Wealth International, Limited

Finance Digest for Week of November 14, 2005

Note:  This week’s Offshore News Digest may be found here.


Money manager Robert Mitchell had turned radioactive in, of all places, a meeting of uranium suppliers and buyers. Attendees were leery of him. The moderator dismissively introduced him as a representative from those strange entities called “investment funds, hedge funds, whatever”. His speech about nuclear investing, delivered with energetic verve, drew tepid applause. Afterward Mitchell sighed and said, “They don’t want me here.”

Reason: Industry regulars fear he will somehow take advantage of them, as nukes finally are coming back to life and uranium prices soaring. Some of their leeriness is cultural – a fast-talking money guy horning in on an insular society. You would think they would have been happy to see Mitchell in their midst since his presence signals a shift in the nuclear industry’s fortunes. Amid surging oil prices and talk of fossil fuels running out, nukes have lost a lot of their taint. The industry’s stocks are hot, up between 44% and 153% over the past 12 months. Companies from miners to reactor makers are now showing double-digit sales increases. The price of concentrated uranium ore (called yellowcake) has doubled from a year ago, to $33 a pound. And there is more growth ahead, says the ever-enthusiastic Mitchell, who buys both uranium and stock in companies that use it.

Link here.


Stop fretting about the stock market. Plenty of stocks are cheap enough to buy, for reasons I have outlined previously. Namely: For a lot of good companies the earnings yield, which is the inverse of the price/earnings ratio, is higher than the yield on high-grade corporate bonds. That makes such stocks cheap – cheap for the company, if it wants to buy in shares; cheap for a corporate acquirer financing a takeover with its own bonds; and cheap for a portfolio investor whose alternative is owning corporate bonds.

Forecasters have wrongly predicted steeply rising long-term interest rates for fully two years. Yet 10-year rates have hovered within a half-percentage point or so of 4.25%. This cheap money has prevailed even as the Fed has jacked up the cost of overnight loans. Any firm whose stock is trading at a multiple of earnings below 22 can buy back its stock or be taken over, increasing the acquirer’s earnings per share. Below are a few such stocks. They are plausible buyback or acquisition candidates but still good investments even if neither happens.

Link here.


Two of my longtime favorite stocks are getting killed. Fannie Mae (47, FNM) is down 34% this year and Freddie Mac (60, FRE) is down 18%. They have both been run through the Wall Street/media/Capitol Hill scandal mill because of accounting problems. Fannie used derivatives accounting to pump up its earnings; Freddie used it to depress its earnings, essentially stuffing profits into a cookie jar for future use. Sometime soon Fannie will put out an earnings restatement that will put the mischief behind it. In both cases the underlying business operations remain strong. These are profitable and growing companies.

Congress created Fannie in 1938 and Freddie in 1970 to help finance housing for the middle class. The two organizations buy mortgages from banks, guarantee the loans and then package them into bonds. Freddie and Fannie either sell these mortgage-backed securities or hold them in their own portfolios. The fear raised by critics is that these two government-sponsored enterprises will run into trouble if the huge amount of mortgage-backed debt they hold ($1.6 trillion) implodes after a wave of mortgage defaults by homeowners. Fortunately, both companies are well capitalized, and the wholesale meltdown of mortgage-backed securities that the alarmists foresee is far-fetched. Yes, it is possible that enormous numbers of homeowners will default. It is also possible that an asteroid will strike the Earth.

Despite the accounting shenanigans, the two have never needed the taxpayers to bail them out. How ironic that the banking community, the source of much of the anti-Fannie fervor, cannot say the same. The problems at the two mortgage giants are getting fixed. Congress is weighing tighter regulation of Fannie and Freddie. The chiefs of both companies and their lieutenants have stepped down. Note: Nobody has gone to jail because of the accounting errors.

But the anti-Fannie faction is not satisfied. A Sept. 29 Wall Street Journal article alarmingly revealed that additional horrid Fannie revelations are on the way. New violations? I am skeptical, and so are many other knowledgeable people. More than a month has passed, and no evidence has emerged to back up the Journal story.

If you own either of these stocks, hang in there. If you do not, buy them. Fannie Mae trades at an estimated 6 times trailing earnings, giving you a margin of safety even if earnings are restated downward. Freddie is at 15 times earnings.

Link here.


What do Slovnia, Venezuela, China, Jamaica and Taiwan have in common? They are the only countries I could find in a scroll through my Bloomberg screen with markets that have underperformed the U.S. this year. Let me suggest a few unorthodox reasons for the unimpressive showing of American stocks. Although greater disclosure is a good thing, the new information we are getting is often useless. The double whammy of Sarbanes-Oxley and accountants terrified of their own liability has conspired to generate 10-Qs and 10-Ks written by lawyers for lawyers. No one else can read them, and that harms investor confidence. Despite the regulatory and legal thickets of U.S. investments, many of us choose to stay at home, since we prefer the devil we know.

The pundit Charles Gave, a truly original thinker and co-head of Hong Kong’s GaveKal Research Partners, has been pointing out for years the phenomenon of the “platform” company. This term refers to companies that manufacture or assemble in low-cost countries and distribute in high-cost countries. The high-cost nations add value in product design, information systems and marketing. A company’s “home country” is merely where it is registered and pays taxes. Classic examples include Sweden’s Ikea and America’s Dell Computer. The challenge is to find one of these great stocks at a reasonable price.

Sweden’s Autoliv (42, ALV) is the world’s leading manufacturer of air bags, seat belt assemblies and other automotive safety equipment. Amid the pessimism surrounding the auto industry, Autoliv is selling at a remarkably attractive 12 times trailing earnings, with a market cap of $3.8 billion. Autoliv is the perfect platform company: It is traded both in Stockholm (where the company is headquartered) and on the New York Stock Exchange. Autoliv manufactures in 30 countries, increasingly the ones with low labor costs such as Turkey and Romania. It sells to the large automakers, many under pressure to lower expenses, but has managed to maintain margins. Even in this difficult industry Autoliv has doubled earnings and tripled cash flow from operations over the past five years. The company is mounting a big stock buyback. Conference calls are held in English, and are a model of clarity.

Other good non-U.S. platform companies: Toyota Motor (91, TM), the world’s most successful carmaker, with a P/E of 14; Nokia (16, NOK), the Finnish cell phone innovator, at a 16 multiple; and Novartis (54, NVS), the Swiss pharma giant, at 20. While their P/Es are affordable, with only Novartis trading above the S&P 500’s average multiple, I am waiting to buy at slightly cheaper valuations.

Link here.


Emerging market bonds have returns not unlike those of junk: long stretches of fat yields punctuated by the occasional catastrophic loss. You might recall Russia’s $26 billion default in 1998 and Argentina’s $80 billion default in 2001. Recently the excess returns on surviving bonds have more than made up for defaults on the stinkers. For the past five years the sovereign debt of nascent economies has performed handsomely overall. Climbing commodities prices, particularly for energy, confidence-inspiring reforms in some (though hardly all) places and still-low U.S. interest rates have propelled these bonds’ total returns far past those of American debt and equity.

Although you can buy individual emerging market bonds yourself, you should not. This arena is pockmarked by gaping bid-ask spreads that will swallow you whole. Minimum purchases are often as high as $500,000, which makes diversifying very expensive on your own. You need at least a dozen countries in the portfolio. A mutual fund is a better idea.

Isn’t there a risk that someone buying today is getting in at the top? That risk exists, but you can take heart from the guy who is the best at emerging debt investing. Mohamed El-Erian has turned in a masterful performance as head of Pimco’s $3 billion (assets) Emerging Markets Bond Fund since he started in 1999. He has clocked an 18.8% annual return over five years. And he says it is not too late to participate, if you are selective about which countries get your money. At the moment, he says, Argentina and several countries in eastern Europe are particularly bad buys. Even if prices for oil and other raw materials dip, he argues, demand is sufficiently strong to keep emerging debt aloft. Bond-issuing governments have ridden the commodities wave and built up reserves to ward off defaults if economic downturns come.

Link here.


No surprise that energy is the S&P 500’s hottest subindex, with a 23% gain since Jan. 1. No surprise, either, that the demand for oil stocks is eliciting additional supply. Nevertheless, good values still can be found among energy outfits with robust prospects in a world of likely continued high demand. They sell at a discount to their peers for reasons ranging from small floats to their concentration in the supposedly played-out, storm-ridden Gulf of Mexico. We culled through initial offerings from the past two years to find stocks with enterprise multiples lower than those of peers and a projected annual earnings growth of at least 10%.

Link here.


The derivatives genie is now well out of the bottle, and these instruments will almost certainly multiply in variety and number until some event makes their toxicity clear. …[They] are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.” – Warren Buffett, 2002 letter to shareholders

For years, experts had warned about the near certainty of disaster. With its unique geography and hurricane-track locale, New Orleans was a city at risk, and it was only a matter of when, not if, a powerful hurricane would eventually roar ashore and overwhelm the Big Easy. To be sure, steps were taken beforehand to try and minimize suffering and disruption in the wake of such a catastrophe. Levees were built up and secured. Arrangements were made to cope with the mass evacuation of hundreds of thousands. Federal, state and local emergency preparedness officials drew up myriad plans to mobilize people and supplies. Nonetheless, when the event many feared finally came to pass in late August 2005, much of those efforts seemed for naught. Instead of organization there was chaos. Instead of action, incompetence. Instead of lives saved, the focus was on what was needlessly lost.

If there was one silver lining to the tragedy, it was the lesson that, as a nation, we needed to be better prepared. Ready, in other words, for the inevitable worst. Indeed, in a September 19, 2005, cover story, “The Next Big One”, Business Week noted as much, describing a litany of potential disasters, from earthquakes to pandemics to “dirty-bomb” terrorist attacks, lurking on the horizon. Curiously though, one threat, a brewing economic hurricane, was not mentioned. That was odd given the magazine’s audience and purview. Nonetheless, it was not a complete surprise, because the disaster that already seems to be unfolding is one few people understand or are even aware of, let alone are prepared for. Once full-blown, however, it is likely to wreak havoc not only in the U.S., but around the world.

No doubt this sounds alarmist, but there are experts who would suggest otherwise. Indeed, such estimable giants of the financial world as Warren Buffett and Bill Gross, founder and principal of Pimco, one of the world’s largest fixed-income managers, have raised serious concerns about this growing menace. In truth, while no one can say for certain when the day of reckoning will arrive, it seems a good bet that if some of those who are in a position to know are worried about the derivatives market and the associated systemic risks, you should be, too. Unlike an earthquake or a car bomb, a derivatives-inspired financial meltdown will not to lead to leveled buildings or bloodshed, at least initially. Yet, the toxic fallout will likely be as painful, long-lasting, and difficult to overcome as any of the more widely discussed scenarios.

The odds seem stacked against a happy ending, and the cyclical nature of financial crises suggests it is definitely the wrong time to be thinking like a Pollyanna. Unfortunately, the reality is, if it all goes horribly wrong, it will not only be Wall Street that suffers. Main Street will, too. In the worst case, brokerage firms and banks will shut their doors. Markets will plunge and many investors will lose everything, Interest rates will shoot sharply higher, taxes will rise, and parts of the economy will grind to a halt, at least temporarily. Those seeking a mortgage, a college education, a job, or even day-to-day sustenance may find themselves left wanting. At a time when many have abandoned prudence in search of profits, and where those who are knowledgeable about the disaster-to-come in the derivatives market are seeking to protect themselves, it is the timeless wisdom that remains true: forewarned is forearmed.

Link here.


A Year ago, Henry R. Kravis, the legendary buyout mogul who invented the modern-day private equity industry, gave a rare speech to a group of investors in a ballroom of the Waldorf-Astoria. In describing how far the business had come, Mr. Kravis, a slight man with a dry wit, recounted how difficult it had been for him to raise $355 million to buy one of his first companies, Houdaille Industries, in 1979. “The availability of financing was our biggest challenge,” he said. “Literally, we had to add up the potential capital sources at that time, which consisted of several banks and insurance companies, and one by one go out and raise the money.” Today, he has the opposite problem. Investors have been throwing money at the red-hot leveraged-buyout industry – so much so that Mr. Kravis now has to turn away some of them, rejecting their cash as a mere “commodity”.

Private equity firms, it seems, now own everything: Hertz, Neiman Marcus, Metro-Goldwyn-Mayer, Toys “R” Us and Warner Music, to name a few. So far this year, buyout firms have spent more than $130 billion gobbling up parts of corporate America. And with more than another $100 billion in unspent money this year still swirling around the industry, there is a lot more buying to be done. The boom is not limited to America: in Britain buyout firms own so many companies that they now employ 18% of the private sector, according to the British Venture Capital Association.

The trillion-dollar question is whether these shopaholics are setting themselves up for a giant fall. If the market begins to show even the faintest signs of strain, this bubble may pop, say many financial analysts as well as private equity players themselves. If that happens, the leveraged-buyout boom and bust that Michael Milken led in the 1980’s could end up looking like a dress rehearsal for the mess to come. As Mr. Kravis said during his speech: “Unfortunately, there is a flip side to having access to plentiful capital. It means that too many people without experience in building businesses have too much money.”

Link here.


Much of the nation has had a lovely real estate boom for the past five years, but the house party is almost over and the cleanup will not be pretty. That is the word from economists and investors who have watched housing prices march ever higher. “The collapse of the housing bubble will throw the economy into a recession, and quite likely a severe recession,” warned a July report by the Center for Economic and Policy Research. In recent weeks, many major investment firms have concurred. Said a Lehman Brothers report, “[A] turn in the housing market is central to our economic forecast.”

“The demographic story behind the housing market boom, as we always thought, was a giant hoax,” wrote Merrill Lynch’s North American Economist, David Rosenberg, in a recent report. If housing prices decline sharply, the effects could be broad. Lehman estimates one-third of the past year’s U.S. economic growth was a consequence of the housing boom. Housing construction is equal to 5% of the national economy.

A downturn in housing could mean more than 1.3 million lost jobs, Goldman Sachs predicts, bumping up the national unemployment rate by 1% and the unemployment rate in house-mad California by 2%. Those numbers do not include likely job cuts in housing-dependent businesses, such as banking, furniture and building materials. The Center for Economic and Policy Research predicts worse, saying a bubble burst would mean the loss of 5 million to 6.3 million jobs. The housing run-up has financed consumer spending, creating more than $5 trillion in bubble wealth, the center estimates. A final nightmare scenario: A federal bailout of the mortgage market is likely if housing crashes, the center predicts. So, if corporate pension funds continue to falter and this dire prediction does come true, the Feds could conceivably be holding your mortgage and your pension.

While there is disagreement on what a downturn will mean, it is widely held that a number of factors could bring prices down. A decline in prices will track interest rates: If rates go up sharply, housing prices will plummet, said Mark Zandi, chief economist at Economy.com, an independent provider of financial research. If rates increase slowly, housing prices may ease gradually. “House prices are at the mountain top,” Zandi said. “All roads lead down. It’s just a question of how steeply.”

Link here.

Report: Housing market cooling.

The pace of home sales are slowing and sellers are finding a harder time getting their asking price for homes, according to a published report. The Wall Street Journal, reporting on the results of a survey of real estate brokers as well as comments from brokers and real estate economists, reported that there are numerous signs of a slowdown in what has been a white-hot home market. The newspaper reported that a survey of top brokerage firms by real-estate consulting firm Real Trends found of home-purchase contracts signed last month dropped 8% from a year earlier at 48 of those firms. Those declines are widespread, according to the report.

The slowing of housing contracts is caused by rising mortgage rates and energy prices, according to the report, as well as numerous articles speculating that there is a “bubble” in housing prices due to recent gains that may be about to burst. The paper quotes real estate brokers as saying that buyers are not as willing to get into a bidding war for a house they want as they were a few months ago. “There’s a newfound sense of urgency among sellers to get out while the getting is good,” said David D’Ausilio, operating partner of Keller Williams CT Realty in Monroe, Connecticut. He said that the supply of homes there is up 14% from a year ago and he forecasts that prices will fall 5 to 10% in his area during the next 12 months.

Greg Rand, managing partner of Prudential Rand Realty in White Plains, N.Y., said that he expects prices there to fall about 3% next year. And Robert Griswold, owner of Griswold Real Estate Management in San Diego, tells the paper that fliers offering condo buyers a car were being handed out at a recent Rolling Stones concert. “The market has definitely turned,” he said. “When you see that kind of advertising and promotion, they are clearly getting desperate.”

Link here.

19th Century Kansas farmland prices.

Occasionally and accidentally, things go well. Occasionally they go badly. Every once in a while things seem to “blow up” – even when they were thought to be under control. And often the things that were expected to keep them under control are the very things that cause them to explode. We illustrate this point with an episode from that fair age before the invention of air-conditioning or reality TV … the late 19th century. From Grant’s Interest Rate Observer comes the story of the great bubble in real estate prices west of the Mississippi. Kansas farmland went up four to six times between 1881 and 1887, according to scholars who have studied the matter. The price of land rose as high as $200 an acre.

The source of the hot air was a combination of things. Nature was rarely kinder to the Great Plains than in the years following the War Between the States. It rained out on the prairies, raising crop yields to levels many thought unsustainable. And then came the railroads. Between 1880 and 1887, Kansas doubled the mileage of rail lines. In that same decade, railroad mileage quadrupled in Nebraska and rose 11 times in the Dakota Territory. Now, farmers not only had bumper crops, but also a way to get them to market. Could there be any doubt that this was not a cyclical boom, but a genuine new era?

Investors thought so. Not only did they rush to buy up the flat land in the trans-Missouri region, they also drove out to lend money to the farmers. Mortgages on these western farms were considered safer than their eastern equivalents – partly because of the expectation of good yields, but largely because a bubble mentality had set in. Western farmland looked like such a sure thing, everyone wanted a piece of the action … either a section of land, or a derivative on it, such as a mortgage.

Typical of a bubble, what begins as little, ends up as too much. It was not long before investors had overbought the western lands and farmers had overproduced the grains that were supposed to support their mortgages. You could sell a bushel of corn for 63 cents in 1881. By the end of the decade, you could not get half that much. Then, in 1887, the weather that had been so unusually good came to an end in a stretch that was unusually bad. A 10-year drought began, in which crops failed about every other year. It was not a new era, after all. As the crops withered, so did the mortgage market. In the last three years of the decade, mortgage lending fell to only 10% of the previous three years’ activity. Land prices fell. Farmers went bust, handing their land over to the mortgage holders, who by then were no longer happy to get it. The farmers themselves left the plains, either west to California or back to the Mississippi Valley.

Farmers and speculators might have learned their lesson. Or they might not. Out of the experience – and falling agricultural prices generally – came a call that political authorities heard with both ears. We should not crucify debtors (farmers who had mortgaged their land) on “a cross of gold,” said William Jennings Bryan. We should not, “press down upon the brow of labor,” a crown of thorns, he went on in glorious humbug. It bothered William Jennings Bryan and the other populists, that people had to pay back loans in currency just as valuable – or even more valuable – than the stuff they borrowed. They demanded a more “flexible” legal tender. Eventually, the call was turned into action; the Federal Reserve was created to make sure that no borrower ever after, had to make good on his debts. Since the Fed was created, the paper dollar has lost about 95% of its value … with a nearly 50% loss during the time of Alan Greenspan alone.

Those who think property prices always go up may want to take note. Today, after huge population growth and nearly 35 years since a debtor was last crucified on a cross with the least trace of gold content, Kansas farmland sells for an average of $800 per acre. Adjusted to 1880 prices, that is only about $20, or barely 10% of the peak prices set 120 years ago.

Link here.

U.K. real estate: crazy is not over?

Here is a fun fact. In the 25 years from 1973 to 1998, the UK’s inflation-adjusted house prices showed no change. And in the 6-year period between 1998 and 2004, those prices more than doubled. The talk of a “bubble” has been just as prevalent in the UK as it has been in the States. The British press has not been shy to print stories about a possible “real estate crash” – especially since last July, when homeowners got their first big scare after house prices took a plunge. Prices still have not recovered, and for over a year now, the market has been “soft”.

But a full-blown crash never came. And lately, the market has even shown signs of recovery. In October, mortgage lending and house prices had their biggest monthly rise since last summer. Brits are even buying houses online! “Buy-to-let investors” are bidding an average of £135,000 on houses they have never seen – except in pictures – at LandlordTrader.co.uk. Buyers’ confidence has been “decidedly upbeat” this fall. And even though an average house still costs five times an average annual salary, there is now talk of “house prices doubling by 2025.”

Clearly, optimism is coming back. But every investor knows that no market moves in a straight line, including real estate. Counter-trend rallies are to be expected. The question is, what is the trend? Is the recent bounce for real – or is it one of a “dead cat” variety? A look at the British stock market may help figure this out. We once did a study comparing U.S. stock prices to U.S. real estate values in 1837-2000. It turns out that historically real estate prices have always lagged the stock market.

It makes sense that they would. Both the stock and the real estate markets are governed by the same social mood. Except, the stock market is a quicker barometer of the buyers’ and sellers’ collective psychology than real estate. Housing is a slow boat with a lot more inertia – partly because houses are less liquid than stocks. But one thing for sure: When stocks head south, eventually so do housing prices. For that reason, British homeowners would be well served to keep an eye on the FTSE. After losing a better portion of its value in 2000-2003, the stock index has recovered significantly, but is still way below its all-time high. If British stocks can sustain their recent advance, it would confirm that British social mood is indeed on a firmer ground. Eventually, that confidence will find its way into the housing market, improving its chances of further recovery.

Link here.


Over the years I have had to unlearn most of what I was taught in Economics 101, and I suspect that today’s students continue to have their hats stuffed with the same rubbish. Apart from the little chart that showed how the price of widgets is a function of the supply/demand curve, the only other useful idea I took away from econ 101 was the law of diminishing returns. Perhaps you remember it too. The classic illustration is fertilizer and crop yields – too much fertilizer, and your added crop yields decline as you continue to dump on more fertilizer.

Now let us discuss debt and economic growth, and you probably know where I am headed: As with fertilizer and crop yields, it is no less true that debt can “yield” economic growth. And yes, there comes a point where too much debt will produce diminishing returns. Question is, “When” is debt at the optimum point for economic growth? Is such a thing even measurable? It is measurable, and that is the good news. The bad news is, the returns from each $1 of new debt in the U.S. economy have been diminishing since 1967. This is plain to see in this chart.

GDP has obviously grown over the years, yet what is even more obvious is how debt has grown far faster. And something tells me that things have not improved over the past 12 months, given that household debt service is at an all-time percentage high, even as the savings rate is at an all-time low (actually in negative territory). The next few days will see a slew of economic reports, plus the appointment of a new Chairman of the Fed. We are also just a few weeks away from the media’s ritual market and economic forecasts for the New Year. Do not expect any of the usual suspects to reprint the chart above, much less discuss what it implies for future.

Link here.


Were it not for computer models, I can think of at least two professions that would mostly cease to exist: 1) Meteorologists, and 2) Economists. Don’t worry, I am not going to suggest that the weather-folk have their computers taken away (even if the typical 5-day forecast does include 3 too many days). But as for economists and their computers, I will put it this way: If you want the plugs pulled and the screens smashed – after all their hard drives are erased, that is – well, just appoint me king for a day.

I do realize that it can be a lot of fun to crunch numbers through the models – input all those variables and watch all the probabilities come out the other side – not to mention how you can tweak the thing until you get the range of outcomes you want. And if the economy has the effrontery not to perform as forecast, well, it is not your fault. It is the model that needs more tweaking.

And while no variable is fail-safe, there actually is an indicator with an amazingly predictive track record over the past 40 years. It is when the “yield curve” gets “inverted”, which means that longer-term Treasury yields are lower than the shorter-term yields. This does not happen very often, and when it does, certain not-so-good things have followed. Common sense suggests that this is the market’s way of saying “Something is wrong.”

Of course, common sense rarely prevails among the folks who use models to study the not-so-good thing called a “recession”. You would think that when recessions have followed every instance of an inverted yield curve over a 4-decade period, economists would make this variable heavily “weighted” – but apparently not. I say “apparently” because in the most recent Wall Street Journal survey of dozens of economists, they ALL forecast positive GDP growth for the coming 12 months. Yet, the yield curve has been narrowing for the past TWO YEARS, and is a very short distance from the point of “inverting”. A chart of the yield curve shows that it now stands where it was in February 2001, just before the start of the last recession.

Link here. A word from “Dr. Smith, Meteorologist” – link.


Corporate America is flush with cash. Lots of it. This little-noticed fact could create great opportunities for value investors. American consumers may be strapped for cash, but American corporations are loaded. Just look at the companies in the S&P 500 Index (generally representative of the market as a whole). Corporate coffers hold in excess of $2 trillion, a staggering amount of dough, and an all time high. For perspective, it is 3.5 times more than in 1993. Even excluding financial companies, which often hold a lot of cash, the amount of cash held by S&P 500 industrial companies is also at an all time high. Cash as a percentage of long-term debt is about 40%. In other words, for every dollar borrowed, companies have about 40 cents in cash. See the nearby chart, “Too Rich” reprinted from the Wall Street Journal.

To look at this trend another way, cash as a percentage of stock market value is higher than at any time since the early 1980s. What do you suppose American companies are going to do with all that cash? After buying another Gulfstream or two for the corporate fleet, and maybe some new oak paneling for the conference room, they might begin to devise more worthwhile uses for their cash, like buying back their own stock or acquiring other companies. Stock buybacks jumped 92% in the second quarter of this year compared with a year ago. But we would also expect cash-rich companies to scout around for acquisitions, especially acquisitions of other cash-rich or value-laden companies. In other words, the companies with lots of cash on the books are not merely the hunters, they are also the hunted. That is why value investors who buy solid, cash-rich companies will stand to reap big profits throughout the upcoming wave of merger and acquisition activity on Wall Street.

Indeed, this is already happening. Worldwide corporate merger and acquisitions are on the rise. But there is another way that value investors reap gains by investing in cash-rich companies: shareholder activism, when one or more shareholders of a company agitate for some sort of value-unlocking event like a stock buyback or a special dividend. Among our current holdings, Intrawest (NYSE: IDR) has felt pressure from activist shareholder, Pirate Capital, to unlock the value in its rich land holdings. And Imperial Sugar (NASDAQ: IPSU), in our Special Reports Portfolio, fought off an unsolicited bid to buy the whole company for $16 per share. Meanwhile, Carl Icahn, the legendary corporate raider, has been stirring up many other corporate boardrooms lately, from Temple-Inland to Kerr McGee to Time Warner, and, most recently, at Fairmont Hotels & Resorts.

But Icahn is not the only activist investor who is making a noise these days. The Wall Street Journal recently noted the “recent wave of hedge fund activism” as hedge funds put pressure on corporate chieftains to unlock the value in their shares. This means that we should see more corporate “events” in 2006 – such as restructurings, buybacks, special dividends, mergers, acquisitions, and the like. Shareholders are becoming more involved in how companies are managed and how their resources are deployed. Right now, we are only seeing the beginnings, the seedlings, of what could later grow into a much larger trend. No matter whether an activist or an acquirer unlocks a stocks value, the shareholder wins.

Link here.


A few weeks ago I was at a small dinner party in London hosted by Charles and Louis-Vincent Gave, the Gave’s of GaveKal Research. They are quite bullish about the longer-term prospects for the world, and as we will see below, argue that something new is happening that may not rhyme with our past economic history. Long time readers know I like history. It is an old friend. It is a very uncomfortable proposition to hear things may be different, as they argue it well. Feeling like having a little fun, I invited Bill Bonner to dine with us, knowing that he takes the very opposite view. With wives and friends there were 10 of us. I made certain that Bill sat next to Louis and Charles, knowing his natural inclination to sit next to the ladies which would have been more fun for him, but would have produced no fireworks.

The discussion at dinner began as Charles and Louis suggested that trade deficits no longer matter. Bill’s eyebrows shot up and he rose to the occasion, coming back with his own arguments. It went back and forth for a few minutes, with your humble analyst egging all of them on. “You’ve got to be kidding,” Bill announced. “You are saying that this time it’s different.” … “That is precisely what we are saying,” shot back Louis. Bill looked at them like he was seeing someone from outer space. “But it’s never different,” he proffered.

Then Louis gave us a copy of his new book, called Our Brave New World where they outline their reasoning. I knew that in Bill’s new book, Empire of Debt, which is subtitled “The Rise of an Epic Financial Crisis” he and coauthor Addison Wiggin make the exact opposite argument. History will indeed rhyme and lead to a serious financial situation, destabilizing the global economy. “History never repeats itself; but it often rhymes,” Our Brave New World asserts, “This simple fact explains why so many financial analysts, market strategists and portfolio managers like to study past economic cycles and market reactions before taking investment decisions. By studying financial and economic history, market participants are able to anchor beliefs on solid facts.”

“Arguing that ‘things are different this time’, we freely admit that we might end up drawing the wrong conclusions,” they admit. So, what makes it different this time? GaveKal suggests a number of things. First, there is a new business model. Just as industrialists were new in the late 1700s, there is now a new model developing. GaveKal calls this new model “platform companies”. The old model was to design or find something, manufacture it, market it and sell it. The new model keeps just the high value added parts and ditches the rest. The new model focuses on research and development, treasury, marketing, and the business process and out sources as much of the low margin work as possible. Think Dell, Wal-Mart, IKEA. Most hotel chains now do not own their properties. The new model is to “produce nowhere but to sell everywhere”. Production is the least profitable of all the processes. Who would you rather be? The Chinese and other Asian companies that make the iPod at a 2-3% margin or Apple who sells it at a 40% margin?

But this process means manufacturing jobs leave the developed world (the United States, Canada, Old Europe, Australia, New Zealand and Japan) and move to the developing world, primarily Asia and Eastern Europe. This is not seen be many observers as a good thing. And indeed jobs have been lost. But more have been found. The reality is that tax receipts, at least in the U.S., are always and everywhere up, even as the Federal government cut taxes! Higher tax receipts means people are making more money. Not everyone, of course.

The real danger to the platform model? Governments and protectionism. As they point out, a Dell computer says “Made in China” but it is really more accurate to say assembled in China. It is made from parts and software from a score of countries. Of course, the “trade deficit” is counted as China’s. Yet, Senator Schumer regularly bashes China, appealing to his union supporters, but fails to notice things like this. Should we also get upset with Korea and Taiwan and Russia and Sweden and the rest of the countries who contributed? We live in a world where our ability to measure economic reality is becoming more and more limited.

In a world where the U.S. government counts Microsoft physical exports as “plastic” because the disks are plastic and only worth a few dollars at most (Dennis Gartman swears he was told this by a government official who was physically counting export shipping at a port), how can we trust the numbers?

It will take two weeks to cover GaveKal’s thoughts. Then we will turn to Empire of Debt. Then I will weigh in with my own. I find there is merit on both views, but think there may yet be a third way to look at our world. And make no mistake, how you come down on this argument is critical. Because the investment strategies one would adopt if you hold these views are quite different. (But wait until the series is finished before you tell me I am nuts.)

Link here (scroll down to piece by John Mauldin). The Dollar Asset Standard – link.


There was a decidedly bullish tone to our 21st annual Global Investment Roundtable in Lyford Cay. Amid a rare year of U.S. under-performance in world equity markets, there was deep conviction that this, too, shall pass. There was the usual hand-wringing over the perils that lurked on the downside, but this seasoned group of largely U.S. investors drew great comfort from the inherent resilience of the global economy and world financial markets over the past 50 years. Globalization, in their view, reinforces this resilience – expanding the pie and providing an increasingly elastic world with a new set of shock absorbers.

Our polling of group sentiment on major macro trends added considerable granularity to this rosy macro conclusion. Fully three-fourths of the assembled investors thought U.S. equities would rise through mid-2006. The group was also optimistic on Japanese equities, but the bullish margin was considerably thinner. And by a factor of two-to-one, the Lyford consensus was bearish on European stocks. The group was relatively bullish on the interest rate outlook: Fully two-thirds of the assembled investors thought the federal funds rate would remain below 4.75% by mid-2006, and only a couple of lonely souls took the bearish side of a 5.5% call on 10-year Treasuries over the same period. The bulk of the crowd thought oil prices would remain below $60 through mid-2006. Finally, the currency view was overwhelming populated by euro-bashers, although the group was more evenly divided over the yen outlook. Last year’s currency call got the annual macro award for the infamous “curse of Lyford Cay”. A year ago, the group was decidedly bearish on the dollar just when it was about to rally after a nearly 3-year decline. I certainly felt their pain.

For me, it all came together at the Saturday evening roundtable discussion at the end of the conference. Unlike the other sessions, there is no structured agenda in this finale to the conference. It is an opportunity to ponder three days of discussions – pull together loose ends, probe unresolved issues, or explore topics that may have been ignored. Sparks flew at this year’s closing session. We kicked it off with an uplifting discussion of pandemics and avian flu. There was a strong sense by the assembled group that pandemics were like other macro risk factors such as debt, asset bubbles, and (gulp) global imbalances – the worrisome what-ifs that never come to pass. Or the shocks that an elastic world has handled in the past and will most assuredly handle in the future.

I think a lot about the so-called built-in shock absorbers of a $44 trillion global economy. And whenever I worry about the dark side of global rebalancing, I always remind myself of the countless examples of the world’s inherent resilience. That has been especially the case in the accident-prone U.S. over the past 5½ years. Of course, the examples of U.S. resilience go back much further into time – wars, double-digit inflation, the twin deficits of the 1980s, the hollowing out of U.S. manufacturing, to say nothing of the stresses of social and racial tension. Time and again, a flexible U.S. economy has proved to be extraordinarily resilient in the face of such adversity. And in a U.S.-centric global economy, America’s resilience defines the world’s resilience.

There was broad recognition that the U.S. and China were likely to remain the key players on the global stage for some time to come. The U.S.-China symbiosis was singled out for special attention in this regard. America has cut a great deal, went the argument, and so has China – the goods-for-bonds trade was widely viewed as logical, sustainable, and in both nations’ interests. I challenged the group on this key point. The real problem, of course, is that this co-dependency is deepening: With America’s overall national saving rate likely to fall further over the next year, the U.S. current account deficit is likely to widen further.

As usual, few of the investors expressed any interest in mainland Chinese stocks. But most were confident that the Chinese growth miracle was here to stay. That is a real switch from the sentiment expressed in years past. Since the late 1990s, my steadfast bullishness on China generally was, in fact, met with great skepticism at this conference. Suddenly, concerns of years past have all but vanished into thin air. China is now viewed as a perma-growth story. This shift in the perception of the China factor underscored a worrisome complacency that was evident throughout most of this year’s conference. The Lyford Cay consensus very much mirrored the sentiment I have picked up in my recent travels around he world. Investors treat economic imbalances like pandemics – low-probability risks that are worth worrying about but not losing sleep over.

As I was leaving Sunday morning, one of the veterans of this conference pulled me aside and said, “Watch out in 2006 – the big crack in equity markets is coming.” Over the years, he has had an uncanny knack for catching big macro trends in stocks, bonds, oil, commodities, and currencies. There was no complacency in the timbre of his voice or in his conviction in the case he was making. He was clearly the minority in an otherwise complacent consensus. And it was not the first time either. The final word from Lyford Cay came from another veteran who noted, “We all know these imbalances you speak of are unsustainable – we just can’t afford to focus on the endgame.” Elasticity or complacency? To me, it sounds more like the latter – and even more like denial.

Link here.


A lot of people seem to be worried about the trade deficit. Scarcely a day passes without a warning on TV, the Internet, or in the press about the looming imbalance of trade. Contribute it, if you must, to my antiquity and inherent crotchetiness, but when I hear nearly universal opinions from the media regarding the dangers of this or that, I cannot help thinking of the boy and the Emperor’s new clothes. As for the trade deficit, I find myself – as usual – in the position of the boy. To my eye, untrained in the ways of economics, the trade imbalance, or deficit, consists of the fact that we are buying more from foreigners than they are buying from us. We are sending more money abroad to buy their goods than they are sending here, to buy ours. My first impression is: hooray!

The “money” that we are spending for foreign autos, clothes, appliances, oil, and food is, in fact, imaginary. It has no substance. It is “credit”, from the Latin word “to believe”. We get “credulous” and “incredible” from the same root. There is no more tangible reality to it than there was to the Emperor’s new clothes. The foreign goods being imported into this country is something obtained, literally, for nothing: money not being a thing. So what is the problem? To this, admittedly, untrained eye, the problem seems to boil down to exchange rates. Our money is imaginary, but so is the money of the Japanese and Europeans. This means that exchange rates cannot be determined by physical means, such as weight or purity, but more arbitrarily.

If the exchange rate is adjusted to favor dollars, i.e., making the dollar “stronger”, foreign goods will become relatively cheaper, and more foreign products will flow into the country, with more unemployment in American industry. This policy will obviously favor some, but harm others. How the matter is decided will depend upon the political clout of the parties involved. On the other hand, if the dollar is “weakened”, foreign imports will suffer, and American industry will benefit, with the result that Americans may be forced to buy higher-priced goods than before. Again, some will benefit, and some lose.

And the problem is not domestic. The fact that we buy more from the Japanese and the Arabs than we sell to them causes them problems, too. They are sitting on mountains of “dollars”. What are they to do with them? Watch them lose value daily via inflation? Buy stuff with them? But what? One thing becomes obvious: the bankers and the government are in this thing together. The banks do not want people to lose confidence in their scrip, because there is not anything else about the money that makes it marketable. Modern governments could not exist without fiat. So who is concerned about the rest of us, who are neither bankers nor politicians?

The hand-wringing and lamenting about the trade deficit overlooks one important thing: it is a problem of the rulers’ making, and short of reforming the system, and returning to a Constitutional monetary system, nothing can remedy it. The bankers/rulers see a return to honest money as suicide; a threat to their very existence. They are right. That is why nothing is going to be done about it, unless the people do it themselves. What are the chances of that?

Link here.


God is, or he is not. Which way should we incline? Reason cannot answer.” - Blaise Pascal

Few are as dismissive of Peak Oil as Exxon’s imperial CEO, Lee Raymond. He has told The Wall Street Journal that “When oil’s at $60 a barrel, at least $20 of that is speculative.” Nearly 3½ centuries ago, the philosopher, Blaise Pascal, planted the seed of modern decision theory with a rather clever apologetics argument. Pascal posited that it is better to believe in God than not, due to the reward-to-risk profile behind one’s choice. Embrace Him, Pascal argues, and you either go to heaven or find yourself none the worse for wear. Choose not to believe, however, and one runs the risk of eternal fire and brimstone.

Why bring up Pascal’s Wager? If you will pardon the odd analogy, believing in peak oil is a bit like believing in God. There is plenty of theoretical evidence to make a strong case, yet there is also plenty of ammunition for the doubters. Like God’s existence, peak oil is truth to some, yet myth to others. And here is the rub: By the time a firm resolution comes around, it is too late to change tack. In this regard, Raymond’s Wager bears strong resemblance to Pascal’s. Like his 17th century predecessor, the modern-day energy CEO weights consequences above probabilities. The key thing is that the reward-to-risk profile for a gargantuan oil major is not what you might expect. In the privacy of Mr. Raymond’s executive chambers, the top brass probably reasoned it out like this:

“If Peak Oil turns out to be false, we will avoid a lot of heartache by sticking with our $20-35 long-term forecast. If Peak Oil turns out to be true, our current sky-high profits will stay sky-high for years, and we can finance further growth by snapping up independents. Therefore, ramping up investment now has major downside risk if Peak Oil is wrong, whereas we can sit tight and still do well if Peak Oil is right. Regardless of probabilities, the consequences favor a conservative stance. … Just one snag: we can hardly share this reasoning with the public. To justify our lack of enthusiasm for investment here and now, we will have to roll out the anti-crisis talking points.”

Pascal might not be proud, but he would certainly recognize the logic. When Lee Raymond exudes gruff conviction in dismissing Peak Oil, it is a conviction that he is serving the best interests of his shareholders, not a conviction that his facts are right. Conclusion: We cannot count on Big Oil to fully address the energy risks ahead. Doing so is simply not in their economic interests. Nor can we count on bumbling government for a workable solution. The only thing we can count on, then, is continued volatility. We will have to keep solving our energy problems the hard way – by the seat of our pants, with no time to spare.

Link here (scroll down to piece by Justice Litle).


With the U.S. now importing 63% more than it exports, nobody is projecting that the trade deficit will drop below $60 billion a month anytime soon, and for the year, the total could well pass $700 billion, easily trumping 2004’s record $665 billion trade deficit. And yet the U.S. dollar rallied on November 10 in the face of the day’s bad news of this soaring trade deficit, and it now stands near a two-year high against the euro, the currency that was supposed to supplant it. And you have to go back to September 2003 to find the last time the U.S. dollar was this strong against the Japanese yen.

Remember back at the end of 2004, when pundits were falling over themselves to predict disaster for the U.S. dollar in 2005? I sure do, because I was one of the folks predicting a dollar decline in 2005. I had seen the error of my ways and reversed my opinion on the dollar in my June 14 column. So, I was only wrong on the dollar for half a year. But I still never imagined the dollar would post something like a 15% gain against the euro at this point in the year. So what is going on? Currencies are supposed to tumble in price when trade deficits climb this high.

There is a logic to the dollar’s rally, though. I will spell it out and then tell you how I think this logic will play out for the tail end of 2005. And explain why you should look out for a turn in the dollar’s fortunes in 2006. I will finish with some suggestions on how to profit from the dollar’s current strength and the turn I see ahead in 2006.

Link here.


Our 12% Letter’s portfolio is made up of twelve income-generating stocks. Some of them are real estate investment trusts (REITs), some are business development/registered investment companies (BDC/RICs), and some are just ordinary common stocks. There are two stocks in the portfolio that I think are typically less understood than all of the rest. One of them, Petrofund Energy Trust (AMEX: PTF), currently yields about 10% annually, while the other, Pengrowth Energy Trust (NYSE: PGH), yields 11%. They are both classified as Canadian Oil Trusts, and have generated both excitement and confusion by investors. This month, we will examine Petrofund and this particular type of investment vehicle.

The term “trust” is a legal term that means to hold an asset for the benefit of another individual or group. A financial trust buys property to hold for another party, giving them the benefits of ownership while the trust management actually owns it. The avoidance of taxes is the primary motivation behind setting up trusts, and Canada has been a better environment for this type of investment, than, say, the U.S. – hence the popularity of investment trusts north of the border. trusts from paying taxes on all profits that are distributed to trust unitholders. The unitholders pay taxes on what they receive, but this avoids double taxation – paying taxes on dividends already taxed at the trust level – and actually increases the amount of the distribution that ends up in shareholders’ hands.

That is the good news. But because of this tax-advantaged structure, investment trusts pay out so much of their earnings in dividends that they have very little cash left to invest in their operations. So if they want to acquire or explore for more oil and gas production, they have to sell more units of their trust, or increase their debt load. Naturally, some trusts raise new capital and invest better than others. Petrofund is one of the best in the business.

Petrofund buys and manages oil- and gas-producing properties mostly in the western part of Canada. The trust has been in existence for about 17 years – it is one of the oldest publicly-owned investment trusts in Canada. The management team has been together for nearly a decade. Throughout that time, the team has demonstrated a talent for prudent and disciplined acquisition of oil and gas assets. Obviously, acquisitions keep the cash flowing to unitholders. However, trusts cannot just buy assets indiscriminately, as capital is scarce and a poor performing group of wells is best left unpurchased. Petrofund typically looks for: 1) areas with mature production, operations and longevity; 2) the bulk of the reserves classified as “proved producing”; 3) modest capital expenditure requirements; 4) consistent cash generation; 5) low-risk development drilling; and 6) an experienced, competent production team. All of these criteria are consistent with smooth cash flow delivery to shareholders.

This acquisition strategy has done two very important things for unitholders of Petrofund: It has grown proved and probable reserves consistently and dividends have remained stable. The primary reason we love Petrofund is because it does – very well – the things it needs to do in order to grow its business and satisfy its shareholders. At the end of 1Q05, it had a very busy drilling program with 73 wells drilled. The acquisitions that the trust is making are having a significant positive effect on cash flow. In fact, cash increased nearly 50% compared to Q1 2004.

With Petrofund, we are making more of a financial call on these shares than an industry call. Still, oil and gas commodity prices are going to affect Petrofund’s cash generation, as will exchange rates, and its ability to add new reserves and sell product. Furthermore, as more oil and gas trusts come into existence, the competition for quality acquisitions will intensify. Net-net, Petrofund is one of the premiere names in the Canadian investment trust universe: solid assets; solid management team; solid dividend-payment history. That is why Petrofund is one Canadian we trust!

Link here (scroll down to piece by Craig Walters).

The quest for 12%.

Urea ammonium nitrate is not a chemical weapon, nor is it a homeopathic dietary supplement. It is North America’s most versatile nitrogen fertilizer. Terra Nitrogen Co. L.P., manufactures more of it than anyone else in the world. Over the last couple of years, as fertilizer prices have been climbing, Terra has been producing robust profits. And Terra has been sharing its success with shareholders by paying out very large dividends. Therefore, at the stock’s current price of $23.73, its trailing 12-month dividend yield has been more than 10%.

But despite the company’s recent strong performance and lavish dividend payouts, the stock has fallen out of favor. Many investors now consider this debt-free, high-yielding stock to be overly risky. I do not. I think the stock’s risks are exaggerated. But I like that the stock has fallen out of favor – that give us a great bargain opportunity. Despite it ominous name, Terra produces nitrogen fertilizer products that are purchased mostly by farmers to improve the yield and quality of their crops. And … that is it. It does not get much simpler than that. That is its business.

Terra sells its products primarily in the Central and Southern Plains and Corn Belt regions of the U.S., placing production very close to its end users. All of Terra’s sales are at the wholesale level. Its customers are exactly as you would expect – national farm retailers, distributors, and traders. An important point to note is that no single customer accounts for more than 10% of sales, so there is no risk of losing a huge percentage of business all at once. As you might imagine, the fertilizer business is literally seasonal. Its sales and cash flows follow the planting, growing, and harvesting cycles of farmers. Not surprisingly, therefore, Terra’s earnings results are also seasonal – highest in the spring, decreasing in the summer, and increasing again in the fall.

Like many manufacturers, Terra is exposed to several industry-specific risks: 1.) Price fluctuations in natural gas. The threat of rising natural gas prices is the biggest single risk for Terra. (And the recent spike in natural gas prices is the biggest single reason why Terra’s stock price has fallen). Natural gas accounts for 65% of Terra’s production costs. 2.) Weather and planting conditions – large deviations from “normal” conditions can reduce demand. 3.) Amount of fertilizers (and types) imported by the U.S. The U.S. imports and exports nitrogen, although we generally end up buying more from overseas than we can produce. 4.) Current and projected grain inventories and prices. Need for increased or decreased crop yields will affect Terra’s sales. 5.) Government policies. Federal incentives may increase the quantity of acres planted, grain inventory levels, and the mix of crops planted.

Back in the mid-1990s, the lure of high gross margins ushered in a lot of players into the nitrogen fertilizer business … too many players. Predictably, fertilizer prices fell to unprofitable levels. Many manufacturers had no choice but to close up their plants and exit the business. Today, the manufacturers who remain are arguably the “right” number of nitrogen suppliers. But fertilizer production is still a very difficult and cyclical business. Afterall, nitrogen fertilizers are commodity products. The best time for all nitrogen producers is when demand is so high for fertilizer that they can pass any increase in natural gas prices on to the customer. This is exactly the situation that has prevailed throughout most of the last 18 months. And demand for fertilizer remains very strong.

The legacy left by the closings of many nitrogen producers in the late 1990s through 2002 was one of high demand versus available supplies. Worldwide nitrogen supplies are still not abundant, and that obviously plays into Terra’s hands. Another factor in Terra’s favor is the relatively weak dollar, which keeps international competitors – many with access to cheaper natural gas – from over exporting into the U.S. This is a time of very favorable product pricing for Terra. Unfortunately, the company is feeling the squeeze of rising natural gas prices and is predicting a small loss for the final quarter of the year.

Terra pays out quarterly distributions based on “Available Cash” levels for the quarter. Available Cash is defined as all cash receipts less all cash disbursements, adjusted for changes in certain reserves. Obviously, therefore, Terra’s fourth quarter dividend will not bring much holiday cheer. But these low expectations for the near-term are exactly what allows us to buy the stock for the long-term. Terra is forever and always a company that earns its money and pays its dividends in uneven lumps. Over a longer timeframe, however, I think this company will continue to reward its investors wit, with. It has almost no debt. It spends nothing on research and development and very little on capital expenditures.

Terra’s stock is just plain cheap. And I think it is cheap because of the market’s perception of Terra’s natural gas risk. However, I think this perception is offering us a real bargain.

Link here (scroll down to piece by Craig Walters).


Natural gas prices burst out of a two-week holding pattern Wednesday (November 16), and they did it in grand fashion. By the close of trade, the market had soared nearly 7% in a single session. Look around for an explanation and you will get more than one. Some say the “unexpected” Energy Department report of a 2.2 million barrel draw in crude oil stocks buoyed prices throughout the complex. Others point to the weather forecast for a “cold snap” that would put the Indian summer on pause, if not end it outright.

Both arguments sound perfectly plausible, yet as always, there is another side to the fundamental story. First of all, the DOE’s “This Week in Petroleum” report does not even cover natural gas. Besides, crude stocks may be down for the week, but oil is not exactly in short supply. As one fundamental analyst interviewed by Bloomberg.com admitted Wednesday, “Inventories are still so high that we could take another chunk out of crude oil supplies and they would still be healthy.” And as for the weather, my question is simple: Shouldn’t everyone, including NYMEX traders, be expecting cooler weather at this point? Last time I checked the calendar, we were pretty deep into November. I have a hard enough time calling cold weather a “snap” at this point in the year, much less stomaching the idea that a forecast for normal seasonal temperatures can cause a 7% surprise in natural gas.

The fact is that something far more interesting is going on with natural gas prices, and you do not have to look beyond the price chart to see it. In Daily Futures Junctures, editor Jeffrey Kennedy focuses on a rare “expanding wedge” pattern in natural gas. To be brief, the latest price pattern leaves little doubt about where we stand in the short-term wave sequence. And today’s huge surge only increases our confidence in the Elliott wave forecast – it offers an excellent sign that natural gas is about to depart from a critical juncture.

Link here.


A week ago I described that day’s episode of table pounding in the Senate over energy prices. But instead of outrage, this political stunt may as well have produced fits of narcolepsy. In turn the media and the politicians finally realized that gas prices were going down instead of up. I guess the moral of the story is, the chattering class will close their mouths and open their eyes only after they realize they are boring the audience. Even the Department of Labor noticed. The release of the October CPI showed a 0.02% rise overall, yet with declines not only in energy but in several other major components as well.

So, now that “rising energy cost” articles have dropped from the current news cycle, it is worth remembering two things: 1.) The scare headlines and “$100 per barrel” forecasts reached an emotional climax at the end of August, just as the price trend was turning south. Yet in the news coverage, perception trumped reality for more than two months. 2.) Too many investors too often chase performance. Unless the past six months proves itself to be unique in financial history, I fully expect to read several stories in coming weeks that describe how a flood of new cash went into energy mutual funds during the summer, most of which will show losses in the third quarter.

There is a pattern at work in all of this. And by understanding that pattern, opportunities can and do appear that most people completely miss.

Link here.


The highflying 1980’s movie Wall Street coined the term, “Greed is good.” Well, that is fine in the movies, but in real life trading things are very different. As the old saying goes, “Bulls make money, bears make money, and pigs get slaughtered.” There are many rules to successful trading, but what I find even more important are the “Seven Deadly Trading Sins” to avoid at all cost. I always teach them to my readers and clients before I suggest they ever make their first commodities trade.

1.) Greed: In reality, greed tends to keep a trader from closing out a position when a reasonable profit has already been made, in the hope that the commodities futures or options price will go even higher. Staying in the market for too long is one of the most common reasons I see people consistently lose money in these markets.

2.) Over-Trading: That feeling of invincibility we get from greed often leads some traders to feeling the need to hold positions in several markets, at all times, on every trading day. Often traders forget that standing aside is a position. Not long, not short, flat.

3.) Fear: Fear will have even seasoned traders second guessing themselves and pulling the trigger too soon on trades or holding positions until the bitter end. Fear leads to trading decisions that become unmanageable. This fear (or insecurity) leads to a false-pride, which tends to keep a trader in a losing position for far too long. The main mistake is the reluctance of a trader to admit that the original trading decision was incorrect. A winning trader must keep their emotions at arms-length in order to consistently achieve their trading goals.

4.) Lack of Commitment: There are some commodities traders who are unwilling to make a serious commitment of time and effort to study and watch the markets. It is also important to engage in training and education that allows them to learn about technical and fundamental analysis, new trading systems and methods, order routing software. Those who do not commit themselves and their time are destined to fail.

5.) Over Analyzing: Or as they say in the industry, “paralysis by analysis”. With today’s vast wealth of information and disinformation on the Internet and elsewhere, we can literally be bombarded with analysis. This analysis can be debilitating and the most important skills a trader can learn is how to pick a trade, how to be disciplined enough to execute it at prices they choose, and then how to hold the trade until it reaches the profit target they set or is stopped out. More often than not, a trader lacking discipline and commitment will change strategy midway through the trade and begin second-guessing the trade immediately.

6.) Lack of Acceptance: A time waster for traders, and one of the biggest hurdles they run into, is acceptance. The inability to accept and limit losses is, in my opinion, the major reason commodities traders fail consistently. Some traders simply hold onto a losing trade for dear life, swearing it cannot go any lower. Compounding this mistake is the practice of adding to an already losing position; sometimes called “averaging down,” when in fact it should be called what it really is: stupid! The sooner a trader accepts that losses come with the territory, and learns to limit losses in advance the more profitable and stress free they will be.

7.) Boredom: Simply put, trading for the sake of trading. This is never a good idea. To be a good and successful trader you need to have conviction and actual passion for what you are trading; some days it is the only thing that gets you through without going insane. Boredom is the worst excuse for trading. Sometimes the best thing to do is for a trader to walk away from the trading screen, shut off the cell phone, turn off the business channel, and go for a walk, or even take a nap.

The seven deadly trading sins are not carved in stone, and there are many more, but what is important is to recognize your emotions, and how they affect your investing approach. There is no confessional for traders, that penance comes from our brokerage firm when they mark our account to market at the end of the day. The best way to avoid this is by not committing any of the seven deadly trading sins in the first place.

Link here (scroll down to piece by Kevin Kerr).


Wall Street executives are always creatively stating reasons why investors should buy stocks. Because corporate profits have been so good, they want investors to look forward to the inevitable year-end stock market rally and forget any negativity they have heard about investing in stocks, or rising interest rates. It is not necessary to look to the future they say; just close your eyes and buy now! When looking in my rear view mirror, I have to admit that profits made on Wall Street have been great. Indeed, as a percent of GDP, profits are pushing a record.

Next year, however, could be a totally different vehicle as this year’s profit engine runs out of gas. Much too much profit has been made in energy and finance. These profits will not last. In addition, the high cost of gas, heating oil, and natural gas (especially as we approach the home heating season), will drag down consumer spending, while increased producer prices dig into corporate profits. Quick energy profits today will come at the expense of every other industry’s profits tomorrow!

The financial industry has grown fat on the carry trade. Low short-term interest rates have made it easy for banks and Wall Street to borrow short and lend long. Indeed, everybody has gotten into the financing act; 40% of S&P reported profits are from financing activities. With the fed funds rate at 4% and rising, the domestic carry trade is dying and there is little to be made borrowing short-term and lending long-term. Moreover, at current credit spreads, there is very little profit to be made borrowing at a high credit rating and lending to a lower credit rating. Making marginal loans today, means only loan losses tomorrow.

This past year, banks and financial institutions have kept their reported profits growing by running down loss reserves, and playing games with derivatives. The joy of derivatives is that a financial institution can always enter into a trade that shows a profit today, even though the likelihood of a loss tomorrow is virtually certain and potentially catastrophic. All those institutions that accepted a fixed interest rate and agreed to pay a floating rate (based on the Federal Funds rate), are starting to suffer as the Fed raises floating rates. Buyers of synthetic CDO equity and insurers against credit default will also see easy profits vanish as the credit cycle turns.

The next problem for corporate profits is growth in corporate sales. It is really hard to keep profits growing when consumers do not have the money to buy the goods and services. Wages and salary growth obviously affect consumer spending and corporate profits in a big way. However, wages have not kept up with inflation, and high paying manufacturing jobs are still heading to Asia. The consumer, who has been spending more than they make and living off home equity extraction for the past two years, is tapped out. Their debt service is already a record – over 125% of disposable income – and is still rising. Borrowers will also be getting hit by higher monthly credit card minimum payments by year-end, and homeowners with adjustable rate mortgages can certainly count on higher interest rates.

Evidence is mounting that many housing markets peaked in June and July and home sales are now at prices 5% below the peak. When home prices are rising, taking out a home equity loan is equivalent to a homeowner giving themselves a bonus or winning the lottery. When prices decline, taking out a home equity loan is clearly an act of desperation needed to raise cash to pay the bills. Housing has truly driven the U.S. economy. Construction spending is estimated to be over one trillion dollars a year (building one new house may add 20 jobs to the economy when all the materials, transportation and labor are factored in), and residential construction makes up about 70% of this amount. However, last quarter results show residential construction is down from its peak.

It certainly appears that economic and business profit cycles have peaked. Falling corporate profits and rising interest rates at this stage of the economic cycle are not a “wall of worry” to be climbed, but rather a brick wall that investors are headed for at high speed. So, if you understand that profit growth and the level of interest rates are important for stock prices, any year-end rally looks like a great time to sell stocks! Also, if you understand that rising consumer spending is required for rising corporate profits, the tooth fairy will need to leave plenty of dollars, not dimes, under our pillows. Cash under the pillow or in the bank is the only rational place to leave those dollars as we rest and wait for better opportunities. Besides, cash will soon offer a risk free 4.5%.

Link here.


Lately, British consumers have grown so “extremely comfortable” with using credit cards that, in 2003, the number of cards in circulation surpassed the number of U.K. citizens (BBC). So comfortable that last summer, consumer debt topped £1 trillion for the first time ever. U.K. remains the “most developed card market in Europe”, and British credit card companies expect the number of cards in use to jump another 40% by 2008.

They may get their wish, but there is a flip side to this increasing reliance on credit. In the third quarter of 2005, the British filed 31% more personal bankruptcies than a year ago – “the largest number since 1960”, and a new record (Dow Jones Newswires). Repossessions in the third quarter were also up: 55% higher than last year – the largest quarterly jump in 12 years. It is not just a British problem. This year, 40% more Germans filed for protection than a year ago. And with the growing chances of an interest rate hike by the European Central Bank, other citizens of the European Union may soon join in. Of course, on this side of the ocean, things are not any better: Through October alone, U.S. consumers filed 49% more cases than in 2004.

Clearly, the growing number of people turning to bankruptcy courts for protection is not just a British trend. What is behind it? Analysts say it is the rising interest rates. True, but why are consumers borrowing so uncontrollably in the first place? Do they not know that one day, interest rates may – and likely will – rise? Don’t they know that one day, the rising house prices, which financed comfortable lifestyles for thousands of homeowners, may – and likely will – stop rising?

They know. But they hope for the best. And just like many other cultural and economic trends, this hopefulness is also a sign of the times. To quote from Robert Prechter’s Conquer The Crash, “Near the end of every major expansion, few creditors expect default, which is why they lend freely to weak borrowers. Few borrowers expect their fortunes to change, which is why they borrow freely.” So, contrary to the conventional wisdom, record-setting credit card debt and insolvency numbers are signs of good times, not bad. Willingness to lend and borrow money, just like willingness to buy or sell stocks, is determined by the health of society’s overall mood. And nothing reflects social mood better than the direction of the stock market.

The British FTSE-100 has been climbing since early 2003, reflecting improving sentiment, and the U.K. consumers’ willingness to borrow has been climbing with it. “The U.K.’s mountain of personal debt continues to have no peak in sight,” says one British industry insider. Actually, if you knew where British stocks were headed, you could reasonably forecast how long the U.K.’s credit binge may continue.

Link here.


If you have had your sights set on the U.S. stock market for the past year, chances are that by now, you have gone totally cross-eyed OR … just really, really cross. Fact is, the frequent ups and downs in the major indexes have been less jack n’ the box than high-powered jackhammer, frustrating bulls and bears alike. So far, the financial press has referred to the ‘05 market in all of the following ways: “Stuck”, “Struggling to find direction”, “Indecisive”, “Spinning its wheels”, and in a very recent Associate Press piece – “Trendless”. Ouch.

As it turns out, though, one man’s amorphous blob is another man’s clearly defined wave pattern. In other words, from where we sit, the price action unfolding in blue-chip stocks is anything but Trendless. Go to your favorite financial news site and locate a typical price chart that combines the action in all three U.S. stock indexes. Click on the “one month” range. Now, to the naked (i.e., fundamental) eye, one can see prices enjoying a steady uptrend from the late October low. In fact, on November 17, this rally propelled prices in the Dow Jones Industrial Average (DJIA) to an 8-month high AND pushed both the S&P 500 and Nasdaq Composite to 4½-year highs. That, though, is where the mainstream take on things ends – about two weeks too late for our taste.

In the October 26 Elliott Wave Theorist, Robert Prechter published a special Interim Report with this important message: “This month’s Elliott Wave Financial Forecast, due out Friday (November 2) may discuss an intermediate-term alternate [bullish] count that is possible for the first time in months. If the market refuses to fall now and instead accelerates upward even for a day or two, this alternate will come into play.

A change in our stance hinged on those specific conditions. And, in the November 2 EWFF, our analysis revealed the one pattern that would justify such a shift. In the words of Elliott Wave Principle, Key to Market Behavior, this pattern implies “dramatic change ahead” and usually ends its reign in “swift”, sharp “thrusts” in the opposite direction. Knowing this, we could not ignore the potential for U.S. stocks to take to the skies. And, on October 28 and October 31, prices gave the warning sign by “accelerating upward”. Now, as Bob Prechter points out in the just-published November 17 EWT, “the rapidity of the move over the past two weeks is compatible with the” alternate case.

The question now is – how long will this rally last? Well, the answer is as close as the November 17 EWT’s updated chart of the DJIA. This picture – along with Bob Prechter’s in-depth analysis of the long-term trend underway in the major indexes – suggests stocks are right on track to the “greatest opportunity in history.”

Elliott Wave International November 18 lead article.


How Hoover’s policies blazed the trail for FDR and wrecked the U.S. economy.

First published in Inquiry, 12 November 1979.

A half-century ago America – and then the world – was rocked by a mighty stock market crash that soon turned into the steepest and the longest-lasting depression of all time. Only the cataclysm of World War II was able to pull the Western world out of the Great Depression. It was not only the sharpness and depth of the depression that stunned the world and changed the face of modern history: It was the length, the chronic economic morass persisting throughout the 1930s, that caused intellectuals and the general public to despair of the market economy and the capitalist system. Previous depressions, no matter how sharp, generally lasted no more than a year or two. But now, for over a decade, poverty, unemployment, and hopelessness led millions to seek some new economic system that would cure the depression and avoid a repetition of it.

Political solutions and panaceas differed; for some it was Marxian socialism; for others, one or another form of fascism. In the U.S. the accepted solution was a Keynesian mixed economy or welfare-warfare state. Harvard was the focus of Keynesian economics in the U.S., and Seymour Harris, a prominent Keynesian teaching there, titled one of his many books Saving American Capitalism. That title encapsulated the spirit of the New Deal reformers of the thirties and forties. By the massive use of state power and government spending, capitalism was going to be saved from the challenges of communism or fascism.

One common guiding assumption characterized the Keynesians, socialists, and fascists of the 1930s: that laissez-faire, free-market capitalism had been the touchstone of the U.S. economy during the 1920s, and that this old-fashioned form of capitalism had manifestly failed us by generating, or at least allowing, the most catastrophic depression in history. Well, were the 1920s not – with their burgeoning optimism, their speculation, their enshrinement of Big Business in politics, their Republican dominance, their individualism, their hedonistic cultural decadence – indeed the heyday of laissez-faire? Certainly that decade looked that way to most observers, and hence it was natural that the free market should take the blame for the consequences of unbridled capitalism in 1929 and after.

Unfortunately for the course of history, the common interpretation was dead wrong: There was very little laissez-faire capitalism in the 1920s. Indeed the opposite was true: Significant parts of the economy were infused with proto-New Deal statism, a statism that plunged us into the Great Depression and prolonged this miasma for more than a decade.

In the first place, everyone forgot that the Republicans had never been the laissez-faire party: On the contrary, it was the Democrats who had always championed free markets and minimal government, while the Republicans had crusaded for a protective tariff that would shield domestic industry from efficient competition, for huge land grants and other subsidies to railroads, and for inflation and cheap credit to stimulate purchasing power and apparent prosperity. It was the Republicans who championed paternalistic Big Government and the partnership of business and government while the Democrats sought free trade and free competition, denounced the tariff as the “mother of trusts”, and argued for the gold standard and the separation of government and banking as the only way to guard against inflation and the destruction of people’s savings. At least that was the policy of the Democrats before Bryan and Wilson at the start of the twentieth century, when the party shifted to a position not very far from its ancient Republican rivals.

The Republicans never shifted, and their reign in the l920s brought the federal government to its greatest intensity of peacetime spending and hiked the tariff to new, stratospheric levels. A minority of old-fashioned “Cleveland” Democrats continued to hammer away at Republican extravagance and Big Government during the Coolidge and Hoover eras. Those included Governor Albert Ritchie of Maryland, Senator James Reed of Missouri, and former Solicitor General James M. Beck, who wrote two characteristic books in this era: The Vanishing Rights of the States and Our Wonderland of Bureaucracy.

But most important in terms of the Depression was the new statism that the Republicans, following on the Wilson administration, brought to the vital but arcane field of money and banking. How many Americans know or care anything about banking? Yet it was in this neglected but crucial area that the seeds of 1929 were sown and cultivated by the American government. The U.S. was the last major country to enjoy, or be saddled with, a central bank. Only the U.S., as a result of Democratic agitation during the Jacksonian era, had had the courage to extend the doctrine of classical liberalism to the banking system, thereby separating government from money and banking. Having deposed the central bank in the 1830s, the U.S. enjoyed a freely competitive banking system – and hence a relatively “hard” and noninflated money until the Civil War. During that catastrophe, the Republicans used their one-party dominance to push through their interventionist economic program, which included a “national banking system” that in effect crippled state-chartered banks and paved the way for the later central bank.

The U.S. adopted its central bank, the Federal Reserve System, in 1913, backed by a consensus of Democrats and Republicans. This virtual nationalization of the banking system was unopposed by the big banks; in fact, Wall Street and the other large banks had actively sought such a central system for many years. The result was the cartelization of banking under federal control, with the government standing ready to bail out banks in trouble, and also ready to inflate money and credit to whatever extent the banks felt was necessary. The autocratic ruler of the Federal Reserve System, from its inception in 1914 to his death in 1928, was Benjamin Strong, a New York banker who had been named governor of the Federal Reserve Bank of New York. Strong consistently and repeatedly used his power to force an inflationary increase of money and bank credit in the American economy, thereby driving prices higher than they would have been and stimulating disastrous booms in the stock and real estate markets. In 1927, Strong gaily told a French central banker that he was going to give “a little coup de whiskey to the stock market.” After Strong’s death in late 1928, the new Federal Reserve authorities brought and end to the deliberate and consistent policy of inflation, and a corrective depression soon arrived.

There are two mysteries about the Depression, mysteries having two separate and distinct solutions. One is, why the crash? Why the sudden crash and depression in the midst of boom and seemingly permanent prosperity? We have seen the answer: inflationary credit expansion propelled by the Federal Reserve System, in the service of various motives, including helping Britain and the House of Morgan. But there is another vital and very different problem. Given the crash, why did the recovery take so long? Usually when a crash or financial panic strikes, the economic and financial depression, be it slight or severe, is over in a few months, or a year or two at the most. After that, economic recovery will have arrived. The crucial difference between earlier depressions and that of 1929 was that the 1929 crash became chronic and seemed permanent.

What is seldom realized is that depressions, despite their evident hardship on so many, perform an important corrective function. They serve to eliminate the distortions introduced into the economy by an inflationary boom. When the boom is over, the many distortions that have entered the system become clear: Prices and wage rates have been driven too high, and much unsound investment has taken place, particularly in capital goods industries. The recession or depression serves to lower the swollen prices and to liquidate the unsound and uneconomic investments; it directs resources – including labor – into those areas and industries that will most-effectively serve consumer demands – and were not allowed to do so during the artificial boom. The recession must be allowed to perform its work of liquidation and restoration as quickly as possible, so that the economy can be allowed to recover from boom and depression and get back to a healthy footing. Before 1929, this hands-off policy was precisely what all U.S. governments had followed, and hence depression, however sharp, would disappear after a year or so.

But when the Great Crash hit, America had recently elected a new kind of President. Until the past decade, historians had regarded Herbert Clark Hoover as the last of the laissez-faire Presidents. Instead, he was the first New Dealer. Hoover had his bipartisan aura, and was devoted to corporatist cartelization under the aegis of Big Government; indeed, he originated the New Deal farm price support program. His New Deal specifically centered on his program for fighting depressions. Before he assumed office, Hoover determined that should a depression strike during his term of office, he would use the massive powers of the federal government to combat it. No more would the government, as in the past, pursue a hands-off policy.

The massive Hoover program was, indeed, a characteristically New Deal one: vigorous action to keep up wage rates and prices, to expand public works and government deficits, to lend money to failing businesses to try to keep them afloat, and to inflate the supply of money and credit to try to stimulate purchasing power and recovery. Herbert Hoover during the 1920s had pioneered in the proto-Keynesian idea that high wages are necessary to assure sufficient purchasing power and a healthy economy. The notion led him to artificial wage-raising – and consequently to aggravating the unemployment problem – during the depression.

After Hoover’s term, Franklin D. Roosevelt simply continued and expanded Hoover’s policies across the board, adding considerably more coercion along the way. Between them, the two New Deal Presidents managed the unprecedented feat of making the depression last a decade, until we were lifted out of it by our entry into World War II.

If Benjamin Strong got us into a depression and Herbert Hoover and Franklin D. Roosevelt kept us in it, what was the role in all this of the nation’s economists, watchdogs of our-economic health? Unsurprisingly, most economists, during the Depression and ever since, have been much more part of the problem than of the solution. When the crash came, Fisher and his disciples of the Chicago school pinned the blame on the wrong culprit. Instead of realizing that the depression process should be left alone to work itself out as rapidly as possible, Fisher and his colleagues laid the blame on the deflation after the crash and demanded a reinflation (or “reflation”) back to 1929 levels. In this way, even before Keynes, the leading economists of the day managed to miss the problem of inflation and cheap credit and to demand policies that only prolonged the depression and made it worse. After all, Keynesianism did not spring forth full-blown with the publication of Keynes’s General Theory in 1936.

We are still pursuing the policies of the 1920s that led to eventual disaster. The Federal Reserve is still inflating the money supply and inflates it even further with the merest hint that a recession is in the offing. The Fed is still trying to fuel a perpetual boom while avoiding a correction, on the one hand, or a great deal of inflation, on the other.

Link here.
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