unemployment. There is simply nothing to prop up the employment market. We are in a severe downward spiral, with layoffs leading to lower consumer spending, leading to more layoffs, and so forth and so on.

Fortunately we will have a change in administration, about two months from today. Thank goodness. I certainly believe that the "recovery package" being touted by President Elect Obama is just what the doctor ordered. The direction of the stock market in the mean time will be dependent largely on to what degree attention is focused on the future Obama recovery package, and not the Bush present. I have noted that there is extreme, and I do mean extreme, bearishness in the community of commentators. To me, this is a bullish signal. But I don't want to try again to predict a bottom, because last time it did not work out too well. Hey, but I was right about retail and about the Las Vegas Casinos. So at least I have been part right.

Posted by Timothy at 12:09 AM | Permalink | TrackBacks (0)

I cannot say that this is a fearless forecast, but I'm calling a bottom. At around 10:40 EDT today the DJIA hit 9,738.30. Call me foolish, I think this is a bottom, cast in panic. It is panic that makes market bottoms, and we have had plenty of it. Although things seem absolutely terrible right now, what with major European banks pitching into the mud, following their American brethren, the elements for recovery have already been set in place. I for one (call me foolish) believe that the financial rescue plan will work. I think it is an intelligent, sensible means to address the meltdown we have been seeing. I think that Paulson will get it working fast, and it will do a world of good for the credit markets. And other than the problems in the credit markets and the housing market, not too much is wrong with us. I think we saw the bottom today.

Posted by Timothy at 1:45 PM | Permalink | TrackBacks (0)

Well, it happens sometimes. There are the long term trends, and then there are occasionally violent pullbacks from those long term trends. We are now in the midst of a violent short term pull back. I remain confident that the long term trends will reassert themselves. These pullbacks are very difficult to predict, and one must generally just try to ride them out, although it is not easy, and I do worry that my investors may be getting quite impatient and distressed.

But let us take a look at what the long term trends are, and what the implications of those long term trends are. Here are the really important trends that I see, over the next 10 years:

1. Economic growth in China, India, Vietnam, Brazil and Eastern Europe.
2. Population growth in Saudi Arabia and many other oil exporting countries.
3. Gradual topping out of the world's petroleum production.
4. Reduction of U.S. trade deficit.

None of these long term trends has changed. There is a fifth trend that has changed dramatically in the last 2 years and that is a gradual decline in U.S. production of natural gas. We have now figured out how to harvest natural gas from shale deposits far more efficiently than before. This has made a huge difference to our natural gas current production and future prognosis. Could the same thing happen with petroleum? It seems unlikely.

Because the long term trends have not changed, I'm not changing my investment philosophy. I know it has been difficult. But these short term violent pull backs are very unpredictable. And they run along an unpredictable course.

I also feel that the demand for natural gas will increase, as it is substituted for expensive petroleum in a number of different areas. Also, at the current prices I would certainly not presume that production will increase. Harvesting natural gas from shale is expensive, and these prices will not support the sort of strong and dedicated effort that has caused production to rise dramatically. The rate of increase from the Barnett Shale, underneath Ft. Worth Texas, will slow. Other shales are not as good sources as the Barnett Shale is. And conventional gas production is declining. So I think the low prices will effect both the supply side and the demand side of the natural gas equation.

With respect to petroleum, give me a break. Inventories are still quite low, and they have fallen over the last year. At these prices demand will return, not only in the US, but in the areas where demand has been growing so quickly. If inventories were above the levels of last year I could see the price decline that we have seen. I don't know what tomorrow's inventory readings will show, but it just seems that there is not really that much petroleum and product in storage and this will over time, tend to support prices.

And with gold, the growing wealth of China is going to eventually cause prices to rise. We are starting the buildup to Chinese Lunar New Year. Eventually that will have an effect. I hope it is soon.

Investors' perception of the steel industry will never cease to amaze me. The level of negativity is just astounding. Nobody believes in steel. But steel production is necessary to support the production of fossil fuels and to support an American industrial resurgence that must happen if we are to reduce the trade deficit that must be reduced.

So call me stubborn, and I do regret the losses in this very, very difficult quarter. But the long term trends are on our side, and they are powerful and will make a difference.

Tim

Posted by Timothy at 10:01 PM | Permalink | TrackBacks (0)

Wow! The August natural gas (“gas”) contract has fallen from a little over $13 per Million BTU to 10.57 at market close today, about a 20% drop in less than two weeks. Is it going to stay down, or pop back up? In favor of staying down there is increasing production from the U.S. deepwater, reduced demand from industries that supply house building materials, electricity from new windmill farms reducing the need for gas generated electricity and a build of 104 Billion Cubic Feet in the week ending July 11, 2008 (“the last week”).

Even taking these factors into account, however, I believe that we will see a price recovery. If the low pressure wave in the Caribbean turns into a hurricane, we will see an extraordinarily fast recovery. But even if it does not, there are many factors that point to higher natural gas prices.

First, it is important to recognize that because the readings for the government storage survey take place at 9 AM on Friday, the last week was far more affected by consumption on July 4 then July 11. And July 4 is a national holiday in which many businesses are closed and consumption of natural gas tends to be far lower than on a normal weekday. Some may be comparing the build for last week, which was the 28th week of the year, with the typical build for the 28th week of the year. But July 4 generally falls in the 27th week of the year, so this comparison is erroneous. Compared with the typical 27th week, the last week was not a particularly large build at all, being just 6 billion cubic feet above the 5-year average of 98 billion. And the week-to-week change is an inherently noisy statistic, so one week’s figure should not drive big price changes.

Between May 29 and July 3 of this year gas storage went from being 66 billion cubic feet below the 5-year-average storage to 120 billion cubic feet below the 5 year average, despite the spot price of natural gas being above $12 per million BTU for the entire period. The weather was a little warmer than usual, but taking the nation as a whole, it was not tremendously warmer. And gas at above $12 per million BTU creates a far more powerful incentive to avoid gas usage than does the current price of $10.54.

Let us imagine that I had a knob that I could turn to change the spot price of gas, and I was trying to handle that knob so that this country would end up with at least 3.2 trillion cubic feet of gas at the autumn peak, an amount generally considered adequate to get through the winter. After viewing last week’s storage figures, I would have nudged the knob a little in the “lower-price” direction and then continued to watch to see what effect the change would have and what sort of weather we would have. But the market has swung the knob a huge amount and I just do not think that it was justified. Moreover there are long term reasons to be bullish on gas.

Just as deepwater gas is being exploited; all other gas production is declining. So it is a contest between the deepwater expanding production and all other production declining to see whether production will increase or decline. Petroleum production, however, is down from last year, and this could be an indication that gas production is, too. It also seems likely that Canadian gas production is starting to decline, based on declining reserves.

Also, wind power still produces a very small percentage of U.S. electricity production. Changes must be made to the electric grid in order for wind power to become a more significant producer. This will take time. Also, although production of house building materials, such as bricks, is way down, production of goods for export is up, and some of this production is bound to use gas.

More importantly, there is a huge, growing consumption driver for natural gas, and that is tar sands production in Alberta. In a conventional mine, where the tar sands are scooped up and dumped into hot, soapy water, gas is used to heat the hot, soapy water. In steam assisted gravity drainage (SAGD) gas heats the boilers to create the steam that is pumped into the earth to heat and soften the bitumen. In either case, gas is combined with the bitumen to provide hydrogen when the bitumen is cracked into smaller molecules. With the high price of petroleum, a tremendous amount of development money has been directed toward the Alberta tar sands, meaning ever more gas consumption.

Also, the price of gas is now less than half that of petroleum, on an energy content basis (a barrel of petroleum has about 5.8 million BTU). So for any activity where there is a choice, there is now an enormous incentive to use gas to get petroleum or to use gas instead of a petroleum product. I know that in many cities where natural gas is available, some people still have heating oil furnaces. There is now a huge incentive to switch over to gas, and it would not take long to recoup the investment in a gas furnace. Some may choose to use small electric heaters to heat whichever room is occupied. These heaters are cheap and very easy to use. In today’s electricity production environment it is quite likely that much of the electricity generated to power these heaters will come from gas. We will not see much effect from this until late fall, but there are, no doubt, industrial users of petroleum products that now have a huge incentive to shift to natural gas or electricity, where we would see the difference immediately.

Finally, hurricane season has just begun. Just because we have not seen any major gas production damaging hurricanes in the last two years does not mean we won’t have one this year. Also, despite the last two years of relatively light hurricane activity, I still feel that the 2005 season was a harbinger of things to come, and that hurricane activity in general will become more of a problem in the future, as Caribbean and Gulf of Mexico waters get hotter in the summer and take longer to cool down in the fall.

There are a number of ways to make money from an increase in gas prices. There is an ETF, having the ticker symbol UNG, which tracks the price of gas. Also, energy producer XTO Energy, Inc. (XTO) is known for producing a high proportion of gas in its hydrocarbon mix and tends to be affected by changes in gas prices more than other energy producers. I would rate both of these a buy.

Posted by Timothy at 10:20 AM | Permalink | TrackBacks (0)

This market plunge makes me optimistic. “Why???,” you may ask. Because I feel that Ben Bernanke will finally learn his lesson, which is, “Don’t talk tough on inflation.” Every single time that Bernanke has talked tough on inflation, the market has tanked. On June 10th, Bernanke stated that, "The Federal Open Market Committee will strongly resist an erosion of longer-term inflation expectations, as an unanchoring of those expectations would be destabilizing for growth as well as for inflation … ." He followed this up with, "Although activity during the current quarter is likely to be weak, the risk that the economy has entered a substantial downturn appears to have diminished over the past month or so … ." Yes, the possibility that the economy had entered a substantial downturn had diminished. But the “tough inflation” talk brought that possibility right back. The very act of making the statement about the possibility having diminished resurrected the possibility of a “substantial downturn.” The S&P 500 index has dropped by 7.79% since June 10. This reduces the Fed’s ability to staunch inflation without sending the economy into an even worse tailspin. The stock market is a leading indicator, one that is causal and not simply indicative or reactive.

This is far from the first time. On June 6, 2006 the stock market tanked after some tough on inflation talk by Bernanke. And earlier, on May 2, 2006 Bernanke had made some comments to Maria Bartiromo that she announced on her news show, and which also clobbered the stock market.

OK. Now we are in a bear market for real. We are down more than 20% from the October 2007 high. Is there any chance at all that we could stop the inflation tough talk? It has been incredibly destructive. This is an economy that has already been battered raw by the sub prime crisis, the resultant fallout in financial institutions and high petroleum prices. Is there any chance that we could enter into a period of benign neglect from the Fed Chief’s statements. He can still raise interest rates. But comments that have phrases like “strongly resist” in them frighten people. They introduce uncertainty that is destructive to people’s ability to make positive decisions and commitments.

But now I’m hopeful that the stock market, this collective mouthpiece of so many, which is nothing if not 100% sincere, will have finally taught Mr. Bernanke that he could just be a little milder in his statements. Could he not simply have said something on the order of, “It looks like there might have been some mild erosion of price stability expectations and it is probably nothing, but don’t worry, if it ever became a serious concern we would take action that I feel certain would be very effective.” This is a market that needs reassurance.

Well, my gut feel is that this has happened enough times so that the stock market has now tamed Ben Bernanke, at least a little. If he does it again, his term really should not be renewed. But I would hate to see him replaced because at least now he has some experience, and some new Fed Chief would not. And it seems that being Fed Chief is a job where there is just no substitute for actually doing it for awhile to get the hang of it.

Posted by Timothy at 3:56 PM | Permalink | TrackBacks (0)

Reach for the Sky – Manitowoc Co. Inc. (MTW)

Yes, construction spending in the United States is down. And now Western Europe appears to be following suit. So Manitowoc (MTW), which gets more than 80% of its revenue from cranes, should not prosper. Except for that the United States and the European Community do not make up the whole world. There will be continuing demand for cranes in the Middle East, China, India, Latin America and Eastern Europe. And with Manitowoc down by almost half since last December, this stock looks like a bargain.

But there is another reason to buy a crane builder. With petroleum prices high and likely to go higher, the world will become more vertical. It was the automobile and the relatively low price of petroleum that allowed American cities to spread out in the first place, from 1950 through about 2005, with a thriving central city giving way to thriving suburbs and then exurbs popping up at the edges. Now the process is working in reverse, with the focus back on the center and housing in the form of multi-story buildings becoming increasingly prevalent. Cranes will be required to build the housing of the future.

Besides constructing housing, going “back to the future” will require new mass transit and commercial structures. This country, and even this world, has an immense amount of construction to do over the next 40 years as we transition from a world of relatively plentiful petroleum to a world with petroleum production that is only a fraction of what it is today.

Mass transit must work on a hub-and-spokes system. The mass transit trunk lines must be where there is a large volume of traffic, which is into and out of a central hub. So if a person wishes to go from point A in the outskirts to point B, also in the outskirts, he will likely take a train into the hub and another out of the hub to point B, as opposed to driving directly to B. Accordingly, if you live near the hub it is much easier to easily reach more places.

If one looks at how urban development in the U.S. looked in 1890, even small cities and towns had multi level structures downtown near the train station. This is the pattern of the future, and it will be built with cranes.

Terex (TEX) gets a big portion of its revenue from sales of aerial work platforms, also handy for multi-story construction, as well as making cranes. Terex has also gone down a lot since last year, and is a bargain, today.

Manitowoc has a trailing PE of 9.37, with Terex coming in at 7.23. These figures show that there is a very strong degree of skepticism on Wall Street regarding these stocks. Perhaps some view them as unexciting rust belt relics who have had their moment of excitement for the decade. But as I see it, the fundamentals are only getting stronger. At some point even a skeptical and inattentive Wall Street will have to take notice, because the money flowing in is just too good to ignore.

Both Manitowoc and Terex make and sell products other than cranes. Manitowoc also builds and sells ships and food service equipment (and has been in the news with a recently accepted bid to acquire British food service equipment maker Enodis). Terex builds and sells a wide range of construction and mining equipment. To me, it’s all good. Some might say that high tech companies are the companies of the future, but I say it is also those companies that will help us construct the fuel efficient cities of the future, namely Manitowoc and Terex.

I own Terex stock, myself, but no Manitowoc. I own both of these two stocks in my mFolio portfolio, however.

Posted by Timothy at 1:12 PM | Permalink | TrackBacks (0)

Ahhhh, the business cycle, etched so very deep into the collective mind of Wall Street. The business cycle, so very important, so very fundamental, that there is even a category of stocks known as "cyclicals." And conventional wisdom states, "Don’t get caught with a cyclical when the business cycle goes south! Cyclical stocks do terribly in the trough of the business cycle. So if you see even a hint that the down side of the cycle is coming, get out, get out. Run for the hills. It’s gonna be baaaad. Oh so very, very baaaaaad."

And what could be more cyclical than steel. Sure, when the good times role, we need steel, out of which to build cars and beautiful office towers. But when the business cycle turns south, we don’t need very much steel anymore. And then, per conventional wisdom, there is a competitive frenzy between the steel companies and they start going under and fools who have been crazy enough to invest in steel lose all there money. And that’s baaad. Oh, so very baad.

Perhaps it is this type of thinking that has caused analysts to rate AK Steel (AKS) at a collective 3.2, where 1 is a strong buy, 5 is a strong sell and the average stock is ranked at about a 2.4. AK steel has had a rating of about a 3.2 during its entire climb from a little over 2, to 72. Well, the analysts sure missed the boat on that one. You would have thought that one of them would have had the guts to issue a buy recommendation. But for the most part, not a one of them did. And this has been a fabulously lucrative stock for those who bought, despite the disapproval of the analysts.

And perhaps it is that sort of business cycle thinking that in the last few days has slammed AKS from a high of 70.54 on Monday, June 30 all the way down to a closing price of 52.79, today, July 3rd. Yes, that is a drop of 25% in a little less than four short days. The new orders information released by the Census Bureau showed a very small drop in steel orders from April to May and the auto makers announced dismal sales figures and wham, did AK steel ever get hit hard. And why not? If this the beginning of a trough in the business cycle for steel, which will represent a harrowing descent for the steel companies, it makes perfect sense.

I am convinced, however, that structural changes in the world economy will continue to boost the fortunes of AK Steel. Sure, it could go down further in this crazy, skittish environment. But, hey, although its course over the next month or two is unpredictable, eventually the fundamentals of the situations will translate to an increased stock price. And what are these structural changes? Well, I discussed four of them in my Marketscope article of April 2005. Now I can think of at least 10:

1. Fossil fuels are being depleted: This is a structural change that will not be reversed. The greater the depletion of fossil fuels the deeper we will have to go to get them out. The greater the complexity of the extraction process, the more steel typically will have to be used. Rather than just drilling down a mile or two and pumping it out, we must drill down a mile or two in a first well, and then drill a bunch of wells around it to inject water or gas or steam to get that oil out. And we must drill more wells, deeper, into smaller pockets of oil and gas. This all takes more and more steel.

2. The huge U.S. trade deficit is not sustainable. We must start to make progress at closing this massive deficit, which is running at about $2,500 per American per year. To do this the dollar must fall. Perhaps not today, or tomorrow, but eventually. As it falls, American steel producers become more competitive with foreign producers. We should also note that the domestic steel industry’s nightmare days came at a time when the dollar was worth about 20% more than the Euro. Those dark days are not coming back.

3. The high price of petroleum means that it costs more to ship steel from overseas. As the United States is a net steel importer, this benefits domestic steel producers because it drives up the price of competing imported steel.

4. The high price of petroleum means that petroleum exporting countries are going on a building spree, using a great deal of steel. The Saudis are planning huge new cities. The steel for these cities comes from all over, and it drives up the international price.

5. The high price of natural gas is making alternative means of electricity production increasingly feasible. That means steel supports for windmills and steel structure for solar facilities (a square mile of pivoting mirrors translates to a lot of steel structure).

6. The high price of petroleum creates an advantage for railroads over trucks. This means the railroads will expand their rail network, which is made of steel.

7. The Chinese government used to encourage steel exports, now they discourage them, to keep the steel in China.

8. The agricultural boom means more spending on agricultural structures, made of steel.

9. The high price of gold, silver, copper and other metals means that more steel will be needed for mining equipment, mine structural supports and processing facilities.

10. Our continuing efforts to fight pollution mean that we will use more steel for sewage treatment facilities and pollution control equipment.

So that is ten structural changes that will cause steel to continue to prosper. U.S. Steel (X) is good also, but AK Steel, with its 3.2 analyst rating and its recent 25% price plunge, is the underdog that I love. It may take another two months for it to bottom out, or it may have hit bottom already. There is just no telling with the investor psychology. But I foresee, that this stock has some more strength and will be moving back up, before too long.

Disclosure: I own AK Steel, myself, and I also own some in my mFolio portfolio.

Posted by Timothy at 12:39 AM | Permalink | TrackBacks (0)

Gandalf Vs. The Barolrog; Napolean Vs. The Duke of Wellington; Rome Vs. Carthage; Sponge Bob Vs. Squidward; Fisher Vs. Spassky; Dempsey Vs. Firpo; Genoa Vs. Venice; Jefferson Vs. Adams; Ming Vs. Manchu; Scott Vs. Amundsen; Yankees Vs. Red Sox; Grant Vs. Lee; Potter Vs. Voldemort; OSU Vs. UofO; Charles XII Vs. Peter the Great; Wright Vs. Le Corbusier; Bryan Vs. Darrow; Alexander the Great Vs. Darius III; Jud Vs. Curly; Turgenev Vs. Dostoyevsky; Trotsky Vs. Stalin; Carranza Vs. Zapata; Girondist Vs. Jacobite; Tokugawa Ieyasu Vs. Hideyoshi; Guelph Vs. Ghibelline; Moses Vs. Pharaoh; Thailand Vs. Burma; Ali Vs. Abu Bakr; Ibo Vs. Yoruba; Atreides Vs. Harkonnen; The Foundation Vs. The Mule; David Vs. Saul; Rama Vs. Ravana; Leo X Vs. Martin Luther; Ferdinand II Vs. Jan Hus; Hamilton Vs. Burr; George III Vs. George Washington; Frodo Vs. Sauron; Nathaniel Vs. Simon Lovelace; Elizabeth Bennett V. Lady Catherine de Bourgh; Capablanca V. Alekhine; Mufasa Vs. Scar; Byzantine Empire Vs. Ottoman Empire; Snow White Vs. The Wicked Queen; Peronist Vs. Anti-Peronist; DeFarge Vs. Darnay; Javert Vs. Valjean; Churchill Vs. Hitler; Cromwell Vs. Stuart; Bourbon Vs. Guise; Montague Vs. Capulet; Pompey Vs. Caesar; Latkas Vs. Hamantashan; Montgomery Vs. Rommel; York Vs. Lancaster; Hatfield Vs. McCoy; Eyre Vs. Scatcherd; Eragon Vs. Galbatorix; Lilliput Vs. Blefescu; Engineer Pete Vs. Steve Barker; Jett Rink Vs. Bick Benedict; OSU Vs. UofM; Nimitz Vs. Yamamoto; Nelson Vs. Villeneuve; Angra Mainyu Vs. Spenta Mainyu; Cortez Vs. Moctezuma; Achilles Vs. Peter Wiggins; Hector Vs. Ajax; UCLA Vs. USC; William Vs. Harold Godwinson; Iconoclast Vs. Iconodoule; Hinayana Vs. Mahayana;

And now for the greatest epic struggle of them all: The Federal Reserve Board Vs. Inflation

Sadly, the result is a foregone conclusion: Inflation will win. More sadly still: there will be a lot of collateral damage on the way.

Posted by Timothy at 2:45 AM | Permalink | TrackBacks (0)

Peak Oilers 135, CERA 80

I remember taking a pleasant mountain hike, and when I got to the mountain peak noticing a strange fellow there with a small bottle of olive oil, who was pouring a little out onto the ground. “What are you doing?” I asked him. “In the holy book of the Braphulthustrins it states, ‘you shall anoint the mountain peaks’” he replied, “I am following the teachings of my religion.” That was my first encounter with a Peak Oiler.

But if you think the Peak Oilers are a little strange, the Cambridge Economic Research Associates (CERA) is stranger still. And even more strange is the continuing credence given to this strange group by all sorts of folks, from the U.S. Government, to the news media. To me, CERA long ago completely annihilated any shred of credibility they may have been thought to have had. Their study deriding the peak oil theory, published November 14, 2006, was ridiculous. While roundly abusing Peak Oilers for their illogic, CERA bounded off into fantasy land itself, counting 704 billion barrels of shale oil in its projection of total global resources. This oil is in solid rock. We don’t know of any efficient way to get it out, and there is real doubt that we ever will. Also, CERA completely accepted the figure of 662 billion barrels in the OPEC Middle East, although at the time it was already clear that this figure was (and still is) entirely bogus. What is wrong with them???? In the one-and-a-half years since the report’s publication, its near-in predictions, at least, have been shown to be entirely wrong.

More recently, on November 30, 2007, CERA predicted that the 2008 WTI oil price would trade in the $70 to $90 per barrel range in 2008. At that time, I was predicting a $100 to $120 per barrel range for the year. Well, we were both wrong, but I was less wrong than they were, and I don’t have a big research budget and staff to help me out. Moreover, the report blamed the “high prices” at the time as being the result of market psychology, rather than fundamentals. But even at the prices of today, U.S. stockpiles are lower than a year ago and lower than average for this time of year. This shows that it is fundamentals that have driven the price up.

There was also an article in today’s New York Times by Jad Mouawad and some compatriot, asking why the price is so high. Can there be any question? Isn’t the answer obvious? Demand growth in China had been driving the price up, but now Russian supply growth has stalled out and Russian demand growth has switched into high gear, together with Middle Eastern demand growth. It is a prescription for higher prices and the prescription is working. At the beginning of the year I did not realize that Russian supply growth would stall out and I did not realize the extent to which Russian demand would grow. And I don’t have a big research staff. I’m sure that if I did I would have nailed it, not, because predictions are difficult. But with a big research budget, and an array of minions, one would have thought that at least CERA would have come a little closer. And one would hope that the New York Times, with the array of resources at its disposal, would be able to offer a more cogent analysis.

Posted by Timothy at 3:45 PM | Permalink | TrackBacks (0)

The exchange traded fund (ETF) world has blossomed with the introduction of designer exchange traded funds (ETFs) that apportion their holdings according to some statistical process other than mere market cap. There are ETFs from Wisdom Tree that apportion their holdings according to total dividend payments. Along similar lines the SPDR Dividend ETF (SDY) invests in the 50 highest-yielding companies in the S&P Composite 1500 that have consistently raised their payouts for at least 25 years. On the other hand, the PowerShares FTSE RAFI US 1000 (PRF) evaluates the 1,000 biggest U.S. companies on the basis of average sales and cash flow over the previous five years, total dividends distributed over the previous five years and latest book value (assets minus liabilities) and apportions its holdings according to a formula based on these factors.

There is a basic philosophical problem with all of these funds. Apportioning according to market cap mimics and therefore accepts the actual distribution of money in the market. This distribution, just like the price of every stock, is that which those with the most money invested have made it. Those with the most money invested, unsurprisingly, have typically hired the best minds, with the most time and the best training to make the investment decisions that have resulted in the relative market caps of the various stocks. Using a statistical guide for the distribution of money into stocks suggests that this process has been inefficient.

The designer ETFs take a subset of the information that has been analyzed by the investors who have set the distribution of market caps, in an ever changing dynamic process. They then take this subset of available information and apply a rigid formula to it. And they appear to believe that this distribution, based on a subset of information and devoid of an ongoing application of human judgment can beat a process based on the full set of information and constantly informed and updated by skilled human judgment.

I don’t buy it.

Now I do swear to you, the reader, that when I began to write this journal entry I had not checked the performance of SDY or PRF. I picked them at random from a short list of designer ETFs. I have just checked performance and over the past two years they have both been beaten by the S&P 500 index. PRF was beaten by about 5%, whereas SDY was absolutely clobbered by roughly 20%. I did not take out the management fees of SDY or PRF, but also did not add in the dividends one would receive if holding the S&P 500. Clearly this is a quick analysis based on only two randomly selected designer ETFs. Nevertheless it tends to bear out my point. You can’t outsmart the market by basing your distribution of money between stocks on a rigid computer analysis of part of the data. It just does not make sense.

Now we all know that in March of 2000 the largest of the large cap stocks were overvalued. Since that time an S&P 500 index in which each stock was equally weighted has far outperformed the actual S&P 500 index in which each stock is weighted according to its market cap. But the designers of the designer index funds are not the only ones who have noticed this phenomenon. There is every possibility that the current market caps in the S&P 500 have been strongly influenced by this past overvaluation. Perhaps the market has actually overreacted. It is possible that the present valuations actually undervalue the largest large cap stocks. But let us theorize that there actually is some attribute of investor psychology which causes the largest large cap stocks to be consistently overvalued. If this were to be the case, surely a better way of addressing this issue would be to apply a secondary weighting to the market cap weighting, which would cause the largest large cap stocks to be weighted slightly lower than they would be in a straight market cap rating. I’m not recommending it, except for as a more sensible alternative to ranking by dividend payments or any other subset of the available financial information.

Market cap is a function of democracy, except for resulting from a process in which each dollar, rather than each eligible person, gets a vote. So Winston Churchill’s famous aphorism about democracy, that it is absolutely the worst system of government, “except for all the rest,” holds true in this context.

Posted by Timothy at 5:10 PM | Permalink | TrackBacks (0)

Were you born yesterday? Because if you were, I have a really great story for you. Its at:

Plan Would Lift Saudi Oil Output

You see the Saudis are going to raise their oil output by 500,000 barrels a day, next month. Yes, according to Jad Mouawad of the New York Times Saudi officials have briefed “analysts” and “oil traders” of their plans. Ahhh, but Ibrahim al-Muhanna, of the Saudi petroleum ministry declined to comment on the reports. Hmmmm, now that is a trifle curious. Why would the Saudi petroleum ministry refuse to confirm the good news? After all, this is what the world has been crying, dare we say, “begging” for. So if the Saudis were really going to do this, would there be a need for secrecy?? It is a little hard to imagine, given that they would win accolades all around. And who doesn’t like accolades? So why would Mr. al Muhanna refuse to confirm the good news? Maybe because it is not true? After all, you can spread all sorts of false reports, but if you have never gone on record with the supposed information, it will be pretty hard for people to blame you after the fact. Especially if Mr. Mouawad never tells us who his sources are.

Mr. Mouawad also lets us know that as part of a “huge expansion program” expected to bring its production capacity to 12.5 million barrels a day by 2009, Saudi Aramco “is planning to start soon an oil field, called Khursaniyah, with a daily production rate of 500,000 barrels per day.” This “could” be made public at an energy meeting scheduled by King Abdullah.

If Mr. Mouawad had taken five minutes to do a simple Google search he would have found the following articles, indicating that Khursaniyah has already been started, more than a month ago, but has just not reached 500,000 barrels per day, yet.

RIGZONE - Saudi Aramco Starts Up Khursaniyah
Apr 22, 2008 ... RIGZONE News - leading source for the latest news and information for the oil and gas industry.
Saudi Aramco Starts Up Khursaniya - 27k - Cached - Similar pages - Note this

Upstreamonline - Aramco 'opens Khursaniyah taps'
Saudi Arabia has kicked off production at its 500000-barrels-per-day Khursaniyah oilfeld, Abdullah Jumah, head of state oil company Saudi Aramco said. ...
Aramco 'opens Khursaniyah taps' - 42k - Cached - Similar pages - Note this

Aramco to miss Khursaniyah deadline
Mar 7, 2008 ... Boost in production to 500000 barrels a day unlikely to be achieved until later in the year....
Aramco To Miss Khuraniyah Deadline - 25k -

Also,….can we please get real for a second. No one ever just flips a switch and starts a field producing 500,000 barrels a day. That is not how it works. Do you imagine that they have all the wells drilled, a huge array of pumps all in place, King Abdullah flips a switch, and they all start pumping at once, filling the pipelines? That would be crazy. Production from an oil field gradually builds over time, as it is increasingly developed. There is never a simple step function from 0 to 500,000 barrels per day.

Mr. Mouawad does note that “Some investors doubt that Saudi Arabia has the capacity to increase its production beyond current levels.” That is the only point in the article that he recognizes, without naming the name “Matthew Simmons” that at least one very smart and very insightful petroleum analyst, who has spent a lot of time and effort studying this issue, does indeed, refuse to believe that “Saudi Arabia has the capacity to increase its production …. .” And why???? For one thing they are working awfully hard to produce at their current levels. For another, the “water cut” at their premier field, named “Ghawar” is up to 30%. This is a real problem. As the Khursaniyah field comes on stream, it is likely to be partially replacing a decline in production at Ghawar.

What has really happened here??? This is my theory. There is indeed a lot of pressure on the Saudi’s to do something to alleviate the high petroleum prices. There is a rising public sentiment, looking to find someone to blame, and OPEC is ever convenient. But if truth be known, I don’t think they can increase their production. I think they would love to produce more oil and sell it at $135 a barrel. But they can’t. Because of the intense ruckus, however, they have decided to pretend to do something, just to see if that mollifies the crazy westerners. So they float a rumor, and host an oil summit. They say they would really like to see the price come down a bit. This part might be true, because they tried to keep prices high in the early 1980’s and it really backfired. So now they might truly be somewhat worried that this latest price increase will lay the seeds of a future price decline. Then again, they are raking it in now, so I don’t think they are too terribly upset. Whether they are, or not, I really doubt that there is a thing they can do about it. Just sit back, enjoy, and host a summit, just to let people know that they are concerned. Float a rumor that they are increasing production, but not go on record so that in two months when people ask, “where was that increased production?” they can say, “we never said we were increasing production.”

Posted by Timothy at 8:30 AM | Permalink | TrackBacks (0)

I just read a Fortune magazine article about Ken Heebner, the manager of GGM Focus fund, who has beaten the market by a huge margin over the past 10 years. The article is an object lesson in why we need Marketocracy. Heebner graduated from Amherst, an extremely prestigious college, and Harvard Business School. Nevertheless it took him 11 years of hard effort to get to the point where he had the chance, as a mutual fund manager, to show what he could do. He had just been fired as an assistant fund manager, for criticizing the head of the firm after having a few too many martinis over lunch. But he had developed enough of a reputation at that job to entice another mutual fund company to hire him. Lucky thing for him and all the people who have made big bucks investing with him.

What is wrong with this picture?? There is this brilliant guy, turns out to be a fabulous fund manager, but it takes him 11 years after graduating from the best business school to get to show his stuff as a fund manager. The point is that you can't tell who is going to be good at it till you give people a chance to actually do it. There were lots of other grads from Harvard Business School, how were we supposed to know that this one was the one who was going to be great as a fund manager?? And the skills that it takes to get that first crack at it in the "real world" are not the ones that it takes to do well after you get that first chance. Sure, there is some overlap. But it is far from a perfect match. Ken Heebner was not all that good at patiently accepting leadership that seemed questionable to him. He, perhaps, did not make the best impression on an interview. Those are the skills needed to get the first chance. His penetrating insight and admirable intellect got him the chance eventually, but it took awhile. Perhaps if Marketocracy had been around back then, it would have taken him a lot less time.

Posted by Timothy at 8:19 AM | Permalink | TrackBacks (0)

Arthur Schopenhauer (1788 - 1860) stated, "All truth passes through three stages. First, it is ridiculed. Second, it is violently opposed. Third, it is accepted as being self-evident."

How very true this is. When I told folks back in 2001 that the price of petroleum was going to rise, they ridiculed the idea, then many violently opposed the notion, now people take it as self-evident that this was bound to happen.

But that is just an example, and not my central point here. Why do people do this?? I think it is to avoid mental dissonance. When something new is first proposed to be true, (e.g. Einsteinian physics, the Big Bang Theory, Evolution) it is likely to conflict with present beliefs. That causes conflict inside the minds of those who hear the new message. They don't like it. People have a strong distaste for mental conflict. That bears repeating, people have a strong distaste for mental conflict. I think that is what the Thirty Years War was all about.

What does this have to do with Marketocracy??? Marketocracy causes mental conflict. To those who believe that all actively managed funds are a bunch of hooey, it is just one more managed fund with a lot of big claims, that are all going to turn out to be nothing. For those who have their money socked away at Fidelity, it is just not going to make sense that people who are not with a big-name, well-established, long-history, big-money, blue-blood, ivy-league mutual fund organization could possibly do better than those who are. For those who work at Fidelity, it might well be infuriating that anybody who is not at a big-name, well-established, long-history, big-money organization and who does not have blue-blood and did not graduate from an ivy-league school could possibly think that he or she could pick stocks better than those who do and did.

But the Marketocracy performance is starting to all add up.

So get ready to start saying that it was self-evident all along, all you big-name, well-established, long-history, big-money types. Yeahhhhhhh, I mean you. Hey, what are you doing reading this anyway, if you are so confident it is all a bunch of hooey.

Timothy Siegel

Posted by Timothy at 9:07 PM | Permalink | TrackBacks (0)

Is mutual fund performance persistent? This is a much debated question, with many journal authors stating that it may be. Of course, Marketocracy, with its lack of other guides depends entirely on persistence of performance for its market edge. Accordingly, Marketocracy is an experiment that should be followed by the academic community, as it would appear to bear out the notion that performance for managers at least, is indeed persistent. If performance were not persistent, the entire Marketocracy model would fail, and the statistics would appear to indicate that it has worked pretty well these last three years.

Timothy Siegel

Posted by Timothy at 6:23 PM | Permalink | TrackBacks (0)

A box without hinges, key or lid,
Yet golden treasure inside is hid.

The Hobbit, J.R.R. Tolkien

The above riddle is one of a wonderful set of riddles that Bilbo Baggins and Gollum trade back and forth in the fifth chapter of The Hobbit.

But now our entire society faces another sort of riddle.

What interest rate is low enough to foster an incipient recovery?
Yet high enough to bolster the dollar and prevent inflation?

Answer: There is none.

Not every puzzle has a solution.

Ben Bernanke's talk has managed to push up the dollar, a little, for now. But export growth and import substitution are some of the main strengths of our otherwise beleaguered economy right now. If the dollar goes up by much, these strengths will go away, too. Also, the U.S. has negative real interest rates right now. So are the U.S. bills, notes and bonds really a good investment? It's hard to see it. Also, if the Fed is going to raise interest rates, what is that going to do to housing? How is the housing market ever going to recover, if interest rates start to go up?

I'm not going to try to predict currency rates in the short term. This month and next month, anything can happen. But there is a long term trend for the dollar, and it's not up. Nothing the Fed can do or say can stop that, because it is based on the fundamental fact that the U.S. has a huge trade deficit that must be corrected. It might take 40 years to do it, but eventually this country will have balanced trade. And only a weaker dollar is going to get us there.

Posted by Timothy at 7:54 AM | Permalink | TrackBacks (0)

Well, I have now chucked my model of petroleum price increases, starting at $60/barrel on January 1, 2006 and increasing at $20 per year. It held true for awhile, and I successfully used it as a guide to get in at the troughs and out at the local maxima, but it must now be superseded by a new model having faster price increases. I am thinking of something on the order of $40 per year.

Along these lines, someone please explain to me why the price is down so much from a week ago. First, it seems to me that the Energy Information Agency's (EIA's) explanation for last week's plunge in inventories, that there was fog on the Houston Ship Channel, was disingenuous. I found this article offered by Indian Reuters. it seems peculiar that they should note this in India, but not in the U.S. edition:
http://in.reuters.com/article/oilRpt/idINN2929207020080529">href="http://in.reuters.com/article/oilRpt/idINN2929207020080529">http://in.reuters.com/article/oilRpt/idINN2929207020080529
.

" HOUSTON, May 29 (Reuters) - The Louisiana Offshore Oil Port (LOOP) said on Thursday some crude oil tankers canceled scheduled deliveries last week, but the only U.S. deep-water oil port operated normally.

Delays in Gulf Coast tanker movements was cited by the U.S. Energy Information Administration when it reported an 8.8-million-barrel drop in U.S. crude oil inventories on Thursday.

"We had a light week last week," said LOOP spokeswoman Barb Hestermann. "They don't happen very often, but they do happen."

The LOOP can offload over 900,000 barrels per day (bpd) in crude oil from tankers and takes 500,000 barrels of crude via pipeline from the offshore Mars platform.

The EIA report of tanker delays left the U.S. Coast Guard and shipping sources scratching their heads after repeated calls from reporters asking if they knew of any problems in the major waterways supplying Gulf Coast refineries.

"I've received several calls and I haven't been able to find anything in the New Orleans sector," said Lt. Stephen Nutting of the Coast Guard's New Orleans office.

Sources along the Houston Ship Channel said operations have been normal for several weeks.

Hestermann said she couldn't provide information about the number of tankers that canceled deliveries or the amount of crude they were scheduled to deliver.

The LOOP continued to make deliveries to Gulf Coast refineries via pipeline throughout the week, Hestermann said.

No major weather problems were seen along the Gulf last week nor were there reports of fog halting traffic along Gulf Coast waterways."

So...was it all a big lie?? Just to reassure a skittish public???

With respect to today's figures, which can be found at

http://www.eia.doe.gov/pub/oil_gas/petroleum/data_publications/weekly_petroleum_status_report/curren
t/txt/table1.txt
and which does not seem to copy over very well, what I typically do is take the change in the total figure and subtract out the propane/propylene component which always moves in a very tight annual pattern. Doing this shows that looking at petroleum and its range of products we are down a little from last week and about 2.5 percent from last year. Even with these high prices causing people to use less fuel, we are still seeing declining inventories. And it certainly looks as though the answer is not fog on the ship channel. This is still the energy consumption light second quarter, so I fail to see anything whatsoever petroleum price bearish about the figures. Do serious traders go by the press reports and fail to review the easily accessible government figures?? It is a little hard to believe.

In any event, for my funds I am going to buy the petroleum price ETF USO and may also buy some Schlumberger (SLB) and Smith International (SII). After all, if some hurricanes hit, watch out for that petroleum price, it is going to be launched into orbit.

Posted by Timothy at 8:21 PM | Permalink | TrackBacks (0)

Q: When the percentage of households that own their home goes down, what goes up? A: The percentage that rent.

Avalon Bay Communities (AVB) builds and runs apartment communities. Accordingly, it is in the one part of the housing market that is healthy. As fewer can own, due to the tightened lending standards, more must rent. Also, some, but not all, of AVB's communities are urban. This is a huge advantage as the nation will slowly de-suburbanize and re-urbanize in response to increasingly tight fuel supplies. Human habitation will gradually become more concentrated, benefiting purveyors of urban rentals. Also, AVB qualifies as an REIT, and has a yield of 3.57%. For those who want a safe and high yielding investment, well you are doing better than 5 year T-notes with this one. And if inflation rises, AVB may well be able to increase its rents and its dividends, unlike a 5 year T-note purchased today which pays out the same set amount, regardless of changes in the inflation rate.

Looking at the chart, as REITS in general got hit, AVB has declined from a high of close to $150, in February of 2007, to about $100 now, even as interest rates have fallen. This is a great example of a stock that has been pulled down because it has been "tarred by the same brush" even though unlike other REITs it is in the right place at the right time, rather than being in the wrong place at the wrong time.

One way in which AVB came to my attention is that it is just about finished building a downtown apartment complex in Bellevue, WA, where I live and work. If this development says anything about the market savvy of their team, then it is a very positive statement. The development is timed perfectly to profit from booming downtown Bellevue. AVB has played its cards exactly right, at least on this occasion.

On the downside AVB does have some far flung suburban developments out there. Well, nothing is perfect, and these will still benefit from the trend towards renting. After all, people need a place to live, and with the high vacancy rate of for-sale housing, and low rate of housing construction, rentals will benefit.

Posted by Timothy at 7:58 AM | Permalink | TrackBacks (0)

Let's imagine that we lived in a society where in order to compete in professional golf, one had to have majored in golf at a prestigious golf college and needed to have done fairly well there. In such a system the professional golfers would be pretty good. But we have a different system to determine who gets to play in professional golf tournaments. It's called, "play golf." It is a better system, because although the system where one majors in golf would be a good system producing good golf players, who had all taken in courses called "golf swing 202" and participated in seminars with names like "sand trap strategies," the system where everyone just plays golf and the best player gets to move up to a higher level is a better system.

There are, of course, very important differences between golf and portfolio management. A golf game can be played in a few hours, but to really get meaningful results in portfolio management takes years. A real golf game can be played without entrusting anyone to big assets, but a real portfolio management game cannot. Accordingly, the portfolio management "competition," to be open to everyone, must be virtual. And one must be patient and wait at least years to get meaningful results. But just as the skills to do well in golf college would not precisely match the skills needed to be a play golf well (although there would likely be a strong positive correlation), so the skills needed to get a Stanford or Wharton MBA likely do not perfectly match those needed to successfully manage a portfolio (although, again, there is likely a strong positive correlation). As long as that correlation is not perfect, there is benefit to be had in opening up the process to all comers. It is a process that takes some patience, but we are seeing some real benefit now, with the MOFQX significantly outperforming its peer group of funds. It's because Ken Kam has found a better way of picking the pickers. The investment community would do well to take a good look at the Marketocracy model, because it is the wave of the future.

Posted by Timothy at 6:43 AM | Permalink | TrackBacks (0)

I believe that over the next 40 years we are going to see a continuing upward climb of petroleum prices. Over the next 10 years I believe that petroleum prices are going to rise by enough to force U.S. consumption of petroleum down from about 20 million barrels a day, now, to about 12.5 million barrels a day in 2018.

I think world production (including natural gas plant liquids) over that time period will fall from about 85 million barrels per day, now, to about 75 million barrels per day in 2018. We are likely to see increased production in Angola, Brazil, Kazakhstan and Iraq, but falling production just about everywhere else, including Saudi Arabia, Kuwait and the United Arab Emirates. Certainly, the United States and China will see lower production 10 years from now, with deep water petroleum having peaked at that point and onshore and shallow water production much lower. Russia, I think, will be about the same or a little lower. North Sea production (UK and Norway) will be way down.

So, if we accept the view that we will have about 10 million barrels per day less to divide among the nations of the world, how will this be divided? I certainly see China as taking a much, much larger share, tying the U.S. at 12.5 million barrels per day. Rapid economic growth and a burgeoning car industry will help China to consume more, even as we are consuming less. If we accept this view, at that point the average Chinese person will consume about 1/4 of the petroleum that an average U.S. person does. Western European consumption will fall, but Eastern European consumption is likely to rise a bit. Middle Eastern consumption is likely to rise a lot. As the price rises the petroleum exporters have more money to spend, and they will spend a portion of the money on more automobiles for their growing populations.

So, again accepting the analysis up to this point, how high does the price have to go to push U.S. consumption down by 7.5 million barrels a day over a ten year period. Well, the good news is that some of the choices consumers are making now will effortlessly follow through to the future. The more fuel efficient mix of cars sold now will effortlessly reduce our future consumption. But we are talking about a huge decrease in consumption, and new big SUVs, while being sold in greatly reduced numbers, are still being sold. Even if the average new car sold today consumed half the fuel of the new car sold 2 years ago, this would still not be enough, because it takes more than 10 years for the entire fleet of cars to be replaced and the number of cars may start growing again. I have to reach the conclusion that petroleum ten years from now will cost about $300/barrel, in current dollars. This would likely result in gasoline prices of about $9/gallon at the local gas station, again in current dollars.

The changes we are going to have to make will be far reaching and will effect every part of society and every aspect of our lives. Product packaging will change, with less plastic being used. Import substitution will reduce the amount of fuel spent bringing goods from abroad. Air travel will see a continuing decline. If we are smart we will start now to build a set of high speed train lines. A much higher percentage of goods will be shipped by train. (I note that currently there is a huge problem with the train line congestion).

So, how can we as investors benefit from this trend? I worry about the oil exploration and development companies because of the possibility of a windfall profits tax. But the oil service companies should not be adversely affected, and may be good deals, now. Railroads are clearly a great deal. Steel producers are huge beneficiaries on several fronts, and they are still relatively cheap (even after their incredible run up in price). Gold miners will be helped by the stoking of inflation by the increasing petroleum price, but hurt because they are major consumers of diesel fuel. And the opportunities to make money shorting stocks are obvious and numerous. I've written before about the fate of the Las Vegas casinos not being particularly bright right now. It's not the business downturn that is going to hurt them, but high air fares and declining disposable income.

Every change brings opportunity, for those who see it coming.

Posted by Timothy at 9:44 AM | Permalink | TrackBacks (0)

In the sense that every object is unique, rareness is quite common. At first it might not seem as if every object is unique, but if we were to measure the surfaces of any object down to the nanometer lever, we would certainly find differences between any given object and every other object in the world. There is a black coffee mug on my desk, apparently the same as the others in its set. But if we were to measure that mug at the nanometer level no doubt the surfaces would undulate differently and have differing microscopic dimples in the glaze. So it is not enough that an object be rare, it is necessary, in order for that rareness to give value to the object, for the object to be rare in a way that makes a difference to an owner.

There are two ways that the differentiating characteristics of an object can boost its value. Either they must yield a utilitarian advantage, or they must be famous. A nuclear power plant is valuable because once it is built electricity can be generated from it using a much less costly stream of fuel than for other power plants that consume fuel. The Mona Lisa is valuable because it is distinct in a famous manner. Let us note that it is so famous that one can just say or write, “The Mona Lisa” without further qualification and virtually every reader more than 10 years old will immediately know what is meant. That is remarkable fame. One might suggest that it is not the fame of the Mona Lisa that makes it valuable, but its beauty. I disagree, because replicas have been created which only an art expert could tell from the original, but they have no value at all, despite being approximately as beautiful. It is fame or utility that makes a rare object valuable.

But for rare objects, there is a real problem of lack of divisibility and fungibility. The Mona Lisa cannot be broken up into pieces without greatly reducing its value. Although it would be silly to discuss the fungibility of a unique object, the class of objects known as “art objects” do have fungibility (a degree of uniformity of value) but hardly any. Each must be valued separately, with no sure way of determining relative values other than holding contemporaneous auctions.

The alert reader will already have gathered that this posting is leading up to the advantages of the precious metals, which are both rare, famous, divisible and fungible, quite a powerful combination for having and keeping value. A quantity of gold can be divided up as much as we might wish. It has complete uniformity of value. Every ounce of gold in the world is worth as much as every other ounce of gold in the world (with the exception of gold formed into a valuable object or existing in a place where there are import restriction on gold). The value is easily determined by just referring to the gold market. Gold is famous. It has been and is the main symbol of wealth in every society I know of. Accordingly, it is no wonder that gold has been used as money for all of recorded history. Technology marches on, but I seriously doubt that the alchemists’ quest of turning lead into gold will ever be achieved.

So the mainstream investment community is foolish to ignore that great potential of gold as the world economy and total world wealth, especially when measured in U.S. dollars, is growing so rapidly. The general dismissal of precious metals as an investment option also opens up the alluring possibility that should the mainstream financial community ever decide that the precious metals could be a good investment, after all, the price will really take off. During the last gold rally, lasting from the beginning of last quarter of 2007 until close to the end of the first quarter of 2008, some mainstream analysts started to say things like, "If you want to invest 5% of your assets in gold, go ahead." Because of their extreme unpopularity as an investment option, precious metals have an immense potential for appreciation. If pension funds were ever to start investing in precious metals, which I certainly believe they should do, then watch out. That would be a gold rally to end all gold rallies.

This scenario is not too far fetched. As gold becomes the best investment one could have made over the past 10 years (it may already be) it will start to gain some credibility as an investment. If it becomes the best 20 year investment, that is credibility. To Wall Street, twenty years means "forever."

Posted by Timothy at 8:28 PM | Permalink | TrackBacks (0)

I see no contradiction between the concept that the stock market is efficient and the idea that a person could outsmart the market on a long term basis, although I think that many other observers do see a contradiction there. I believe that market efficiency is largely a matter of perspective. Let us take the perspective of "Joe Investor." Joe investor has an IRA of $200,000 and he would like to get the maximum return on this budding nest egg. He has above average intelligence and is quite interested in the stock market. He reads a few different publications on this subject and is considering using the advice given in these publications to make investment decisions. He has some of his money invested in individual stocks and another portion in mutual funds. From Joe's perspective, unfortunately, the market is efficient, for the following reasons:

1. With respect to stocks:
a. Anything he reads will have been read by hundreds of thousands of other investors.
b. Whatever the article writer has gotten right will have had its value diluted by a movement of the stock in the recommended direction.
c. Whatever the article writer has gotten wrong will mislead Joe.
d. The mutual fund managers, capital managers and big-money investors who are trading in Joe’s stocks will have much deeper and more complete knowledge of the issuing companies, and their business environments, than Joe has.

2. With respect to mutual funds: Any mutual fund that has performed well enough, long enough, to really show that it is being managed with skill, and has not just been the beneficiary of good luck, will either:
a. Have so much money to manage that it will have a very difficult time meeting previous performance levels, achieved while managing much less money; or
b. Be closed to new money, so that Joe will not be able to invest in that fund.
Moreover, there is no way to tell, for most funds, when there is an actual change in management.

So, for Joe Investor, the market is efficient. He might as well, indeed, invest in a passive instrument, such as an index fund.

Does this mean that it is not possible to beat the market on a regular basis? Of course it does not. Joe is working on the assumption that standard sources of information, interpreted in a straightforward manner (i.e. accepting the advice they give) can work. Nothing, of course, is that simple. In order to beat the market one must disagree with the current, most widely accepted (by the big money players, that is) market wisdom. One must free him or her self from commonly accepted images of industries and question every societal bias. One must be broadly informed, think independently, and have very strong analytic skills that one trusts as a guide.

Take, for example, my bet on the steel industry in 2003, when it had the worst imaginable image as a rust belt, sunset industry. I challenged that image, by asking why the domestic steel industry had that image. The conclusion I reached was that it was at least in part due to a dollar that had been very strong in the eighties (Reagan era supply side economics) briefly dipped in the early nineties, but then came roaring back and given an extra boost by the Asian currency crises of 1998. No wonder the domestic steel industry had suffered such a string of painful reversals. The strong dollar, the low price of fuel and comparatively low wages abroad had encouraged a flood of imports. But the dollar had already begun to fall at that point and any thinking person had to realize that the trade deficit of that time was unsustainable (although it continued to grow, even after that). Moreover, the increasing price of fuel would make it more expensive to import steel from distant countries. Now the domestic steel industry is doing great. The price of stock of AK Steel has risen from a low of about 2 and 1/2 in 2003 to 65 today (it was recently over 70 before dropping back a bit).

By questioning the accepted wisdom (and industry image) of the time, that the domestic steel industry was a rust belt, sunset industry, and by looking at the bigger international and historical picture behind that image, I was able to make a lot of money, both virtually and actually. What stunned me, and continues to puzzle me, was the power of that imagery in the minds of people that I would talk to, who simply could not accept the idea that the domestic steel industry would stage a comeback. The poor image, of course, made the deal so much sweeter, because it made it possible to purchase shares at what, in retrospect, was a ridiculously low price.

So for someone who examines the broad historical trends, who understands that just because things are a certain way right now does not mean that it is normal for things to be that way, who challenges industry images and looks deeper for the underlying causes of growth or decline, and who enjoys doing this and is good at it, the market is not efficient at all. It veers crazily in one direction, sending stocks of companies with no earnings up to dizzying heights one year, only for them to come crashing down and out of business the next. That is not efficient. Right now the stock prices of companies that own Las Vegas casinos are at high levels that makes no sense whatsoever. After all, their earnings were down with $100/barrel petroleum in the first quarter, what will $130/barrel-and-up petroleum do to them this quarter and next? Also, there is a crazy lack of recognition for the growing tidal wave of inflation that will sweep over our society, changing everything. There was an article in the New York Times business section yesterday advising how to manage one's bond portfolio with the threat of inflation in the air. I know how a bond portfolio should be managed: LIQUIDATE.

I would never say that beating the market is easy. The market is not logical, but rather a chaotic, illogical beast. But if one is patient and insightful, those reckless swings can become very profitable.

Posted by Timothy at 1:54 PM | Permalink | TrackBacks (0)

This conversation will take place at different times in different industries. But gradually more and more U.S. importers will have this conversation:

Mr. Smith: Mr. Chan if you do not shave another 5% off, we will just have to take our business elsewhere.

Mr. Chan: OK. Good luck with that.

Mr. Smith: Perhaps you did not here me aright. I SAID, we will have to TAKE OUR BUSINESS ELSEWHERE.

Mr. Chan: OK. Good luck with that.

Mr. Smith: But don't you know that you need our business. We sell in the United States of America, the world's richest market. From the Texas Oil Billionaires, to the swanky shops of New York City, to the inestimable wealth of Silicon Valley and even Redmond, Washington, home of Microsoft. That is a market you cannot pass up. You need to sell through us, into the world's biggest, the world's baddest, the world's richest market.

Mr. Chan: Actually, right now the United States accounts for 12% of our sales, and we don't make any money off of it because you drove such a hard bargain last year at this time. We're in business to make money. If you want to go elsewhere, go.

Mr. Smith: That is impossible. You are bluffing.

Mr. Chan: No, 40% of our sales are in China, another 20% are in the rest of Asia, then 20% in Europe, and finally 7% in the Americas outside of the U.S. and 1% in Africa and Oceania. Those sales are growing, so if we lost 12 % of our least profitable sales, it would only mean a temporary disruption. And we would actually be more profitable.

Mr. Smith: Well, OK. You don't have to lower another 5%.

Mr. Chan: Actually, we are going to have to raise our price by 5%.

Mr. Smith: Oh well. I guess that's life.

Posted by Timothy at 10:33 PM | Permalink | TrackBacks (0)

I have for quite some time now predicted sharply higher petroleum prices. But even for me this last run up is unexpected and even a bit frightening. Take a look at this link: http://www.eia.doe.gov/pub/oil_gas/petroleum/data_publications/weekly_petroleum_status_report/current/txt/table1.txt.
Page down to near the bottom, to see the inventories of petroleum and petroleum product in the United States. Crude oil is down by 5 million barrels from last week, and total inventories are down by 3.5% from last year. Granted, these statistics are far from pinpoint accurate, but to have declined by 3.5% during a year in which petroleum prices went steadily upward is very disconcerting. It shows that this price run-up has not been caused by speculation but rather by fundamental market forces. It also brings up the question of when this will end. What price is high enough. In the New York Times this morning there is a front page article entitled, "Airlines' Cuts Making Cities No-Fly Zones" by Micheline Maynard. It's also on-line at http://www.nytimes.com/2008/05/21/business/21air.html?_r=1&hp&oref=slogin.
Take a look at the table of number of commercial flights from major airports in January '08 vs. January '07. It is clear that airlines have cut back on the number of flights pretty dramatically. As the headline indicates, many (nearly 30) airports have entirely lost commercial service. We must be avoiding petroleum use by cutting back on the number of flights, BUT IT'S NOT ENOUGH!!!!! Perhaps American Airlines' new scheme to charge for even a single item of checked luggage will do the trick, and start inventories rising again. But it's hard to know how much will be enough.
On the other hand commercial aviation is booming, in Dubai, that is. And it's booming in Qatar, Riyadh, Shanghai and Mumbai.

We have to start thinking about how we can arrange things in this country so that we use substantially, that is substantially less petroleum. The SUV must become smaller and less powerful. Airline flights must be replaced by train and bus rides. Cities must become more compact, reducing the amount of driving necessary.

This is the result of our success in proselytizing for the Free Enterprise System. We convinced China, Vietnam and Russia to join is in the free market quest for prosperity. But now they can compete with us for the world's resources. Could we have it any other way, and yet be a moral people?? "Really, although we don't choose communism ourselves, we think it is a great fit for you (smirk, smirk)." I don't think so. We all knew the world would some day run out of petroleum. Now we just have to learn to live with it a little earlier than we otherwise would have.

In the meantime, imagine the United States using less petroleum, and think about how it will be different. Then invest accordingly. The future is arriving a little sooner than expected.

Posted by Timothy at 3:09 PM | Permalink | TrackBacks (0)

Must we enumerate everything? I used to eat at the Panda Inn in West LA, where they had a delicious dish called, "Three Ingredient Tastes." When I saw that I thought, "The numbered list is a pretty strong element in Chinese culture." But, then again, it is western culture that originated such famous enumerations as the Ten Commandments and the Seven Deadly Sins. So I guess the numbered list is a cultural constant.

Not to rebel against a universal element of culture, I will now discuss the Three Ingredient Tastes of Gold Demand. The first is growing world wealth. This is a little bit like bread dough rising. It does not change much, from one day or even week or even month to the next. But it is steadily increasing. The growing economies of China, India, Brazil, Russia and Vietnam all have increasing gold purchasing power (measured in dollars-worth of gold), but it's not much different from what it was a month ago or even six months ago. Fast-forward 30 years, however, and the size of the Chinese economy is likely to be much larger than that of the United States, with India, perhaps, not that far behind. This will lead to a tremendous growth in gold prices over the next 30 years. But it does not mean that the price of gold should be higher this month than last month, because the size of these economies has not changed very much in a single month.

Next, there is sensible investment demand for gold. This is affected by things like interest rates and the consumer price index. This tends to increase when inflation figures are high (or interest rates are low), but falls back down a little if inflation numbers read lower or interest rates tick up. It's a little unpredictable, like a faucet being turned on and off by an invisible hand (credit to Adam Smith).

Finally, there is the demand for gold caused by an increase in the price of gold, or short term speculative demand. Yes, some people will buy gold for no other reason than a perception that the price of gold is "going up." This exaggerates the movements in the price of gold, because this group of buyers also tends to sell very quickly (frequently automatically) if there is much of a drop in the price of gold.

So, how do we play the gold market. First, don't be left out. It is certainly true that for those investors who look for productive resources, such as car plants, to invest in, gold looks to be a nonstarter. Gold is not productive. For the most part it just sits there. But productive resources, by and large, are not intrinsically rare. More car plants can be built. More retail outlets can be built. More soap factories can be built. And, more restaurants can be built. Intrinsic rareness is an extremely good (and rare) quality for an investment. It makes up for the fact that a bar of gold sitting in a vault is not productive.

And gold does perform an economic function, in the sense that it is a store-of-value. The value of this function changes dramatically with perceived need. If the dollar is a good store-of-value, then there is little need for gold. But the dollar's role as a store-of-value is increasingly coming into question. If the dollar has stopped acting as a good store-of-value, and it sure has not been very good over these last few years if you are someone who travels to Europe, then the need for another will become increasingly apparent. The precious metals are far too easily dismissed by the mainstream investing community. They are fungible, dividable and rare like nothing else. They are rare by nature, whereas a million dollars is rare as a human construct. As such, the rarity of a million dollars is far more vulnerable to the shifting tides of human affairs than is the rarity of 1,100 troy oz of gold (about a million dollars worth right now). Everyone should own some gold. This is especially true today, as the huge U.S. trade deficit continues to, and will continue to, exert downward pressure on the dollar and as petroleum scarcity causes the price of petroleum to rise dramatically.

My strategy is to slowly buy in the troughs. The dough of the world economy is rising, little at a time, and it will by itself boost the price of gold over time. It is not something that can be seen on a daily basis. What can be seen on a daily basis is the change in investment demand for gold, and most particularly the short term speculative demand. When those set in, it is probably good to wait awhile and ride the wave, but then start getting out. That is a tough decision to make, but if you get out a little at a time, just as you got in a little at a time, you are likely to have a good ride on that wave of speculative demand, and still not be wiped out when it comes crashing down.

I think the next wave is going to be a doozy.

Posted by Timothy at 9:25 PM | Permalink | TrackBacks (0)

No, I don't mean that these comments will be stupid. I'd like to react to some comments in today's New York Times Business Section from the the "Market Maker" column by Nelson D. Schwartz bearing the headline "A Peak Behind the Price at the Pump." The first comment is that of Mr. Schwartz who writes, "While no one disputes that China and other emerging economies are craving more crude, the stunning rise of oil from $62 a a year ago is hard to explain as only a matter of supply and demand. After all, analysts have noted adequate inventories." Excuse me??? If the price rises to a point higher than supply and demand would dictate, then inventories should rather quickly become more than adequate. The higher price should restrain demand and increase supply, causing inventories to become bloated. This is what happened in the summer of 2006, when prices rose to the high $70s per barrel. The fact that U.S. inventories, as reported by the Energy Information Agency of the Department of Energy (http://eia.doe.gov) are slightly lower now then at the same time last year indicates that prices have not, for the most part, been above the point that supply and demand dictates. The most recent rise to levels in the mid 120's is too recent to evaluate, however. If, in a few weeks inventories rise above the levels of a year ago it could well be an indication that the price has risen too high and is due to fall. One thing that I feel certain of is that these prices will severely cut into demand. Yes, demand for oil is price inelastic, but not completely so. There is elasticity there. And we are seeing it and will see more of it.

The second statement is an implied quote from one William H. Brown III, an independent energy consultant in Chappaqua, New York, "Based on more traditional fundamentals like the cost of finding, producing and shipping crude, oil should be in the mid-60s." Excuse me!!!????!!!! If we spend $X to find, develop and produce Y barrels of oil, and if X/Y = $60/barrel that does not, does not, does not mean that if we spent $2X we would find, develop and produce 2Y barrels. Even if the additional $X could be spent efficiently, that oil drilling rigs would pop into existence at the right price and that trained workers would materialize and could be hired at the same rate as if we were spending only the original $X rather than $2X, it still would not mean that 2Y barrels would be found, developed and produced. This is because at any one time, there are only a certain number of good prospects for exploration and development. So saying that a cost of $60 per barrel to find, produce and ship oil should set the price at $60 barrel is a little like saying that if it costs X amount to produce a bushel of corn, that should set the price of corn. If the price goes above X, farmers should just increase their expenditures per acre and grow more corn. WELL IT DOES NOT WORK THAT WAY. It's possible that even if a farmer doubled his expenditures he would not grow a single additional ear because he is already spending all the money that can sensibly be spent to grow the maximum amount of corn on his land. And it's possible that if we doubled our expenditures for finding and producing oil, we would not find and produce very much more oil at all, because we are already spending all the money that can be sensibly spent on those efforts.

None of this is to say that the basic point of the column, that some of the price increase in crude is due to dollar hedging is perhaps not correct. But wouldn't one expect to see a little more of that hedge money going into gold, rather than oil. For my money, basic supply and demand has been the principal driver of the increase in oil prices, with other factors playing supporting roles. Sure, it may have run up a bit too high. What we have seen over the last few years is an oscillation about a rising mean, and we could be at the high point of an oscillation. But the mean has been rising because of supply and demand, and that is not about to stop.

Posted by Timothy at 10:33 PM | Permalink | TrackBacks (0)

U.S Retailers are being squeezed between rising prices for imported goods and declining disposable income for Americans. This is not a short term trend. By the time the squeeze is over, the stage will be as littered with bodies as it is at the end of "Hamlet." Sears Holdings is terminal, as are the private buyouts: Linens 'n Things, Mervyns, perhaps Toys R Us, and possibly Dollar General. This is a squeeze that will shake retailing to its foundations. Real Estate Investment Trusts that focus on Malls and "Lifestyle Centers" will be pushed to the limit, if not over.

This is all part of a great shift from consumer driven growth to producer driven growth that is necessary for the United States to reduce its huge trade deficit. Until the trade deficit is reduced significantly there will continue to be intense downward pressure on the dollar. The falling dollar will drive up the cost of imported goods, which is a good thing for American manufacturers. It's a huge problem for retailers, however, as they will have a difficult time passing along the price increases. Making the situation even worse is the drop in disposable consumer dollars available to Americans. With food and fuel prices way up and with the possibility of obtaining a home equity loan gone for many, if not most, there is just not the money to spend on other goods that there once was. As the number of disposable consumer dollars shrink, competition for the remaining dollars will grow more intense. Retailers with healthy profit margins in 2007 will see them shrink in 2008. Those who did not have healthy margins in 2007 will be challenged to have any profit at all in 2008.

As an example of how inescapable the coming price increases will be, let us consider a pair of inexpensive gym or tennis shoes, imported from China. First, many of the materials used to make this type of shoe, such as the synthetic rubber of the sole, have their origins in either petroleum or natural gas. Both have risen in price dramatically. Then, the labor of the Chinese workers who assemble these shoes has risen in price in terms of Yuan. Also, the Yuan has risen in value, relative to the dollar. The fuel necessary to move the shoes across the Pacific Ocean has dramatically risen in price, and the fuel needed to truck them to the store has risen in price. Add it all together, and it equals a situation where the store selling those shoes must raise its price.

But the people coming to buy those shoes have had to spend more on gas to get to the store. They have spent more on groceries, just to keep themselves fed. They are going to check the ads carefully and price compare over the Internet. They may buy the next pair of shoes over the Internet, from Amazon.com, yet another challenge to the brick and mortar stores. They will endeavor to drive the hardest bargain possible, because they must. Or they can decide to do without. And that is a real problem for retailers, who must sell, at a profit, to stay in business.

Exacerbating the problem is the heady growth that U.S. retailers, such as Target (TGT), Lowes (LOW) and Kohls (KSS) have experienced over the past 5 years. The growth premiums built into stock prices are not yet altogether gone, although they have certainly been reduced in the last few months. But now the pricing of stocks should reflect a concern for solvency and an awareness that profits may not only be reduced in 2008-2009, but they may give way to losses. It is also difficult to quickly put a brake on the expansion in the numbers of stores. It seems that each company is revising its expansion plans downward, but it won't be enough. Wal-Mart, for example, opened 80 stores in March. Some of them replaced older stores rather than being truly new additions, but that is still a lot of stores. Lowe's and Walgreen's continue their expansions, somewhat slowed, but still at a pretty good clip. Costco appears to be barely slowing its expansion, if at all. Its expansion of market share must come at the expense of some other store or chain. Consumers definitely have a choice, making the potential for price competition so very brutal.

The only chains that may emerge unscathed are the ones that have a large rural connection. This is a huge advantage for Wal-Mart, its roots are rural and it has a huge presence in the southern farm belt, in particular. But chains with a suburban focus, such as Target (TGT), Kohls (KSS) and Home Depot (HD), are going to be tested as never before.

I believe that Sears Holdings (SHLD) is in deep trouble. This is the company that operates both Sears and Kmart, and which is largely owned by entities controlled by Eddie Lampert, the famous hedge fund manager. They have squandered such an incredible amount of goodwill over the last two years, that they meet this downturn very ill prepared. Even now that they are spending on image-building advertising, there is not a consistent effort to present a lively and engaging shopping experience to those who respond to the commercials and venture into a Sears or a Kmart store. Advertising only goes a small way in persuading people to patronize a store chain. Most are likely to patronize a set of stores that they are familiar with. There is a certain efficiency to this, because consumers learn the store layout. They learn where the items they want are located. They have a comfort level with the store that causes them to return. So the goal of advertising should be to convince consumers to just give a store a try. After that, the shopping experience must be positive enough that the shopper will form a habit of patronizing the chain. Unless the stores are fun to shop in, people who respond to the ad, and give a store a chance, won't come back. So the lack of updating of Sears and Kmart stores is slowly deadly. The money saved by foregoing store updating shows up in the balance sheet and the income statement. The loss of goodwill remains unrecognized in the balance sheet and income statement. But in a severe consumer spending downturn like this, that goodwill is needed as never before. I believe Sears Holding is terminal. This downturn will be so terrible that the company will not survive.

I do have puts (a bet that a stock will go down in value) on both Sears Holdings and Target.

Posted by Timothy at 7:09 AM | Permalink | TrackBacks (0)

After the posting of my last entry, Edmund Ho, chief executive of the Chinese special administrative region for Macau, stated that no licenses would be granted for new casinos or expansions of existing casinos in the near term future. This caused the price of stock in the Las Vegas Casino companies that have licenses in Macau: Wynn (WYNN), Las Vegas Sands (LVS) and MGM Mirage (MGM) to take about a 10 percent jump. And right after I said they are headed down. Not to mind, they are headed down, quite soon.

First, the decision to stop issuing licenses will not have an effect on business for at least 2 years, as expansions including planning, license application and construction generally would take two years. Second, it does not mean that there will not be more competition for the established casinos of Macau, because there will be competition, first from Singapore were two new huge casino resorts are under construction, the first to be opened in early 2009, but also now from Taiwan, where the president elect, Ma Ying-jeou, favors permitting the local governments of the Penghu island group to issue casino licenses.

In fact, it was the competition from outside Macau that appears to have prompted Mr. Ho to make the statements about not approving any more licenses. Also, Ma is from the more Beijing-friendly part of the Taiwan political divide, so perhaps by the time casinos are built in Penghu it will be possible for mainland Chinese people to travel to gamble in them.

In any event, a gaming license in Macau is not the license to print money that it might have once appeared to be. Don't get me wrong, Macau is a fabulous place to be for the casino companies. It is just not quite as golden as first appeared after the opening of the Sands casino hotel there, where Las Vegas Sands is reputed to have netted back its investment in a mere nine months. But that was the first western, Las Vegas style casino there. And all those marketing techniques that had been built up in the fiercely competitive Las Vegas market for years proved very successful in Macau, where there had been a casino monopoly for many years. Now that there is more competition both from Wynn and MGM and from the operations of the Stanly Ho empire, revamping to compete, it won't be quite as easy to rake in the big bucks.

The Singapore casinos, the first of which is being developed by Las Vegas Sands, are a particular threat to the high roller market, which represents the Lion's share of the take in Macau. High rollers can afford to go wherever they want. Also, they like new and opulent, which the Singapore casino resorts will certainly be. So, far from being an edict against competition, the Macau decision against new licenses was a recognition that plenty of competition is coming, and no more is needed right on Macau, right in the immediate future.

Everything I stated about the Las Vegas Market still holds. I just read today that house prices in Las Vegas fell 24 percent in March from a year earlier. That represents a huge decrease in wealth for Las Vegas residents. Even though Boyd Gaming Co. (BYD) has come down from 50 to 18 over the last year, it still looks to be worth shorting this stock, as the locals market, which it has a good share of, looks to be sure to be trounced.

But Wynn is still at very high levels, with a PE of about 25, and the rise of fuel costs is likely to just savage their bottom line. Even if the number of visitors only falls by a small amount, the remaining visitors will be wooed so much more strongly, and expensively, principally with lower room rates, that the fall in revenue is likely to be just devastating. And the Wynn Encore, a huge new casino hotel right next to the Wynn, is still under construction and likely to open in late 2008 or early 2009. The squeeze is on. And the stock still has a substantial growth premium.

I do own puts (a bet that a stock will fall in value) on Wynn Casinos (WYNN).

Posted by Timothy at 5:38 AM | Permalink | TrackBacks (0)

"This part of the economy has seen steady expansion for the last 30 years. Now that is a durable trend."

NOT.

No portion of the economy can grow significantly faster than the overall economy, forever. If that were to happen, that part of the economy would gradually take over the entire economy. If the semiconductor industry grew significantly faster than the overall economy forever, eventually every person would work making integrated circuits. There would be no hospitals, doctors, dentists, etc. At some point the growth has to stop being significantly faster than the overall economy and become either insignificantly faster or even slower. Or, that growth could be thrown into reverse.

When growth goes into reverse it is a great money making opportunity, because when growth becomes shrinkage stock prices can really plummet. There is typically a growth premium factored into the recently-growing industry's stock prices, which will be soon removed. Then, the fact that the industry was growing works to the disadvantage of each one of the individual players. It is too late to cancel projects half-way finished. They get finished and simply add to the misery of competing entities.

This is the sad tale of Las Vegas today. The number of visitors is on its way down, and that shrinkage in the number of visitors could accelerate as airlines pass along the increased cost of fuel to their customers and cut back on the number of flights. All at the time that new projects are being completed. The huge, over 3,000 room Palazzo has just been placed into direct competition with the Wynn. Also, the Trump Tower 1, which includes a condo hotel has recently been completed. An MGM condo hotel is opening this summer. It would be bad enough if the number of visitors was holding steady. But as it is on the way down, disaster is striking in a huge way.

Here are the four trends that will devestate the Las Vegas casino resort industry:

1. The high price of fuel, making it more expensive to get to Las Vegas and driving down the number of visitors.
2. The reduction of disposable income for Americans.
3. The continuing completion of partially constructed projects.
4. The devastation of the local Las Vegas economy.

There is a counter trend in the weak dollar promoting tourism from abroad and keeping U.S. tourists in the U.S. But it's not strong enough to counter the other four.

With respect to trend 2, the increasing price of food and gasoline and the decreasing value of houses (depriving many of the possibility of getting a home equity loan) is definitely reducing the disposable income of Americans. If there is less money, there is less money to get to and take to Las Vegas. I believe that disposable income will be under pressure for years to come. The United States must start consuming less and producing more if we are ever to reduce our huge trade deficit, which is unsustainable and will, one way or another, be reduced.

Regarding trend 4, each partially built casino will either be completed, adding to the growing surplus of hotel rooms, or canceled. If it is canceled, that adds to the misery of Las Vegas, where legions of people working in the home building business have lost their jobs. With the cancellation of a project, and it does appear that the Cosmopolitan project might very well end up not being built (see http://www.reuters.com/article/ousiv/idUSN0328923220080409)
another legion of construction workers will lose their jobs. The Las Vegas unemployment rate, at 5.4% is already higher than the national average of 5.1%. What's more, the drastic slump in house values, much worse than the average for the nation, will curtail home equity lending, depriving potential casino patrons of the cash needed to gamble. Some gamblers, even at the big fancy hotel casinos, are locals. It might not be a very high percentage, but they do make some difference.

What makes the opportunity particularly prospectively lucrative is that the stocks of the Las Vegas casino companies have growth premiums still built into the price. Wynn, in particular, has a price to sales ratio of about 4 and a PE ratio of slightly over 40. It would appear that these valuations presume future growth. If that growth is actually shrinkage, the growth premium will go away. Along with the darkening prospects this could make for a particularly swift decline in stock prices.

This is not a temporary dip for the Las Vegas casinos, it is a trend reversal that will last on the order of 20 years. Fuel prices are just going to continue going up and disposable income will continue to fall. We may never have another blow-out consumption-driven growth period like 2003 through 2006 ever again. Well, not for awhile, at least.

But Las Vegas itself (not the casinos) may see a comeback, by way of solar power. The casino melt down is going to dominate for at least five years, however, before other industries can generate enough steam (no pun intended) to pick up the slack.

I do have puts (a bet that a stock will go down in price) on Wynn Casinos (WYNN).

Posted by Timothy at 3:41 PM | Permalink | TrackBacks (0)

I am reading a book, A History of Venice, by John Julius Norwich, that I can recommend without reservation. As I read, I am struck by the parallel between Venice, the powerful republic that dominated Mediterranean trade for over 500 years, and Google. Both Venice and Google have a subtle yet critical advantage over their competitors. In both cases, this advantage matters far more in any analysis of future prospects than the latest news of ships arriving laden with goods from the Levant, or paid clicks per month.

In the case of Venice the great advantage was the defensibility of the Venetian lagoon. It seems strange to me that a lagoon could be a better protective shield than a strong wall or mountain redoubt, yet this was the case. The shifting sands of the lagoon bottom made navigation through this body of water very difficult. When the Venetians knew an invading army was approaching, they would remove the navigational markers they used to guide themselves, and make their lagoon unnavigable to others. They could still sail in and out from memory. As a result they were able to survive unscathed as invading armies sacked all the other northern Italian cities. It cannot be coincidental that pluralistic political systems evolve in easily defended places like the British Isles and North America, and so it is unsurprising that the Venetians developed an intricate system of republican government that served them well for over 1,000 years, providing a man created advantage to match the natural advantage provided by the Venetian lagoon.

In the case of Google the great advantage is that Google has ensconced itself at the top of the web. Having done so, they are now impregnable, yet able to threaten all other web enterprises. A search engine is the top point from which the entire web can be seen. From this high vantage point the user descends to a particular website that is spotted in his search, and may descend further to a particular page in order to purchase, for example, a pot or pan. Having taken the high ground, Google has the resources to continually invest in their search engine, to provide the type of search experience that users want. Why would I ever try another search engine? I know Google. I know it works. I know it works quickly. I know how to use it. To try another search engine would be to take a risk I do not want to take. A Google toolbar is on, at least, tens of millions of computers. That is a huge intangible asset and a huge advantage that no competitor can hope to trump.

The Google position at the top of the web provides an advantage of visibility for any service Google may wish to introduce. To find an example of this I just went to Google and typed in “The Grapes of Wrath.” Not to disappoint, the first hit in the Google list was for Google Books, a service with which I was not previously familiar. Not surprisingly, when I went to Google Books I was given the opportunity to purchase this book from several different web sources. Book sellers tremble. Google is in a position to take its cut. Google did not have to run a hundred million dollar advertising campaign to make me aware of Google Books. They only had to make it pop up first when I did a search for a particular book title. THAT IS AN ADVANTAGE.

The web is still growing. More people are getting web access or upgrading to high speed access. More people are taking the plunge to order items on line. More people from around the world are starting to use the web. This translates to built in growth for Google even without the constant rollout of new initiatives. But new initiatives will be rolled out, because just as the sanctuary of the Venetian lagoon fostered an innovative and effective system of government, so the web supremacy of Google is fostering an innovative and effective corporate culture. The best and the brightest want to work with the best and the brightest-at Google.

The famous contemporary poet, Billy Collins, said that a reader should not tie a poem to a chair and try to force a confession out of it. In like manner, the financial analyst who wants to bring Google into his world of measurable quantities, like paid clicks per month, completely misses the point. Get your damn calipers off of Google. That bears repeating: Get your damn calipers off of Google. That was so much fun I think I’ll do it again: Get your damn calipers off of Google. Don’t try to grab Google and pull and tug into your room of financial figures. Go to its peak of delicious possibility. You will understand Google far better if you do.

Now if you are a day trader, feel free to disregard every single word I have written. None of this will make a difference day to day or week to week or even month to month. But true investing is the art of seeing reality as it really is, and profiting from it. To do that, one must be a little patient, because fools will tug the stock price up and down for silly, insubstantial reasons. But if you buy some Google stock and wait for a year or two, I make bold to predict, you will not be disappointed.

Posted by Timothy at 1:32 PM | Permalink | TrackBacks (0)

The stock market is efficient, yet it is not. If we define efficiency as the use of publicly available information to set the price of stocks according to the most widely accepted information analysis methods, used by the biggest money players, it is indeed efficient. But that leaves a question: If the stock market is efficient, why do prices change so often by so much?? If we were to define efficiency as the use of publicly available information to accurately predict future returns, we would have to say that the accuracy is largely missing, or at least that the expectation of future returns varies dramatically from one year to the next. If we presume that the more recent estimates of future returns are more accurate than the older estimates, then something was wrong with those older estimates.So, why did the big money players, using the most widely accepted information analysis techniques come to incorrect conclusions regarding future returns?? To some degree, I am puzzled. It seemed obvious enough to me that the dotcom boom would bust, that U.S. machinery and steel stocks would rise and that Latin American markets would rise. Why wasn't it obvious to everyone?

I have a few theories. One is that even the big money players are vulnerable to a drive to conformity born of the greater error penalty accompanying unpopular choices. If 80% of the investment community believes that A is a great investment, then if manager 1 goes along with this point of view and invests in A and he is wrong, well, so was everyone else. He was just doing what all the other managers were doing. He never pretended to be a genius, just a pretty good money manager. But if he bets against A, against the other 80% and he is wrong, then he is an idiot. Everyone else saw that A was good, why didn't he?? At the time he placed his bet against A, it deprived him of credibility, just because it went against the norm. When A goes up, he is really "in the soup." He feels that 20 years later, when he is traveling incognito in New York, and he mentions that he has not been on this particular subway since 2008, the person next to him will say, "Oh, around here we call that the year of manager 1's huge mistake" and burst out laughing. So even the best and the brightest, shepherding the most money, are vulnerable to a tendency to defend their future reputations by adopting an investment strategy that does not differ "too much" from the most widely accepted contemporary viewpoint.

This drive to conformity, such a huge factor in human affairs, tends to warp stock values by making trends and biases more persistent than they would otherwise be. For example, it has taken the steel industry quite awhile to shake its terrible image from the 1990's and early 2000's, when Bethlehem Steel, among others, went broke. AK Steel (AKS) had a low in the 2's back in 2002, but now it is a little over 68. And I'll be darned if it isn't true that during that whole, hugely-profitable-for-some trek up, its mean analysts' rating never got better than a very, very bad 3. The bad image from the earlier years has stuck like glue that the domestic steel companies just cannot seem to shake off. Not to mind. The terrible image has kept the doors of opportunity open for those who don't mind taking a risk and going against the analysts' ratings. Back in 2005 I wrote a Marketscope piece recommending the domestic steel companies. Directly afterward, their stock values plunged. But all of my reasoning was long term, and now the prices are 3 to 5 times what they were before that plunge. It was difficult when I had gone against the accepted viewpoint and felt that I had lost. But I never lost the confidence of my vision. I kept the bet going and have won big since that time.

It is my basic point, although I know that I cannot prove it, that the drive to conformity lent persistence to the bad image of the steel industry. Each analyst was afraid of going against the negative consensus view. So that negative view persisted far beyond the time when it was reasonable. The truly sad effect is that portions of the domestic steel industry were sold to foreign entities during that time. I don't mean to sound like a narrow minded Chauvinist, but those were valuable assets that were sold to foreign entities at woefully low valuations. It is just very sad that no Americans (well moneyed enough to do it) saw that value and held onto it.

Posted by Timothy at 1:57 PM | Permalink | TrackBacks (0)

I started out in tech but have shifted about in sectors as opportunities have presented themselves. As of January 22, 2006 I am lightening up on energy, which has had a pretty good run, and building up a little more in basic heavy industry.

Well, I got almost completely out of energy and am now getting back in (April 15, 2006). My object now is to be half invested in energy by May 15, 2006, if buying opportunities present themselves. It would be great if the price of crude would drop to under $65 a barrel before then, so I could fill up my tank.

If not, I will just be content with what I have and the diversity of this portfolio.

Posted by Timothy at 1:56 PM | Permalink