Recently, I proudly and confidently proclaimed that GOLD was ready to head for $2,000. As Bill Clinton's former press secretary, Dee Dee Myers, used to saying when Billy was caught lying, that forecast is "no longer operational".
An interesting dynamic has put itself into motion. As GOLD continues to hover near its highs, the equity market is rapidly falling apart. Precious metals mining companies are battling a tug-of-war between higher metals prices versus a vastly more difficult environment for equities.
This sets up a very difficult question: how does one play the market volatility? Carefully.
During the financial meltdown of 2008-09, GOLD held up pretty well, gaining a "flight to safety" bid. Despite the very good action in GOLD, however, mining stocks got blasted for losses of up to 90%. Any one of a number of events could trigger an explosion in the metal: war in Iran, a breakdown of the Euro-Zone, more quantitative easing or more problems in the financial system. This list is hardly exhaustive.
The above notwithstanding, many signs have emerged that another DEFLATION scare is imminent. The money supply is plunging at un-precedented rates. DEFLATION. Bond yields have broken to new multi-generational lows. DEFLATION. Bank loans and credit are contracting at historic rates. DEFLATION. The dollar, despite all the government spending and low interest rates keeps rallying. DEFLATION.
The "Gold Bugs" index, also known as the HUI, has been carving out an ascending wedge pattern. These are normally, but not always, bearish. The HUI has also approached the 500 level on several occasions, and can't seem to break through. A material violation of either 475 on the downside or 500 on the upside would provide a pretty good indication of what to do.
It's possible that GOLD itself could rally while precious metals stocks could decline. So, for now, the best bet is the metal itself. I would be VERY cautious about the equities at this juncture. I tend to think there will be a better buying opportunity down the road.
As to the metal, I would use $1,225 as a stop level. If it breaks below, chances are that we will see some decent downside and there will be a much better entry point. For now, the amber light is flashing.
Warning Will Robinson!
So, what to do here? If you're going to stick with your portfolio of miners, I would at least add a hedge to insulate against equity pressure. Personally, I like the inverse ETFs FAZ, SKF and TWM. There are plenty of others you can use. I would NOT recommend purchasing a GOLD inverse ETF. What's the point of being both long AND short?
As investors, it is ever so important to not get wedded to a particular point of view or to stay either perma-bull or perma-bear. The easiest way to lose money in the world is to be stubborn and insist that your pre-conceived notions must be correct. Minimize your losses and wait until a better opportunity presents itself.
Marko's Take
Wednesday, June 30, 2010
Monday, June 28, 2010
Chewing Tobacco
The tobacco industry is, by far, the most maligned in the United States. The animosity to the industry, however, is quite understandable. Tobacco companies produce a very harmful and addictive product. The industry is fraught with false advertising and reputedly very shady tactics.
So, tobacco is the only industry characterized by harmful products and often questionable business practices, right? Sure, unless you want to include spirits distillers, automobile manufacturers, oil companies, drug companies, fast food companies and many restaurants, aircraft maufacturers, nuclear utilities, processed food companies, consumer products companies, mobile phone manufactuers and most of the rest of the Fortune 500!
Despite the product risks, most industries are accepted because the products or services are consumed by so many. We drive cars, but lots of people die in car accidents. We drink wine and vodka despite the risk of liver damage and cardiovascular disease. We live on Prozac and Xanax, which are sometimes fatal, because they help keep us sane. We love our cell phones despite the brain damage. Get the picture?
Economically, each of these industries producing harmful products has huge benefits. They employ millions of people, they pay lots of taxes. Most of their products are sought-after world wide because alternatives are relatively few in many cases.
The economics are not really controversial, however. In the case of tobacco. it really gets down to the very emotional health issue. Anyone with half a brain understands the numerous health problems caused by chronic tobacco use. About 20% of the United States adult population choose to smoke. So, what I wonder is: why does lung cancer trigger more contempt than liver damage or brain damage or death by airplane crash?
The tobacco industry has repeatedly shot itself in the foot over the years. Critics have unearthed irrefutable evidence of some extremely nefarious business practices. They market to teenagers, suppress studies that implicate them, employ an army of lobbyists to garner favorable political treatment, ignore health to enhance the likelihood of long term use of their product and are constantly being litigated against. Them, and just about every other industry!
Doesn't tobacco kill? Yes, it most certainly does. But, so do nuclear reactors, oil rigs, car crashes and Big Macs. Hmm, I'm still missing the difference. How is tobacco different?
Oh yes, it kills OTHERS! It has spill-over effects on non-smokers via second hand smoke. Cars kill other people than the driver. So does burning fossil fuels. So do alcoholics. What's the difference, again?
The fact that tobacco kills, is actually a double-edged sword. Yes, the deaths are unfortunate and unnecessary. But, shortening life spans has some major societal and economic benefits. Longer life spans are placing major weight on Social Security and other entitlement programs which disproportionately benefit the elderly. So, the health risks borne by tobacco smokers actually transfers wealth to non-tobacco smokers. When looked at this way, non-smokers certainly should understand how they benefit from smokers. Thus, the big picture is not as clear cut as they may have believed.
The tobacco industry is actually operating at some major disadvantages via the rest of corporate America. For example, what industry is forced to run ads which tell people NOT to use its product? Only one other as far I can tell: utilities.
An additonal high-profile source of negative publicity is the endless lawsuits. Unfortunately, the tobacco industry is a virtual full-employment act for attorneys. The industry is continually sued by smokers for the adverse health risks they knowingly chose to ignore. In addition, some people are quite comfortable arguing that the cigarettes lit themselves and jumped into their mouths. The same folks who sue because their McDonalds coffee was too hot! What's the difference?
The mind-set that life should be without risks has been encouraged by politicians for years. We want no recessions, so we interevene in the economy. We can't stand health risks, so we pass unnecessary legislation to "protect" us against the consequences of our own well-informed choices. You can't have that Double-Cheeseburger... it's BAD for you.
If you're a non-smoker, just remember the following: every person that lights up reduces YOUR tax burden and is less likely to draw scarce financial retirement resources. Chew on it, and see what you think.
Marko's Take
So, tobacco is the only industry characterized by harmful products and often questionable business practices, right? Sure, unless you want to include spirits distillers, automobile manufacturers, oil companies, drug companies, fast food companies and many restaurants, aircraft maufacturers, nuclear utilities, processed food companies, consumer products companies, mobile phone manufactuers and most of the rest of the Fortune 500!
Despite the product risks, most industries are accepted because the products or services are consumed by so many. We drive cars, but lots of people die in car accidents. We drink wine and vodka despite the risk of liver damage and cardiovascular disease. We live on Prozac and Xanax, which are sometimes fatal, because they help keep us sane. We love our cell phones despite the brain damage. Get the picture?
Economically, each of these industries producing harmful products has huge benefits. They employ millions of people, they pay lots of taxes. Most of their products are sought-after world wide because alternatives are relatively few in many cases.
The economics are not really controversial, however. In the case of tobacco. it really gets down to the very emotional health issue. Anyone with half a brain understands the numerous health problems caused by chronic tobacco use. About 20% of the United States adult population choose to smoke. So, what I wonder is: why does lung cancer trigger more contempt than liver damage or brain damage or death by airplane crash?
The tobacco industry has repeatedly shot itself in the foot over the years. Critics have unearthed irrefutable evidence of some extremely nefarious business practices. They market to teenagers, suppress studies that implicate them, employ an army of lobbyists to garner favorable political treatment, ignore health to enhance the likelihood of long term use of their product and are constantly being litigated against. Them, and just about every other industry!
Doesn't tobacco kill? Yes, it most certainly does. But, so do nuclear reactors, oil rigs, car crashes and Big Macs. Hmm, I'm still missing the difference. How is tobacco different?
Oh yes, it kills OTHERS! It has spill-over effects on non-smokers via second hand smoke. Cars kill other people than the driver. So does burning fossil fuels. So do alcoholics. What's the difference, again?
The fact that tobacco kills, is actually a double-edged sword. Yes, the deaths are unfortunate and unnecessary. But, shortening life spans has some major societal and economic benefits. Longer life spans are placing major weight on Social Security and other entitlement programs which disproportionately benefit the elderly. So, the health risks borne by tobacco smokers actually transfers wealth to non-tobacco smokers. When looked at this way, non-smokers certainly should understand how they benefit from smokers. Thus, the big picture is not as clear cut as they may have believed.
The tobacco industry is actually operating at some major disadvantages via the rest of corporate America. For example, what industry is forced to run ads which tell people NOT to use its product? Only one other as far I can tell: utilities.
An additonal high-profile source of negative publicity is the endless lawsuits. Unfortunately, the tobacco industry is a virtual full-employment act for attorneys. The industry is continually sued by smokers for the adverse health risks they knowingly chose to ignore. In addition, some people are quite comfortable arguing that the cigarettes lit themselves and jumped into their mouths. The same folks who sue because their McDonalds coffee was too hot! What's the difference?
The mind-set that life should be without risks has been encouraged by politicians for years. We want no recessions, so we interevene in the economy. We can't stand health risks, so we pass unnecessary legislation to "protect" us against the consequences of our own well-informed choices. You can't have that Double-Cheeseburger... it's BAD for you.
If you're a non-smoker, just remember the following: every person that lights up reduces YOUR tax burden and is less likely to draw scarce financial retirement resources. Chew on it, and see what you think.
Marko's Take
Friday, June 25, 2010
Obama's Latest Folly: Financial Reform
It simply amazes me that politicians believe that any problem can be fixed by more regulation. Uncle Sam is right in the middle of the Federal National Mortgage Corporation (Fannie Mae, or FNM) and Federal Home Loan Mortgage Corporation (Freddie Mac, or FRE) fiascos. Senator Chris Dodd (D-CT) and Representative Barney Frank (D-MA), both beneficiaries of lavish campaign contributions, made sure that these two entities could operate in the most favorable possible business environment, that is, before their help led to the two firms' demise.
Then, of course, we have the cushy relationship between Goldman Sachs, aka "Government Sachs" (GS), and the entire Obama Administration. Gotta be something in it for them!
The Securities and Exchange Corporation (SEC) completely ignored warnings about Bernie Madoff. So now that we've established the government's expertise at regulating various aspects of investing, the answer is to regulate MORE??
Let's not forget the Federal Reserve (Fed). Keeping interest rates way too low and for too long directly led to the twin asset bubbles: real estate and tech stocks. The solution? Keep interest rates even lower and for longer! See the logic?
The Financial Reform Bill was passed this morning. The Obama Administration pushed hard for this legislation to "protect the consumers" that it has, thus far, been completely unable to do. This is how governments think: create a problem, then justify even more intervention to solve the very problem they created. Think we have too much debt? Issue MORE of it! Regulations failing to do their job? Create more bureaucracy and more regulations! Simple.
Major provisions of the bill include:
New regulatory authority for federal officials to seize and break up large troubled financial firms without taxpayer bail-outs in cases where the firm's collapse could destabilize the financial system. U.S. Department of Treasury would supply funds to cover the up-front costs of winding down the failed firm, but the government would have to put a "repayment plan" in place. Regulators would recoup any losses incurred from the wind-down afterwards by assessing fees on financial firms with more than $50 billion in assets.
The establishing of a new, 10-member Financial Stability Oversight Council, comprising existing regulators charged with monitoring and addressing system-wide risks to the nation's financial stability. Let me guess. Members of the council will be alumni of Government Sachs?
The so called "Volcker Rule" would curb propriety trading by the largest financial firms, though banks could make small investments in hedge and private-equity funds. Of course, we should all expect "Government Sachs" to be exempted. If they can't insider trade ahead of their clients, how are they going to make money? Lend? Nahhh!
Derivatives would be subject to comprehensive regulation, especially in the over-the-counter market, including the trading of the products and the companies that sell them. However, the riskiest derivative trading operations would have to be spun-off into affiliates.
A new Consumer Financial Protection Bureau within the Federal Reserve will be created, with rulemaking and some enforcement power over banks and non-banks that offer consumer financial products or services such as credit cards, mortgages and other loans. The new entity will be staffed by alumni of "Government Sachs". (Sarcasm intentional!)
The bill would also provide for a complete "sham" overview of the Fed, by mandating a one-time audit of all of the Fed's emergency lending programs from the financial crisis. The Fed also would disclose, with a two-year lag, details of loans it makes to banks through its discount window as well as open market transactions - activity the Fed currently doesn't disclose. I'm holding my breath. (Sarcasm intentional!)
The legislation would set new size- and risk-based capital standards, including a prohibition on large bank holding companies treating trust-preferred securities as Tier 1 capital, a key measure of a bank's strength. Since former capital requirements were set by Uncle Sam, naturally the new standards are likely to be just as effective. (Sarcasm intentional!)
Larger banks would be subject to a special assessment to raise up to $19 billion to offset the cost of the bill. The fee would apply to financial institutions with more than $50 billion in assets and hedge funds with more than $10 billion in assets, with entities deemed high-risk paying more than safer ones.
Let's not forget the credit-rating agencies! The bill would establish a new quasi-government entity designed to address conflicts of interest inherent in the credit-rating business after the SEC studies the matter. It would also allow investors to sue credit-rating firms for a "knowing or reckless" failure to conduct a reasonable investigation, a lower liability standard than the firms were lobbying to get. Never mind that no one actually CARES what the Standard & Poor's and Moody's think. We MUST regulate them!
What will be the effect of this bill? Simple! Whatever the bill was designed to accomplish, expect the opposite. We can expect less systemic liquidity, a renewed credit crunch and either a obscenely profitable banking sector, or one that goes out of business! The good news? More employment, power and bonuses for all our friends at "Government Sachs"!
Marko's Take
Then, of course, we have the cushy relationship between Goldman Sachs, aka "Government Sachs" (GS), and the entire Obama Administration. Gotta be something in it for them!
The Securities and Exchange Corporation (SEC) completely ignored warnings about Bernie Madoff. So now that we've established the government's expertise at regulating various aspects of investing, the answer is to regulate MORE??
Let's not forget the Federal Reserve (Fed). Keeping interest rates way too low and for too long directly led to the twin asset bubbles: real estate and tech stocks. The solution? Keep interest rates even lower and for longer! See the logic?
The Financial Reform Bill was passed this morning. The Obama Administration pushed hard for this legislation to "protect the consumers" that it has, thus far, been completely unable to do. This is how governments think: create a problem, then justify even more intervention to solve the very problem they created. Think we have too much debt? Issue MORE of it! Regulations failing to do their job? Create more bureaucracy and more regulations! Simple.
Major provisions of the bill include:
New regulatory authority for federal officials to seize and break up large troubled financial firms without taxpayer bail-outs in cases where the firm's collapse could destabilize the financial system. U.S. Department of Treasury would supply funds to cover the up-front costs of winding down the failed firm, but the government would have to put a "repayment plan" in place. Regulators would recoup any losses incurred from the wind-down afterwards by assessing fees on financial firms with more than $50 billion in assets.
The establishing of a new, 10-member Financial Stability Oversight Council, comprising existing regulators charged with monitoring and addressing system-wide risks to the nation's financial stability. Let me guess. Members of the council will be alumni of Government Sachs?
The so called "Volcker Rule" would curb propriety trading by the largest financial firms, though banks could make small investments in hedge and private-equity funds. Of course, we should all expect "Government Sachs" to be exempted. If they can't insider trade ahead of their clients, how are they going to make money? Lend? Nahhh!
Derivatives would be subject to comprehensive regulation, especially in the over-the-counter market, including the trading of the products and the companies that sell them. However, the riskiest derivative trading operations would have to be spun-off into affiliates.
A new Consumer Financial Protection Bureau within the Federal Reserve will be created, with rulemaking and some enforcement power over banks and non-banks that offer consumer financial products or services such as credit cards, mortgages and other loans. The new entity will be staffed by alumni of "Government Sachs". (Sarcasm intentional!)
The bill would also provide for a complete "sham" overview of the Fed, by mandating a one-time audit of all of the Fed's emergency lending programs from the financial crisis. The Fed also would disclose, with a two-year lag, details of loans it makes to banks through its discount window as well as open market transactions - activity the Fed currently doesn't disclose. I'm holding my breath. (Sarcasm intentional!)
The legislation would set new size- and risk-based capital standards, including a prohibition on large bank holding companies treating trust-preferred securities as Tier 1 capital, a key measure of a bank's strength. Since former capital requirements were set by Uncle Sam, naturally the new standards are likely to be just as effective. (Sarcasm intentional!)
Larger banks would be subject to a special assessment to raise up to $19 billion to offset the cost of the bill. The fee would apply to financial institutions with more than $50 billion in assets and hedge funds with more than $10 billion in assets, with entities deemed high-risk paying more than safer ones.
Let's not forget the credit-rating agencies! The bill would establish a new quasi-government entity designed to address conflicts of interest inherent in the credit-rating business after the SEC studies the matter. It would also allow investors to sue credit-rating firms for a "knowing or reckless" failure to conduct a reasonable investigation, a lower liability standard than the firms were lobbying to get. Never mind that no one actually CARES what the Standard & Poor's and Moody's think. We MUST regulate them!
What will be the effect of this bill? Simple! Whatever the bill was designed to accomplish, expect the opposite. We can expect less systemic liquidity, a renewed credit crunch and either a obscenely profitable banking sector, or one that goes out of business! The good news? More employment, power and bonuses for all our friends at "Government Sachs"!
Marko's Take
Thursday, June 24, 2010
Fund Of Hedge Funds Becoming Obsolete
We've written before about some of the issues with Hedge Funds that are less than desirable for prospective investors, especially the fee structure which creates an element of moral hazard. Even more egregious are the "Funds of Hedge Funds" (FOFs), which charge an additional layer of fees for the "value-added" of selecting individual funds and combining them into a basket.
FOFs were designed to accomplish several objectives that an individual investor might not have the resources to achieve on his or her own. They pride themselves as "experts" on each individual fund by performing extensive due diligence and detailed statistical analysis of their return profiles. In addition, they create better diversification by placing 10 or more funds in a pool. Investors are also given access to funds that have closed to new investment, except through the fund baskets.
Great concept in theory, but like so many others, often fails miserably in practice.
FOFs, for their services, usually charge both an additional management fee and often take a modest performance fee. The hedge fund norm is a 2% management fee combined with a 20% performance fee. The FOF often adds another 1% and 10%, respectively, brining the total to a very steep 3% and 30% of profits. This fee structure, in a world of single digit returns, makes the entire FOF concept ensure that investors will achieve sub-standard returns.
In addition, despite the claims of great due diligence, so many FOFs have been caught in manager wipe-outs. Industry fixtures Tremont and Ivy Asset Management, two firms that were former clients, both got trapped by Bernie Madoff. In fact, every hedge fund manager meltdown, beginning with Askin Management in 1994, Long-Term Capital Management in 1998 and then the slaughter in 2008-09 has exposed the weaknesses of the FOF industry.
The bloom is off the rose. In year-end 2007, FOFs represented a massive 43% of assets. Currently, it is down to 34% and shrinking. FOFs have a growing list of detractors.
David Swensen, the long-time manager of Yale University’s endowment, recently slammed FOFs, claiming among other things, they “are a cancer on the institutional investor world”.
Although Mr Swensen has a well-renowned track record, his group isn't the only one to have added value over the past couple of decades. In fact, as a substitute for equity investments over the past 10 years, the Hedge Fund Research (HFR) FOF Index has performed remarkably well, returning 5.4% a year versus a return of minus 1.4% for the S&P 500, with a volatility of 6.2% versus 15.1% for large cap equities.
Nevertheless, the very public failures have stuck a knife in FOFs. According to a recent report by HFR, FOFs are liquidating much faster than they're being created.
Hedge fund liquidations rose in the first quarter of 2010 with 240 funds closing during the period, according to the HFR Market Microstructure Industry Report recently released. Liquidations were disproportionately skewed towards FOFs, with 102 closing in the quarter. This marks the 7th consecutive quarter in which FOF liquidations have exceeded new launches.
Fee pressure is finally making itself present in the industry. Average incentive fees declined by 8 basis points to 19.12% in the 1st quarter of 2010, the steepest drop since the 2nd quarter of 2008, although average management fees were unchanged at 1.58%. Variance between the best and worst deciles of performance narrowed in the less volatile period, with the top decile of all hedge funds returning an average of 15.2%, while the bottom decile lost an average of 8.6%.
“Both investors and fund managers are continuing to exhibit a heightened sensitivity to leverage and risk, even with the benefit of the performance recovery from 2009,” said Ken Heinz, President of HFR. “Managers are employing lower levels of leverage in response to higher realized asset volatility and higher costs of obtaining leverage, as well as investor preference for a less volatile return profile.”
Caveat emptor. What this all should tell you is that if the people who spend every day talking to hedge funds, analysing their returns and statistically measuring how much value they add can be fooled, so can you. Another reason to avoid this entire industry.
Marko's Take
FOFs were designed to accomplish several objectives that an individual investor might not have the resources to achieve on his or her own. They pride themselves as "experts" on each individual fund by performing extensive due diligence and detailed statistical analysis of their return profiles. In addition, they create better diversification by placing 10 or more funds in a pool. Investors are also given access to funds that have closed to new investment, except through the fund baskets.
Great concept in theory, but like so many others, often fails miserably in practice.
FOFs, for their services, usually charge both an additional management fee and often take a modest performance fee. The hedge fund norm is a 2% management fee combined with a 20% performance fee. The FOF often adds another 1% and 10%, respectively, brining the total to a very steep 3% and 30% of profits. This fee structure, in a world of single digit returns, makes the entire FOF concept ensure that investors will achieve sub-standard returns.
In addition, despite the claims of great due diligence, so many FOFs have been caught in manager wipe-outs. Industry fixtures Tremont and Ivy Asset Management, two firms that were former clients, both got trapped by Bernie Madoff. In fact, every hedge fund manager meltdown, beginning with Askin Management in 1994, Long-Term Capital Management in 1998 and then the slaughter in 2008-09 has exposed the weaknesses of the FOF industry.
The bloom is off the rose. In year-end 2007, FOFs represented a massive 43% of assets. Currently, it is down to 34% and shrinking. FOFs have a growing list of detractors.
David Swensen, the long-time manager of Yale University’s endowment, recently slammed FOFs, claiming among other things, they “are a cancer on the institutional investor world”.
Although Mr Swensen has a well-renowned track record, his group isn't the only one to have added value over the past couple of decades. In fact, as a substitute for equity investments over the past 10 years, the Hedge Fund Research (HFR) FOF Index has performed remarkably well, returning 5.4% a year versus a return of minus 1.4% for the S&P 500, with a volatility of 6.2% versus 15.1% for large cap equities.
Nevertheless, the very public failures have stuck a knife in FOFs. According to a recent report by HFR, FOFs are liquidating much faster than they're being created.
Hedge fund liquidations rose in the first quarter of 2010 with 240 funds closing during the period, according to the HFR Market Microstructure Industry Report recently released. Liquidations were disproportionately skewed towards FOFs, with 102 closing in the quarter. This marks the 7th consecutive quarter in which FOF liquidations have exceeded new launches.
Fee pressure is finally making itself present in the industry. Average incentive fees declined by 8 basis points to 19.12% in the 1st quarter of 2010, the steepest drop since the 2nd quarter of 2008, although average management fees were unchanged at 1.58%. Variance between the best and worst deciles of performance narrowed in the less volatile period, with the top decile of all hedge funds returning an average of 15.2%, while the bottom decile lost an average of 8.6%.
“Both investors and fund managers are continuing to exhibit a heightened sensitivity to leverage and risk, even with the benefit of the performance recovery from 2009,” said Ken Heinz, President of HFR. “Managers are employing lower levels of leverage in response to higher realized asset volatility and higher costs of obtaining leverage, as well as investor preference for a less volatile return profile.”
Caveat emptor. What this all should tell you is that if the people who spend every day talking to hedge funds, analysing their returns and statistically measuring how much value they add can be fooled, so can you. Another reason to avoid this entire industry.
Marko's Take
Wednesday, June 23, 2010
New British Petroleum Bond Issue Very Interesting
After being strongly "encouraged" by the Obama Administration to pledge $20 billion into an escrow fund, British Petroleum (BP) is now looking to raise new capital through an upcoming bond issue. The debt is expected to yield 8-9%. BP should be happy, Tony Soprano charges 2 points a week.
BP has rapidly descended to the 2nd company "America loves to hate". And yes, the 1st, "Government Sachs" is participating in the underwriting.
The obvious question is how well the proposed yield compensates investors for BP's very uncertain credit risk and future liabilities. The less obvious answer is that it does.
One need not do a comprehensive analysis to determine the attractiveness of these bonds.
Despite a loss of 50% of its market capitalization in 2 short months, BP is still worth nearly $100 billion. The current value already takes into account expected liabilities from the oil spill. There are no more than a handful of companies in the world with market capitalizations of that magnitude.
BP's total debt at the end of the 1st quarter of 2010 stood at $32 billion, giving it a very comfortable debt/market cap ratio of about 0.35. The company's leverage is consistent with an investment grade borrower.
The company earned $16 billion in 2009 with much lower oil prices, and another $6 billion in the 1st quarter from operations. The recently enacted dividend cut provides another $2 billion in cash flow. At the current earnings rate, the total debt issue is less than annualized earnings. BP's price/earnings ratio is now less than 5.
But what about the future unknown liability from shareholder lawsuits? Tobacco companies have faced them for decades, but none have defaulted. Remember 20% plus yields on Phillip Morris (MO)?
Drug companies have faced them for years, but none have defaulted. The auto companies DID default, but not from litigation. Instead, it was from poor operations and mounting pension and health care liabilities.
In the 1970's, Texaco, then rated Triple A, filed Chapter 11 to restructure onerous pipeline contracts. No one lost any money.
At 8-9%, BP's bonds would yield more than approximately 40% of the entire junk bond universe, and more than troubled sovereign credits Portugal, Ireland and Spain. Only Greek debt is higher.
Highly charged incidents like oil spills tend to swing investor sentiment to un-justifiable extremes. Those who can ignore the market noise from all the hand-wringing stand to make great profits.
Marko's Take
BP has rapidly descended to the 2nd company "America loves to hate". And yes, the 1st, "Government Sachs" is participating in the underwriting.
The obvious question is how well the proposed yield compensates investors for BP's very uncertain credit risk and future liabilities. The less obvious answer is that it does.
One need not do a comprehensive analysis to determine the attractiveness of these bonds.
Despite a loss of 50% of its market capitalization in 2 short months, BP is still worth nearly $100 billion. The current value already takes into account expected liabilities from the oil spill. There are no more than a handful of companies in the world with market capitalizations of that magnitude.
BP's total debt at the end of the 1st quarter of 2010 stood at $32 billion, giving it a very comfortable debt/market cap ratio of about 0.35. The company's leverage is consistent with an investment grade borrower.
The company earned $16 billion in 2009 with much lower oil prices, and another $6 billion in the 1st quarter from operations. The recently enacted dividend cut provides another $2 billion in cash flow. At the current earnings rate, the total debt issue is less than annualized earnings. BP's price/earnings ratio is now less than 5.
But what about the future unknown liability from shareholder lawsuits? Tobacco companies have faced them for decades, but none have defaulted. Remember 20% plus yields on Phillip Morris (MO)?
Drug companies have faced them for years, but none have defaulted. The auto companies DID default, but not from litigation. Instead, it was from poor operations and mounting pension and health care liabilities.
In the 1970's, Texaco, then rated Triple A, filed Chapter 11 to restructure onerous pipeline contracts. No one lost any money.
At 8-9%, BP's bonds would yield more than approximately 40% of the entire junk bond universe, and more than troubled sovereign credits Portugal, Ireland and Spain. Only Greek debt is higher.
Highly charged incidents like oil spills tend to swing investor sentiment to un-justifiable extremes. Those who can ignore the market noise from all the hand-wringing stand to make great profits.
Marko's Take
Tuesday, June 22, 2010
Some Considerations For Selecting Junior Miners
Now that the investment clarion has been sounded, investors may wish to do their own homework for evaluating candidates for investment. Among the several dozen decent publicly traded companies how does one decide which ones to invest in?
While not an exhaustive list, here are some things every investor ought to keep in mind. Follow these rules, and your chances of getting in trouble will be greatly diminished.
Ask and answer the following questions:
1. Where Are The Operations Located?
In my opinion, the biggest risk currently is geo-political. Some countries are dependent on their mining industries and are not terribly interested in having foreign interests, i.e. us, coming in and pillage their resources for our own profit. The risk is nationalization.
A recent case is that of Crystallex International Corporation (KRY), whose mining interests were nationalized by Venezuela. KRY stock sold for more than $4 per share as recently as 2007, before losing a mind-numbing 98% of value to hit 10 cents per share. It has recovered somewhat to trade at $0.45 today.
Personally, I prefer to stick to North American companies which operate in some combination of Canada, the United States and Mexico. I tend to avoid companies with the bulk of their operations in Africa, whose countries tend to be perpetually unstable and subject to ethnic conflicts and new governments. It's impossible to predict which country in what continent will be unsafe, so I stick to where I believe the business environment will not be subject to change without warning.
2. What Aspect Of Mining Is The Company Involved With?
The junior mining sector is basically divided into explorers, developers and producers. The explorers are like oil wildcatters. They can have the greatest gains and the most severe losses. Some junior explorers to consider are U.S. Gold Corporation (UXG), Explor Resources Inc. (EXSFF) and Vista Gold Corporation (VGZ).
Most explorers wish to develop their projects, but some don't. Vista Gold successfully developed its Nevada-based operations to form Allied Nevada Gold Corp. (ANV), which was later spun-off to shareholders at a tremendous profit.
The key risk to an explorer is that its projects turn out to be not viable economically. NovaGold Resources, Inc. (NG), which has a 50% interest in the Galore Creek project, had to suspend development in late 2007 as cost estimates proved way too low. The stock lost 99% of its value from more than $20 per share to about 25 cents in one year.
3. Is The Company Profitable?
The only companies that can report profits are producers. Some geo-politically safe producers include Aurizon Mines Ltd. (AZK), New Gold Inc. (NGD), ECU Silver Mining Company (ECUXF) and Hecla Mining Company (HL). Each of these is profitable and getting more so, based on recent financial reporting.
Given the very favorable mining economics prevailing today, the list above is far from extensive.
4. Is There An Asset Play?
Some companies are primarily an asset play. They hold already drilled and largely delineated projects. Probably the best asset play out there is Seabridge Gold (SA), which boasts more than 60 million ounces of economically viable Gold, in addition to a slew of other minerals such as Copper.
Producers can also be terrific asset plays. ECU is not only currently producing and profitable, it also boasts what is now the 4th largest resource base of Silver, at a fraction of the market capitalization of high-quality giants such as Silver Wheaton Corp. (SLW) and Pan American Silver Corp. (PAAS).
5. Does The Company Have Sufficient Financial Resources?
Miners who are not generating cash flow are dependent on the capital markets. The financial meltdown of 2008-2009 placed these companies under extreme financial duress. Developing, drilling and exploring is capital-intensive and requires regular infusions.
It's important to note both how much liquid resources a company has and its offsetting debt obligations. If too much debt is coming due and the financial markets are frozen, the company may have to raise additional funds at extremely bad terms. Companies with limited financial resources got particularly bludgeoned in the 2008-2009 meltdown.
6. Is This Company Likely To Acquire Or Be Acquired?
Undoubtedly, as the mining industry starts to boom, there will be a slew of mergers and acquisitions. Any company making an acquisition will typically do a "stock-for-stock" transaction, which will dilute the acquiror while paying a premium to the acquiree.
This is why I tend to avoid the larger companies. To remain competitive, it's more cost-effective to acquire in-ground assets than to go through a long and expensive exploration, drilling and development process. Existing projects have far less risk.
The companies most likely to acquire are primarily the majors such as Newmont Mining Corporation (NEM), Barrick Gold Corp. (ABX), Yamana Gold Inc. (AUY) and Goldcorp. Inc. (GG). Even higher-quality intermediate producers such as IAMGold Corporation (IAG) or Eldorado Gold Corp. (EGO) can be expected to join the acquisition race.
If you hold a company that gets acquired, you receive an instant windfall. While you may be disappointed that the ride to much higher prices has been cut short, you can easily re-deploy the gains you just received in another junior.
Naturally, this is just a brief checklist of the items to look into prior to making a sizable investment. There are many more items to consider such as quality of management and liquidity of the stock. And, a technical review of the stock would also be a very important criteria.
Great fortunes can be made in the next several months for investors who can make good decisions as to the horses they choose to get them to the finish line. Most important is to avoid the big loss. Another obvious factor to incorporate is good diversification. For those investors who are not comfortable with making these choices, an excellent vehicle which includes 40 juniors and intermediates, is the Exchange-Traded Fund GDXJ.
Marko's Take
While not an exhaustive list, here are some things every investor ought to keep in mind. Follow these rules, and your chances of getting in trouble will be greatly diminished.
Ask and answer the following questions:
1. Where Are The Operations Located?
In my opinion, the biggest risk currently is geo-political. Some countries are dependent on their mining industries and are not terribly interested in having foreign interests, i.e. us, coming in and pillage their resources for our own profit. The risk is nationalization.
A recent case is that of Crystallex International Corporation (KRY), whose mining interests were nationalized by Venezuela. KRY stock sold for more than $4 per share as recently as 2007, before losing a mind-numbing 98% of value to hit 10 cents per share. It has recovered somewhat to trade at $0.45 today.
Personally, I prefer to stick to North American companies which operate in some combination of Canada, the United States and Mexico. I tend to avoid companies with the bulk of their operations in Africa, whose countries tend to be perpetually unstable and subject to ethnic conflicts and new governments. It's impossible to predict which country in what continent will be unsafe, so I stick to where I believe the business environment will not be subject to change without warning.
2. What Aspect Of Mining Is The Company Involved With?
The junior mining sector is basically divided into explorers, developers and producers. The explorers are like oil wildcatters. They can have the greatest gains and the most severe losses. Some junior explorers to consider are U.S. Gold Corporation (UXG), Explor Resources Inc. (EXSFF) and Vista Gold Corporation (VGZ).
Most explorers wish to develop their projects, but some don't. Vista Gold successfully developed its Nevada-based operations to form Allied Nevada Gold Corp. (ANV), which was later spun-off to shareholders at a tremendous profit.
The key risk to an explorer is that its projects turn out to be not viable economically. NovaGold Resources, Inc. (NG), which has a 50% interest in the Galore Creek project, had to suspend development in late 2007 as cost estimates proved way too low. The stock lost 99% of its value from more than $20 per share to about 25 cents in one year.
3. Is The Company Profitable?
The only companies that can report profits are producers. Some geo-politically safe producers include Aurizon Mines Ltd. (AZK), New Gold Inc. (NGD), ECU Silver Mining Company (ECUXF) and Hecla Mining Company (HL). Each of these is profitable and getting more so, based on recent financial reporting.
Given the very favorable mining economics prevailing today, the list above is far from extensive.
4. Is There An Asset Play?
Some companies are primarily an asset play. They hold already drilled and largely delineated projects. Probably the best asset play out there is Seabridge Gold (SA), which boasts more than 60 million ounces of economically viable Gold, in addition to a slew of other minerals such as Copper.
Producers can also be terrific asset plays. ECU is not only currently producing and profitable, it also boasts what is now the 4th largest resource base of Silver, at a fraction of the market capitalization of high-quality giants such as Silver Wheaton Corp. (SLW) and Pan American Silver Corp. (PAAS).
5. Does The Company Have Sufficient Financial Resources?
Miners who are not generating cash flow are dependent on the capital markets. The financial meltdown of 2008-2009 placed these companies under extreme financial duress. Developing, drilling and exploring is capital-intensive and requires regular infusions.
It's important to note both how much liquid resources a company has and its offsetting debt obligations. If too much debt is coming due and the financial markets are frozen, the company may have to raise additional funds at extremely bad terms. Companies with limited financial resources got particularly bludgeoned in the 2008-2009 meltdown.
6. Is This Company Likely To Acquire Or Be Acquired?
Undoubtedly, as the mining industry starts to boom, there will be a slew of mergers and acquisitions. Any company making an acquisition will typically do a "stock-for-stock" transaction, which will dilute the acquiror while paying a premium to the acquiree.
This is why I tend to avoid the larger companies. To remain competitive, it's more cost-effective to acquire in-ground assets than to go through a long and expensive exploration, drilling and development process. Existing projects have far less risk.
The companies most likely to acquire are primarily the majors such as Newmont Mining Corporation (NEM), Barrick Gold Corp. (ABX), Yamana Gold Inc. (AUY) and Goldcorp. Inc. (GG). Even higher-quality intermediate producers such as IAMGold Corporation (IAG) or Eldorado Gold Corp. (EGO) can be expected to join the acquisition race.
If you hold a company that gets acquired, you receive an instant windfall. While you may be disappointed that the ride to much higher prices has been cut short, you can easily re-deploy the gains you just received in another junior.
Naturally, this is just a brief checklist of the items to look into prior to making a sizable investment. There are many more items to consider such as quality of management and liquidity of the stock. And, a technical review of the stock would also be a very important criteria.
Great fortunes can be made in the next several months for investors who can make good decisions as to the horses they choose to get them to the finish line. Most important is to avoid the big loss. Another obvious factor to incorporate is good diversification. For those investors who are not comfortable with making these choices, an excellent vehicle which includes 40 juniors and intermediates, is the Exchange-Traded Fund GDXJ.
Marko's Take
Sunday, June 20, 2010
The 12 Steps Of An Empire
Every empire goes through what appears to be an inevitable series of conditions which accompany its rise to dominance and then its fall to ashes. This has proven especially true for the 3 key modern empires: the British, the American and the Soviet Union.
So, what are the signs of a rising or falling empire? They all seem to progress in 12 repeating steps:
1. Escape From Tyranny Through Revolution Or Civil War
Every empire begins from the ashes of either a civil war or revolution which results from the unacceptable societal, economic or political conditions preceeding it. In America, we had the Revolutionary War, which was brought about as the colonists sought to escape religious persecution. It could also be an economically-inspired uprising such as the worker's rebellion in the Soviet Union, leading the rise of the "utopian" Marxist state.
2. Dawn Of The Age Of Idealism, Hope And A New Political Doctrine
In the United States, the American Revolution led to the writing of the Constitution, probably the greatest document ever written. In the Soviet Union, by comparison, Karl Marx' "Das Kapital", outlined the ideal worker's state where everyone was to contribute according to their abilities and receive according to their needs. In Britain, it was Adam Smith's "Invisible Hand" from "The Wealth Of Nations".
Das Kapital sounds great in theory....terrible in practice.
3. Rise Of Economic And Military Power
The adoption of complete laissez-faire capitalism, combined with a new frontier of rich, unexploited resources ushered in the American rise to power. By World War I, the United States was a major economic and military power.
By World War II, America stood alone as the sole nuclear power. The Soviet Union, which never quite achieved economic power as a result of its centrally-controlled economy, nonetheless became a huge military power and soon joined America as the 2nd atomic-ready nation. Prior to the United States' rise to number 1, Britain ruled the skies of Europe with its Royal Air Force.
4. Political Stability
In the early growth stages of an empire, the vast majority of the population is nationalistic and usually quite devoted to the political system created to address the inequities that characterized the prior system. It could be the rejection of a class system in the Soviet Union, or the rejection of restricted personal freedoms which led to the creation of our Bill Of Rights. Either way, the new political system is highly embraced and thought to be the ultimate answer to a perceived notion of fairness.
5. Gradual Social Decay
Before you know it, other constituencies want to join the party. In America, there have been the suffragettes demanding gender equality or the civil rights movement which sought racial equality.
In Britain, the various splinter groups of the oppressive Catholic church sought religious equality. In the Soviet Union, religious persecution led to huge emigration of Jews to ultimately form Israel.
6. Restriction Of Freedoms
As the Empire grows and progresses, certain groups start to feel left out, especially as the new economic order benefits some more, even much more, than others. Those groups feeling left behind, will begin to form a political majority and learn how to use the new political system to take resources from others.
President Franklin Delano Roosevelt, during his administration, fundamentally changed the political system and destroyed the Constitution with the New Deal. In it, freedom-destroying institutions such as Social Security were created, a juggernaut that was set in motion for which we are now paying a dear price. In addition, Roosevelt changed the Supreme Court in such a way that the Constitution was rendered invalid by the ultimate law-making body. That beautiful document, sadly, will never recover.
7. Quantum Economic Or Military Change
In order to become an Empire, any country must, at least lead either an economic or military revolution, but preferably both. In the United States, the "assembly line" led to our own "manufacturing revolution". The advent of nukes, led a military revolution. But, that wasn't all.
This country also led the "high-tech" revolution begun with computer technology and carrying through Al Gore's invention: the internet. The Soviet Union, because of its inefficient economic system, had to resort to a massive military buildup which resulted from its fear of Adolph Hitler's Germany. The Brits controlled a global trading empire with interests in virtually every continent.
8 Rise Of Colonialism
Every Empire, as it gets more powerful, with the population still supporting it, will seek to protect or expand its reach.
The Soviet Union annexed the East Bloc creating the Warsaw Pact, including East Germany, Romania, Czechoslovakia, Poland, Bulgaria and Romania. The English presence was felt in far away places such as India, Australia, South Africa, Rhodesia, New Zealand, Canada, Scotland and Ireland. The United States created NATO (North Atlantic Treaty Organization) in response to the Soviet Bloc. During the aftermath of World War II, the entire planet fell into "spheres of influence", a code word for which military power you were aligned with: The Soviet Union's or America's.
9. Asset And Monetary Inflation
Every military buildup proves a huge boom to the economy and is supported politically. Politicians refuse to acknowledge the "law of diminishing returns" since they will buy arms and expand forces until increased expenditures begin to create economic distortions. The population will increasingly question the government's resource allocation decisions. Remember "Guns And Butter"? New thinking political doctrine held that you could spend lavishly on both domestic welfare programs AND have an unlimited defense budget. It was wrong.
Politicians learn that they can remain in office by promising everything, regardless of truth. They all arrive at the perfect solution: PRINT MONEY! What debt? Let's pay our bills in paper we just created.
10. Economic Decay
The growing burden of providing escalating social programs and military expenditures will start to affect the economy in an irreversible fashion. Budgets, that were formerly routinely balanced, will now start to have increasing deficits. Of course, deficit spending will be defended and, for a long period of time, money creation will seem to lead to great wealth.
The result of monetary solutions is that they lead to increasing inflation and ultimately destructive asset bubbles. The currency will lose value. The process will repeat as deficits get greater, money creation increases, inflation gets higher and the economy gets weaker. The process repeats.
11. Societal And Political Decay
As economic distress begins to be noticed, various interests begin to align. A united society becomes divided along gender, racial, demographic and economic lines. Each views the others with contempt and seeks to use the political system to combat the others.
Eventually, the combat turns to other forms of protest such as violence and civil unrest. The political authorities, in order to stem the violence, will restrict personal freedoms, perhaps even creating an internal security force such as the Department Of Homeland Security. Adolf Hitler had such a department. They knew it later by a different name: The Gestapo.
12. Escape From Tyranny Through Revolution Or Civil War
Yes, you can assume it's coming to a theatre or drive-in near you.
Marko's Take
So, what are the signs of a rising or falling empire? They all seem to progress in 12 repeating steps:
1. Escape From Tyranny Through Revolution Or Civil War
Every empire begins from the ashes of either a civil war or revolution which results from the unacceptable societal, economic or political conditions preceeding it. In America, we had the Revolutionary War, which was brought about as the colonists sought to escape religious persecution. It could also be an economically-inspired uprising such as the worker's rebellion in the Soviet Union, leading the rise of the "utopian" Marxist state.
2. Dawn Of The Age Of Idealism, Hope And A New Political Doctrine
In the United States, the American Revolution led to the writing of the Constitution, probably the greatest document ever written. In the Soviet Union, by comparison, Karl Marx' "Das Kapital", outlined the ideal worker's state where everyone was to contribute according to their abilities and receive according to their needs. In Britain, it was Adam Smith's "Invisible Hand" from "The Wealth Of Nations".
Das Kapital sounds great in theory....terrible in practice.
3. Rise Of Economic And Military Power
The adoption of complete laissez-faire capitalism, combined with a new frontier of rich, unexploited resources ushered in the American rise to power. By World War I, the United States was a major economic and military power.
By World War II, America stood alone as the sole nuclear power. The Soviet Union, which never quite achieved economic power as a result of its centrally-controlled economy, nonetheless became a huge military power and soon joined America as the 2nd atomic-ready nation. Prior to the United States' rise to number 1, Britain ruled the skies of Europe with its Royal Air Force.
4. Political Stability
In the early growth stages of an empire, the vast majority of the population is nationalistic and usually quite devoted to the political system created to address the inequities that characterized the prior system. It could be the rejection of a class system in the Soviet Union, or the rejection of restricted personal freedoms which led to the creation of our Bill Of Rights. Either way, the new political system is highly embraced and thought to be the ultimate answer to a perceived notion of fairness.
5. Gradual Social Decay
Before you know it, other constituencies want to join the party. In America, there have been the suffragettes demanding gender equality or the civil rights movement which sought racial equality.
In Britain, the various splinter groups of the oppressive Catholic church sought religious equality. In the Soviet Union, religious persecution led to huge emigration of Jews to ultimately form Israel.
6. Restriction Of Freedoms
As the Empire grows and progresses, certain groups start to feel left out, especially as the new economic order benefits some more, even much more, than others. Those groups feeling left behind, will begin to form a political majority and learn how to use the new political system to take resources from others.
President Franklin Delano Roosevelt, during his administration, fundamentally changed the political system and destroyed the Constitution with the New Deal. In it, freedom-destroying institutions such as Social Security were created, a juggernaut that was set in motion for which we are now paying a dear price. In addition, Roosevelt changed the Supreme Court in such a way that the Constitution was rendered invalid by the ultimate law-making body. That beautiful document, sadly, will never recover.
7. Quantum Economic Or Military Change
In order to become an Empire, any country must, at least lead either an economic or military revolution, but preferably both. In the United States, the "assembly line" led to our own "manufacturing revolution". The advent of nukes, led a military revolution. But, that wasn't all.
This country also led the "high-tech" revolution begun with computer technology and carrying through Al Gore's invention: the internet. The Soviet Union, because of its inefficient economic system, had to resort to a massive military buildup which resulted from its fear of Adolph Hitler's Germany. The Brits controlled a global trading empire with interests in virtually every continent.
8 Rise Of Colonialism
Every Empire, as it gets more powerful, with the population still supporting it, will seek to protect or expand its reach.
The Soviet Union annexed the East Bloc creating the Warsaw Pact, including East Germany, Romania, Czechoslovakia, Poland, Bulgaria and Romania. The English presence was felt in far away places such as India, Australia, South Africa, Rhodesia, New Zealand, Canada, Scotland and Ireland. The United States created NATO (North Atlantic Treaty Organization) in response to the Soviet Bloc. During the aftermath of World War II, the entire planet fell into "spheres of influence", a code word for which military power you were aligned with: The Soviet Union's or America's.
9. Asset And Monetary Inflation
Every military buildup proves a huge boom to the economy and is supported politically. Politicians refuse to acknowledge the "law of diminishing returns" since they will buy arms and expand forces until increased expenditures begin to create economic distortions. The population will increasingly question the government's resource allocation decisions. Remember "Guns And Butter"? New thinking political doctrine held that you could spend lavishly on both domestic welfare programs AND have an unlimited defense budget. It was wrong.
Politicians learn that they can remain in office by promising everything, regardless of truth. They all arrive at the perfect solution: PRINT MONEY! What debt? Let's pay our bills in paper we just created.
10. Economic Decay
The growing burden of providing escalating social programs and military expenditures will start to affect the economy in an irreversible fashion. Budgets, that were formerly routinely balanced, will now start to have increasing deficits. Of course, deficit spending will be defended and, for a long period of time, money creation will seem to lead to great wealth.
The result of monetary solutions is that they lead to increasing inflation and ultimately destructive asset bubbles. The currency will lose value. The process will repeat as deficits get greater, money creation increases, inflation gets higher and the economy gets weaker. The process repeats.
11. Societal And Political Decay
As economic distress begins to be noticed, various interests begin to align. A united society becomes divided along gender, racial, demographic and economic lines. Each views the others with contempt and seeks to use the political system to combat the others.
Eventually, the combat turns to other forms of protest such as violence and civil unrest. The political authorities, in order to stem the violence, will restrict personal freedoms, perhaps even creating an internal security force such as the Department Of Homeland Security. Adolf Hitler had such a department. They knew it later by a different name: The Gestapo.
12. Escape From Tyranny Through Revolution Or Civil War
Yes, you can assume it's coming to a theatre or drive-in near you.
Marko's Take
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