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THE NEXT ATTACK ON GOLD HAS BEGUN
“If you bet on a horse, that’s gambling. If you bet you can make three spades, that’s entertainment. If you bet cotton will go up three points, that’s business. See the difference?” ~~ Blackie Sherrod
“Counterfeiting, when practiced by a private agency not licensed by the government, is denounced as theft and is prosecuted by the government. When counterfeiting is practiced by a national government or a government-licensed central bank and fractionally reserved commercial banks, it is referred to as scientific monetary policy and heralded by free market economists as being in the public interest.” ~~ Gary North (derived)
It has been no surprise whatsoever that governments take exception to alternative currency systems such as E-Bullion, BuillionVault, and James Turk's Goldmoney. These systems are isolated from the worldwide financial monitoring system and by that fact come under suspicion as enablers of money laundering, tax evasion, terrorism ... blah blah blah.
A deeper issue is that the alternative currency services are a threat, however distant, to the government monopoly on money, and from there the whole tissue of lies that justifies the state-run counterfeiting operation that is the fractional reserve banking system. Gary North notes a recent volley across the bow of gold-based money services.
When governments want to expand power over the monetary system, they invoke the need to clamp down on money laundering by criminals. There is a problem here. After these laws and new rules are passed, crime never goes down, but our privacy does. That is a problem for us. It is not a problem for governments.
The Toronto Globe and Mail ran a story on money laundering and new Web-based businesses that allow people to buy small amounts of gold and then spend this gold as money. The development of these businesses is the preliminary step to the restoration of private money. This is regarded with great hostility by national governments and central banks. National governments ever since 1914 have worked with central banks to remove gold from circulation as money. This began with the outbreak of World War I. It has never ceased.
The development of the credit card was the culmination of a dream of every fractional reserve banker. Bankers in a fractional reserve system have always feared the withdrawal of currency by depositors. This reverses the fractional reserve process. It shrinks the money supply.
By substituting digits for currency, bankers have solved this problem. A depositor can move digital money out of his account, but it is transferred to another digital account. The system does not lose deposits. When someone withdraws currency and does not redeposit it, the money supply declines. So, credit cards are a banker's dream come true. The threat of bank runs by depositors has ended.
But now a handful of small companies have offered depositors a way to substitute digital money for gold stored in a vault. This gold can now be spent digitally. This creates the threat of a rival form of money. Hardly anyone accepts gold for transactions. So, the threat to banks is remote today. It is merely the first hesitant step in the creation of an alternative monetary system. Yet this threat has aroused the hostility of some government organizations: those that monitor money.
This alternative money avenue is tiny. Hardly anyone knows of these firms. Fewer still have signed up. Nevertheless, some government agencies are preparing to make war on these tiny firms. "This thing must be nipped in the bud." The Globe and Mail reports on this new pressure by governments:
Canada's financial intelligence agency warns that criminals may be exploiting Internet-based companies that convert cash into electronic gold, exposing a new front in the international effort to restrict terrorist financing and money laundering.
While other channels of money laundering are successfully being shut down, authorities are increasingly worried about a proliferation of "digital precious metals operators" websites that offer clients a chance to conduct Internet business in units backed by gold and silver rather than paper currencies.
The Financial Transactions and Reports Analysis Centre of Canada, or FINTRAC, has produced a report on this supposed threat to the public. It is bad, the report says. It is huge. It is everywhere. The reporter summarized this report. These companies are "facilitating millions of transactions on the fringe of the international financial system -- the equivalent of a Wild West where legitimate businesses, privacy-seeking individuals and criminals can mingle just out of reach of the law."
We know what the Wild West was. It was where the U.S. government had not sent a marshal to police everything. The Wild West was just out of reach of the law, meaning Federal law.
At stake is the effectiveness of the financial reporting rules that countries such as the United States, Britain and Canada enacted in response to the Sept. 11, 2001, terrorist attacks. A network that allows individuals to move money around the world means criminals can avoid commercial banks and other financial institutions required to turn over their records to the government.
You can see where this is headed. Legitimate businesses and privacy-seeking individuals are going to be told to surrender to the Greater Good of the Government in its program of stamping out criminals and terrorists. We all know how successful these government efforts have been so far. We are therefore supposed to accept more of the same.
"As financial institutions and non-financial businesses increasingly deter money laundering and terrorism financing, adaptable and technology-savvy criminals and terrorist financiers will likely see other unregulated, exploitable avenues to further their nefarious purposes," concludes the report, which was made available under the Access to Information Act.
"Digital precious metals may become one of them."
One firm that offers these services is Goldmoney. Its vault is located in London. The company is outside the jurisdiction of Canada and the United States. It has done a great deal to restrict access by criminals. But none of this matters to governments. The firm's offense is that it offers a way for individuals to escape mass price inflation, which is always the creation of central banks. This escape hatch is considered criminal by governments.
Why Governments Hate Gold
When a society's monetary system is based exclusively on private contracts and voluntary exchange, civil governments find it difficult to make money by counterfeiting. They cannot directly control the monetary system. They can influence it through legislation and the courts by altering what constitutes a legally enforceable contract. The main interference here is a government's decision to allow banks and private storage facilities to issue receipts -- IOUs -- for gold or silver that are not covered 100% by the quantity and fineness of the metal promised on the receipt. This violates private contract law. It authorizes fraud. It legalizes counterfeiting. But the government is not helped much by this interpretation of contracts. Banks and warehouse storage facilities are the main beneficiaries.
The history of civil government has been a history of the governments' assertion of sovereignty over money. They do not prove the case for such sovereignty as an inherent attribute of civil government. They do not even mention this theoretical problem. There merely enforce the principle by law.
There is a reason for this. All civil governments, with the lone exception of Byzantium from 325 to 1453, have deliberately tampered with the metal content of the monetary unit. They have practiced counterfeiting. They have added less expensive metal to the silver or gold and have then spent the new money into circulation at the older, higher value.
This is theft. Governments steal from naïve, trusting individuals who sell at yesterday's prices on the assumption that the nation's official counterfeiter has not, coin by coin, stolen silver or gold and replaced it with tin or some other base metal. The skeptics see what has happened and raise prices, or they borrow with the intention of repaying the loan with money of reduced purchasing power.
Counterfeiting, when practiced by a private agency not licensed by the government, is denounced as theft and is prosecuted by the government. On the other hand, whenever counterfeiting is practiced by a national government or a government-licensed central bank and fractionally reserved commercial banks, this is referred to as scientific monetary policy. It is heralded by free market economists as being in the public interest.
Central banks are charged with the responsibility of carrying out monetary policy. The major purpose of the Federal Reserve System (and other central banks) is to regulate the money supply and provide a monetary climate that is in the interest of the entire economy. (Gwartney & Stroup, Economics, 4th edition, p. 281).
A Moral Issue
Sometime around 750 B.C., the prophet Isaiah identified the practice of monetary debasement as one of a series of government acts against the public interest.
Thy silver is become dross, thy wine mixed with water (Isaiah 1:22).
The process of debasement, he argued, was initially moral debasement. It affected the entire nation. "Wash you, make you clean; put away the evil of your doings from before mine eyes; cease to do evil" (Isaiah 1:16). Then it became judicial debasement. "Thy princes are rebellious, and companions of thieves: every one loveth gifts, and followeth after rewards: they judge not the fatherless, neither doth the cause of the widow come unto them" (Isaiah 1:23). But its most visible mark was monetary debasement. This led to the debasement of wine, i.e., product quality debasement. He warned of God's wrath to come.
Therefore saith the Lord, the LORD of hosts, the mighty One of Israel, Ah, I will ease me of mine adversaries, and avenge me of mine enemies: And I will turn my hand upon thee, and purely purge away thy dross, and take away all thy tin (Isaiah 1:24–25).
Academic economists refuse to identify monetary debasement as a moral issue. Economics textbooks at every level discuss fractional reserve banking in terms of technical issues, never moral issues. The only exception is Murray Rothbard's little-known textbook on money and banking, The Mystery of Banking. He identified fractional reserve banking as immoral. It involves theft. The book was never adopted by any economics department. It soon went out of print. You can download it for free here.
There is moral cause and effect in society. Because counterfeiting by any agency is immoral, because it deliberately forces the redistribution of wealth from those who spend the money late in the process, after prices have risen, society suffers. An assault on the integrity of contracts undermines cooperative ventures.
Whenever the government or its licensed monopoly, the national central bank, spearheads this assault, the public is unable to defend itself. It does not even suspect there is a problem until the rate of price inflation is widespread. Even then, the government and its spokesmen blame speculators for rising prices.
Right Hand vs. Left Hand
Jesus said, "But when thou doest alms, let not thy left hand know what thy right hand doeth" (Matthew 6:3). His point was that we are not to seek fame from our giving.
Take heed that ye do not your alms before men, to be seen of them: otherwise ye have no reward of your Father which is in heaven. Therefore when thou doest thine alms, do not sound a trumpet before thee, as the hypocrites do in the synagogues and in the streets, that they may have glory of men. Verily I say unto you, They have their reward (Matthew 6:1–2).
That thine alms may be in secret: and thy Father which seeth in secret himself shall reward thee openly (Matthew 6:4).
In the field of civil government, the right hand ought to know what the left hand is doing. Otherwise, policy may be at cross-purposes.
This is what monetary policy is in the United States and Canada. Both nations produce gold coins. They are not really coins. They are not counted in the money supply. But they look like coins. People can buy them.
Problem: evil criminals and terrorists can use these non-coins in their nefarious plans. These non-coins leave no paper trail of digits.
My advice is that we should take advantage of the governments' schizophrenia. If we can legally buy a little future freedom, we should.
I recommend using digital gold storage facilities that are legally incorporated outside the United States, and whose vaults are also outside. But the little guy should first buy gold coins issued by his nation's mint. Maybe after the first $10,000, he should consider an off-shore vault program.
The war on gold will continue. For my free Ebook on this, click here.
GEORGE SOROS: ROCKETING OIL PRICE IS A BUBBLE
George Soros notes that an oil price chart fits the parabolic pattern characteristic of bull market blowoffs, and thus we should expect a substantial decline ... in time.
Speculators are largely responsible for driving crude prices to their peaks in recent weeks and the record oil price now looks like a bubble, George Soros has warned. The billionaire investor's comments came only days after the oil price soared to a record high of $135 a barrel amid speculation that crude could soon be catapulted towards the $200 mark.
In an interview with The Daily Telegraph, Mr. Soros said that although the weak dollar, ebbing Middle Eastern supply and record Chinese demand could explain some of the increase in energy prices, the crude oil market had been significantly affected by speculation. "Speculation ... is increasingly affecting the price," he said. "The price has this parabolic shape which is characteristic of bubbles."
The comments are significant, not only because Mr. Soros is the world's most prominent hedge fund investor but also because many experts have claimed speculation is only a minor factor affecting crude prices. ...
At just over $130 a barrel, the price has doubled in around a year, causing misery for motorists and businesses. However, Mr. Soros warned that the oil bubble would not burst until both the U.S. and Britain were in recession, after which prices could fall dramatically. "You can also anticipate that [the bubble] will eventually correct but that is unlikely to happen before the recession actually reduces the demand. ... The rise in the price of oil and food is going to weigh and aggravate the recession."
The Bank of England recently warned that soaring energy and food costs would push inflation above its target range for most of the next 18 months, making it more unlikely that it will cut borrowing costs soon.
Mr. Soros warns Britain is facing its worst economic storm in living memory, dwarfing those of the 1970s and early 1990s, with a housing slump and serious recession. He said: "The dislocations will be greater [than in the 1970s] because you also have the implications of the house price decline, which you didn't have in the 1970s."
The warning undermines predictions that Britain will suffer only a brief and relatively painless recession, unlike the precipitous dives of previous years. Mr. Soros also warned that the Bank's inflation report represents a "Faustian pact", obliging it to keep interest rates high to control inflation, even as the economy is starting to slump. "You had the nice decade," he said. "Now that is over and you are in a straitjacket."
A hedge-fund pro says big institutional investors are behind run-ups in oil and other commodities. Where is Will Rogers when you need him?
Alan Abelson, former Barron's editor and writer of that newspaper's lead "Up and Down Wall Street" column since the 1966, is not sold on the idea that high oil prices are the handiwork of speculators.
If stupidity got us into this mess, then why can't it get us out?" That ingenuous but intriguing query was posed by the stand-up cowboy humorist Will Rogers, whose aw-shucks persona masked a devastatingly sardonic wit.
In his inimitable fashion, Will was addressing one of the numerous messes that our beloved nation found itself enmeshed in at one time or another during the first three decades of the late and not particularly lamented 20th century. He was, befitting his well-worn Stetson and faithful lariat, incredibly quick on the draw with a sly barb for government, Congress, the president and politicians.
It was he, you may recall, who remarked that Alexander Hamilton started the U.S. Treasury with nothing, "and that was the closest the country ever came to breaking even." And who reckoned that "an economist's guess is liable to be as good as anybody else's." And who defined diplomacy as "the art of saying 'nice doggie' until you can find a rock." And who confessed, "I am not a member of any organized political party; I am a Democrat." And who insisted, "I don't know jokes; I just watch the government and report the facts."
Will, lest you get the wrong impression from this random sampling, was by no means all acid and vinegar. He had a soft spot for young people anxious about making the right choice of a profession, as evidenced by this thoughtful piece of advice: "Make crime pay. Become a lawyer."
Of course, Will Rogers lived in a simpler age, when the problems were far less complex than those we face today. Still, Homo sapiens has not changed all that much, nor, we are afraid, has the quality of our leaders. And any public-spirited person searching for an exit strategy from the mess we are now in may well be tempted, as Will suggests, to give stupidity a chance.
The trouble is, though, that most of those responsible for our present straits have other, apparently more pressing priorities. The president has his hands full, poor chap, straightening out the rest of the world, even though the rest of the world does not seem to have the faintest desire to be straightened out. In any case, as you can well imagine, that Sisyphean task leaves him with scant time to bother much with incipient recession, the remorseless slump in housing, killer fuel and food prices and similar minor distractions at home.
Congress, for its part, is fixated on staging the latest Capitol Hill extravaganza: the march of the petro perps (the top brass of the oil goliaths) up Capitol Hill for their daily public spanking by the solons and then their being sent home to repent of their sins. To which, once home, they respond, as would anybody with a sore butt, by promptly raising prices at the pump.
Ah well, rather than brooding over the failings of our commander-in-chief and chosen representatives, let us look on the bright side, as Will urged us to do by pointing out how lucky we are that "we don't get all the government we pay for."
Washington fiddled while Wall Street burned. That would make a snappy headline for these scribblings, but we must admit that it would not be entirely accurate on either score. Which is cause for both regret and relief.
Relief, in that even though a funny thing happened to the stock market last week -- it took a quick U-turn from rally to retreat -- the damage has been painful but nowhere near catastrophic. ... Regret, because if the powers-that-be in D.C. were only fiddling, they could not be dreaming up schemes that seem designed to make a bad situation worse. And that is one thing even critics like ourselves have to concede Washington is really good at.
What made the stock market metamorphose from spirited advance into straggly decline was that the euphoria induced by the conviction that the worst of the credit crunch was over and the menace of recession was receding ran smack up against reality and, as in any collision between evanescent vapor and gritty substance, it is no contest which gets creamed.
It was not anything fancy that cooled things off just as investor sentiment started to work up a head of steam, and it comes in three simple letters: O-I-L. Crude continued on its tear, scaling one new peak after another, reaching $135 a barrel before pausing for breath. And it was oil, as well, that stirred Congress from its customary slumbers.
Besides such old favorites as a windfall-profits tax on oil and gas producers and repealing tax breaks they now enjoy, our louche lawmakers would ban price gouging, subject OPEC to the slings and arrows of attorneys pursuing antitrust actions and dampen speculation in the futures markets by mandating higher margins and stiffening the rules on index funds that dabble in oil and assorted other commodities. (We are indebted to ISI Group's excellent policy report for the latest info on what our congressfolk are busily brewing.)
That last item -- the rising ardor in Washington to do something to shackle the big, bad speculators in commodities and especially oil and gas -- drew some fuel from both interested and disinterested parties. Good old OPEC, in the person of its secretary-general, Abdalla Salem El-Badri, denied that it had the slightest thing to do with soaring crude prices. Gosh, who could ever harbor such an unkind thought? The blame, El-Badri emphasized, should be laid squarely at the door of those market-kiting speculators.
He is not, in case you wondered, the disinterested party mentioned above. That designation, by his own vouching, belongs to a fellow named Michael Masters, proprietor of a hedge fund unsurprisingly called Masters Capital Management, who testified last week before a Senate subcommittee. The burden of his presentation was that such deep-pocket investors as corporate and government pension funds, sovereign wealth funds, university endowments and kindred institutions are in no small measure responsible for the spectacular run-ups in commodities, particularly food and, of course, oil.
He dubs this motley group "index speculators," and he feels quite strongly that Congress should act pronto to curb their pernicious practices. He offers a kind of tutorial on commodities speculation, replete with graphs and charts and other quasi-scholarly trappings.
Mr. Masters seems well versed in the fine points of commodities trading, and he is passionate in his belief that the major stimulus for the fiery gains in oil and food are those big-bucks players. His testimony created a bit of a buzz in the Street, and it is certainly worth a read. That speculators -- especially in the past five or six months, when their normal haunts, the equity markets, were frequently in the dumps -- have been active in the futures arena is no secret. Ironically, we recall a similar plaint -- but in reverse -- made to us by a prominent Texas oil guy who beefed bitterly that speculators were behind the then sharply depressed price of oil.
We suspect that Mr. Masters gives rather short shrift to the impact of both exponential growth of demand not only from China but from India and other emerging countries on the price of oil, and reasonable and growing concern about prospective supply. For all his worthy effort, we found his case not entirely persuasive and, at best, as the old Scotch verdict has it, not proved.
The piece immediately below quotes extensively from Masters's testimony. "Passionate" is a good adjective to describe how he feels about the big speculators.
This does not mean obviously that we think oil is a slam dunk to reach $200 a barrel. Nor, having just forked over $4.25 a gallon to keep our jalopy going, that it and its most prominent derivative are immune to the effects of spiking prices, especially in an economy as stressed as this one.
In our brief exegesis of why oil has been acting as if some practical jokester gave it a hot foot that has sent it in panicky flight to the moon, we deliberately neglected to mention the dollar as a leading suspect. In the main, we suppose, because it is both so evident and widely recognized as a causal agent, but also because we have cited it long and often as the root of so many of our ills that it might seem just a tad repetitious, which it is.
Yet we cannot resist taking still another swipe at the dark forces that have conspired to debase the ragged greenback and, in the process, contrived to make life miserable in so many ways for the denizens of this fair land. As Peter Schiff, who runs Euro Pacific Capital, tartly observes in his latest epistle, it is too bad that the Supreme Court, in ruling that U.S currency is unfair to the blind, failed to also declare it unfair to everyone who buys gasoline.
To Peter, the big move in crude and gasoline is symptomatic of the bill that has come due for years of reckless consumption and dollar devaluation that have priced us out of markets to which we once held "unchallenged title." Signs of America's falling standard of living are everywhere, he laments.
And he posits that the current round of belt-tightening is "simply the down payment on the government's massive bailout of Wall Street investment banks and mortgage lenders." And he morosely predicts, "As the Fed creates money to buy bad mortgages and other shaky securities held by banks and brokerage firms, the value of the savings and wages" of us poor slobs will continue to shrivel.
That means that the cost of a good many more of the things that we take for granted will shoot up. "Four dollar gasoline," he warns, "is just the beginning."
THE GREAT OIL SWINDLE
This is a less circumspect, more gloves-off analysis of what is going on in the oil market or, more precisely, the oil products futures exchanges. It is speculators driving up the price says Mike Whitney, and it is fueled by the Federal Reserve's profligate money/credit creation policy. So far not really different from George Soros's and Alan Abelson's analysis above. But Whitney has a cynical additional take on the matter, primarily based on the same testimony by one Michael Masters that Abelson finds less than fully convincing.
Whitney thinks the Fed and accomplices are trying to help the investment banks bail themselves out of the mortgage-backed securities debacle by making it easy for them to collectively squeeze the oil and other commodities markets -- somewhat like the Hunt Brothers excellent silver adventure in the late 1970s, except no regulator will pull the rug out from under them as happened with the Hunts.
Strong stuff. The cynicism is justified. But could the feds really think the major players in the financial industry can bail themselves out by running up commodities prices? Are the really that stupid? (Don't answer that!)
The Commodity Futures and Trading Commission (CFTC) is investigating trading in oil futures to determine whether the surge in prices to record levels is the result of manipulation or fraud. They might want to take a look at wheat, rice and corn futures while they are at it.
The whole thing is a hoax cooked up by the investment banks and hedge funds who are trying to dig their way out of the trillion dollar mortgage-backed securities (MBS) mess that they created by turning garbage loans into securities. That scam blew up in their face last August and left them scrounging for handouts from the Federal Reserve. Now the billions of dollars they are getting from the Fed is being diverted into commodities which is destabilizing the world economy, driving gas prices to the moon and triggering food riots across the planet.
For months we have been told that the soaring price of oil has been the result of Peak Oil, fighting in Iraq, attacks on oil facilities in Nigeria, labor problems in Norway, and (the all-time favorite) growth in China. It is all baloney. Just like Goldman Sachs prediction of $200 per barrel oil is baloney. If oil is about to skyrocket then why has G-Sax kept a neutral rating on some of its oil holdings like Exxon Mobile? Could it be that they know that oil is just another mega-inflated equity bubble -- like housing, corporate bonds and dot.com stocks-that is about to crash to earth as soon as the big players grab a parachute?
There are three things that are driving up the price of oil: the falling dollar, speculation and buying on margin. The dollar is tanking because of the Federal Reserve's low interest monetary policies have kept interest rates below the rate of inflation for most of the last decade. Add that to the $700 billion current account deficit and a National Debt that has increased from $5.8 trillion when Bush first took office to over $9 trillion today and it is a wonder the dollar has not gone "poof" already.
According to a January 4 editorial in the Wall Street Journal: "If the dollar had remained 'as good as gold' since 2001, oil today would be selling at about $30 per barrel, not $99 (today $126 per barrel). The decline of the dollar against gold and oil suggests a U.S. monetary that is supplying too many dollars."
The price of oil has more than quadrupled since 2001, from roughly $30 per barrel to $126, without any disruptions to supply. There is no shortage. It is just gibberish.
As far as "buying on margin" consider this summary from author William Engdahl: "A conservative calculation is that at least 60% of today's $128 per barrel price of crude oil comes from unregulated futures speculation by hedge funds, banks and financial groups using the London ICE Futures and New York NYMEX futures exchanges and uncontrolled inter-bank or Over-The-Counter trading to avoid scrutiny. U.S. margin rules of the government's Commodity Futures Trading Commission allow speculators to buy a crude oil futures contract on the Nymex, by having to pay only 6% of the value of the contract. At today's price of $128 per barrel, that means a futures trader only has to put up about $8 for every barrel. He borrows the other $120. This extreme "leverage" of 16 to 1 helps drive prices to wildly unrealistic levels and offset bank losses in sub-prime and other disasters at the expense of the overall population."
So the investment banks and their trading partners at the hedge funds can game the system for a mere 8 bucks per barrel or 16 to 1 leverage. Not bad, eh?
Is it possible that gambling on oil futures might be a temptation for banks that are already underwater from a trillion dollars worth of mortgage-related deals that have "gone south" leaving the banking system essentially bankrupt? And if the banks and hedgies are not playing this game, then where is the money coming from?
I have compiled charts and graphs that show that nearly 2/3 of the big investment banks' revenue came from the securitization of commercial and residential real estate loans. That market is frozen. Besides, this is not just a matter of "loan delinquencies" or MBS that have to be written off. The banks are "revenue starved". How are they filling the coffers? They are either neck-deep in interest rate swaps, derivatives trading, or gaming the futures market. Which is it?
Of course, there is one other possibility, but if that possibility turned out to be right than it would cast doubt on the legitimacy of the entire financial system. In fact, it would prove that the system is being rigged from the top-down by our friends at the Banking Politburo, the Federal Reserve. Here goes:
What if the investment banks are trading their worthless MBS and CDOs at the Fed's auction facilities and using the money ($400 billion) to drive up the price of raw materials like rice, corn, wheat, and oil? Could it be? Could the Fed really be looking the other way so it can bail out its banking buddies while they drive prices skyward?
If it is true; (and I suspect it is) it has not done much good. As the Associated Press reported yesterday [Friday, May 30]: "The Federal Reserve announced Thursday that it will make a fresh batch of short-term cash loans available to squeezed banks as part of an ongoing effort to ease stressed credit markets. The Fed said it will conduct three auctions in June, with each one making $75 billion available in short-term cash loans. Banks can bid for a slice of the available funds. It would mark the latest round in a program that the Fed launched in December to help banks overcome credit problems so they will keep lending to customers."
Another $225 billion for the bankers and not a dime for the struggling homeowner! The Fed is bankrupting the country with their permanent rotating loans to keep reckless speculators from going under. So much for moral hazard.
As far as speculation, there is ample evidence that the system is being manipulated. According to MarketWatch: "Speculative activity in commodity markets has grown 'enormously' over the past several years, the Homeland Security and Governmental Affairs Committee said in a news release. It pointed out that in five years, from 2003 to 2008, investment in the index funds tied to commodities has grown by 20-fold -- to $260 billion from $13 billion."
And here is a revealing clip from the testimony of Michael W. Masters of Masters Capital Management, LLC, who addressed the issue of "Commodities Speculation" before the Committee on Homeland Security and Governmental Affairs this week:
"Today, Index Speculators are pouring billions of dollars into the commodities futures markets, speculating that commodity prices will increase. ... In the popular press the explanation given most often for rising oil prices is the increased demand for oil from China. According to the DOE, annual Chinese demand for petroleum has increased over the last five years from 1.88 billion barrels to 2.8 billion barrels, an increase of 920 million barrels. Over the same 5-year period, Index Speculators' demand for petroleum futures has increased by 848 million barrels. The increase in demand from index speculators is almost equal to the increase in demand from China.
"Index Speculators have now stockpiled, via the futures market, the equivalent of 1.1 billion barrels of petroleum, effectively adding eight times as much oil to their own stockpile as the U.S. has added to the Strategic Petroleum Reserve over the last five years. Today, in many commodities futures markets, they are the single largest force. The huge growth in their demand has gone virtually undetected by classically-trained economists who almost never analyze demand in futures markets.
"As money pours into the markets, two things happen concurrently: the markets expand and prices rise. One particularly troubling aspect of Index Speculator demand is that it actually increases the more prices increase. This explains the accelerating rate at which commodity futures prices (and actual commodity prices) are increasing. The CFTC has taken deliberate steps to allow certain speculators virtually unlimited access to the commodities futures markets. The CFTC has granted Wall Street banks an exemption from speculative position limits when these banks hedge over-the-counter swaps transactions. This has effectively opened a loophole for unlimited speculation.
"When Index Speculators enter into commodity index swaps, which 85-90% of them do, they face no speculative position limits. ... The result is a gross distortion in data that effectively hides the full impact of Index Speculation." (Thanks to Mish's Global Economic Trend Analysis)
Masters adds that the CFTC is pressing to make "Index Speculators exempt from all position limits" so they can make "unlimited" bets on the futures which are wreaking havoc on the global economy and pushing millions towards starvation. Of course, these things pale in comparison to the higher priority of fatting the bottom line of the parasitic investor class.
Brimming oil tankers are presently sitting off the coasts of Iran and Louisiana. The Strategic Petroleum Reserve has been filled. Demand is flat. The world's biggest consumer of energy (guess who?) is cutting back.
As CNN reports: "At a time when gas prices are at an all-time high, Americans have curtailed their driving at a historic rate. The Department of Transportation said figures from March show the steepest decrease in driving ever recorded. Compared with March a year earlier, Americans drove an estimated 4.3% less -- that's 11 billion fewer miles, the DOT's Federal Highway Administration said Monday, calling it "the sharpest yearly drop for any month in FHWA history."
The great oil crunch is another fabricated crisis. Another "smoke and mirrors" fiasco. Another Enron-type shell-game engineered by banksters and hedge fund managers. Once again, the bloody footprints can be traced right back to the front door of the Federal Reserve.
SPIEGEL INTERVIEW WITH WARREN BUFFETT
There is not much new to chew on in this interview for veteral Buffett followers. In fact, one could say that Buffett has not said much new in the last three decades. He has just articulated and followed his simple philosophy, come hell or high water, while paying diligent attention to the blocking and tackling involved in execution. And that is the most important lesson in the end.
Spiegel: Real estate prices have plunged rapidly in the United States, energy is getting more expensive by the day, the financial sector is in a miserable condition and new risks are lurking everywhere. Can the United States even avert a recession anymore?
Warren Buffett: Well, I am not an expert on the economy. I could not make any money predicting the course of the economy for six months or a year. But I do believe that we are already in a recession. Maybe not according to the economists' definition. That would require two consecutive quarters of negative growth. We have not reached that point yet. But people are already feeling the effects of the recession. It will be deeper and last longer than many believe. But my business models are not based on current forecasts. In fact, they are completely independent of forecasts. Even if the world went under, I would still be buying companies.
But you yourself have said that the party is over.
Yes, but I was just talking about the insurance sector. For decades, it was possible to make relatively good money in insurance. But those days are now gone.
What about the financial industry?
The party is never over there. Sure, there will always be new upheavals. We are now experiencing one of those upheavals, as evidenced by the near-collapse of investment bank Bear Stearns. But this sort of thing also presents huge new opportunities for investments, even if this is happening in a chaotic period.
Suddenly so optimistic? You yourself have referred to some of the tools of the financial industry as "weapons of mass destruction." It sounds almost like what German President Horst Köhler said about the financial markets, which he described as "a monster."
I do not condemn the entire industry. When I mentioned weapons of mass destruction, I was merely referring to the out-of-control trading in derivatives. It does not make sense that hundreds of jobs are being eliminated, that entire branches of industry in the real economy are going under because of such financial gambles, even though they are in fact completely healthy. Besides, these types of constructs are so complicated that hardly anyone understands them anymore.
Even bankers do not know what is going on anymore.
They concocted a poisonous brew, and in the end they had to drink it themselves. This is something bankers are normally extremely loath to do. They would rather sell it to someone else.
How can these financial instruments be monitored?
That is the problem. You can no longer control or regulate this sort of thing. It has taken on a life of its own. You cannot put the genie back into the bottle. The American central bank, the Fed, tried to exert its influence by lowering interest rates, for example. The Fed and the U.S. government have absolutely no interest in promoting the extreme fluctuations we are now experiencing. Nevertheless, they were also unable to prevent them.
Based on your logic, any future U.S. administration will also be powerless. Who would you like to see as the next president?
Before they launched their candidacies, I told the two current Democratic candidates: I support you. I have donated the maximum amount of money allowed by law to the Democrats, and I have spent the same amount of money to support both Barack Obama and Hillary Clinton. But that is like being married to two people. You have to make a decision at some point. I chose Obama, and I hope that he wins. ... I just happen to agree with many of his views, starting with his modern proposals for abortion and reproduction policy and ending with the fiscal policy he envisions.
You have come to Germany to invest in family-owned companies. What do you find so attractive here?
We are looking for large, well-run companies that we understand right away. The one condition is that they have grown over several decades. Companies that are three or four years old are out of the question. Of course, many families will not be interested in selling such attractive companies. I understand that completely. But sometimes there is a good reason to sell the company, after all. When that happens, we want the families to think of us first.
Who is on your shopping list?
I do not have a specific shopping list. I am looking for companies with a long-term, permanent competitive advantage, companies that are managed by good people and that are good value. We have only 19 people at Berkshire in Omaha, which is why we need good local managers. I can think of a number of companies in Germany that would interest us. But as an outsider, I cannot say when the circumstances are right for a sale. That is why these people should call me directly.
Whose call would you welcome in particular?
It would not be good for me or the companies if I told you their names.
The German economy is in a highly robust state at the moment, while a few other Western countries are having economic problems. How do you account for this?
It shows that the Germans know something about business. In fact, the strong euro works against Germany. But if an exporting nation like Germany is still strong, it proves that the supply and quality are right. And that many correct decisions were made in the past and that reform efforts were worthwhile.
In addition to companies like Coca-Cola and Procter & Gamble, you have invested many billions of dollars in reinsurance companies. Now insurance premiums are falling. Did you make a mistake?
I have been in the business since 1970, and it has always gone up and down. Perhaps I will not make quite as much money in the next 12 months, but overall I believe that the industry is in good shape, despite the current slump. When we buy something, we stay forever and forever. Many find this irritating, but that is just the way we are.
Munich Re was the first German company in which you invested directly. Another investment for posterity?
We have two different categories at Berkshire Hathaway. There are 76 companies that we own permanently. And then there is a trading inventory. Munich Re is part of the second category.
Have you met with the executives at Munich Re?
Yes, two years ago. We also bought shares in another German company ... I would rather not say [which]. Those shares are also part of our trading inventory and can be quickly sold again.
You have pledged about half of your fortune to the Bill & Melinda Gates Foundation. What happens with the other half?
In addition to the Gates Foundation, I have pledged money to four other foundations. So far, 80 percent of my stock holdings have been firmly committed to these five organizations. I have promised that I would ultimately donate every one of my shares in Berkshire Hathaway. My will clearly specifies what will happen to the remaining shares. But I can still change this decision while I am alive. ...
How does your immense wealth affect your everyday life?
I have everything I need. But that is also the way I felt at 25, when I did not have that much money yet. I have a wonderful family. I have a job that I love and wonderful people who help me with it. It cannot get any better than that.
What is your take on the new class of the super-rich, such as the many Russian oligarchs who ostentatiously show off their wealth?
Well, if it makes them happy ... It doesn't do anything for me. I am happy when I can spend every day doing the things that I like to do. That is my luxury. Things could have gone differently, but I was lucky.
You have no interest in a new mansion in Omaha, or perhaps a luxury house at the beach? After all, you have been living in the same house for decades.
Buffett: I don't need 15 houses. Owning real estate does not mean much to me. I do not like to think about things like that. I do not need 12 boats, or even the world's largest boat with a crew of 80. I would have to take care of them, to worry about them. I get a lot more fun out of life without all the bells and whistles.
LUMBER AND PAPER MILLS STRUGGLE AS TIMBER STANDS TALL
One might think with housing in the dumps that the timber companies are seeing weaker markets for their product. Partially correct, but booming pulp demand from Asia and wood chip demand from Europe is partially offsetting that. Meanwhile, the trees the timber companies are withholding from the market while they await stronger markets keep growing. This is a nice option to have while waiting through a slump! This article suggests that when lumber demand recovers, timber companies will be sitting pretty.
A standard renewable resource economics optimization problem concerns when to harvest a stand of timber. Glossing over real world issues like output price and interest rate uncertainly, the intuitively appealing answer is that as long is the net proceeds one could obtain from delaying the harvest is greater than what you could get by harvesting now and investing the proceeds in an interest-bearing instrument, you should hold off on harvesting. Young trees grow quickly, so you should almost always let them keep growing. A stand of mature trees grows very slowly, so usually those are the ones you would harvest first. But if prices are expected to increase, you might hold off on harvesting mature trees as well. Apparently this is the situation the timber companies find themselves in now.
There is a classic squeeze going on in the timber markets right now. As you might expect, the U.S housing slump is reducing demand for finished lumber. Meanwhile, timber, pulpwood, and paper prices are rising worldwide -- but curiously, profit margins are eroding. ...
The global commodity boom has created a supply/demand price imbalance between the four distinct industry sectors that rely on timber as a raw material. In fact, that imbalance is a huge mismatch, and savvy investors may be able to wring substantial returns from the winner.
You see, timber companies have shrewdly maintained monopoly-like control of raw materials to hold the line on prices, despite the economic downturn. They are doling out enough -- and only enough -- supply to maintain sufficient revenue streams to pay the bills. Meanwhile, their downstream relatives are suffering. In a sense, timber owners are weathering the storm. And when the storm is over, their profits should explode.
It is a complicated scenario being driven by a number of economic factors including the declining U.S. dollar, classic market demand/supply ratios, emerging markets growth, and even export quotas and tariffs. ... The end game could send timber company profits - and your portfolio -- soaring in the next 12 months to two years. ...
As lumber prices have swooned to a 5-year low, wood has been piling up at lumber mills. Sawmills throughout the U.S. and Canada have been reeling since the second quarter of 2007, when lumber prices collapsed to below the cost of production. Here is what is happening now:
Particularly hard-hit are the big lumber mills in Canada, which ship much of their production to the U.S. The key factor was the unprecedented run-up in the Canadian dollar. With sales denominated in U.S. dollars and costs accrued in Canadian dollars, a wide range of Canadian producers were running in the red and simply ran out of money.
- In the United States, single-family-housing starts dropped 1.7% in April to a seasonally adjusted annual rate of 692,000 units, the lowest monthly production rate since January 1991, and a jaw-dropping 42% below 2007.
- U.S lumber consumption is expected to drop, from 64 billion board feet to 43 billion board feet from 2006 to 2008. A drop of 21 billion board feet in the span of three years is simply staggering, equal to the total production of the Top 20 softwood lumber producers in the U.S. market for all of 2007.
- North American lumber at the Chicago Mercantile Exchange has fallen as low as $209 per thousand board feet, down a whopping 56% from its peak of $473 in 2004 -- at the apex of the housing boom.
- Lumber companies in the Billion Board Foot Club, a measurement of the largest lumber companies in the world, was reduced from 22 to 15 in 2007. Six of the victims to be cut were in North America.
In addition, Canada mills must pay a 15% duty to ship lumber into the U.S. That puts the price at those mills at about $175 per thousand board feet, said Gerry Van Leeuwen, vice president at International Wood Markets Group, a Vancouver-based lumber consulting firm. "There is just no way anyone is making any money," he added.
In the past, sawmills only needed to wait for interest rates to decline before ramping up production. Now, however, they will have to wait until the housing glut is over before lumber demand gets back to normal. And that is not likely until mid-2009 at the earliest. Our advice is not to bet the farm on lumber companies right now.
Meanwhile, pulpwood and paper has been in a strong bull market for almost two years. Demand for paper and pulp remains strong -- from overseas markets, in particular. And that demand does not appear likely to ebb anytime, soon.
Overall, world paper demand is moving ahead, buoyed by accelerating growth in Asia. The surge in paper demand in Asia is driving a huge appetite for both virgin pulp and recycled fiber. In 2006, alone, China's imports of wood pulp jumped 150% to 7.5 million tons. Increased exports have also helped pulpwood prices.
The weak U.S. dollar makes it cheap enough for pulp and paper companies to purchase products in the U.S. and ship them overseas. On top of that, demand from European utility companies for wood pellets should keep pulpwood prices elevated. Believe it or not, European utilities have turned to wood chips to produce power in order to lower their greenhouse gas emissions in accordance with the Kyoto protocol.
So you would think paper and pulpwood mills would be humming along, bringing in record profits. ... There is a huge fly in the ointment for pulpwood-and-paper mills.
Paper mills, of course, rely on pulpwood as raw material. Pulp mills, in turn, operate on small logs and wood chips -- a byproduct of lumber production. And, as you might expect, the weak market has lumber mills cutting back on production. This is forcing pulpwood mills to rely on buying more logs or raw timber, says Daniel Stuber, of Forest2Market.com. The lack of available chips has produced a big demand for small, lower quality logs. The fact is, pulp mills are using twice as many logs as they normally would to satisfy production levels. And they are getting hit right in the wallet.
"One of the bright spots for timberland owners is the demand from the pulp-and-paper industry," Stuber said. "Land owners have been withholding stands with larger trees until saw-timber prices rebound, but they have been able to generate revenue through thinning practices and harvesting younger stands."
In other words, conditions are forcing the pulpwood mills to buy timber no matter what the price -- or go out of business. The higher cost of pulp is being passed straight along to the paper mills. And they are frantically trying to pass those increases along to purchasers.
Blake Hutchison, director of purchasing for the Menomonee Falls, Wisconsin-based printer Arandell Corp., says that most, if not all paper mills increased prices for 2008 by 5% to 7%. But they still cannot keep up with soaring pulp prices. "Keep in mind that even with the recent price increases, paper mills are still losing money," Hutchison said. So don't bet the farm on pulpwood and paper mills, either.
Line Your Pockets with Timber
The truth is, timber owners are sitting back, biding their time, and withholding their high-quality tracts of timber until the market recovers. When the markets turn around, look for timber owners to cash in ... When that happens, you can join them. ...
The U.S. has about 500 million acres of potentially productive timberland, more than 2/3 of which is now privately held. Environmental restrictions and loss of land to development pressures have greatly reduced the global availability of timberland. Reduced cutting on public lands has increased the value of private forests, and has also increased imports from international sources. In 2004, for the first time ever, the U.S. became a net importer of wood.
Most U.S. timber is owned by timber investment management organizations [TIMOs]. Worldwide, TIMOs have attracted more than $20 billion of investment from institutional investors. For instance, Harvard Management, which invests $27 billion of the university's endowment and pension money, has 10% of its assets in timber.
But now there are public companies that are available as investment vehicles for the small investor. Here are a few to consider:
Claymore Global Timber ETF: Launched in November 2007, this exchange-traded fund tracks the Clear Global Timber Index, which includes companies that own or manage forested land, harvest the timber from it, and produce finished products. Companies that do not own or manage forested land and harvest trees are excluded from the index. It has broad exposure to the industry and that might be a drawback for now. Listed among its top 10 holdings are Weyerhaeuser, International Paper, and other paper and lumber companies.
Rayonier -- Operating as a real estate investment trust, Rayonier owns 2.5 million acres of timberland in the United States, New Zealand and Australia. It also produces a small amount of finished lumber and cellulose products. Despite the economic slowdown, Rayonier has grown earnings at a 24% annual clip for the last five years, and has a history of positive surprises to analysts' estimates.
Plum Creek Timber Co. -- Also an REIT, Plum Creek owns 8 million acres of timberland (all in the U.S.) and is focused primarily on owning and managing timberland, although it also sells plywood and wood chips. It is 66% owned by mutual funds, with Invesco Ltd. (IVZ) currently ranking as its largest stakeholder. Plum Creek has a 25% operating margin and its dividend yield has averaged 4% over the last five years.
This rather interesting article on how timberland has performed as an investment over the 1987-2006 timeframe is a good starting point for considering the whole asset class. It informs us that there may be more to the simple story one hears -- e.g., here -- that timber provides returns comparable to equities with less volatility while also being negatively correlated with equity returns. Which is another way of saying that future performance may not match past performance.
Having said that, timber is a class hard asset that typically does well during inflationary times. If inflation gets still worse from here, we would expect it to do well.
THE OVERLOOKED TREASURES
Forbes financial columnist cum value investor cum mutual fund manager John Rogers is suspicious of the runup in commodity prices, and is finding some quality stocks at reasonable prices. His highlighted recommendations all seem like reasonable if unspectacular values.
In some ways I have never seen a market like the one we are in, but in one way it feels all too familiar. I noted here last December that volatility was back, and since then it has only increased. In the first three months of 2008 the Standard & Poor's 500 moved 2% or more on 12 trading days, which was 1/5 of the time. By comparison there was not a single 2% day in all of 2004 or 2005. [Which is amazing.] In my quarter-century of investing, I cannot recall stocks being so jumpy.
Of course, most of the movement has been downward. In the first quarter of 2008 domestic and international stock markets fell sharply across the board. Nothing was spared. But while equities tumbled, the boom-and-bust commodity world, which I consciously avoid, took off.
Commodities ranging from gold to dairy have been on a price run-up not seen for decades, if ever. As of May 5, on the Chicago Board of Trade corn is up 49% since the beginning of last year, wheat futures are up 58%, soybeans 86% and rice 105%. As I write, oil has just hit $121 a barrel, a rise of 1,000% in a decade.
The commodity craze is what is giving me déjà vu. We have seen exuberance like this before -- with Internet stocks in the late 1990s and with housing more recently. In other words, there is growing evidence of a bubble. And as everyone knows, the bigger the bubble gets, the more spectacular the pop.
The commodity bulls argue that demand in China and India is causing an epochal change that has reset prices permanently higher. They say current prices not only are justified but are just the beginning of a prolonged upward march. "It's different this time!" they proclaim. To which another money manager, Howard Marks, recently responded, "Those four little words are always heard when the market swings to dangerously high levels. It is not just a sign of an absurd condition, it is a prerequisite."
The problem is that when commodity prices first started to increase, the so-called smart money suddenly rediscovered them as an asset class. That is what created the bubble. In January 2000 commodity mutual and natural resources funds and exchange-traded funds held $5 billion in assets; 8 years later they hold $105 billion.
When the herd is stampeding toward one overcrowded watering hole, I prefer to plod along slowly in a different direction. This is a great time to be a value investor. Wonderful stocks that tend to be expensive are getting overlooked and are gradually becoming cheap enough for me to buy. So my portfolios are getting an upgrade without my having to pay a premium.
I feel as if the market handed me my most recent purchase, Tiffany (44, TIF), in its trademark blue box. It contains exactly what I like to see in a company. Its brand recognition rests on a reputation for unrivaled quality. Its managers are smart, experienced and predisposed to act like owners. Its smooth earnings streams have led to a rock-solid balance sheet. After an unspectacular Christmas season in 2007, investors got spooked, fearing the company might suffer in a recession, but I do not think the sort of people who shop at Tiffany are about to go looking for jewelry on the cheap. Even if business is temporarily light, I believe Tiffany will be selling for far more three years from now than it is today. Its shares trade at a 26% discount to my estimate of their intrinsic value.
Another luxury brand I have been buying is Sotheby's (27, BID), which I first purchased last fall. Shares of the auctioneer fell 40% within two days in November after a Van Gogh valued at between $28 million and $35 million failed to attract a suitable bid at auction. It was as if investors thought the entire fine art market was crashing. I believe, though, that individuals auctioning off investment-grade art will continue to demand the expertise of either Christie's or Sotheby's, and only the latter is publicly traded. The skeptics worry that as the market suffers, hedge fund managers may not buy multimillion- dollar paintings. Maybe, but there still will be Russian oil tycoons and Indian steel magnates. I believe the stock is undervalued by 31%.
Another contrarian purchase is CB Richard Ellis (23, CBG), a global real estate services and money management firm. When I bought it last fall, it was an even more contrarian choice than Tiffany or Sotheby's. That was just when the fear surrounding all things related to real estate was turning into panic and investors were dumping the stock. One theory held that the residential housing crisis would somehow spread to commercial real estate. Another was that commercial transactions would drop off on their own. To my mind, such figurings ignore one big fact: Most companies do not want the fuss of managing their properties, and so they let experts like CB Richard Ellis do it for them. I think it would be worth $35 per share to an acquirer.
BEAUTY AMID THE HOUSING UGLINESS
Forbes columnist/money manager Lisa Hess makes a case for the two dominant U.S. home-improvement retailers, Home Depot and Lowes. The former is a former Nifty 50-type stock beloved by growth stock buyers. Its stock now sells at the same price it did 10 years ago, and at around 12 times trailing earnings. My how times change. Even Home Depot's dividend yield, at 3.3%, is worth noticing. Lowes has stagnated for a mere six years, and is selling for a slightly higher multiple appropriate to its earlier stage in the business lifecycle.
Investing with an eye towards an industry recovery by buying into the highest quality participants selling at depressed valuations is not necessarily the path to outsized gains, but it is a low-risk path to above average gains.
California always seems to lead the way. In the last housing recession, in the early 1990s, the streets of Los Angeles were lined with shiny new Lamborghinis and Maseratis even as house prices stagnated. Why? The stock answer was that you can live in your car, but you cannot drive your house. Today an awful lot of West Coasters must be sleeping in the back seat.
The news just gets uglier and uglier. U.S. foreclosure filings doubled in the first quarter to 650,000 properties, or one in every 194 households. In California the rate was one in every 78. Bloomberg is reporting that the market valuation of home builders has collectively fallen so far that they all may be dropped from the Standard & Poor's 500. The aggregate market value of builders Lennar, Pulte Homes, D.R. Horton and KB Home is $13.9 billion, down from $43 billion at their 2006 peak.
In February the S&P/Case-Shiller home price index for 20 metropolitan regions was off 12.7% from the previous year. That index measures resales of specific homes, probably the most accurate statistic we have. As for residential mortgage lenders, Residential Capital, for one, is proving to be a black hole for its parent GMAC. Its operating loss for the first quarter was $859 million, after it needed two $1 billion cash infusions last year and a quickly arranged $750 million credit line in April.
How bad can this thing get? I regret to say I have no crystal ball. What I can foresee, however, is that the housing market has to stabilize eventually as prices fall to affordable levels. We will know we have hit bottom when the cocktail party chatter starts to say it is smarter to rent than to buy.
Until then, the long-term investor willing to pay attention during the next few quarterly earnings cycles can find some great values. Two companies whose stocks have been beaten down but that stand out with their great balance sheets and real staying power are Home Depot (29, HD) and Lowe's (25, LOW). Home Depot, the world's largest home-improvement retailer, is a mammoth enterprise. It has 2,258 stores, covering 235 million square feet. Its market capitalization is $49 billion, and it generates only $2.2 billion in free cash flow (operating cash flow less capital expenditures). It sells at a trailing price/earnings ratio of slightly under 13 and has fallen 24% over the past year. It has been dogged by a reputation for terrible service and claims of worker exploitation, but its chief executive, Frank Blake, can fix those problems.
Only a year ago people were talking of Home Depot as a potential leveraged buyout candidate. We all discussed earnestly whether the LBO would cost $100 billion and how the credit market would absorb so much debt. The transaction was presumably to be funded by the real estate on Home Depot's books, and we debated how much of a premium private equity funds would have to pay over the $40 share price.
Today the company still owns 87% of its stores, and the intrinsic value remains. Lehman Brothers has done an analysis of a possible tax-free spinoff of Home Depot's real estate into a real estate investment trust, and it finds that those holdings are worth $31 billion, or $19 a share. Management still has authorization to repurchase $12.8 billion in Home Depot shares, and it says it will recommence once business improves. The company's market capitalization is less than 70% of its 2007 sales. It is a far better investment today than a year ago.
Lowe's Cos., the other big home-improvement retailer, has a 5% market share, roughly half that of Home Depot. Selling at 0.8 times sales and 14 times trailing earnings, Lowe's is at its most attractive valuation in years. Unnerved investors have lost sight of the growth opportunity it still offers. Nearly all of Lowe's sales are in the U.S. The company opened its first stores in Canada late last year and anticipates further expansion in Mexico. Investors are totally overlooking that.
Accurately timing a bottom is an exercise in frustration, though we all try. What is abundantly clear is that housing is returning to more realistic levels and the bubble in mortgage finance is working its way through the system. Even some of the subprime-structured finance market has fallen to attractive levels, to the point where issues are yielding 10% to 15% on the assumption that so many underlying mortgages will default that losses will reach 50%. The National Association of Realtors may not be unbiased, but it does have a monthly housing affordability index that shows an up trend from the end of 2007.
The nadir for the real estate industry may have not yet arrived. But the time to buy these retailers is now.
THIS HOME BOOM IS STILL ALIVE
Brazil is enjoying a residential building bonanza for all the right reasons. And foreign investors are welcome.
Hyperinflation destroys an economy's debt markets, which means no mortgages for houses. Hyperinflation is associated with capital underinvestment and poor real economic performance as well. What happens when sound monetary policy is established? As a rule, one would expect economic performance to improve. And in time a bond and mortgage market will emerge, and credit will start to flow into the housing market. Both of these factors will drive real housing prices up.
This is the situation in Brazil today. This past decade much of the world was indulging in a credit orgy which capped an already long history of credit overindulgence. Meanwhile, Brazilians were just discovering what credit was. That, among other reasons, is why Brazil's real estate boom is not a bubble. You might want to try cashing in on the stong real estate market there by buying into that sector of the Brazilian stock market. Just beware that you would also be betting that the strong commodities markets will continue, thereby continuing to drive Brazil's new-found economic strength.
Hyperinflation. Political crises. A plummeting currency. For decades something always supported the adage that Brazil is the country of the future -- and always will be.
Not anymore. Fueled by low interest rates, sound fiscal policy and robust demand for its commodities, Brazil is a darling of emerging markets these days. The economy grew 5.4% in 2007 and should deliver something close to that again this year. Stocks, measured in Brazilian reais, are up 55% since January 2007. Inflation is down 2/3 in six years to 4.29%, about the same as in the U.S.
As in Mexico four years ago, Brazil's real estate market has been a prime beneficiary of the drop in borrowing rates and other good economic news. The difference is that Brazil's market is open and drawing in enormous amounts of foreign capital, says Citigroup Latin America strategist Geoffrey Dennis.
U.S. institutions started sniffing out Brazilian real estate deals a few years ago. The $242 billion California Public Employees' Retirement System has partnered with Houston developer Hines to invest a reported $1.2 billion in Brazilian real estate. Equity International, owned by Chicago tycoon Sam Zell, began investing in Brazilian real estate in 2004.
Is it too late to join the party? Hardly. Decades of capital scarcity have created huge pent-up demand. Buyers are ready to soak up 7 million houses and apartments. In Rio de Janeiro the vacancy rate for high-end office space is 3.4% (versus 7.2% in Manhattan). "Brazil has become the nimble sprinter among emerging markets," says Equity International Chief Executive Gary Garrabrant.
Nor has it stumbled the way the U.S. has. The term "subprime" has yet to enter the vocabulary in Brazil, where home buyers traditionally borrowed from relatives and paid cash. When the mortgage market started taking off a few years ago, the longest term on a home loan was 10 years. Now 30-year loans are available, with interest rates of 13% to 14%. "In the past no one would get financing. We had inflation of 30% a month," says Fabio Maceira, chief executive of the Brazilian subsidiary of property management firm Jones Lang LaSalle.
Brazilian mortgage originations have more than quintupled since 2003 to $22 billion last year, according to Jones Lang. There is plenty more room for growth. The total came to 2% of GDP; the corresponding ratio for the U.S. was 14%.
Another big change: Property developers have been tapping the equity markets for capital, with much of it coming from abroad. All told, 20 Brazilian real estate firms, most of them residential home builders, listed shares last year. Consolidation now seems inevitable, with the smart money betting on the strongest builders, says Tomas Awad, senior strategist at Itau Securities in Sao Paulo.
Equity International began investing four years ago in Gafisa, which began building high-end homes but has expanded down-market. With American Depositary Shares at $37.35, Gafisa has a market value of 37 times projected 2008 earnings of $73 million on $869 million in revenues.
The majority of the stocks in the table below trade only on Sao Paulo's Bovespa exchange. Even so, buying shares online via E-Trade is fairly painless. A $10,000 purchase will cost $13 or so in commissions. For the ones with dividends but without an ADS, there is the added nuisance of converting semiannual payments from reais into dollars.
Cyrela Brazil Realty, Brazil's biggest home developer, is run by billionaire Elie Horn. It began by building luxury apartments in Sao Paulo and Rio de Janeiro. It has since expanded into middle- and lower-income housing in 43 cities. Public since late 2005, it expanded revenue 53% last year to $1 billion; profits jumped 74% to $274 million. At a recent $14, it trades at 17 times expected 2008 earnings.
Construtora Tenda, the largest low-income home builder, went public last October and posted a loss of $22 million on $176 million in revenues in 2007. Demand is strong for its apartments and town houses, which sell for an average $43,000. Revenue should more than triple this year to $590 million, with the firm swinging to a profit of $98 million, estimates Itau Securities' Awad. At a recent $4.91, Tenda trades at an affordable eight times expected 2008 earnings per share.
Says Awad: "Brazil is so behind everywhere in everything that this is not a short-term boost. It is a 5- to 10-year cycle we are entering.
PIPELINE TO PROFITS
You want a piece of the energy business that will not get hurt if oil crashes? Take Gabriel Hammond’s advice and own some pipeline’s.
Oil and gas pipelines charge by the pound or gallon of product shipped, not by the value of product shipped. They have maintenance spending requirements, but these are relatively small. So most of the cash flow generated is free cash flow. In short, a pipeline is an asset that has investment characteristics somewhat similar to a bond, but with a yield that fluctates.
Interestingly, the cash flow yield from a pipeline should also be inflation-hedged: There is no reason to think that shipping rates pipelines can charge will not vary with the general price level. So if the cash flow yield percentage is accommodatingly large, pipelines look like an interesting possibility for yield investors. The one fly in the ointment is that most publically traded pipelines are in Master Limited Partnerships, which -- like all LPs -- can be a major annoyance when it comes time to fill out one's tax return.
MLP distributions yields average 7.5% of market prices today, or 3.6 percentage points more than yields on 10-year Treasurys. That compares with a historical average of only 2.25 points over Treasurys, says Stephen Maresca, an MLP analyst at UBS. We do not have anything to add to that conclusion, except that it seems reasonable.
Gabriel Hammond is a fund manager from central casting. Raised in a posh Washington, D.C. suburb, he got a degree from Johns Hopkins, spent two years at Goldman Sachs and then set up his own fund firm (current assets under management: $250 million). The one kink in his story is that Hammond, 29, does not dabble in growth stocks or distressed debt. His game is rusty metal tubes buried deep underground. Hammond's Dallas firm, Alerian Capital Management, taps into oil and natural gas pipelines via tax-advantaged vehicles called master limited partnerships, or MLPs.
Every day 280,000 miles of pipelines shuttle 63 billion cubic feet of natural gas around the U.S. About a quarter of them are held as MLPs. A separate 100,000-mile network hauls 20 million barrels of crude daily, with 70% in MLP hands.
The 50 exchange-listed MLP pipelines and storage units have a combined value of $120 billion. There is more capital en route. The U.S. is expected to put another $100 billion into its natural gas infrastructure over the next decade. The pipelines' income streams should hold up even if energy prices drop. That is because they get so much per pound shipped, not per dollar of product. ...
The partnerships are typically formed when big companies decide to raise cash by hiving off hard assets. Once public, MLPs trade like stocks. The twist is that they are partnerships, which means they pass on earnings and depreciation to investors. Come tax time, that means investors typically pay ordinary income taxes on about 1/5 of distributions, which have grown 8% to 10% annually in recent years.
The other 80% of distributions are considered nontaxable returns of capital that reduce a partner's cost basis. That means they turn into future capital gains, taxed either much later (when the investor sells the shares) or never, if it winds up in his estate and enjoys the capital gains step-up at death. There are some further subtleties (the tax treatment of partnerships is bizarrely complicated), but the bottom line is that investors holding MLPs that own depreciating assets are taxed leniently.
The downside of investing directly in MLPs is complexity. Pipeline partnerships are a particular problem because they must calculate, and investors must report, gains and losses in each state they traverse. The resulting K-1 tax forms are so cumbersome that many financial advisers suggest bothering with MLPs only for six-figure investments.
A simpler alternative is to own the exchange-traded iShares in one of two industry stalwarts, Kinder Morgan and Enbridge. These trade, and are taxed, like ETFs and require no K-1 filings. Kinder Morgan is the largest MLP by market cap at $15.2 billion; Enbridge is valued at $4.8 billion. They are precisely the sort of workhorse pipelines that Hammond favors (see table).
In 1997, in Hammond's freshman year at college, he put $2,000 earned as a swimming instructor into his first online brokerage account and started trading. The tech bust was raging by the time he graduated in 2001 with a double major in economics and international relations. Yet Hammond's account had ballooned to $17,000, thanks to blue chips like Caterpillar and Altria.
After graduating, Hammond ... took a job as an energy analyst at Goldman Sachs in New York. It turned out to be a front-row seat for Enron's collapse and the shock waves it sent through the pipeline industry. "Companies were selling assets to stave off bankruptcy," recalls Hammond. As firms like El Paso and Dynegy raced to raise capital, some spun off pipelines into MLPs. When it was over, Hammond was the only one in Goldman's energy and power group interested in covering the partnerships.
In the 15 years since tax changes had paved the way for modern MLPs, a mere 15 had been launched and had a combined value of $20 billion by 2003. In the market recovery that followed Enron's collapse, however, the partnerships started to draw yield-hungry investors. Hammond was convinced the MLP business was poised for a growth spurt, like the one REITs had enjoyed a decade and a half earlier.
He began putting together Alerian in July 2004 and trading MLPs with $5 million under management from Hans Utsch, a portfolio manager at Federated Investors, whom Hammond had met at a luncheon. Hammond struggled just to pay the bills but earned 15% his first half-year in operation. That was good enough to lure investments from two Wall Street firms, which declined to be named.
A year after Alerian's launch Hammond had $50 million under management. His timing was outstanding. In the four years after he set up Alerian, the MLP sector's market cap tripled and Alerian's total returns came in at 20% annually. In June 2006 Hammond's little firm launched the Alerian Master Limited Partnership Index, the first to track MLPs. A year later he added BearLinx Alerian MLP Select, an exchange-traded note that trades like an ETF and tracks the firm's MLP index.
Despite MLPs' hefty returns over the past decade, tax-exempt institutions have shied away from investing directly in them because of tax complications. (It is similarly a bad idea to hold MLPshares in a tax-deferred account.) But they are a fine choice, he says, for retail investors in high tax brackets who can stomach the paperwork.
MLP distributions average 7.5% of market prices today, or 3.6 percentage points more than yields on 10-year Treasurys. That compares with a historical average of only 2.25 points over Treasurys, says Stephen Maresca, an MLP analyst at UBS. No surprise, he is a bull on the sector.
THE BIG PICTURE
Fads and fears are merely distractions. The two most important things about constructing a portfolio: having a reasonable allocation of your assets and keeping your costs down.
This is an excellent introduction from Forbes on how to achieve satisfactory risk-adjusted returns over time. The first rule of making money is not to lose it. The Forbes suggestions all address this at least indirectly: stick to what works rather than follow the mob into what is popular, know enough about what you are doing so that you are not scared out of your positions when they get cheap, and do not let you money by drained by high trading and management cost.
The dollar is lower than ever against the euro, gas prices are higher than ever, Egyptians are rioting over food shortages and Sam's Club is rationing rice. Such upheaval aside, it is business as usual on Wall Street: Small investors are repeating past mistakes by focusing on the market's short-term troubles rather than on their own long-term objectives.
Instead of diving into tech stocks or housing near the peak, the masses are this time pouring into Treasurys and commodities, says Christine Benz, personal finance director at Morningstar in Chicago. Small investors pumped $10.4 billion into mutual funds and exchange-traded funds specializing in Treasury Inflation-Protected Securities over the last year, driving up the price of TIPS and thereby lowering future returns. Buy one now, at least in a taxable account, and you are just about guaranteed to be a loser.
In January the government issued a 10-year TIPS at $99.14 per $100 with an after-inflation yield of 1.7%. It now sells for $101.05, and the yield is down to 1.5%. The bond protects you against inflation, but still, this is a very bad deal. If the cost of living goes up 3%, the bond gives you a total return of 4.5%, and all of that return is taxable immediately. If your tax bracket is 35%, you lose more than 1.5 percentage points to taxes. Subtract inflation and your real, aftertax return is negative. ... If you buy the Treasury through a fund, you will be even worse off because funds have overhead.
Putting the TIPS in a 401(k) postpones, but does not eliminate, the tax punishment. When the money comes out, it will be subject to post-2009 federal tax rates (all but certain to be higher than today's) and, somewhat surprisingly, state income tax as well.
Why are retail investors falling all over themselves to buy TIPS? Because they are in a panic. The price of gasoline is going up, and TIPS have the specious appeal of beating the cost of living. They are missing the big picture. "Investors, as usual, are getting in at the worst time and ignoring stocks," says Morningstar's Benz.
Whatever happens to bonds and commodities from here, the rush from one hot sector to another is usually far more profitable to the brokers clipping commissions off each buy-and-sell order than to people aiming to pay for college and retirement. What investors should be doing when panic is in the air is tuning out the market's day-to-day distractions and focusing on multidecade goals. That means sticking to two basics: deciding what asset categories to own and finding ways to own them cheaply. We will restate this simple philosophy as four rules.
Think About Allocation. Most people do not give any thought at all to how they allocate between stocks, bonds, cash and commodities. They just buy what has worked lately.
What Wall Street refers to as a "flight to quality" amid short-term troubles often turns out to be a flight to mediocrity over the long haul. Lately that flight has been a stampede into bonds, especially Treasurys, for their safe-haven status. True, they do not default. But they do something else bad. They eat away your purchasing power.
We cannot prove it, but we suspect that most of the people buying 10-year Treasurys today are not buying because they expect terrific returns over the next decade. They are buying because they witnessed great returns over the past year (great compared to stocks, at any rate). As investors bid up bonds over the last year, Vanguard's Intermediate-Term Treasury Fund posted a 10.5% total return. Meanwhile, its yield has fallen to 3.1%. That is a pretty good forecast of what you will get owning this fund for the next decade.
That is a terrible return. It is highly likely to be negative after inflation and taxes. See the arithmetic above, where we showed how a 4.5% yield is likely to net a negative real return, too. You have to expect extraordinarily good things on the inflation front to like a 3.3% return. Indeed, our 3% assumption for inflation is pretty conservative. In the past year the cost of living went up 4%. Could stocks do worse than 3.3%? Sure. They are, after all, risky. But what is likely?
During one-year periods over the past two centuries stocks have outperformed government and corporate bonds 60% of the time, according to an updated edition of Stocks for the Long Run, by Wharton finance professor Jeremy Siegel. Stretch the time frame to 5-year periods and stocks excel 70% of the time, with their wining percentage rising to 95% for periods longer than 20 years.
The moral of this story is that investors who can sleep through the bumps should weight their holdings heavily toward stocks, argues Edmund (Ned) Notzon, chairman of the asset allocation committee for fund vendor T. Rowe Price. Under his direction, T. Rowe's target-date retirement and college savings funds are the most equities-laden in the business.
Investors in their 20s and 30s should hold at least 90% of assets in stocks and cut that only to 55% at age 65, he recommends. Given inflation's corrosive effects, even octogenarians should hold 40% of their stash in stocks, throttling back to 20% at age 95, and then only if they do not much care about what is left for their heirs, he says.
If you are working with a blank slate, or tax-deferred account, the simplest way to diversify is through a single fund that covers the earth and relieves you of the temptation to load up on hot regions or sectors or abandon out-of-favor ones. Vanguard launched a Global Stock Index Fund and ETF last month that tracks the FTSE All-World Index of 2,800 companies and includes a 55% weighting outside the U.S. At 0.25% a year in fees, it is the cheapest global index around.
A second way to own the world is to buy country- or sector-specific mutual funds or ETFs. Then when one gets beaten up, harvest the losses to offset gains elsewhere when you rebalance. The key is reinvesting by the original plan, regardless of the market's swings.
Beware of overlap, too. Gazprom, for example, is the top holding in Fidelity's Emerging Markets and Aggressive International funds. Similarly, before buying an energy fund, note that energy stocks already compose 13% of the market-cap-weighted S&P 500. Many fund Web sites update holdings monthly, versus semiannually in SEC filings.
Be a Cheapskate. As Vanguard founder John C. Bogle put it, investing is one business where you get what you don't pay for. Pony up the average 1.5% of assets that U.S. equity no-load funds charge and over time you are likely to lag the market by about that much.
More, actually, according to Madrid's Universidad Carlos III professors Javier Gil-Bazo and Pablo Ruiz-Verdu. That is because managers keep fees high in precisely those funds whose investors are inattentive, they concluded after studying actively managed funds in business for at least two years. "A significant fraction of investors responds at best sluggishly to differences in afterfee performance," the professors wrote in a working paper. "Funds exploit that fact and charge high fees."
The flip side is that sophisticated investors care dearly about performance, and therefore fees, so the best managers keep them low. Postscript: The 10 cheapest actively managed funds are all from Vanguard.
What about all those broker-sold load funds? They are hardly ever worth the money. On average they clip 5.5% off savings before they go to work and charge 1.3% in management fees versus 1% for no-load equity funds. If you really need hand-holding, consider using a financial planner who charges a flat fee or 1% or so of assets a year to put you into low-cost mutual funds or ETFs.
One cost not captured in most fee tables is the brokerage commissions funds run up buying and selling. Where the fees do turn up is in reduced performance. The best way to minimize them is to buy ETFs, index funds or others with low turnover ratios. You can also gauge the net effects of brokerage costs by reviewing Forbes's fund tables, which include them in fees. We do not, however, include the effect of bid-ask spreads, which are significant but hard to quantify. Our advice on this score is to be leery of high-turnover funds.
Think About Risk. We are not averse to taking risks, or we would not be saying kind things about the stock market. But we do think you should be contemplating it before putting your money down. If you do not, you might react badly to a market spill. You might, in short, buy high and sell low. That is what befell a lot of the investors who stampeded into tech funds in 1999 and 2000. One way to measure risk for a stock fund is to evaluate its performance separately in bull and bear markets. Forbes does that for you with its fund grading system, available here. Risky funds tend to get As and Bs in bull markets and Ds and Fs in bear markets. Example: Fidelity Select Electronics. Conservative funds have the reverse profile, like Fidelity Select Insurance.
Another measure, available for any investment with a performance history, is how widely the returns have strayed from their long-term average. For example, you look at how monthly returns over the past 3 or 5 years have danced around the monthly average. The analysis is usually presented as an annualized standard deviation. For the Vanguard S&P 500 Index Fund, the standard deviation over five years is 8.9%. Pimco's Commodities Real Return Strategies Fund far outperformed the Vanguard index fund over that period but took big chances. Its annualized standard deviation was 17.8%. You can find standard deviation figures on Morningstar's Web site.
Do Not Buy Past Performance. At any given moment there will be funds that have done well in the past 5 or 10 years and trumpet their results in ads. Do not buy thinking that future returns will be as good as past ones. You should, to be sure, buy a fund with a good history rather than a bad one, but past performance is a pretty weak indicator.
In 1976 Vanguard's S&P 500 Index offered retail investors their first chance to passively track stocks. At the time there were 308 U.S. stock funds big enough to be listed in the Forbes Mutual Fund Survey. Over the succeeding 32 years 89 of these funds, or 29%, have beaten the Vanguard index fund. This is a decent measure of how likely it is that a managed fund will beat the index over such spans.
Over the years a lot of the stinker funds have been merged out of existence. Only 205 of the 308 at the starting line are still in the race. Were you foolish enough to use 205 as your denominator, you would erroneously conclude that 43% of actively managed funds beat the passive one.
Among the 10 best-performing actively managed funds (see table) that beat Vanguard's index over 32 years, 7 are no-loads and all have below-average fees. (Loads are not figured into our performance numbers; expenses are.) Only one top-10 fund is a small-cap, although small stocks supposedly outperform large ones over time. Topping the list: Fidelity's recently reopened Magellan, with a 17.8% annual return to the Vanguard index's 12%. That includes market-beating results for 9 years when Magellan was closed.
Bottom line: Getting a hot fund may win a sprint or two, but nothing trumps a diverse portfolio and steady hand over time.
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