Wealth International, Limited

Finance Digest for Week of May 14, 2007

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


Stepping into a field of May flowers, you may think that the world is now a sunny and beneficent place. The harsh weather of recent months is a bad memory. After the market’s horrifying drop of February and early March, stock prices have climbed back above their previous highs. But the market, as measured by the Chicago Board Options Exchange Volatility Index (or VIX), is still choppier than it was last fall.

I suspect that more turbulence is ahead. Too many contradictory factors are loose. What is an investor to do? Hunker down and you might just miss a nice rally. Charge into the market and you might get slammed. There is a way, though, to build an investment bridge between terror and and terra firma. It is called a pairing strategy – a way to seek real returns no matter which way the markets wend. The ideal method of doing this is via exchange-traded funds, some of them newly hatched. Basically, you pair two long ETFs that track well-known indexes with two short ones. Equal amounts go into each of these four baskets.

This mix will not keep up in bull markets. At best the portfolio will record tepid, single-digit gains. But your investments likely will not collapse in a broad downtrend. The ETF long-short admixture is far cheaper than hedge funds, which claim they can outfox the market. Hedge funds typically slap you with 2% yearly fees and slice a fifth of the profits off for themselves. Invest $1 million in a collection of hedge funds that merely break even, while some go up a lot and some down a lot, and you could easily be paying $40,000 a year in fees. Put $1 million into the mix of four ETFs recommended here and you will be paying only $7,100 a year in fees.

There are other ways to hedge. You can buy a put on an index to protect your $1 million, but that also will cost you more. My ETF hedge has you tilting your strategy to be bullish on foreign stocks and bearish on U.S. ones. The umbilical linkage between American and global markets means that when we sell off, they sell off. But with the faster-growing overseas economies, when we rally back, they rally back more.

For the shorts, buy ETFs tracking the Dow Jones industrial average for domestic large companies and the Russell 2000 for small ones. That is equal amounts into the ProShares Short Dow 30 (DOG) and the ProShares Short Russell 2000 (RWM). These two ETFs strive to return the inverse performance from the indexes. Both have annual fees of 0.95%. On the long side I would opt for the iShares MSCI EAFE (EFA), with a 0.35% fee, to cover large companies in the developed world outside the U.S., and the Wisdom Tree International Small Cap Dividend (DLS), whose fee is 0.58%, for small companies in the same countries.

During the troubled first quarter the pairings fared well. They were up a collective 6.5% (excluding dividends), vs. the S&P 500’s 0.2%. In the quarter’s worst selloff (2/21-3/5) this portfolio was down 0.4% as the S&P dropped 5.7%. For the first period’s best rally (3/6-3/26) our pairings inched up 2.9%, while the market posted 3%. But you bought peace of mind.

Link here.


For the moment, nothing is hotter than a cold financial institution. On Wall Street somebody seemingly threw a switch. The subprime mortgage crisis is not so intractable after all, the revised story line goes. Certainly not when Representative Maxine Waters (D-California) has so generously volunteered the taxpayers’ money for the cause of keeping the nation’s overextended borrowers in their overencumbered houses. Then, too, the bulls contend, a new era dawned with the news of the leveraged buyout of SLM Corp., a.k.a. Sallie Mae. Now every underperforming bank, thrift or mortgage lender is supposedly in the crosshairs of a private equity titan.

Almost every one. Bladex, shorthand for the Banco Latinoamericano de Exportaciones S.A. (NYSE: BLX, 19), is absolutely out of consideration – due to the nature of the Panamanian bank’s mission as well as the structure of its ownership. Bladex is a supranational hybrid, founded to promote the growth of South American trade. It is controlled by the public sector (including 23 regional central banks and monetary institutions) but capitalized, in good part, with private funds.

Bladex had a near-death experience in 2002. Late in the 1990s management contracted a kind of new-era grandeur. Bladex diversified away from trade finance, which it knew, into working-capital lending, which it knew not, and at exactly the wrong time. Following a post-2000 wave of Latin American defaults, the bank acquired a new management, a smaller balance sheet and, of course, a much smaller stock price. The bank’s most devastating blow was the December 2001 Argentinean default. Bladex was in over its stockholders’ heads, with net Argentinean exposure totaling $1 billion, or 167% of net worth. You might have forgotten, though Bladex has assuredly not, that Argentina’s GDP plunged by more than 50% from the precrisis peak to postdefault depths. “[T]here are no cycles in Argentina’s economy,” a man at the bank reflected in early 2004. “There are more like cyclones.”

The speaker was Jaime Rivera, newly installed Bladex chief executive. He vowed to return the bank to profitability and to its roots in trade finance. He promised to speed the workout of the bank’s Argentinean exposure. These things, and more, he has accomplished. Last year the bank generated 36% growth in operating income (earnings before taxes and nonrecurring items) on the strength of rising fee income and net interest income. And it closed out all but the tag ends of its Argentinean recovery mission.

Rivera has not yet generated a competitive return on equity. He has a good excuse. Bladex is hugely overcapitalized, a legacy of the years of overcaution that followed the period of reckless abandon. The primary, or Tier 1, capital amounts to no less than 22.3% of March 31 assets. Because of this cushion, the board recently gave the stockholders a raise in the shape of a higher dividend. The shares now yield 4.6%.

Just because Bladex once drove into the ditch does not mean that it will forever after remain on the straight and narrow. One point of vulnerability is the world-beating, Chinese-led commodities boom. Latin American exports jumped by 21% last year, according to the Inter-American Development Bank, the third consecutive year of 20%-plus growth. And intraregional trade managed to outpace the external kind.

When China hiccups or India sneezes or a politician utters the dirty word “protectionism”, Bladex’s shareholders shudder. On the other hand, they are armored against adversity by a relatively cheap share price. The stock (it has ADRs) trades at 14.2 times trailing 12-month net income and 1.2 times March 31 book. You can find U.S. banks and thrifts almost as cheap, but you will not find many nearly so well-capitalized. Bladex has come back from the abyss.

Link here.


Certain oracles have been predicting rising interest rates for at least the past six months. I think rates are somewhat more likely to drop than go up. Signs of a weakening economy we are seeing develop now (slower home sales, dipping corporate earnings, etc.) will spur the Federal Reserve to ease them.

It is impossible to really know where rates are going, but it is not hard to hedge your bets a little. Put some of your cash to work in an investment that will benefit from a decline in rates. Buy some zero coupon bonds. These are the ones that pay all their interest at maturity. With them you do not have the risk of reinvesting coupons at disappointing yields. In other words your yield to maturity in this part of your portfolio will be exactly what you expected when you bought the bonds.

As with coupon-bearing bonds, zeros are available from the U.S. Treasury as well as from corporations, and in taxable and tax-exempt varieties. With some scarce exceptions, I do not like corporate zeros because there is too much risk of a deterioration in credit quality. A leveraged buyout of the issuer surely would turn your nice investment-grade paper into junk overnight.

It is commonly said that taxable zeros should go only in a tax-deferred account like a 401(k). The advice is sound, but the reason usually given is wrong. The usual reasoning is that zeros cause tax misery because you have to declare the interest income currently even though you will get your hands on the interest only years later. But even if you have cash from other investments or a paycheck with which to cover the tax bill on your zero, the real problem is that interest from corporates and Treasurys is taxable at stiff ordinary income rates. So try to keep all your taxable bonds, whether or not they have coupons attached, in your tax-deferred accounts. Use taxable accounts for stocks or tax-exempt bonds.

Because of the flat yield curve, interest rates on zeros are not very different from those on conventional bonds. Treasury zeros yield between 4.5% and 5%. The one due in February 2017 is priced at 63 cents per dollar of maturity value. That gives it a yield of 4.8%, a tad above the 4.7% on a coupon bond due at the same time. This zero would be a fine addition to the IRA of someone planning to retire in ten years.

If you are not investing a minimum of $50,000 in zero coupon Treasurys, then buy a Treasury zero bond fund. Below $50,000 the transaction costs are too disproportionately large to make the trip worthwhile. American Century has four no-load funds with final maturity dates of 2010, 2015, 2020 and 2025. American Century Target (NYSE: TGT) 2010, for instance, pays out in three years. The fund expense is 0.57% of assets yearly, the minimum investment $2,500.

Go to the government’s Web page, for a list of Treasury yields. Ask your broker to look at his Bloomberg terminal and quote the institutional bid and ask on the zero you are interested in. How far away from the midpoint of that spread is his net price for the $100,000 face amount you are buying? If the markup is 1% or more, shop around. For those in high tax brackets not in need of cash flow, zero munis make a lot of sense.

Link here.


“Small Stocks have offered better returns over the past 70 years than any investment except loans to new businesses.” That interesting little quote comes from a great series of books titled Bloomberg Personal Bookshelf. My favorite in the series is Investing in Small-Cap Stocks by Christopher Graja and Elizabeth Ungar.

That quote got us reminiscing about stocks whose businesses are focused on lending money or investing directly in new and existing businesses. Those small-caps – Ares Capital (Nasdaq: ARCC) and MCG Capital (Nasdaq: MCGC) have done extremely well. These two small-caps are business development companies (BDCs). Regulated by the Investment Company Act of 1940, A BDC must be organized in the U.S. for the purpose of investing in or lending to mostly private companies and giving them managerial assistance when needed. BDCs can receive capital from shareholders and other sources all in an effort to invest in long-term, privately held businesses. Ares and MCG are prime examples of a type of business where investors can buy shares in what are really a basket of privately owned companies.

While these can be great investments, you should be warned of their typical growth patterns. When a private equity firm is in its infancy and only starting to develop its portfolio, its first few initial investments will probably have low or negative returns. Returns will be heavily impacted by management fees, which are taken out of the firm’s committed capital. It may take some time before the portfolio grows in value to overcome the fees and show just how good its managers are at making profitable private investments. If you plotted the firm’s returns in the early years up to and past the point that management fees are overcome by investment profitability, it would form a “J” pattern.

Eventually, the private companies in which the firm has invested will hopefully appreciate, garnering a valuation for the private equity firm that is higher than the sum of the original investments. Ultimately, big gains can be realized as some of these investments are sold off for large cash sums. There are no guarantees, of course.

Not all BDCs can be like the legendary Allied Capital (NYSE: ALD). On April 24, 2007, the company declared its 175th consecutive quarterly dividend! That is almost 44 years of not missing a dividend payment. And for the last 10 years, Allied’s internal rate of return on its investments and loans has been approximately 22%. BDCs can be a great source of high yields and high returns.

Link here.


Merrill Lynch filed its Q1 10Q this week. We now know that total assets expanded $140.5 billion, or 67% annualized, to $982 billion during the quarter. Assets were up $250 billion, or 34%, y-o-y. This puts combined Big Five (Morgan Stanley, Merrill Lynch, Goldman Sachs, Lehman, and Bear Stearns) Q1 asset growth at an incredible $379 billion (41% growth rate) to $4.033 trillion. Big Five assets inflated $843 billion over the past year, or 26%. For comparison, bank credit is up about $580 billion y-o-y.

Identical to their Wall Street brethren, Merrill’s growth was predominantly in the area of securities finance. With JPMorgan and Citigroup added to the mix, “Big 7” combined “repo”/“fed funds” liabilities expanded an unprecedented $267 billion during the quarter, or 62% annualized. Forget the traditional M2 and M3 aggregates –- the current monetary expansion is dominated by a historic yet unrecognized inflation in “repo” instruments. From the New York Fed’s weekly Primary Dealer Transaction Report, we see that Primary Dealer “repo” positions (in Treasuries, agency, and MBS) are up an astounding $533 billion y-t-d, or 45% annualized, to $3.981 trillion. This is another key data point confirming the degree to which the monetary system has run amok. And it is certainly no coincidence that “repos” are these days expanding in similar degree to foreign central bank reserves.

It is my view that U.S. securities finance has evolved into a primary source of system liquidity creation, the finance that then inundates the world’s market and economies, only to be “recycled” by foreign central banks back to our securities (and “repo”) markets – where it again provides the liquidity to sustain more credit creation and bubble excess. Wall Street securities lending operations at the same time provide an endless supply of Treasuries to “mop up” global dollar liquidity, while creating an unending supply of cheap liquidity for securities leveraged speculation.

Some years back (1999) I proposed the concept of an qInfinite Multiplier Effect”. This potential is now being fulfilled. When, for example, a foreign central bank “recycles” dollar liquidity through the purchase of Treasuries, this finance is immediately available to be “multiplied” infinitum in the modern day securities finance arena. Say the Bank of Japan buys $100 million of Treasuries from a hedge fund, a (“carry-trade”) speculator using this short-sale as a source of finance for the purchase of higher-yielding securities. Here, a $100 million of dollar liquidity that the Bank of Japan initially acquired by exchanging yen finance with, say, Toyota then flows to the hedge fund. For the hedge fund, this liquidity becomes buying-power for the purchase of ABS from, e.g., Merrill Lynch. Merrill would then have liquidity for its investment banking clients to finance a jumbo mortgage or perhaps an acquisition. This entire $100 million of finance can then follow various paths as it flows back out to the world financial system whereby it can again be recycled in its entirety right back to our securities markets.

In the traditional “multiplier” example, (closely regulated) bank finance circulated within the credit/banking system, creating new deposit IOUs during the lending process. Bank liabilities were the principal component of system “money”, where they could at least be easily tallied and monitored. Today, (unrestricted) securities market finance/liquidity circulates through an expansive and increasingly non-transparent credit system. From securities transaction to securities transaction, this process creates myriad new debt instrument IOUs through a multitude of lending processes (some financing the real economy but most financing the securities and asset markets). This unchecked expansion of a broad range of sophisticated securities market-based liabilities, intermediated globally through various types of institutions and vehicles, now comprises the vast majority of system “liquidity”. This finance cannot be readily accounted for or monitored, let alone regulated by monetary authorities.

Witnessing extraordinary monetary developments, I have lately been thinking a lot about checks and balances. For good reason, there exists today unwavering conviction that checks and balances and the separation of powers are fundamental to freedom and democracy. Our Founding Fathers were incredibly wise and masterful statesmen. When it came to the scourge of the abuse of power, unsound money ranked right up there with tyranny. They were hard money men who would be appalled by the current state of monetary affairs, the power concentrated in the hands of the Wall Street “money”-men, and the untenable debt load we owe to foreign governments and financiers.

Money and finance are not conducive to the necessary checks and balances. Finance is always changing and evolving at a pace that ensures that very few actually understand the new instruments and methods and even fewer the true course of monetary developments (until it is too late). And you can be certain that when the boom catches a head of steam there will be fanciful talk of a New Era coupled with steadfast intolerance for checking monetary excess. Today, “money” or “liquidity” cannot even be adequately defined, let alone monitored and regulated. Worse yet, in this credit-induced boom-time euphoria, rabid ideologues (think Kudlow and Laffer) equate free markets in goods and services (the Economic Sphere) with a “free” marketplace in unrestricted finance (the Financial Sphere). Checks and balances and the separation of powers are recognized as absolutely paramount to a healthy democracy, yet these principles are somehow viewed with intense disdain when it comes to modern finance-based capitalism.

A great amount of historical precedent has me convinced that unchecked money and credit pose the greatest risk to free market capitalism. The economic literature from the ‘30s, ‘40s and ‘50s is replete with invaluable insight into such matters. The experience of the financial crash and Depression left deep emotional and analytical scares with respect to the damage inflicted by the unscrupulous “money changers” and reckless speculators. Glass-Steagall and the Banking Act of 1933 were to ensure that power over the U.S. financial system and economy were never again concentrated in the hands of “Wall Street”. But by the ‘60s, memories had begun to fade. Milton Friedman emerged with alluring historical revisionism. And the adoption of a statistical and quantitative “hard science” approach radically changed the nature of monetary analysis.

Henry C. Simons, in The Journal of Political Economy in 1936, wrote, “We must avoid a situation where every business venture becomes largely a speculation on the future of monetary policy. In the past ... private initiative has been allowed too much freedom in determining the character of our financial structure and in directing changes in the quantity of money and money-substitutes. On this point there is now little disagreement. In our search for solutions of this problem, however, we seem largely to have lost sight of the essential point, namely, that definite, stable legislative rules of the game as to money are of paramount importance to the survival of a system based on freedom of enterprise. ... What matters is the character of the financial structure which banking creates – and the fact that, in the very nature of the system, banks will flood the economy with money-substitutes during booms and precipitate futile efforts at liquidation afterward.”

In practice, the “Infinite Multiplier Effect” is restrained by the natural limitations in the demand for borrowed funds. In the case of traditional lending, finance will expand at a rate to satisfy the demand for funds for real economic endeavors (i.e., business capital investment). Despite some rather outrageous lending excesses, even the expansion of mortgage finance was limited to a degree by the capacity of households to borrow.

Today is different. The prevailing demand for borrowing emanates from securities markets activities – specifically for M&A and leveraged securities speculation. In both cases, “the sky’s the limit.” As such, we are in a period of extraordinary capacity for finance to mount a powerful burst of expansion – which it has been doing. Wall Street and the global leveraged speculating community have become enormously big and powerful. Foreign central bank “recycling” of dollar liquidity has evolved into one of history’s most remarkable (and dangerous) monetary processes. Wall Street has begun to position for the next easing cycle with tens of trillions of securities available for such an endeavor.

The monetary backdrop has clearly become extremely unstable – I will refer to it as an “unchecked liquidity dislocation”. The question then becomes, can monetary affairs settle down to a less unwieldy posture? Or are we instead now firmly locked in a Minsky Ponzi “deviation amplifying system” – that at some unpredictable time and in some unpredictable fashion comes to a predictably devastating conclusion?

Link here (scroll down).


Never have so many made so much money from junk bonds, and that worries Dan Fuss. Fuss, whose $10.7 billion Loomis Sayles Bond Fund has been the best performer among its peers the last 10 years, says high-yield, high-risk securities are showing unmistakable signs of a bubble. Yields are near record lows relative to government securities even though sales of the riskiest bonds increased 39% from last year, debt has grown faster than earnings and the economy is expanding at the slowest pace in five years.

“I haven’t felt this nervous about a market ever,” said Fuss, who has been working in the banking and securities industries since 1958. His fund has returned an average 9.91% a year for the last decade, the best of 45 funds with similar investment rules, according to Lipper.

Martin Fridson, head of high-yield research firm FridsonVision LLC, and Mariarosa Verde, managing director of credit market research at Fitch Ratings, say sales of junk bonds and the record $366 billion of leveraged buyouts may lead to the worst bear market for bondholders. The last time junk bonds tumbled was in 2002, when companies defaulted on $166 billion of their securities, according to Moody’s. Merrill Lynch’s High Yield Master II Index fell about 2% that year as yields on the securities rose to a record 11.2 percentage points over Treasuries. Speculative grade, or junk, bonds are rated below Baa3 by Moody’s and BBB- by Standard & Poor’s.

“The downside is likely to be very severe,” said Fridson, who led Merrill’s high-yield strategy group until he left in 2003 to start his own firm. He predicts that in the next few years the default rate may reach or surpass the 2002 level, when WorldCom and Adelphia Communications filed for bankruptcy. About 1.5% of junk-rated companies have defaulted on their debt this year, near the lowest in a decade, Moody’s says. “Defaults are almost non-existent today and, well, we know that does not hold forever,” said Thomas Lee, who stepped down last year from Thomas H. Lee Partners LP, the Boston-based takeover firm he founded 32 years ago. “When the economy goes bad, defaults will spike up from 1% into the 9% level. If that happens then the financing part grinds to a halt” for LBOs, he said.

More than half of the junk bonds sold this year were used to pay for LBOs and mergers and acquisitions, according to Barclays Capital. Money is so easy to come by that for the first time some investors agreed to let borrowers choose to make interest payments in cash or in additional bonds. “This is fantasy land for corporate treasurers,” said Edward Altman, a professor of finance at New York University’s Stern School of Business. They “are smiling like Cheshire cats” and borrowing conditions “entice them to increase their leverage.”

The growth of “toggle” bonds is a symptom of too-easy credit, Fridson said. Giving companies the ability to pay interest with more debt rather than cash shows they “have a reasonable likelihood of needing to exercise that option,” he said. There have been 10 sales of toggle bonds this year, amounting to $5.14 billion, the most ever, according to S&P.

JPMorgan Chase analyst Peter Acciavatti, the top-ranked high-yield analyst in Institutional Investor magazine’s annual poll the past four years, lowered his default forecast for the end of this year to 1.25% from 2% on a dollar-weighted basis, in part because issuers have taken advantage of low rates to refinance and extend maturities. “I don’t see the catalyst for rising defaults except for the economy. If the economy gets worse from here it will eventually start to have a toll on earnings and leverage,” he said.

Fuss, 73, said the likelihood of losses has prompted his Loomis Sayles fund to invest in longer-maturity Treasuries while he waits for the yield spread between corporate and government bonds to increase. Franklin Resources, which manages more than $120 billion in fixed-income, has been “significantly” paring its investments in CCC bonds over the past 18 months, said Eric Takaha, director of high-yield at Franklin. The average bond in Franklin’s high-yield portfolios is rated a “mid-to-high” B, up from a “mid-to-low” B during the same time period, he said.

Companies are piling on debt even as the economy slows. The total debt for about 300 companies rated BB and B expanded by 16% last year, double its growth in 2005, according to Fitch. Debt strategists at Morgan Stanley calculated in a report last month that leverage is rising for eight of the 15 high-yield industries it covers, the first “meaningful” increase since 2002. Ford Motor is $23 billion deeper in debt than it was a year ago. Its $3.7 billion of 7.45% bonds due in 2031 trade at a yield premium of 4.63 percentage points, down from 5.38 a year ago, according to Trace, the bond-price reporting system of the NASD. Ford is rated Caa1 by Moody’s.

Credit quality “is moving in a less desirable direction,” said Fitch’s Verde. Bond investors should also worry because companies are adding more senior secured loans, which rank ahead of junk bonds in a bankruptcy, Verde said. The average recovery rate for unsecured bonds may fall by as much as 10% from its historical average of 40 cents on the dollar because of the rise in loans, according to Fitch. “Structural risks are rising. They are simply being masked by the low default rate.”

More than $108 billion of so-called covenant-lite loans, or those that do not hold borrowers to limits on quarterly debt, have been completed this year, compared with a total of $36 billion in the previous 10 years, according to S&P’s LCD. “The normal thing is two to four years after the issuance for defaults,” said NYU's Altman. “Deals with little covenants, toggles, push back the timeline. But it’s gotta happen.”

Link here.


The vast amount of cash flowing through buyout firms is reshaping businesses, industries, and the US economy, as evidenced by the pending sale of automaker Chrysler Group. Cerberus Capital Management LP, a New York buyout firm, yesterday said it will spend $7.4 billion to buy the struggling Chrysler unit from DaimlerChrysler AG. The German company, the maker of Mercedes-Benz, acquired Chrysler in 1998, for $36 billion.

Chrysler becomes the latest in a recent series of megadeals engineered by buyout firms, which often buy struggling public companies, take them private, and revamp them away from the pressures of Wall Street. What often emerge, economists said, are firms that are more competitive. But becoming more competitive can mean plant closings, layoffs, and other cost-cutting measures.

Fueling the buyout spree are billions of dollars from investors and billions more in low-interest credit. Buyout firms combine investors’ money with large amounts of borrowed money to make the acquisitions. The goal is to improve the companies’ financial performances, with the idea of selling and taking profits in three to five years. Interest rates around the world are near historical lows, while the outsized returns produced by buyout firms – sometimes in the triple digits – are attracting more and bigger investors, including wealthy individuals, pension funds, and college endowments. In 2006, buyout funds raised nearly $200 billion from investors, surging from $24 billion in 2003, according to Moody’s Economy.com.

“There is so much money sloshing around that it has to be put to work,” said Howard Anderson, a professor at MIT’s Sloan School of Management. As in all booms, said Mark Zandi, chief economist at Economy.com, there is a risk of a bust. Since these deals rely on large amounts of borrowed money, an economic downturn could cut into the cash needed to service the debt, and lead to a domino effect of bankruptcies. “Good things in financial markets almost always lead to excess,” Zandi said. “We may not be there yet, but we are heading there.”

Chrysler became a likely target for buyout firms as its poor performance hurt the stock price of DaimlerChrysler, which came under increasing pressure from investors to sell the unit. Chrysler lost $1.5 billion last year. The pressure led Daimler to unload its American unit for what analysts said was a bargain price. Cerberus will acquire about 80 percent of Chrysler by agreeing to invest most of the $7.4 billion in the company, plus take on the billions of dollars in pension and healthcare obligations. The U.S. auto industry has struggled in recent years in the face of foreign competition and high costs, leading to plant closings and thousands of job cuts. Toyota’s share of the U.S. market has risen to about 16% from 10% five years ago, while the share of the largest U.S. automaker, General Motors, fell to 23% from about 29%, according to Edmunds.com. The U.S. auto industry’s problems were underscored yesterday by reports the Ford family is considering selling its controlling interest in Ford Motor. Last year, Ford lost a record $12.6 billion.

Cerberus’s acquisition could prove the right medicine for what ails Chrysler, analysts said. As a private firm, Cerberus and its management team will be able to take difficult steps that might take time to pay off, without worrying about meeting the quarterly expectations of Wall Street.

Link here.

Weak dollar, excess cash help fuel M&A boom.

Global financial markets awash in liquidity, due partly to a weak dollar, have spawned a flurry of mergers and acquisitions this year, and as long as the greenback remains soft the boom has further to run. The weak dollar, which has been pressured by gloomy U.S. growth expectations and diminishing yield advantage over other major currencies, has triggered huge increases in foreign exchange reserves for countries such as China and Japan that do not want a soft dollar because it erodes their export competitiveness.

The surge in foreign exchange reserves by global central banks and a robust stock market have ensured lots of cash to fund M&A deals, analysts say. The surplus has kept global interest rates low and made financing of these transactions a lot cheaper. Rising M&A transactions that tracked increasing global reserves also happened in the mid-to-late 1990s, analysts say.

“To the extent that you have central banks intervening to keep the value of their currency at a competitive level by accumulating dollar reserves at a rapid pace, that is going to boost liquidity and be one of the factors contributing to M&A activity,” said Nick Bennenbroek, head of currency strategy at Wells Fargo Bank in New York,

When central banks intervene in the foreign exchange market, they buy dollars and sell the local currency to keep their unit weak. These banks, however, try to offset the inflationary impact of the increased local currency in circulation by selling government securities. But often the accumulated dollars in central banks’ reserves are not fully sterilized and their recycling into the bond market keeps longer-dated yields below their appropriate level.

Link here.


Shift to automated trading eliminates the need for brokers on the floor of the Big Board.

Bear Stearns slashed the value of its New York Stock Exchange specialist unit and will take a $225 million charge as the shift to automated trading eliminates the need for brokers on the floor of the Big Board. The NYSE’s new automated trading system has eliminated work for floor traders who now handle about 18% of the 1.6 billion shares traded daily on the Big Board, down from 86% at the start of 2006, according to the exchange’s Web site. Shares of LaBranche & Co., the biggest specialist firm, have declined 38% in the last year as increased electronic trading reduced demand for its services.

Link here.


I drove to Florida recently, and the billboards along the interstate unfolded like the pages of an American novel. “Pecan Pralines”. “All You Can Eat”. “Lose Weight Now”. “See Disney Free!” “Live Alligators!” More recent themes, “Worlds Largest Adult Toy Store”, and “Butt Naked Exit Now”, passed by as regularly as sex scenes in the pages of a typical paperback. But there was another old Florida message visible again, almost everywhere you looked: “Fabulous Investment Opportunity”, “New Luxury for Sale – Reduced”.

Despite all the signs about luxury, I did not see much evidence of the actual stuff. Real luxury is not found where I was traveling, in the boondocks of South Georgia and out on the swampy Gulf coast of north Florida. But the national obsession with luxury has arrived there, from billboard to sign post along the highways and in the towns, marching with the armadillos and fire ants.

Many parallels can be drawn between today’s obsession with luxury, and the same behavior in 1929, and even 1637 in Amsterdam. In February 1933, Bernard Baruch offered his take to the U.S. Congress by first quoting Charles Mackay’s Tulip Mania description from Extraordinary Popular Delusions & the Madness of Crowds. “Everyone imagined that the passion for tulips would last forever. People of all grades converted their property into cash and invested it in flowers. Foreigners became smitten with the same frenzy and poured into Holland from all directions.”

Baruch also recognized a key similarity between 1929 New York and 1637 Amsterdam when he quoted Mackay saying, “Holland seemed the very antechamber of Plutus.” The remark is a reference to the luxury binge that accompanied the runaway speculation for tulip bulbs. Mackay noted, “Houses and lands, horses and carriages, and luxuries of every sort, rose in value.” The latest outbreak is true to form. At this point, even as the real estate depression gathers, the most expensive houses are among the few that keep rising.

This chart shows the S&P 500, the Hedge Fund Enablers Index, composed of large investment banks, and the Merrill Lynch Lifestyle Index of luxury stocks. The chart patterns are remarkably similar. Thanks to all that leverage, the market has been more than twice as good to investment bankers and even better to providers of luxuries for clients, owners and employees of investment banks. Notice, however, the banking group’s subtle inability to surpass its February peak. This is a critical divergence that should eventually be followed by a massive reversal of Wall Street fortunes.

The 1889 edition of A Brief History of Panics and Their Periodical Occurrence in the United States by Clement Juglar noted, “The symptoms of approaching panic, generally patent to every one, are wonderful prosperity as indicated by very numerous enterprises and schemes of all sorts, by a rise in price of all commodities, of land, of houses, etc., etc., by an active request for workmen, a rise in salaries, a lowering of interest, by the gullibility of the public, by a general taste for speculating in order to grow rich at once, by a growing luxury leading to excessive expenditures, a very large amount of discounts and loans and bank notes and a very small reserve in specie and legal tender notes and poor and decreasing deposits.”

Of all the billboards, the one that stuck in my memory, the one that seemed really important read – “Warning! Florida Residents May Defend Themselves With Deadly Force”.

Link here.
Record debt, record optimism? – link.


It all started in late 1989, when the Nikkei 225, Japan’s benchmark stock index, climbed to an all-time high of 38,915, reversed, and by April 2003 fell to just 7,699 – a deflationary collapse of over 80%. As the Nikkei was falling, the Japanese economy followed suit. The Bank of Japan tried hard to cure the deep recession of the 1990s with an ultra-low interest rate policy, but in vain. For 15 long years the country’s economy could not reverse its bad luck.

Things only started to improve after the stock market had bottomed in 2003. In Q4 2004 Japan even posted a modest GDP gain. However, that year the Nikkei began to lose momentum again, and towards the end of 2004, optimism at Japanese companies declined sharply, unemployment rose, and production and sales fell. What is worse, in February 2005, consumer prices suffered a steep drop – a sign that the battle with deflation was not over.

Surely you have noticed a pattern. As the Nikkei went up and down, so did the Japanese economy. We at Elliott Wave International have always said that the economy usually follows the stock market. Many conventional economists say that as goes the economy, so goes the stock market. Obviously, Japan’s case contradicts their premise, as does the more recent example of a strong rebound in European economies, which only came after the rebound in European bourses that started in 2003.

From an Elliott wave standpoint, it only makes sense that the economy follows stocks. After all, what is economy? Loosely defined, it is the result of people’s combined productive efforts. Without people, there is no economy. If people work hard and spend freely, the economy grows. If people get lazy and tighten their purse strings, the economy sputters. In other words, a country’s economy only “feels” as good as its people. If people felt better as the economy improved, the economy would grow forever, until we all lived in a happy land of hard-working, ever-confident consumers where the GDP only got stronger. But we don’t. We have highs and lows in every single economic indicator. We even have recessions and depressions.

So if it is people that make the economy “happy” – and not the other way around – what makes people happy, then? The answer, from an Elliott wave viewpoint, is social mood, our collective emotional state. When it is negative – as it was in Japan throughout the 1990s – the economy sputters. When it turns positive, the economic growth comes back. The reason why the stock market usually leads the economy is that the economy is a pretty slow boat, and it takes a while for people’s emotional state to get reflected in the GDP numbers. Stocks are simply a much quicker measure of social mood.

Let’s get back to Japan. The Nikkei has rallied since 2003, indicating the countrywts improving spirits. The big question now is where is Japanwts economy likely to go from here? Have the renewed stock market and a new real estate fever finally conquered deflation? A look at the Nikkei’s trend may help answer that question. As you can see in this chart, the rally from the April 2003 low is likely an ABC correction. What is more, the move that started in early 2006 counts best as a diagonal triangle – a very telling Elliott wave formation. Here is what Prechter and Frost write about diagonal triangles in Elliott Wave Principle: Key to Market Behavior:

“In all cases, they are found at the termination points of larger patterns, indicating exhaustion of the larger movement. A rising wedge is bearish and is usually followed by a sharp decline retracing at least back to the level where the ending diagonal began. A falling wedge by the same token is bullish, usually giving rise to an upward thrust. Either way, they both imply the same thing: dramatic reversal ahead.”

This “dramatic reversal” will not come tomorrow. But one thing seems likely. The rally Japan’s social mood has experienced since 2003 has probably been just a correction.

Link here.


Stock options are pure speculations. The chance of loss is quite high. If you cannot afford to lose money on them, you should not be buying them. While the potential rewards of options are very tempting, anyone who forgets about the potential downsides is toast.

Unfortunately, that stark warning also scares away people who could benefit from options. People who have built solid portfolios, and can easily afford to speculate a bit. They are the opposite of traders who blindly rush in focused on the gains. Instead, they only see the potential losses. That is why I offer a simple suggestion – try options trading for yourself. With just a few minutes a day, you can learn how profitable options can be, without risking a single cent.

In the old days (as little as a decade ago) the best way to do this was by paper trading. As the name suggests, it does not involve any real money. Or even a broker. Instead, you simply chose an option and kept track of it each day. With a few simple calculations, you could see how you would have done if you actually made the trade. There are still plenty of good things to say about paper trading. It forces you to work, tracking down prices and calculating potential profits. If you are going to put that much time into an activity, you might be more inspired to do well. It is a good trait to have if you ever decide to trade for real.

But today, lots of Web sites offer “virtual trading” -- free computer programs that let you practice trading without putting any money at stake. Most require you set up a membership account – not an actual brokerage account – containing basic information like your age and interests. Of course, some of these sites might use this information to try to sell you stuff. And with privacy concerns a big issue today, you might want to be careful with how much information you hand over. My advice is to stick with the programs on well-known trading sites. They have a reputation to maintain, and they are not going to do anything to risk alienating a potential client.

When you sign up, you will get a username and password to get to your account. You will also get a small sum of virtual money to start trading with. I have not signed up for many virtual trading accounts, so I cannot honestly compare and contrast them all for you. However, a colleague recently opened up a mock account on the Chicago Board Options Exchange (offered by Options Express).

The CBOE virtual trading site starts you off with $5,000 in virtual money. You can use that fake money to simulate trading any of the securities the CBOE tracks -- from stocks to options, even some futures. The Web site does its best to make the trading as realistic as possible. Price quotes are based on the actual prices seen on the exchange. When you wish to buy something for your virtual account, you are given the same kind of choices that you would face if you were actually buying a real security. You can dictate limit and stop orders. You can make day orders or standing “good to cancelled” (GTC) orders. You can even choose to write options or use covered calls.

After you make your virtual order, the software does the rest. If you placed a market order, the security is added to your virtual portfolio. If you used a limit order, the program will not place your order until the real market hits your limit price. The program even levies a virtual commission charge on each of your trades. You can also set sell orders, even trailing stops. After that, it is just a matter of logging in to see how you are doing.

Programs like this can be a very useful tool for gauging how well you would do in the options market – making any lingering fears disappear. Of course, there are some important differences between real investing and virtual investing that you need to keep in mind. It is a lot easier to trade when you are not spending real money. But virtual trading is so lifelike, you might actually lose sight of that when you really start trading. This is especially true since actual trading will involve money you can afford to lose. If you are not careful, it will all seem like a game ... and in games, taking unnecessary risks is part of the fun.

The solution is to treat your virtual account as actual money. Do not make crazy trades just because you can. Instead, only make trades you would make in real life. It is not only the best way to get a feel for how you would actually do with options, it is also the easiest way to transition from virtual trading to real trading. Once you see how much money you are missing out on by not using real money, you will soon want to try your hand at actually trading options.

Link here.


When it comes to judging a stock’s potential, there are really just two schools of thought. They are called fundamental analysis and technical analysis. And while successful traders often use both types of analysis, the most successful traders master one or the other.

In general, fundamental analysts concern themselves with a company itself. They dig into financial statements and balance sheets. They calculate assets vs. liabilities, sales vs. profits – all the nitty-gritty details to find out what a company is really worth. Fundamental analysis can be a great way to find stocks for your portfolio that you plan on holding for a long time. But just because a company looks great on paper does not mean the stock market will agree. In the short term, anything can happen. And that is where technical analysis can help.

Technical analysts rarely worry about companies themselves. They are more concerned with the company’s stock price. Using charts or other systems, a technical analyst tries to decide where a stock price is going next. A solid technical analysis system is a great way to take advantage of short-term stock moves. In fact, my proprietary charting system is one of the reasons for my options service’s incredible success. I look for stocks on the verge of big moves up or down. Then I choose the best options to take advantage of the move.

I am also a big advocate of having a firm trading strategy in mind. To help guide that strategy, I calculate to very important numbers – support and resistance. These two numbers are the bread and butter of technical analysts. Each one tends to calculate support and resistance in different ways. So how I calculate them is not really important. It is just important to know what the terms mean.

The technical answer is, support is an area of expected institutional buying. Resistance represents expected professional selling. Support represents the expected “floor” of a stock. That is, the lowest price you can expect it to go. When the price falls to this price, institutions and investors tend to step in, buying up the stock. That buying “supports” the stock price. Of course, support is not foolproof. In fact, stocks can and often do break through their support lines. The bears are in control. When a stock breaks through resistance, on the other hand, it is a bullish sign. Resistance can be considered a stock’s ceiling. It is the price a stock is expected to have trouble breaking through. Resistance is not absolute, either. And if there are more buyers than sellers, the stock will break through resistance. It is a good sign the stock is on a bull run.

Knowing a stock’s support and resistance can help you decide what to do with your options. An option’s price follows a stock price. So knowing the “floor” and the “ceiling” can help you determine your trading strategy. If a stock breaks through support, it is falling – and the bears are in charge of a stock price. If you have a call option, it can be very bad news for you. You may want to consider selling the option in case the stock goes even lower. Of course, a lower stock price is what you want to see if you have a put on it.

If you want to make a lot of money in options, it is essential to buy and sell at the right price. Support and resistance are two tools to help you find that right price. Use them correctly – as part of your total money management system – and you should quickly increase your profits.

Link here.


Best Buy (BBY: NYSE) is the king of electronics, effectively crushing every other electronics retailer that dares stand in its way. This $23 billion retailing giant has decimated the likes of Circuit City Stores (CC: NYSE), a stock that analysts scream for people to sell about once a week now. Best Buy has eaten into Circuit City’s margins, causing the flailing chain to cut prices. Shares of Circuit City are down almost 50% since October. Earlier this month, CC dropped to a 52-week low of $16.52 after the company announced it would post a first-quarter loss mainly due to lagging big-screen TV sales. Circuit City also withdrew its earnings outlook for the first half of the fiscal year, despite major efforts to cut costs and get back on track.

Circuit City’s outlook may be bleak. But there is one troubled specialty electronics retailer that makes Circuit City’s problems seem minimal. This company has watched its share price tumble from $7.50 a year ago to only 45 cents. This company barely has the working capital to continue its operations, plans to close 49 stores and cut its workforce by 20%. Its financial situation is so grim that it may have to file for Chapter 11 bankruptcy protection if it is not able to raise enough money to keep its head above water. The company is high-end electronics retailer Tweeter Home Entertainment Group TWTR: NASDAQ).

Despite Tweeter’s many problems, it could find its own market niche that the bigger retailers will not be able to touch. Tweeter operates 153 electronics stores in 22 states. Its mission is to provide high-end audio and home theater packages to selective electronics shoppers. This model is getting whipped by the big players like Best Buy and Wal-Mart, both of which can offer better prices on similar items.

But it might not be lights out for Tweeter just yet. The company is closing about a third of its stores. And if it manages to stave off bankruptcy, we believe it has a shot to rebound because of two key factors. Tweeter can offer something that Best-Buy and Wal-Mart cannot – expert service. The kid in the blue shirt at Best Buy can only tell you so much about which receiver would work best with your dream home theater setup. Tweeter, on the other hand, can offer expert help in a smaller, more comfortable environment. Their sales staff undergoes 80 hours of initial training before hitting the floor – and that is just for trainees. These are people who will be able to answer your complicated questions.

The second reason you may see a Tweeter resurgence is the questionable health of the retail sector right now. Wal-Mart is already suffering from lower retail numbers, and Best Buy might not be far behind. A blow to consumer confidence could hurt the big-boxes across the board if America decides to suddenly decrease spending. Tweeter, on the other hand, could be spared the brunt of this retail slowdown. Since Tweeter caters to wealthier shoppers, who generally are less effected by economic slowdowns, sales could still materialize.

Link here.


The Federal Reserve, the Bank of England and the People’s Bank of China have all been faced with the same unpleasant reality. By their irresponsible monetary policies they have enabled gigantic asset bubbles that are redistributing wealth towards the criminal classes and in the long run will impoverish everybody else. Their reaction has been similar. To a large extent they have washed their hands of the problem.

The BoE’s response was most rational. It put up interest rates, though only by 1/4%, far less than is required to right the foundering ship of Britain’s economy. The People’s Bank of China at least deplored the bubble, though it failed to recognize to what extent its irresponsible monetary policies and suppression of the yuan’s exchange rate had fueled it – but then after all, these people are nominally Communists. One cannot expect them to get it right every time when they are shown so many bad examples from abroad. The Fed on the other hand kept interest rates flat, as it has since last June, while easing its anti-inflationary language slightly – thus essentially acting as enabler to the Wall Street speculators, who had by last Friday convinced themselves yet again that interest rates were about to drop.

Britain faces Hobson’s choice.

All three countries have similar problems. In Britain, housing prices around London have soared far beyond the range of average or even affluent Britons. This is not just a question of monetary policy, which has been over-expansive but not excessively so. More important has been the increasing dichotomy between foreigners, who are not taxed on their “worldwide income” and Britons who are. This has caused an enormous influx of wealthy rootless cosmopolitans to settle in London, where the great majority of their income is tax-free, either because it involves one or other illicit activity abroad or because, in the financial services business, good lawyers can structure their clients’ activities and remuneration optimally. Since taxes on the average Briton have at the same time risen inexorably, as has government spending, the result has become a two-tier society, in which untaxed foreigners occupy the real estate that Britons who did not inherit it have no hope of owning.

There is not a good solution to this problem. Imposing British tax on foreigners, while unquestionably equitable and enabling some of the groaning burden on British taxpayers to be lifted, would almost certainly cause the financial business of the City of London to decamp elsewhere. The most probable destination would be Dublin, a master manipulator of its tax system, which is also facing a real estate meltdown and probable economic recession, and whose desire to gain business at the expense of Britain is second only to France’s.

The Hobson’s choice now faced by any British government of whatever political color is that the financial services businesses that appear to produce so much wealth will only remain in London if their mostly foreign managers are exempted from the taxes that normal Britons must pay. The problem is soluble only after a major financial crash, which will bankrupt many of the foreigners, devastate the London housing market and sharply reduce the importance and profitability of the financial services business. But that is not a fate to be wished on any country, however inevitable it may in the long run be.

Little hope of the Chinese middle class keeping their savings.

China looks like the country with no problems. Its last real recession was probably the hyperinflationary recession of 1948-49, as Mao Ze-dong consolidated power. The Chinese stock market is up 50% this year, after a rise of 130% last year, and is now selling on a P/E ratio of 45, while 1 million new brokerage accounts are being opened each week. Given that the Chinese banking system pays 2% on deposits at a time when true inflation is around 6%, and that it is still illegal for Chinese individuals to invest abroad, this exuberance is not surprising.

Zhou Xiao-chun, Governor of the PPoC, can do no more than wring his hands. Any attempt to raise deposit rates to a more appropriate 6-7%, or lending rates up to a more appropriate 11-12%, would push the Chinese banking system into cataclysmic meltdown, since its bad debts almost certainly exceed $1 trillion. Even in China, that represents 40% of GDP, an amount that could with difficulty be financed but that would be hugely economically damaging until it had been safely funded with foreign debt.

There would appear to be very little hope of the Chinese middle class keeping their savings secure from a combination of a stock market crash and a banking system meltdown. Further, the uncovering of losses in Chinese state owned companies, and the new paradigm of resources at least for a few years being tight in China will cause huge unemployment at the state controlled behemoths that have been propped up by the banks, together with a major downturn in the Chinese urban real estate markets that have been so frothy in the last few years. About the only consolation for the Chinese people will be that they will be joined in their losses by the half-witted foreigners who invested frenziedly in the IPOs of the now-bankrupt Chinese banking sector.

Of the three, the U.S. probably has the grimmest next few years.

In the U.S., the Fed’s initial decision last August to hold rates at 5 1/4% was plausible. The stock market had hiccupped in May and it could be argued that the U.S. economy needed time to catch up with rate increases already enacted and begin slowing inflation. However the stock market is up 15% since that initial decision and inflation is trending inexorably upwards, at 4% on the latest quarterly GDP deflator figure. Thus it has become clear that the current rate level has no inflation-suppressing effect. Meanwhile, in the financial markets confidence is not absent but grossly excessive, as fringe operator after fringe operator launches billion dollar buyout attempts.

Of the three economies, the United States probably has the grimmest next few years. Britain will do fine for those not involved in financial services or exposed to the London real estate market. China has cost advantages that are not going away, as more and more of its rural young migrate to the cities and enter the market economy. China’s downturn will be even more cushioned if the recent extension of private property rights to the rural poor proves effective, enabling the peasant masses to raise minimal capital and either start small businesses or redeploy to the cities. In the long run, China will be a highly successful economy unless the government prevents it. The occurrence of a few financial crises and disasters along the way does not change this prospect.

For the U.S., the reality is a darker one. Too much of its manufacturing capability has been redeployed to the Third World. Too much wealth has been squandered in speculation and overpriced real estate. Too much low quality immigration has taken place, undermining the living standards of the low-skill domestic workforce. An economic downturn will produce a Manichean struggle for the remaining resources, as occurred during the 1930s. In an era when protectionist sentiment is already rising, this is more than likely to produce a wrenching reorientation of U.S. society away from free trade and the free market and towards some kind of impoverished big-government socialism.

Thus burdened, U.S. business will find it very difficult indeed to climb out of recession and resume the process of improving living standards. U.S. commentators have since 1990 sneered at Japan, which found itself mired in stagnation for 15 years. However the future for the U.S. is likely to be more painful, as stock and real estate excesses must be worked off simultaneously at a time when the federal budget is under strain due to the retirement of the baby-boomers. This is, however, appropriate. It is the U.S., through the Fed that has since 1995 indulged in an orgy of irresponsible money creation that has fueled a decade of worldwide over-consumption. The Fed has been blamed for the onset of the Great Depression. That verdict is a little harsh but its responsibility for the unpleasantnesses ahead is unequivocal.

Finally, by referring in the first paragraph to the “criminal classes” I am not implying that these financial bubbles benefit only the Russian mafia. Far from it. I am simply anticipating by a few years the verdicts of the U.S. and EU judicial systems. In a world where former Enron Chief Executive Jeffrey Skilling gets a 25 year jail sentence, can anyone doubt that when the downturn finally comes a selection of currently highly regarded hedge fund managers, private equity find managers and investment bankers will find themselves facing several decades behind bars? They will be unlucky, just as was Skilling, that their particular organization suffered the spectacular bankruptcy that caused the random wheels of U.S. or EU justice to grind into action. However the reality today, before the crash, is that there is no way of telling which of the moguls will be indicted and which will survive to endow major charitable foundations. Such is the lottery of a market bubble.

Link here.


In dramatic fashion James Doohan went where no man has gone before. Well, at least where no remains have gone before. And he was not alone, he had a cabin mate. Mr. Doohan, who played Scottie on Star Trek, died a couple of years of ago, but on April 29 his ashes, along with those of Gordon Cooper, a real live astronaut, so to speak, were launched into space via a privately run rocket ship called the Spaceloft XL. What could be a more fitting tribute to Scottie, the earnest engineer who always managed to get a wee bit more of the Enterprise just in time to get Capt. Kirk out of a jam? At last Scottie could accomplish his dream of breaking the shackles of earth to plunge headlong into the unknowable darkness of infinity.

Except that he wound up in New Mexico. Even though the SpaceloftXL was a real live rocket charged with carrying out real “experiments”, once the capsule reached the edge of space it popped its shoot, reversed trajectory, and floated back to the earth. No journey to the edge of the universe. No alien encounters. To the layman, the SpaceloftXL looks a lot like a super-sized version of the model rockets launched every day on soccer fields across America. But instead of a toy soldier, it was Scottie who was wedged into the capsule. The rocket, along with its cargo, is lost on a mountain in the Land of Enchantment. For Scottie, eternity is filled with Southwestern architecture.

Many homes experienced a moon shot over the past few years, yet they too have fallen below their peak trajectory. There are plenty of stats to describe the unwinding of a bubble that turned shelter into a can’t-miss investment. Among the least prominent is the number of vacant homes sitting on the housing market waiting for something good to happen. On March 31 there were 2.2 million homes vacant and for sale – the highest number since at least 1965, and a 57% increase over two years prior. The increase says a lot about the investment characteristics of single family housing, or at least about the momentum investors who are losing altitude along with confidence in their parachutes. That is, they want out now.

Naturally, the vacant homes are adding to existing home investories, a metric which came in 17.1% higher in March than the year-ago level. And because the rate of home sales slowed, when measured as months of supply, inventory actually increased to 7.3 months. Inventories of new homes are setting records of their own. New homes for sale at the end of March reached 545,000. Although the supply of new homes dipped to 7.8 months vs. 8.1 months in February, the February rate was the highest in 16 years. And the inventory of new homes may be understated because the data do not include cancellations.

Builders hate this inventory bulge. They are giving away swimming pools to cut back their own inventories, they are writing off options on raw land, and they refusing to build on the land they retain.

What they cannot control is the refusal of sellers to pull their own homes off the market like Mr. Greenspan said they would. People were not supposed to get in a bind to sell, because after all, if you have a house you can just live in it. And housing prices were not supposed to go down, because if you can live in a house, what is the rush to sell at a loss? But somehow, people are in a bind to sell – so many of them that home prices are dropping, virtually unheard of behavior in a market that the former Fed chairman assured us was not like the stock market. Part of the problem is that houses become a lot less livable when mortgage rates adjust higher. Or when property taxes hikes outrun income growth. Or when homes turn from investments to liabilities.

There are those, however, who think that some markets are immune to gravitational forces because of their special location on the planet. Take Frank and Roy Dalene, who according to Dan Dorfman, are starting a $100 million real estate fund to do tear downs in the Hamptons. The pitch: (1) The Hamptons are the Hamptons. (2) Despite the numerous “For Sale” signs even there, the ultra high end market is impervious to a downturn. (3) There are plenty of ratty million dollar houses can be bulldozed and replaced with homes going for upwards of $10 million. (4) The Dalenes already do 75% of their luxury home building business with Wall Street folks. (5) Last year Wall Street scored as estimated $24 billion in bonuses. (6) You cannot spend all that money on fast cars and big art.

It will be interesting to see how the fund performs given that the Hamptons may be the epicenter of the most bubbles ever to descend on single location on planet earth. Certainly the Hamptons are the beneficiary of the investment banking, private equity and hedge fund bubbles. And according to realtors Dorman interviewed, the Hamptons are also the hot ticket for rich foreigners, eager to take advantage of a weak dollar, a symptom of excess credit generally.

In what could turn out to be a classic bubble in a bubble event, a single hedge fund may buy all 1,000 shares of the upstart fund, a reminder not only of the Hamptons’ powerful mystique, but also that often there is no “hedge” in “hedge fund”. But unless the Hamptons can repeal the laws of credit bubbles, the trajectory of even the Dalenes’ favorite market is bound to roll over as the various bubbles unwind. Whether Hamptons homeowners will merely have a bumpy ride or burn up on reentry is anyone’s guess.

Link here.
Home builders in a hole – link.


As Treasury Secretary Henry Paulson continues to drum up interest in direct investment in the uu, he will rely on a set of skills that only a long-time Wall Street pro can truly master. It is part of the investment banker’s playbook to perform financial makeovers on questionable companies that they are engaged to sell, a process commonly known as “putting lipstick on a pig.”

As the U.S. economy continues to slow, and non-U.S. markets consistently produce much better returns on invested capital, Paulson will need to pull off an unprecedented act of porcine cosmetology to keep the foreign funds flowing. In addition, the persistent weakness in the U.S. dollar practically assures that any takers will likely find that they are the ones being led to the slaughterhouse.

Paulson recently visited a UK-based company that employs 1,500 Americans at several manufacturing and distribution facilities in several states. However, while investment of this sort is badly needed, it represents just a small fraction of the money that Americans borrow. Because the vast majority of foreign “investments” come to us in the form of consumer loans, a more appropriate venue for Paulson’s comments would have been a local Wal-Mart, Best Buy, or condo project. Whether in Treasury bills, mortgage-backed securities, or collateralized consumer debt, such loans do nothing to improve the long-term health of our economy. They merely serve to keep our necks above water until the financial tide eventually overwhelms us.

Legitimate foreign investment, in profitable businesses such as the one Paulson visited, are increasingly less attractive as other nations have superior infrastructures, better trained and educated workforces, lower taxes, and fewer regulations. Serious reforms to both capital and labor regulation, and efforts to shore up the sagging greenback are required for such an effort to bear fruit. Bank of China’s announcement that they will allow greater flexibility in the Yuan will only make Paulson’s job that much more difficult.

Ben Bernanke came to Paulson’s aid with a can of hairspray and some mascara. Speaking in Chicago, the Fed chairman gave his assurances that the meltdown in the sub-prime mortgage market would not affect the broad U.S. economy – despite continued evidence of slowing retail sales, record high gasoline prices, escalating food prices, mounting inventories of unsold homes, and real estate auctions in which foreclosed homes sell for 30-50% below their “appraised” values.

Perhaps the most important take from the current “Invest in the U.S.” campaign is the fact that the U.S. needs to pass the hat in the first place. How can a nation that fancies itself the leader of the free world be so dependant on foreign capital? The fact that we do not generate sufficient domestic savings to satisfy these needs ourselves should be extremely troubling. The fact that so few on Wall Street even appreciate the significance of this fact is even more so.

Link here. China widens yuan trading band, boosts flexibility – link.


The notorious Smoot-Hawley Tariff Act of 1930 – a policy blunder of monumental proportions that played a key role in sparking a global trade war and the Great Depression.” ~~ Stephen Roach, Managing Director Morgan Stanley, March 30, 2007

When the U.S. economy contracted after the collapse of the 1929 stock market bubble, the U.S. Congress acted. And as it often happens in history, the action backfired. Instead of protecting the U.S. economy and markets, the Smoot-Hawley Tariff Act of 1930 plunged the U.S. and the world into the Great Depression of the 1930s.

The road to hell is paved with good intentions. That was true in 1930 and is true today in 2007. The U.S. Congress, looking for someone to blame for America’s mounting economic problems – increasing trade deficits, loss of jobs, declining competitiveness, etc. – is now blaming China. And, once again, instead of protecting America’s economy, the U.S. Congress is about to pull the lynchpin on the global economy.

Accusing China of currency manipulation is more than a little self-serving. Currency manipulation is, in fact, the domain of the U.S. Without the U.S., currency manipulation would not even be possible. After WWII, the U.S. dollar was the foundation of the global financial system. America owned 75% of the world’s monetary gold and that gold backed the U.S. dollar. Currency manipulation was impossible because the U.S. dollar was tied to gold and all currencies were tied to the U.S. dollar.

Between 1949 and 1971, because the U.S. had a positive balance of trade its gold supplies should have increased. Instead, they disappeared. In two decades, the U.S. overspent its entire hoard of gold and in 1971 announced that the U.S. dollar was no longer convertible to gold and that it would keep what gold it had left instead of paying those it owed. In 1973, the U.S. then went off the gold standard and plunged the world into monetary chaos. For the first time in history, the world’s reserve currency, the basis of world trade, was not backed by gold or silver. Money was no longer intrinsically valuable. Money now was only a piece of paper, an IOU.

The next year the foreign exchange markets began to grow exponentially as speculators now determined the relative value of currencies. No longer needing to transfer gold (which it no longer had) to balance its trade deficits, the last positive U.S. trade balance was in 1975. In 2007, the U.S. trade deficit is heading for $700 billion as the U.S. can pay its creditors – mainly China – with paper instead of gold.

The U.S. has now chosen China to be its whipping boy, the reason for America’s economic troubles. So be it. Blaming China will play well in the U.S. where R no longer stands for responsibility. It will also lead the world into economic chaos. Whatever Congressional action is enacted to “protect” American markets in 2007 will do the same as the Smoot-Hawley Tariff Act of 1930.

America is in trouble and it is looking for someone to blame. Last year it was illegal immigrants crossing its borders from Mexico. This year it is China. But if America wants to know who is really responsible, it need look no further than into a mirror. But America does not want to know the cause of its problems. America wants someone to blame – and it wants to blame someone else.

Link here.


We have a battle on our hands. It is the Battle for $700, and it is just the latest clash in a long war being fought between gold and its perennial antagonist – the gold cartel. I feel like an old soldier, having already endured so many of these battles. They happen because gold is undervalued, which means that it is being exchanged for dollars at too cheap a price. So gold tries to correct this imbalance in a normal market response by climbing higher, but is prevented from doing so by the gold cartel. It is these confrontations that have led to the recurring battles.

I think we can learn from these head-to-head clashes. There are lessons from the past that can be disheartening at times like this when gold gets repeatedly repelled from $700. It is important to recognize that every time gold and the cartel have battled in the past, gold eventually won.

For example, back in March 2001, gold eventually broke through the lines the gold cartel had mobilized at $272, and climbed higher. But the gold cartel staged a retreat, and eventually we got the War for $325. It took another 6 months, but $325 was indeed hurdled, on December 6, 2002. So important was that battle that I continued to write about $325 for months. For example, I penned the following in February 2003:

“For the past six years of this 20-plus-year consolidation, gold traded under $325. During this period gold moved out from weak hands into the strong hands that were accumulating it at those bargain basement levels. To make that base even more convincing and technically significant, we had a selling climax in the middle of that base when gold was dumped after the Bank of England announcement, causing it to reach a low of $252 in July 1999. ... [W]ith the breakout above $325, gold’s base was firmly in place. This base defines the bottom in gold. Time will tell of course, but I don’t think we’ll ever see those prices again. ... Because gold is moving higher from such historically undervalued levels and because so many people have been left standing on the platform when the gold-train started pulling away from the station with the break above $325, it is onward and upward for gold from here.”

And so it was. But then came the battles for $420, $450, $500, and since last May, we have been fighting the Battle for $700. Gold will win this time too, but again, we are frustrated and irritated that there is even a battle at all.

Who is the gold cartel? And what are they trying to accomplish? The gold cartel is an alliance of governments and a few bullion banks. This group is led by the U.S. government (USG). Though their aims are different, their congruent interests put them on the same side. The U.S. government wants the U.S. dollar to continue as the world’s reserve currency. But the dollar is no longer worthy of holding this privileged position. It is not sound money that can be used reliably in international commerce. It is being inflated and debased. So the USG has a problem. Gold has always held the position of international money, and currencies only became reserve currencies because they were “as good as gold” – which is what the dollar used to be. Now, however, gold and the dollar are competitors, with the result that a rising gold price shows how badly the dollar is being managed. This reality decreases the demand for the dollar, making it more difficult for it to remain unchallenged as the world’s reserve currency.

Consequently, the USG wants a low gold price to make the dollar look good. Its strategists believe that a low gold price will make people think the dollar is being well managed, which obviously is a necessary precondition for anyone to continue using it. After all, if people truly understood how vulnerable the dollar is to a collapse, the demand for the dollar would decline even more rapidly than it is already declining.

Most other governments within the U.S. orbit work toward the same objective. Though they may be envious of the dollar’s privileged position, in the end they accept it because these other governments are also fiat money advocates. By keeping the dollar-monetary system functioning, they can also perpetuate the myth of fiat money by creating their own currencies ‘out of thin air’, thereby enabling these governments to do what all governments want, namely, to use newly created fiat currency to preserve their own position of privilege and power.

Their aims are clear, but governments do not directly trade in the gold market. They enlist the help of the 2 or 3 largest bullion banks. The banks make money in two ways. First, they earn the contango. By being short at all times, they earn the interest income available from gold. Because gold is money, its future contracts always trade at a higher price than the spot price. This is called contango. Because they are not money, other commodities usually trade in backwardation, meaning their future contracts trade below the spot price. By being short the contango, bullion banks are always selling gold for future delivery above the spot price. If the spot price is unchanged or lower when those future commitments come due, the bullion banks make money on the difference between the price at which they sold and the spot price on the due date. But if the spot price is higher, they lose money, so clearly the bullion banks do not want a rising gold price.

The second way bullion banks make money is by what I call “picking the market’s pockets”. There are a number of ways they do this. For example, because they execute the government's trades, they know when large amounts of gold are going to be dumped into the market as part of the gold’s cabal’s price manipulation scheme. So the bullion banks “front run” those trades by selling first, and then profit from the price slide that occurs when the big government order is dumped on the market.

It can be discouraging when viewing this state of affairs. However, we should instead focus on the important parts, which are that gold is in a bull market that is now more than six years old and that notwithstanding this fact, gold remains undervalued. Or to put it another way, the dollar is overvalued. The Battle for $700 will end the same way the other battles have ended. Gold will win the battle. The gold cartel is losing the war. In the end, the market is bigger than the government.

Link here (scroll down to piece by James Turk).

Gold stocks in a rising gold market.

While there are a number of ways to play rising gold prices, my personal favorite is the higher-quality junior precious metals exploration companies. Those are companies with a high-risk profile (few will ever actually make an economic discovery), but you can apply analytical screens to them that greatly lower that risk – leaving some truly extraordinary upside. How extraordinary? While an extreme example, on the back of the Eskay Creek discovery Consolidated Stikine Resources went from 10 cents per share in 1988 up to a high of $73 in 1990!

These stocks do well during periods of crisis for several reasons, but mainly because they are such a small sub-set of the financial landscape that even a fractional increase in interest sends them soaring. And this time around, I think we are going to see the high end of the range that these stocks are capable of, for the following reasons:

Increase in equity accounts. Thanks in no small part to the dot-com boom, never before have more North American households been involved in equity markets. As the gold stock story filters through to them, they will find it highly appealing and they will have the ability to act immediately. Furthermore, such people are trend followers. They know nothing except to buy stocks that have a positive chart. For the first time since the Internet bubble burst, they are going to have a real tiger by the tail. In other words, for the very first time in their history, gold stocks are going to have not only the cognoscenti but the unwashed masses piling in. The bull market will be breathtaking when this gets underway.

Hedge funds. In a similar vein, we now have the whole new phenomenon of hedge funds, which have grown like kudzu all over the financial tree. They were a non-factor in earlier bull markets, but now number over 12,000 and manage on the order of $1 trillion. Moreover, the majority of these funds are run by 20- and 30-somethings with little experience in a real bear market and are herd-like and aggressive to boot. Gold is increasingly finding favor as an asset class with the hedgers.

London’s AIM. Thanks in no small part to the incessant meddling by U.S. regulators, the AIM is increasingly becoming the “go to” market for resource companies, offering these companies exposure to a wider audience than the less trafficked Canadian markets which have traditionally been home to the junior exploration companies.

Convergence of higher gold prices and discoveries. Perhaps most important is that, for the first time ever, we should witness a round of economic mineral discoveries against the backdrop of a major bull market in gold (and silver) prices. The trickle of financings for precious metals exploration that began soon after gold’s 20-year bear market came to an end in April of 2001 has turned into a small flood. In fact, according to the Metals Economic Group, in 2006 the amount of money raised for exploration topped $7.6 billion, the 4th year in a row that there has been an increase, and the highest total since they began tracking the numbers in 1989.

All that money – much of it in the hands of teams headed by experienced pros let go by the large gold companies during the long bear market – has set off a massive number of new and fast-moving exploration initiatives, using the latest technology and squarely focused on the world’s most prospective geological addresses. If all unfolds as it can, and likely will, for the first time ever, we will benefit from a concurrence of a discovery market with much higher precious metals prices. Toss in a lot of investors with a lot of cash, nervous about the outlook for global financial markets and looking for a trend to fall in love with, and you have all the elements necessary for you and me as early investors in the resource sector to pull down truly extraordinary gains.

Do not get overly greedy. Don’t mortgage the house to buy gold stocks. But do make sure that you move toward being fully invested. Depending on your willingness and ability and level of risk tolerance, this might take you up to 20-25% of your portfolio.

You are going to find good reason to love gold stocks. But I hope you will not fall in love with them. I am a philosophical gold bug, but not always a gold bull. I always keep in the back of my mind that gold shares are not heirlooms, but burning matches. And while I still think this market will see gold’s biggest run in history, when it is over these stocks will lose 90% of their value – as does any class of stocks when a mania ends. But the good news is that the mania has not even begun.

Link here.


When we attempt to judge risk in markets we try to analyze and identify what to be afraid of. We think, read and assess data using our rational neocortex, the newest part of our brains, to try to identify danger before it actually happens. One problem is that identifying risk is a job that also belongs to the amygdala, a very fast, survival-oriented group of neurons in a much older part of the brain. There is reason to believe this shared duty makes us a poor judge of certain kinds of risk.

The amygdala helps form and store emotional memories associated with scary events. Research indicates that during the fear experience, long-term connections are “hardwired” to memories of the stimuli, and so we react more readily the next time. During episodes of fear, the amygdala overrules the the neocortex. But the neocortex has its own problems. We are not computers, and when try to evaluate the probability of future events, we often default to biases, stereotypes and the opinions of others to increase our comfort or lessen our analytical work load. This works well enough in a calm, slow-moving environment, but when the pace quickens and fear takes hold, the amygdala takes over and reason gives way to emotion.

An article at wired.com tells about a variety of irrational responses to the Virginia Tech shootings. In brief, the author concludes that we are biased and a bit outdated in our risk assessment. “We tend to exaggerate spectacular, strange and rare events, and downplay ordinary, familiar and common ones. ... Our brains are much better at processing the simple risks we have had to deal with throughout most of our species’ existence, and much poorer at evaluating the complex risks society forces us to face today.”

If societal risks today are complex, what about the financial markets? Risk tolerance has been at record levels for so long it seems normal. Leverage is ubiquitous. The book, Risk: A Practical Guide for Deciding What’s Really Safe and What’s Really Dangerous in the World Around You, says people tend to exaggerate risks that are spectacular, rare, personified, talked about, and externally imposed – and tend to minimize risks that are unspectacular, common, anonymous, and willingly taken. The book also lists many misperceptions about risk, including that “We are much more afraid of risks when uncertainty is high, and less afraid when we know more.” And, “We are more afraid of risks that we are more aware of and less afraid of risks that we are less aware of.”

Terrorism and global warming have been riding a risk-perception seesaw in the past few years with first the one, then the other on top. Regardless of the actual danger, the one seen as most risky is the one most in the news. Market risk is not much in the news today, so most investors are not very aware of it. That means that right now investors should not see the market as risky. And judging by sentiment indicators, they don’t.

All the more reason for you to think for yourself, and be wary of defaulting to biases, stereotypes and opinions of others.

Link here.


Mohnish Pabrai, a popular speaker at the Value Investing Congress and portfolio manager of Pabrai Investment Funds, reminds me of a young Warren Buffett. He has delivered roughly 30% annualized returns to his investors since launching his partnership in 1999, similar to the return Buffett earned for his partners in the early years of his career.

Pabrai delivered a great presentation about the dilemmas that often face value investors. I have just read his great book, The Dhandho Investor: The Low-Risk Value Method to High Returns. I want to share my thoughts and a few quotes. Value Investing Congress attendees received a copy of Pabrai’s book at registration. It is still available on Amazon, but perhaps not for very long. His last book, Mosaic, which I received at last year’s Congress, must be out of print. It was selling for $475 on Amazon. I recommend Pabrai’s books for anyone who wants to learn how the world’s top value investors think about risk.

Literally translated, “Dhandho” means “endeavors that create wealth”. Pabrai tells interesting stories about entrepreneurs that built empires following the time-tested principles of hard work and frugal living. But what makes Dhandho investors unique is their intelligent use of outside capital to invest in ventures where risk and reward can be boiled down to the phrase “Heads, I win. Tails, I do not lose much.”

The world is a very uncertain place and this uncertainty can ruin the best-laid plans of brilliant entrepreneurs. Dhandho investors realize this and seek to minimize the size of the losses they can potentially suffer. The best way to minimize the size of losses in the stock market is to minimize the price you are willing to pay for shares in a business.

Pabrai writes about how Lakshmi Mittal, one of the richest men in the world, has achieved remarkable success in the steel business, a business most ignore – for many good reasons. His company, Arcelor Mittal, is now a leading steel producer listed on the NYSE under the ticker “MT”. Mittal’s strategy relies on paying low prices for undesirable steel mills, implementing disciplined cost controls and expanding market opportunities. Perhaps Lakshmi Mittal is a fan of John D. Rockefeller. In the early 1870s, Rockefeller was certain that the refining business was on the verge of a massive shakeout. Thus, he was consumed with a focus on efficiency in his operations.

Both Mittal and Rockefeller sought to buy assets on the cheap and constantly wring costs out of the steel business and the oil business. They knew that low-cost commodity producers survive – and even thrive by consolidating the industry at low prices – when commodity prices weaken. Commodity companies are not playing a zero-sum game. There are clear long-term winners, mediocre players, and unfortunately, many outright frauds. Mittal has definitely established a very valuable “moat” of low-cost steel production that can continue growing as long as cost discipline remains a focus.

Is it true that “commodity companies have no moat”?

What other kinds of moats can companies use to defend their businesses? In the wake of the proposed Alcoa-Alcan merger, one of the speakers at the Value Investing Congress warned the audience that “commodity companies have no moat.” This is generally true in a world where 10% or 15% of the world’s population has a virtual monopoly on consumption of its natural resources – as in the 20th century. This is not true in today’s world, where natural resources must be shared among a larger consuming population and it is not cheap or easy to scale production quickly enough to meet demand.

What does this mean for commodity companies like BHP Billiton (BHP) and Companhia Vale do Rio Doce (RIO)? The term “no moat” may apply for small-fry commodity companies, but not for those like BHP Billiton, whose management still assumes very low future base metal prices when they decide whether or not to invest in a new mine. BHP has learned to survive in a low commodity price environment and should continue thriving as long as management remains disciplined in their decisions.

“No moat” also does not apply to CVRD. Based in Brazil, CVRD is the most dominant miner of iron ore in the world. CVRD controls 35% of the seaborne iron ore trade, followed by Rio Tinto and BHP Billiton, with 25% and 20% market share, respectively. The fragmented steel industry has to write awfully big checks to these players for their crucial raw material. There is really nowhere else to get reliable supply. Not only has this Brazilian giant kept production costs low, it also has long held the luxury of being able to force price increases onto its customers – including the formidable Arcelor Mittal. Its growth in earnings and cash flow resembles its chart below.

When CVRD acquired nickel miner Inco last summer, most media sources considered it a sign of a top in the commodities market. In hindsight, it now appears that CVRD not only made a great strategic move, but got a real bargain. Earnings from Inco’s operations are soaring. So I would argue that CVRD’s competitive moat holds two qualities: access to world-class, low-cost metals in the ground and a management team with great foresight. This moat can keep growing, provided humans keep fashioning iron ore into steel.

Technology moats can shrink.

As investors, we must not remain psychologically anchored to the past. The world is changing and investors need to adjust their perspective. Commodity companies, indeed, have strong moats. If you do not agree, try starting your own iron ore mining business and competing with CVRD or BHP Billiton on price. Their expertise, managerial talent, and, most importantly, massive cumulative past capital investments in mines make these companies irreplaceable. And steel companies must now pay these dominant producers an arm and a leg for what they all need – critical steel ingredients like iron ore and nickel.

Countries like China, India, and Brazil have sprinted out of the gates in the 21st-century economic race. We should assume that they are not going to squander another century of progress on idiotic socialist or communist projects that turn back the clock on living standards. We should not assume that we are the only ones that can think for a living and that everyone outside the Western world should “sweat” for a living. Using the example of Google, Pabrai does a great job illustrating how this old economy/new economy concept should be applied to fundamental stock analysis:

“If we were to look at a business like Google, it starts getting very complicated. Google has undergone spectacular growth in revenues and cash flow over the past few years. If we extrapolate that into the future, the business appears to be trading at a big discount to its underlying intrinsic value. If we assume that not only is its growth rate likely to taper off, but that its core search business monopoly may be successfully challenged – by Microsoft, Yahoo, or some upstart – the picture is quite different. In that scenario, the current valuation of Google might well be many times its underlying intrinsic value.
“The Dhandho way to deal with this dilemma is painfully simple: Only invest in businesses that are simple – ones where conservative assumptions about future cash flows are easy to figure out.”

It is not that you cannot make money in technology. You have just got to be extremely confident that the technology you are investing in is not made obsolete within a couple of years. Who knows if Google or Yahoo – or Baidu – will dominate the search engine business during the 21st century?

What separates all-star investors from mediocre investors? It is the accuracy of the assumptions in their valuation models. Emerging economies are growing. They need copper, iron ore, nickel, oil, gas, coal, and other building blocks of Western living standards. You do not have to make heroic assumptions about what technology will look like in 10 years to make money in leading commodity companies – companies that have wide moats. To lower your risk while investing in commodity companies, follow the “Dhandho” principle of paying the lowest possible price. Maybe you will get a shot at lower prices the next time the media mistakenly calls the end of the commodities bull market.

Link here.
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