Wealth International, Limited

Finance Digest for Week of March 29, 2004


Some of the nation’s savviest investors have learned to “just say no” to buying overpriced U.S. stocks. “Legendary Investors are Drowning in Cash,” observes Morningstar’s Gregg Wolper. “When several of the very best managers all say they are having an extremely difficult time finding anything to buy at prices that make sense -- not just in the U.S. stock market, but in the bond arena and foreign markets, too -- it is worth paying attention. In fact, it is remarkable how many top-flight managers currently have more than 20% of assets in cash and say they find compelling opportunities scarce to nonexistent.”

Warren Buffett made his billions by buying low and selling high. So is it not significant that the Oracle of Omaha is finding almost nothing to buy? At the end of 2003, Berkshire Hathaway held 23% of its assets in cash -- up sharply from the single-digit levels of the previous four years. Jean-Marie Eveillard and Charles de Vaulx, the legendary managers of First Eagle Global Fund, are also piling up cash. “Eveillard can’t find anyplace to invest the fund’s cash,” Wolper reports, “which [stands] at 23% of assets. And this for a fund that can freely invest in bonds, too. Sounding like Buffett, [Eveillard’s partner], Charles de Vaulx said high-yield bonds are overpriced now, too.”

“... When so many justly respected managers are sounding the same cautious note, it makes sense to listen,” Wolper concludes. “Even the greatest managers can’t consistently predict the direction of the markets -- and by and large, they don’t try to. But right now, their words -- and deeds -- speak volumes.”

Link here.


John Templeton is maximum bearish on the housing market. Jim Rogers expects a long, deep decline in the dollar. Warren Buffett is negative on stocks, bonds, and the dollar. George Soros foresees a bond market rout. Bill Gross expects a recession at least as deep as in the early 1980s. On the other hand, President Bush and the U.S. Congress are certain we are only one good employment report away from everlasting prosperity -- it must be true because Alan Greenspan said so.

Clearly, we have a difference of opinion here. Templeton, Rogers, Buffett, Soros, and Gross versus Bush, Congress, and everyone else in Washington, D.C. This is a hard call. One group wants return on capital and interest on principal. The other group is interested in returning to the capital and has no principles. Nevertheless, conventional wisdom is that politics trumps economics.

In a historical sense politics does prevail -- until the situation becomes unsustainable -- and then economics returns with a vengeance. Whether it is John Law and the Mississippi Company three hundred years ago, the rising sun of Japanese stocks and real estate fifteen years ago, or the sovereign bonds of Argentina last week, when bubbles reach unsustainable levels it does not matter whether the politicians want to keep them inflated. They pop.

All it will take to pop this bubble is a meaningful upward shift in the yield curve. In an economy addicted to easy credit, cheap credit, and excess credit, there is no way that increasing interest rates can be other than excruciating. Greenspan is hoping that some smooth and slow deflation of the multiple bubbles in the economy can be brought about by a very gradual, very well-telegraphed increase in rates when the time comes. Financial history says otherwise.

Link here.


Whenever overly excited journalists, politicians and pseudo-economists start telling you the United States should worry more about economic strength in China and India than about economic weakness in Europe, Mexico and Canada, remember to check what they said about Japan and Germany overtaking the U.S. economy a mere decade ago.

Link here.


According to an announcement made by the company last week, 93% of the voting shares chose to reject a move to reincorporate in the United States, which was proposed in a bid to remove the “the negative stigma of being lumped in with tax avoiders”. The vote additionally rejected the arguments of some shareholders that Bermudian law does not give them adequate legal protection in the event of fraud. Tyco’s share rose 4% on the back of the announcement.

Link here.


There is always a bull market somewhere in the economy. It could be junk bonds, real estate, a particular currency, tech stocks, foreign markets, land, blue chips, or small caps. Today we are in a bull market in gold and commodities. Oil and gas are at all-time highs while metals such as silver are up more than 25% in 2004. Gold had been in a secular bear market and is now in a secular bull market. Market technicians use the term secular not in the religious sense, but to indicate a long time period. Not an entire century, but perhaps to represent events that occur “once in a lifetime” because they are so long. This chart shows the bubble in gold forming in the late 1970s, the bust in 1980, and a subsequent 20-plus-year downtrend in gold prices.

Trend lines are not magical, nor do they predict the future. They only help you visualize the past. Within the secular bear trend there were are four complete cycles of cyclical bull and bear markets with peaks in early 1980, 1983, 1988, and 1996. The trend lines suggest that the bear market is over, that a cyclical bull market is in progress and that it might be the beginning of a secular bull market. Trend lines do not come with a money-back guarantee. If the price of gold were to go to $200/oz. these trend lines would disappear and new ones would emerge in their place.

Link here.

You can’t eat gold!

Slogans come and go. Popular political slogans reflect the prevailing political lies of a generation, which get replaced by the political lies of the next generation. President Roosevelt made famous the phrase, regarding the national debt: “We owe it to ourselves.” These days, the fundamental reality of that slogan is becoming apparent: some people owe it to other people. Now I have not heard it in years.

Forty years ago, when I was just getting started, this slogan was widespread, though not part of the national consciousness: “You can’t eat gold.” I have not heard that slogan in 25 years. All it took was the rise in the price of gold from $35 to over $800, 1971 to January, 1980, to put the slogan out of circulation. Gold’s post-1980 retreat in price did not revive the old slogan. Gold has not approached $35 an ounce since 1971. When gold bugs quadrupled their money by ignoring “You can’t eat gold,” the sloganeers retreated. Of course gold is inedible. In most societies, money is inedible. It is a primitive society indeed where people eat the currency unit. Don’t plan to eat Federal Reserve Notes. But they could make a good fire-starter.

Link here.


The definition of chutzpah? To run a business so deeply in debt that your interest expenses alone nearly doubled your operating income in 2003, helping to produce an $87 million loss on the year. ... and then deciding to write a book titled, How to Get Rich. Actually that is chutzpah on steroids; indeed, not many people are capable of it. But if you need a hint about who the fellow is, here is the only other one you get: He is the founder/chairman/CEO of this business, and it bears his name -- yet when asked his own financial liability for the company’s debt, he remarked: “This has nothing to do with me.... This has to do with a company in which I’m a major shareholder.”

These are Donald Trump’s thoughts on the nearly $2 billion in bond debt that the Trump Hotels and Casino Resorts is “struggling to repay”, as reported politely by The New York Times. “Trump Hotels had barely enough cash to support day-to-day maintenance and refurbishment,” according to an analyst named in the article.

Link here.


I see nothing great fundamentally about the Micron business: Management is typically over-optimistic, and the company’s cash flows are not great. That said, fluctuations in DRAM pricing -- irrespective of the underlying cause -- can present good opportunities to take a position in a stock like MU for a few weeks. Consequently, I believe early May looks like a good time to take a long position in MU. The stock should appreciate very nicely into and through the summer.

Link here.


First recorded in the 1890s, that adage deserves to be etched in bronze above every investor’s desk. And we are talking not just about net earnings but also about all the modern variations on that figure, such as operating earnings, a.k.a. EBITDA (earnings before interest, taxes, depreciation and amortization). You might think that by focusing on operating earnings, as leveraged-buyout meisters are wont to do, you avoid one of the most subjective aspects of net income, namely the rate at which capital expenditures are charged off to earnings as depreciation. But, as Warren Buffett has wisely noted, EBITDA can be even more dangerous than net income because it tempts the investor to think of cap-ex as a luxury.

“Among those who talk about EBITDA and those who don’t, there are more frauds among those who do,” Buffett once said. “Either they are trying to con you, or they’re conning themselves.” In the 2003 annual report for Berkshire Hathaway, Buffett defines intrinsic value as “the discounted value of the cash that can be taken out of a business during its remaining life.” Note the word “cash”. That would be cash after necessary levels of capital outlays. If you want to know what FedEx is worth, look at what is left after it has paid for trucks and airplanes, not before.

Why isn’t the bottom line a good measure of extractable cash? Because so many of the numbers above it in the profit-and-loss statement are subjective. What is interesting about the choices behind those numbers is that not a single one changes the balance in the company’s checking account. If you want a fair measure of extractable cash, the ultimate end in running a business, try free cash flow. To get the number, start with “cash flow from operations” shown on the flow-of-funds page right after the P&L. Now subtract maintenance-level cap-ex. Absent any clear-cut information about which plant and equipment outlays expanded the business and which merely kept existing business alive, assume that all fell into the latter category.

This little exercise will not guarantee that you will fill your portfolio with the next Microsoft, but it might save you from investing in a WorldCom or Adelphia Communications. Two companies where free cash flow per share has been growing more rapidly than earnings per share during the past three years and currently EPS are Black & Decker (NYSE: BDK) and John H. Harland (NYSE: JH).

Link here.


How well will stocks do over the next decade? There have been oodles of pundits suggesting that they will go nowhere. The proposition that they will just stay flat for ten years running is, of course, absurd; stocks gyrate wildly. The talking heads, rather, mean that average annual equity returns will be somewhere around zero. That is almost as absurd. My guess -- and at least I am willing to admit that it is no more than a guess -- is that stocks’ total return will average something better than 7% per year over the next decade.

Stocks compete against bonds, specifically low-grade corporate bonds. Think like an accountant and recall where both sit on a balance sheet -- one atop the other on the right-hand side. Enter my WAG model. All scientists know WAG models -- the “wild-ass guess”. And that is all this is. Now, measure the prospective return on low-grade bonds by the yield on Baa (low investment-grade) issues. In 78% of all ten-year periods since 1925, average stock returns have beaten the beginning Baa yield. The only times this was not true were long ago. The last was the period 1981-90, when the Baa yield started at 16.8%. Before that the exceptions were decades beginning in 1972 and 1973, near the big stock market top. So, after a three-year bear market starting in 2000, I am more than 75% confident stocks will beat the current 6.2% Baa yield over the next decade.

Link here.


In the past, I have frequently discussed long-term price cycles and observed, based on research carried out by economists such as Nikolai Kondratieff among many others, that these long waves last between 45 and 60 years, with each rising and declining price wave lasting around 22 to 30 years. These long price cycles are well supported by historical price statistics of the 19th and 20th centuries. The last commodity rising price wave took place between the mid-1940s and 1980 and was then followed by a declining price wave, which most likely came to an end in 2001, when commodity prices, adjusted for inflation, reached their lowest level in the history of capitalism.

But upon further consideration, while accepting the existence of long price waves for an index of commodities, I have also come to the conclusion that price waves for individual commodities tend to be of far shorter duration. In addition, different commodities move up and down quite independently from each other. Sugar went through two huge price cycles in the 1970s before settling down for the next 20 years or so in a price range of between 2.5 cents and 16 cents.

I am mentioning this fact because investors should be aware that commodities can reach a new all-time high and subsequently new lows within a brief period of time, since during the price boom massive additional supplies are produced that later depress prices. In other words, investors who are betting on commodity price increases should be aware that significant downside volatility for individual commodities, even in the context of a long-term commodities bull market, is almost a certainty!

There is one commodity, however, about which a very bullish long-term fundamental case can be made: crude oil. Unless the entire Asian region goes into a lengthy recession/depression in the next few years, oil demand will undoubtedly continue to rise. There is also the supply side of the equation to be considered. In 1956, M. King Hubbert predicted that U.S. oil production would peak out in the early 1970s. Hubbert was then widely criticized by some oil experts and economists, but in 1971 Hubbert’s prediction came true. Hubbert’s methods of oil reserve analysis now predict that a peak in world oil production will occur sometime between 2004 and 2008.

Link here (scroll down to Marc Faber piece).


In his speech before the Independent Community of Bankers of America on March 17, 2004, Alan Greenspan, concluded that the US banking system is in healthy shape. According to the Fed Chairman, the weakness in credit quality that accompanied the recent recession has clearly been mild for the banking system as a whole, and the system remains strong and well positioned to meet customer needs for credit and other financial services. The latest data, however, indicate that there is some deterioration in the quality of bank credit. In the fourth quarter, the charge-off rate of real estate loans rose to 0.26% from 0.13%, while the consumer loans charge-off rate jumped to 3.04% in the fourth quarter from 2.76% in the previous quarter.

Furthermore, not once during his entire speech did Greenspan mention the Fed’s policy that has driven down interest rates to their current lows, much less how this policy is a major factor behind the appearance of a supposedly strong banking system. The policy can generate the illusion of success, to be sure. But when it is reversed -- as it inevitably must be -- the illusion is shattered to reveal the painful facts of reality. Contrary to Greenspan, the expansion of the banking system and its apparent strength is built on shaky foundations.

There are two kinds of credit: that which would be offered in a market economy with sound money and banking (good credit) and that which is made possible only through a system of central banking, artificially low interest rates, fractional reserves, deposit insurance, and bailout guarantees (false credit). Banks cannot expand good credit as such. All that they can do in reality is to facilitate the transfer of a given pool of savings from savers (lenders) to borrowers.

The existence of fractional reserve banking and all the other institutions that assist in the creation of false credit have been in place for a very long time, generating ongoing bouts of boom and busts and distorting the economic system. What makes the prospect more serious this time is the low savings rate, the rock-bottom interest rates, the sad condition of household balance sheets, and the vulnerability of banks themselves. Since a large chunk of current bank credit was created out of “thin air” there is high likelihood that it will evaporate back into “thin air”. It seems to us that against the background of rapidly deteriorating real fundamentals the Fed will be forced in the not too distant future to reverse its stance, thus setting in motion the inevitable liquidation of various artificial forms of life that currently comprise bank balance sheets.

Link here.


The British public are borrowing, spending and consuming as if there is no tomorrow: house price increases are accelerating, mortgage advances are soaring and borrowing on plastic and via overdrafts continues to rise at spectacular rates. All this is happening despite the Bank of England’s best efforts to slow the process by raising interest rates twice since November. We have become a nation -- from the Government down -- which is living on the nevernever.

Despite Chancellor Gordon Brown’s optimism that the good times will keep rolling, such a view looks increasingly like a gravity-defying act. For the history of all financial bubbles -- and make no mistake, we are in the middle of one now -- is that they end by bursting. In the process, many people can be hurt.

Link here.


Tech stocks generated a lot of the hot air that inflated the equity bubble of the 1990s. When the tech sector blew up, so did the larger bubble. And while many tech shares did well during the 2003 rally, the overall sector remains far below the all-time highs of 2000. This is not true of financial stocks: This past January, the Philadelphia/KBX Banks Index surpassed the all-time high it had set three years earlier. At 21%, financial stocks represent today’s largest share of the S&P 500; when the bear market began in 2000, it was the tech sector which occupied the “largest share” throne.

There are other parallels between tech stocks then and financial stocks now. Many of the “hottest” tech shares were Internet companies that paid no dividends, had no earnings, and could not even say when profitability would arrive. Faith drove share prices higher in the absence of facts. Today it is not faith that could not move mountains but mountainous debt that drives the earnings of banks and brokerages. Low interest rates have stimulated the culture of leverage. Even endowments and foundations are using “alternative investments” such as hedge funds, which use derivatives, which stacks leverage upon leverage.

And virtually no one questions the wisdom of this inverted debt pyramid, in the same way that in 2000 almost no one questioned such claims as “P/E ratios don’t matter anymore.” Almost no one, that is. We questioned the “wisdom” then and we do so now. More importantly, we go beyond questions and offer answers based on market history, technical indicators, and Elliott wave patterns.

Link here.


The answer may be a little bit of both. And as with everything Chinese, at least seen from our shores, it can also be confusing. Plus, we must deal with the issue surrounding the revaluation of the renminbi.

There are any number of ways to spin recent Chinese growth and the prospects for growth in the future. There is no doubt, however, that China is the source for the recent rise in commodity prices of all types. Last year, China consumed 40% of the world’s cement, 7% of the world’s total consumption of crude oil (surpassing Japan as the #1 importer of oil), 31% of global coal, 30% of iron ore, 27% of steel products, and 25% of aluminum. The pressure on scrap metal prices, copper, tin and zinc are clear. This is from an economy that is much less than 10% of the world’s GDP. And as fast as China is building infrastructure, it is still behind the curve. There is only 60% of the needed rail network capacity for moving coal from the port areas into the interior. Last year, China grew officially at 9.1%. Private estimates are closer to 12%. Such growth is unsustainable, if for no other reason than infrastructure cannot keep up with the growth demand.

Sometime between 2015-2020 China is expected to overtake Japan to become the world’s second-largest economy. All other things being equal, China would need to grow its GDP 3% faster per year than the U.S. for some 65 years to catch the world’s number one. An improving exchange rate against the U.S. dollar would, of course, shorten this period... and you can count on an improving exchange rate over the next few decades. But China is not without its share of obstacles to growth... some obvious, some less so. For instance, China faces a serious problem of water shortages.

In my view, China still has a lot of boom left in it. There is going to be a lot of opportunity in that country, especially for those that do their homework and find value in the emerging companies. But investors who blindly buy any stock with a Chinese connection are likely to end up sadder, but wiser... My bet is that we have yet to see the top of a Chinese bubble, which will take decades to develop. Along the way, there will be recessions and a few odd crises, and some serious corrections. Why should China be any different than any other market?

Link here (scroll down to John Mauldin piece).

Renminbi to float -- dollar to founder?

There is little doubt that a floating renminbi would trigger all sorts of changing economic trends. But depending upon when and how the float is begun, it may not be the disaster for the dollar that many expect. There are a lot of forces at work, and it is not at all clear that the immediate effect will be a dramatic revision of the dollar. It is a very complicated situation for the Chinese leadership. Rocking the boat by taking risky gambles in not in their genetic structure. They will eventually float, as they know they need to do so. But they will do so slowly and at their own pace.

The argument from American manufacturers today supports letting the renminbi rise so that they can “more effectively compete”. What they could just as well say, although it is less politic, is that they want American consumers to pay more for the products we import, thus creating inflation and lowering American lifestyles. Calling for the Chinese to float the renminbi is one of the cases which could prove the old line, “Be careful what you wish for...for you might get it.” Then again, if the Chinese continue to grow as they have, it is likely they will indeed resolve some of their problems to the extent that when they do float their currency, it will indeed rise. Timing is everything.

Link here.

Hong Kong announces new proposals to improve listing regulations.

Following a public consultation, the government of Hong Kong has announced new measures to improve listings regulation, to “enhance market quality.”

“We are pleased to note that there is overwhelming support for giving statutory backing to certain fundamental listing requirements and expanding the dual filing system,” announced the Secretary for Financial Services and the Treasury, Mr. Frederick Ma.

The Consultation Conclusions recommend codifying the more important listing requirements, i.e., financial reporting and other periodic disclosure, disclosure of price-sensitive information and shareholders’ approval for notifiable transactions. In parallel, the Government will introduce a bill into the Legislative Council to the effect that breaches of statutory listing requirements will become a new type of market misconduct.

Link here.


The resemblance of President George W. Bush’s recent call for affordable high-speed Internet access for all Americans by 2007 to Herbert Hoover’s 1928 slogan of a “chicken in every pot” is simply too much to ignore. While these may seem to be unrelated issues, to those who know anything about American political history, this was a spooky pronouncement, with an ominous outlook for the future if you compare Hoover’s situation then to Bush’s predicament today. Just like Hoover, Bush’s call was not original. Hoover paraphrased France’s King Henry IV who said that he hoped each peasant would have “a chicken in his pot every Sunday.” Bush’s remark merely reiterated Al Gore’s call for an “information superhighway” for all Americans.

The predicament in which Bush now finds himself is eerily similar to Hoover’s, albeit self-imposed by his profligate federal spending, a massive $550 billion deficit, and a $7 trillion national debt accumulated from previous annual deficits. Hoover’s period of speculation was in the stock market using other people’s money. Bush’s period of speculation is in public debt, using largely foreign investor’s money, to be repaid with interest by future generations of American taxpayers not yet conceived. The situations are essentially the same, except that the debt load of the nation today is at an all-time high, unprecedented in the history of the world.

All indications point toward a major stock market correction, maybe yet this year. If it comes before the election, Bush’s goose will be cooked and you can forget about a “chicken in every pot” and high-speed Internet access in every home. If it comes after he is reelected, Bush will still be replaced by a socialist Democrat, just like Hoover was. In either case, Bush would be blamed for a stock market crash and the following debacle, but unlike Hoover, Bush would actually deserve it. Odds are good that history will record Bush as the man who finally broke the bank of the world’s richest nation.

Link here.


What element is scarcer than gold, a better conductor than silver and denser than lead? The answer is platinum -- the strategic metal for industries, armies... and astute investors. Platinum is one of six metals that make up the platinum group of metals (PGMs). The other five are: palladium, iridium, rhodium, ruthenium and osmium. Certainly, the last four are relatively obscure. Even palladium is not widely known. All six of the PGMs have unique properties, and their value continues to expand in this age of industrial revival and high technology. But of the six metals, platinum has the greatest economic importance of the PGMs and is found in the largest quantities.

Platinum is found in products ranging from the stealth bomber to the fountain pen. It is used in cancer-killing drugs, pacemakers and magnetic nuclear resonance imaging. One in four goods manufactured today either contains PGMs, or PGMs have played a key role in their manufacture. Platinum’s use is growing in fiber optics and medicine. Its use in jewelry has been surging over the past decade and today represents 38% of overall platinum demand. An equal percentage of platinum demand comes from the automobile industry, which uses the white metal to reduce carbon emissions and greenhouse gases in catalytic converters. As the developing world continues to buy and build more cars with catalytic converters, the demand for this strategic metal will increase further. The critical global usage of platinum is for car emission control, fuel cells, catalysts, telecommunications technology and cancer treatments. Over the past decade, demand for platinum increased by 60%.

Global supply of platinum is dominated by production from South Africa, which accounts for 80% of new mine production. And fully two-thirds of the world’s new production (i.e., production not from recycling and recovery) comes from a single property in South Africa -- the Bushveld Igneous Complex, which is 20 times larger than the world’s next largest deposit. It is next to impossible to increase Bushveld’s output beyond its current level.

The white metal doubling in price since 2001, and is now over $800 per ounce. The bull market in platinum is driven by the inability of new supplies to keep up with growing global demand. Over each of the past four years, supplies of platinum have fallen short of demand. With inventories falling, the price has risen to a 24-year high, and the outlook remains extremely bullish. The general assumption is that the long-established deep mines such as Bushveld will be unable to meet growing demands, and innovative mine executives are shifting some of their focus to large-scale open-pit operations. The same shift occurred in gold mine operations in the 1980s, as South African deep mines became less productive. If they have even a fraction of the success that some gold companies have had, shareholders of companies involved in this type of platinum mining will collect windfall profits.

But despite strong fundamentals, there is some risk that platinum’s high prices will hurt demand in the jewelry industry, which accounted for 42% of demand in 2002. When the Fed finally starts to make noise about raising interest rates, platinum prices are likely to come under pressure. Demand from the auto catalyst manufacturers, which accounts for some 40% of platinum demand, is also likely to suffer, albeit to a lesser extent. It is likely to lose some market share to palladium, especially as the latter is some $600 per ounce cheaper than platinum. Technically, then, platinum looks vulnerable to a correction in the near term. However, with the fundamentals set to remain tight, any decent pullback in platinum prices should be a good buying opportunity.

Link here (scroll down to John Myers piece).


In the event you have not been paying attention to copper -- and most investors have not -- it is currently selling for around $1.30 per pound. For reasons I will touch on now, it is getting ready to go a lot higher. JP Morgan’s estimate of the world mine supply of copper in 2003 was 10.77 million tons. Throw in scrap amounting to another 1.1 million tons and you arrive at a total estimated annual supply of about 11.87 million tons. Brooke Hunt, a respected mining consultation firm, estimates that -- with all copper production running at 100% of capacity and with Coldelco’s 180,000 ton stockpile coming on to the market, a one time event -- total excess capacity among suppliers could add another 1.2 million tons, for a total of about 13 million tons.

But that is a hypothetical total because it is iffy at best to assume that all mines can produce at 100%. So, that is the supply side of the equation. On the demand side, world consumption of copper in 2003 was estimated at just a figurative hair under supply, at 11.83 million tons. The news flash, however, is that demand is increasing: JP Morgan estimates that in 2004 demand will rise to 12.35 million tons, and accelerate from there. Considered from another angle, with the current growth rate in demand running at over 400,000 tons annually, even assuming all capacity is brought on line, within 3 to 4 years available supply will not be able to meet world demand.

Why the looming imbalance? As is so often the case these days, look to China and India, where the rush to build the infrastructure necessary to sustain economic growth is soaking up commodities on a global scale. In the case of copper, it is largely in the form of wire and piping. Put simply, there is no end in sight to copper demand. The big issue with supply is that the majority of the world’s copper deposits have already been discovered, mostly in the 1960s. New discoveries are hard to come by and tend to be deeper and harder to mine.

Bottom line: the odds of the mining industry being able to find and bring on enough new mine supply to head off the coming copper crunch -- in the short, medium or even long-term -- is slim to none, and slim is being body-searched at the airport on the way out of town. It is a very good time to start paying attention to copper.

Link here.


Japan’s GDP grew at an annualized rate of 6.4% in the final quarter of 2003 and its trade surplus ballooned by more than 50% in February, compared with a year earlier. Manufacturers are brimming with a confidence they have not felt for nearly seven years, according to the quarterly Tankan survey, and some of that optimism is even spreading to the service sector, ending four years of negative thinking. It is easy to conclude, therefore, that Japan’s strengthening economy warrants a stronger yen. But that conclusion would be a little hasty. For Japan, a cheap yen is not just a way to conquer foreign markets; it is also a way to conquer deflation -- and with the GDP deflator, a broad measure of the price level, still falling by 4.4%, that battle has yet to be won.

Link here.


As the broader markets have improved, Wall St. layoffs have ceased and headhunters have once again been on the prowl. To be a banker or broker with appreciative clients, or a derivatives trader with an expertise in financial modeling, or even (amazingly) a security analyst with a following is to be in demand again. The largest gains in compensation, however, have come in an area where there is no evidence of increased demand or tight supply: the market for chief executives.

Top bosses’ pay dipped with profits in the past couple of years -- although it could never have been called low. It has bounced back handsomely. The numbers are the product of complex compensation agreements described in barely comprehensible legalese in the securities firms’ proxy statements. One thing about them is plain, though: they are huge. Citigroup estimates the earnings in 2003 of Sandy Weill, who stepped down as chief executive last autumn, at $45 million; Bear Stearns values its chief executive’s compensation at $39 million; at Merrill Lynch, the corresponding figure is $28 million; at Lehman Brothers, it is $23 million; at Goldman Sachs, $21 million; and at Morgan Stanley, $14 million. According to Graef Crystal, a compensation expert, more accurate figures may be a bit higher. A big source of the discrepancy in valuation is the method of appraising stock options.

Meanwhile, Charles Prince, who has succeeded Mr. Weill as chief executive, received a restricted stock-grant worth $15 million as a retention bonus. It may be surprising that one needed to be paid, given that Mr. Prince was an internal appointee. In any case, it is hard to imagine that he would leave so soon after accepting the top job. Most of the firms say in their proxies that in arriving at compensation agreements they use comparisons with one another. This suggests that compensation rises in something like lockstep. It also makes the economic rationale of chief executives as a group hard to fathom.

The stockmarket itself seems to have come to terms with the high compensation demands of securities firms by valuing them at a sharp discount to the market average, concludes Ira Kay, a compensation consultant at Watson Wyatt. By paying out so much of their earnings to their employees, investment banks are, in effect, always in the process of going private. For the chief beneficiaries, life at the moment is good.

Link here.


It is a universal behavior, in that you are just as likely to see it from Wall Street professionals as from individual investors. Also, performance chasing is similar to an addiction, in that many people keep repeating the mistake instead of learning from it. For example: Today everyone calls the 1990s bull market in stocks a “bubble”, but that is not what they were thinking at the end of 1999. Household participation in the market had reached record levels, as new individual investors flooded into equities. As for the professionals, Dow 36,000 appeared three months before the Dow’s all-time high; the book made the best seller’s list.

And the author of Dow 36,000 indeed appears NOT to have learned what can happen when you encourage investors to chase a market after it has performed exceptionally. Yet this time around it is not stocks but commodities, which he sat up and took notice of in a recent Washington Post column: “They’re going up in price.” Never mind that the price rise has been explosive, between 50% and 100% over the past two years, depending on the commodity index you follow -- and never mind that in 2002 this fellow himself wrote that investors should not invest in commodities. If they are “going up in price,” well, let the chase begin.

Link here.


For decades, our case has been that the Fed would aggressively accommodate virtually every aspect of a great financial mania and would never voluntarily do anything to curb it. No matter how reckless and absurd the speculation became, this was the case. Some would claim that the Fed tightened as administered rates increased to 6% in 2000. As with the Fed’s behaviour through the culmination of previous bubbles, increases in the discount rate followed the rise in short rates normal to any bubble.

Our position has been that the Fed would not voluntarily tighten but, as with any speculative bout, the phenomenon has its own ability to tighten. This is better understood by considering that most of the so called “liquidity” apparent during a boom is actually money borrowed against the convictions that soaring asset prices will continue forever. The consequence of this manic condition before or during the construct of central banking has been that the moment prices turn down the real power shifts from promoters to margin clerks, whose job description is vastly different to that of a central banker.

Quite simply, soaring asset prices permit an equivalent credit expansion and, with the exhaustion of speculative abilities, prices turn down, which forces a credit contraction. This is clearly described in an editorial in the July 11, 1932 edition of Barron’s: “The Federal Reserve policy of cheapening credit through the purchase of government bonds has been unable to make a dent in the conservatism of borrower or bank lender, in short, every anti-deflationary effort has yet to provide positive results. The depression is sucking more and more bonds into its vortex.

With adequate to ample evidence, this has been the pattern of booms and what is more, as with that one, there have always been attempts by officialdom to prevent or ameliorate the consequences natural to rampant speculation -- always without material significance. The now short-term uptrend in the dollar is part of the exhaustion being displayed in the hot action in both tangible and financial assets ranging from low-grade bonds to international shipping rates. The key question is -- can the Fed continue to “print” and thereby force asset speculation to even greater heights? Part of the answer would include the distinctive contraction in the money supply since August...

Following a period of great financial recklessness, all that is needed to make the senior currency relentlessly strong is to have most of the debt expanded during the boom to be contracted in the senior currency. During our boom, it is reasonable to conclude that by far the largest amount of debt has been financed in New York, with both interest and principal payable in dollars in New York. The world has experienced the biggest financial boom in history and this has included the biggest debt issuance in recorded history. In trader’s parlance, this is equivalent to a huge short position in the dollar. In the past when seemingly insurmountable debt and foreign exchange problems occur, a revulsion for debt develops -- and for the shorts to cover their bets they have to buy the debt-denominated currency. Obviously, the final of the sequence is a long way off, but in the meantime investors should be aware that the U.S. dollar can thus, despite policymakers opposing ambition, become chronically strong. [Ed: Sounds like Japan today -- see this story.]

Link here.


Dow Jones & Co. is reshuffling its benchmark industrial average for the first time in more than four years, ousting old-economy stalwarts AT&T, International Paper, and Eastman Kodak in favor of financial services company American International Group, telephone carrier (and former AT&T subsidiary) Verizon Communications and drugmaker Pfizer. The moves, due to take effect at the start of trading April 8, were designed to give a more accurate snapshot of the overall U.S. economy, said John Prestbo, editor of Dow Jones Indexes and markets editor of The Wall Street Journal, which manages the index.

“Our main focus in this particular group of changes was not who do we kick out or replace. It was to recognize the trend of the growth of the financial or healthcare sectors,” Prestbo said. “When it came to selecting companies to leave the Dow to make room for the new ones, we took recognition of another trend, and that is basic materials stocks have become less important, less weighty in the market.”

Although composed of just 30 companies, Prestbo defended the Dow Jones industrial index as an accurate barometer of the markets, noting that it has closely tracked with the much broader Standard & Poor’s 500, which sees far more use among financial analysts. “It’s simply the best known stock index in the world,” he said. “People who talk about the market in terms of what’s happening today, or over the past five years or whatever, speak the language of the Dow.”

Link here.

... which is likely to help the new entrants how much?

Since their inclusion in the DJIA on November 1, 1999, the following stock price declines have occurred: Microsoft -46%, Intel -29%, Home Depot -26%, SBC Communication -53%. AIG, the financial/insurance behemoth, is the largest of the new additions. I noted two days ago that financial stocks represent today’s largest share of the S&P 500 (21%). In the fourth quarter, these companies accounted for a third of the profits earned among members of the S&P.

Link here.
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