Sunday, January 31, 2016

The Limerick of Finance for 01/31/16

Chinese copycats steal at will
Cheap knock-offs still give them a thrill
They make a quick buck
Counting only on luck
Cashing in on some grey market bill

China's Shanzhai Economy Mocks Innovation

China has a long tradition of "shanzhai" knock-off goods. Companies shamelessly copying global brands without compensation or even attribution contribute to China's poor reputation for quality manufacturing and intellectual property (IP) protection. Shanzhai extends to more than just brand image. It permeates every aspect of China's allegedly miraculous growth, including real property and government statistics. Its persistence poses risks to Western investors who underestimate China's resistance to cultural change.

PwC republished Booz's 2009 report regarding shanzhai as an innovative phenomenon. It may have appeared innovative when China was trying to convince the West that its booming production would translate into what we would recognize as an advanced economy. Things never worked out that way. Breakneck production without the rule of law to protect innovation eventually turns off international investors.

China somehow managed to fool amateur observers into thinking that everything would be okay once it grew out of its wild frontier phase. The Atlantic in 2014 interpreted shanzhai as an evolutionary crowdsourced ecosystem for innovation. Silicon Valley would recognize innovation without IP protection or market share as an invitation to further piracy. The Wall Street Journal had a similar analytical lapse in 2009, more from a political and cultural standpoint. Astute observers integrate social and political trends into economic analysis if they understand those trends from a native perspective.

Native mainland Chinese have not developed the legal and political traditions the Anglo-West relies upon to protect property rights, including IP. Some Chinese innovator making shanzhai wearable tech is unconcerned with the product quality or global branding that leads to defensible market share. They're still in it for the fast buck because they cannot count on legal protection outside China or political protection within China. Western observers who cannot see shanzhai through Chinese eyes would find this inscrutable. Personal connections through "guanxi" matter more than rules and laws. The Chinese Commonwealth "bamboo network" diaspora matters more than sovereign trade agreements. The West continues to misinterpret these concepts by pretending to see in China what it wants to see in its own culture.

Shanzhai has metastasized beyond consumer goods into real property. Freakonomics noted in 2013 how shanzhai skyscrapers copy other popular building designs. Run a Google image search of China's property boom to see entire cities containing replicas of Paris' Eiffel Tower, quaint European town squares, and parts of Manhattan. China's government economic statistics have long been unreliable, according to descriptions of the Keqiang Index. Replacing that index with something the UNDP or WTO can audit would be a sound step. Instead, the WSJ reported in 2015 that China's State Council would replace the Keqiang Index with measures tracking quality of life. The state is acting in the spirit of shanzhai innovation, copying Western ideas wholesale without grokking how enforcing laws means breaking personal ties.

The shanzhai apotheosis is a huge red flag for US investors with exposure to China. Mainland China's economic growth is more mirage than reality, notwithstanding CSIS's "Broken Abacus" 2015 nonsense that China's economy is bigger than what it self-reports. Try reconciling national-level economic data with provincial-level data and see how China's national authorities guide subordinate governments into supporting its fabrications. Investors betting on US-traded instruments for Chinese stocks or ETFs are gambling that reality will eventually catch up to fantasy. Shanzhai's continued dominance of Chinese business culture makes that a poor gamble.

Full disclosure: No positions in any Chinese investments. BTW, I have corrected the spelling of "shanzhai" after publishing this article.

Financial Sarcasm Roundup for 01/31/16

Sarcasm on Sunday is way better than attending church. You could listen to some preacher lie about the nature of the universe, or you can listen to me tell the truth about finance.

Alphabet and Apple battle it out for the valuation world heavyweight championship. Both companies are symptoms of the Silicon Valley tech bubble. Investors have chased these stocks because ZIRP made savings accounts look stupid. Apple's (AAPL) P/E is deceptively low at 10 and Alphabet's (GOOG) is really high at 31. Both companies depend very much on smartphone users replacing costly phones more often than necessary in the developed world's saturated markets. Financial advisers who toggle their portfolio optimization searches with "high risk" aren't doing their risk-averse clients any favors by selecting overpriced tech stocks.

The IMF and its lending cartel will review Greece's bailout progress. It's really sick how the world's most important financiers play "extend and pretend" with a country that has no interest in paying its debts. Forcing losses on creditors would clear up credit quality questions a lot faster than extending maturities. I would have hung the foreclosure sign on the Acropolis by now but the IMF never called me to ask for advice. Athens should hire me to fix their problems if they can pay me in something other than gyros (which I really like to eat BTW).

Big SIFIs are cutting the biggest deals with the SEC to settle dark pool allegations. I have always wondered why investors deliberately walk into something they know is dark. The banks telling investors they will get the best execution in dark pools are also the same source of prime brokerage credit for HFT hedge funds trading in those pools. Willfully blind investors, duplicitous banks, and greedy HFTs all jumped into those dark pools to rip each other off. The traditional investors are always the dumbest money in the room, so of course they got taken to the cleaners.

I told you this was better than a church sermon. I'm more entertaining and honest than any religious leader. I should start my own religion so people can properly worship me.

Saturday, January 30, 2016

The Haiku of Finance for 01/30/16

Energy market
Demand for cheapest sources
Cost of pollution

Financial Sarcasm Roundup for 01/30/16

Saturday is supposed to be a slow news day, but it's never too slow for sarcasm.

The US economy probably slowed down in Q4 2015. Business surveys from the private sector are probably more reliable than government figures. Federal agencies have been monkeying around with their methodologies for too long under political pressure to report rosy results. Voters get fed up with ruling elites when official results don't square with daily life. The next administration can do a lot to restore Americans' confidence in government just by reporting honest numbers.

The Zika virus is boosting a few life science stocks. Curing disease is a good reason to invest in drug makers. Day trading a stock with the expectation that disasters will pump a quick profit is immoral, not to mention just plain stupid. There is no assurance that the UN WHO or any other powerful body will hand these companies a contract. Greed and wishful thinking drive dumb investor reactions to headline dangers. There is no drug to cure stupidity.

Hedge funds misjudged the yen. The BOJ invalidated a whole bunch of investment philosophies overnight. I've said before that currency positions are useful mainly as hedges for cash reserves, not pure-play bets. Hedge funds are running out of ideas if they think betting big on a currency is innovative. George Soros made a big currency bet once against the British pound and it worked once. There is no law that says it must keep working. People running hedge funds can work as janitors after the yen bankrupts them.

Xerox is splitting itself. Carl Icahn wins again. I've always admired the guy because he forces companies to do right by their shareholders. He would probably make an excellent US Treasury secretary if Donald Trump wins the presidential election. I would like to see some corporate raiders and deal-makers break up some of the US government's less efficient agencies. Privatizing Social Security and Medicare could work like an insurance company spin-off. I wouldn't buy those split stocks because I've read the Bowles-Simpson reports on those entities' eventual insolvency, but some mutual fund manager is dumb enough to go for it.

Most writers would sign off by saying they hope everyone else's Saturday is going well. I'm not like most writers. I don't care about how your Saturday is going. My Saturdays are the definition of awesome.

Friday, January 29, 2016

The Haiku of Finance for 01/29/16

Microcap sector
Track imperfect trend data
Benchmarks not so great

Small Business Indicators For Microcap Sector Choices

Microcap stocks are notoriously hard nuts to crack. They are the part of the capitalization-weighted investment universe that is typically less liquid, transparent, and profitable than large-cap choices. Investors do have some indicators they can use to estimate turning points in the microcap sector's aggregate health. A small number of microcap ETFs help diversify away company-specific risk.

The NFIB's Small Business Economic Trends (SBET) is one possible proxy for the sentiment of small business owner-investors. It combines data on both future plans and current results. The December 2015 report puts the Index of Small Business Optimism at 95.2, below the long-term average of 98. The small sample size and seasonal adjustments limit the index's usefulness. The SBET also does not disclose the average revenue, net income, or asset quality of its sampled businesses, so investors cannot presume any strong equivalency with microcap stocks.

The Wells Fargo / Gallup Small Business Index is probably a more robust indicator than the NFIB SBET. Gallup's index methodology also relies upon a small sample size but discloses a revenue range that could easily include the lower bound of the microcap sector's revenues. The index is one more addition to an investor's toolkit. BTW, this index also registered a decline in optimism in late 2015.

The Paychex IHS Small Business Jobs Index covers a vast sample size, so data quality here is less of a concern than with the previous two indexes. Measuring job growth helps investors determine whether small companies can afford to expand and handle higher sales volumes. Job gains at the end of 2015 were on a slight downward trend since early 2014, punctuated by some up months.

Dun and Bradstreet’s U.S. Economic Health Tracker covers a Small Business Health Index for payments and credit, with a large data set. The Tracker shows small business performance worsening so far this year, with weak payment performance. That makes two weak optimism indexes, a declining jobs index, and a weak payment/credit health index so far to start 2016.

Our macroeconomic data indicators for small businesses are not the only ways to understand microcaps. Investors need to know how different index providers assemble the microcap universe, because this ultimately determines ETF composition. The Boglehead wiki on US micro cap index returns compares several microcap indexes. The Wilshire index has the longest history, so performance data for products based on that index would be the most reliable.

Only a small number of ETFs cover the microcap sector. PowerShares Zacks Micro Cap ETF (ticker PZI, expense ratio 0.70%) and First Trust Dow Jones Select MicroCap ETF (ticker FDM, expense ratio 0.60%) are very thinly traded. Investors will face more difficulty with trade execution in thinly-traded securities. The Zacks product follows a proprietary index and the First Trust product follows a select index, so their returns are not directly comparable to those of ETFs that follow wider indexes.

The iShares Micro-Cap ETF (ticker IWC, expense ratio 0.60%) is more actively traded and has a larger market capitalization than PZI or FDM, and its construction from the Russell Microcap Index makes its methodology more reliable. Other details are less encouraging. It is currently heavily weighted toward the finance, health care, and information technology sectors. Those areas are all very much in bubble territory thanks to the Federal Reserve's easy credit (finance), unsustainable Medicare payouts (health care), and VC-funded startup unicorns gorging on cloud services (IT). Consider also how the R-squared result for IWC (at its Yahoo Finance risk data) declined from 77.77 at the 10-year mark to 47.66 in the most recent three-year period. The more recent period's performance thus has progressively less to do with the underlying index. That is a worrisome sign for an ETF that is supposed to stay very close to an index's results.

Investors are welcome to track the above four macro indicators and relate them to the microcap sector's leading products. Weakening indicators imply tougher times for small businesses. Leading index products that are increasingly divergent from their benchmarks (and more expensive than large-cap ETFs) are causes for concern.

The sad tales of microcap stock promotions gone wrong are always with us. The bad old days of investor relations conferences and seminars have given way to spam email stock scam promotions. Microcaps are easy prey for all manner of bad actors. The most broadly diversified instruments will at least give investors exposure to larger trends that can lift young, high-risk public companies to larger capitalizations.

Full disclosure: No positions in any securities mentioned.

Financial Sarcasm Roundup for 01/29/16

People take self-identification to new extremes in the digital age. I self-identify as sarcastic, which ought to be a distinct personality type.

Japan's central bank goes for negative interest rates. That should pry the last yen out from under savers' mattresses and push Japanese investors into riskier territory. The positive feedback loop from such a nonsensical policy will never solve Japan's structural problems. Switzerland did this for a while but they had a strong currency. Japan's results will be worse.

Puerto Rico expects to issue new debt. The old debt isn't working out too well, so the new stuff will have to pay junk-bond type interest. Paying out 5% just isn't going to cut it with investors who got burned. No one likes taking a valuation haircut. I am so glad I never owned Puerto Rico bonds. They will make very nice wallpaper after several re-issues.

Theranos keeps having one problem after another. Specious tech claims and poor lab conditions should not justify a multi-billion dollar private market valuation. A whole bunch of top-shelf VC firms have staked their reputations on a business they never understood. I can imagine the panicked phone calls up and down Sand Hill Road about what desperate measures anyone can take to keep this unicorn from tipping over. Save the energy for the post-mortem court cases, people.

I may try self-identifying as a housecat just to see how people react. Nah, just kidding.

Thursday, January 28, 2016

The Haiku of Finance for 01/28/16

Safely transport oil
Pipelines are still the best way
Railcars come second

Safely Transporting Oil By Railroad

The oil price crash impacts the railroad sector. Transporting freight gets cheaper, but demand for railcars to bring oil out of the Bakken fields and other places where pipelines were never laid is now dropping off. Refer to US DOT MARAD's 2008 study "Impact of High Oil Prices on Freight Transportation" for technical discussions of how the rail sector behaved under different conditions. Times have changed, perhaps permanently. Safety rules can also change with the times.

Railroad accidents made headlines when America's oil shale boom was roaring. Horrific, sensational railcar explosions are less useful justifications for transportation policymaking than statistics. The US DOT's Federal Railroad Administration (FRA) Office of Safety Analysis has the data. Running a ten-year report shows that total accidents declined by over 31% from 2006 to 2015, with percentage declines in every single subcategory. Rail transport has gotten safer than ever during the oil shale boom.

Oil shale's critics used to claim that Bakken oil was more volatile and thus more dangerous to ship in railcars. The National Transportation Safety Board's (NTSB) chair debunked this claim after some high-profile accidents. A refining industry study also found that Bakken crude fits within existing oil safety standards. The volume of fuel spilled, not its chemical composition, determines its potential hazard. Anyone can search the American Fuel and Petrochemical Manufacturers (AFPM) website for "Bakken crude" and see the evidence.

Forest Ethics does the public a disservice with its alarmist Oil Train Blast Zone tool. The relatively small number of rail accidents could never endanger millions of Americans, as the tool misleadingly implies. Requiring railroad operating companies to emplace blast barriers around every yard and connecting track in populated areas would be costly and probably unnecessary. It would be better for the railroad industry, along with FRA and NTSB, to take a Six Sigma approach to estimating deaths from oil-related transport accidents. Reducing mortality is important and statistics will show us exactly which locations need better safety measures.

Policy advocates are often remarkably ignorant of science, math, and economics. I don't think a typical anti-hydrocarbon advocate can perform an energy returned on energy invested (EROEI) comparison between biofuels (for example) and hydrocarbon fuels. They are welcome to start with refining and transport data from the Western States Petroleum Association and the California Energy Commission but I don't think they'll have the patience to get very far.

I am not prepared to demonize tar sands and oil shale as "extreme fuels" in the style of some renewable energy advocates. Hydrocarbon energy will be part of human life for a few more decades until renewable energy's infrastructure catches up. Pipelines are the safest and cheapest way to transport oil over long distances. Railcars are still the next best way despite the pleadings of safety paranoiacs.

Financial Sarcasm Roundup for 01/28/16

Hatred and love are powerful emotions. Sarcasm is not an emotion but it may be even more powerful.

The Federal Reserve made markets nervous yesterday. I say tough luck for wimpy stock market experts. Big players have had it too easy with ZIRP subsidizing their gambling. Moving toward a more historically normal interest rate environment means crybaby institutional investors will lose money. Just look at the confused commentary coming from Wall Street's idiots. They don't remember what normal feels like and their bond trading desks are full of Millennial whipper-snappers who think credit is always free.

The US Treasury alerts us to derivatives clearinghouse risks. That sure throws some cold water on the theory that transparency and mark-to-market pricing would make derivatives less threatening to the economy. The Fed and SEC have planned for trading halts and fund backstops. Now they need to think about liquidity backstops for clearinghouses. I suspect that will be a bridge too far in a crisis, so AIG-style instant firm resolutions will be the preferred risk mitigation tactic instead.

China's statistics chief is in trouble. Beijing couldn't keep their numbers frauds hidden forever and now they need a public scapegoat in true Manchurian style. The news may fool a few Western investment firms (the ones that don't understand China) into thinking things will get better when the head stats guy is replaced. A couple of high-profile career terminations won't stop the Chinese stock market's slide.

I try really hard not to hate people, even if they deserve it. Hateful people deserve sarcasm instead.

Wednesday, January 27, 2016

The Haiku of Finance for 01/27/16

Over-rated stuff
Eventual implosion
More chances to short

Financial Sarcasm Roundup for 01/27/16

It's not enough to have weekly sarcasm. I need to exhibit daily sarcasm. Alfidi Capital must be the unchallenged premium source of financial sarcasm every time the sun rises.

Iran's president says getting filthy rich cures radical nutjobs. He didn't quite say it like that but I like to think that's what he meant in translation. Reuters is too kind to quote heads of state that way. Iran is about to unlock $150B in frozen assets and return to exporting oil as sanctions are lifted. It pays to play nice with one's neighbors. Iran should spend that windfall on something other than harassing student protesters. Meeting the Pope may be the key to convincing Rome's street vendors to import Iranian lavashak (a.k.a. Persian fruit leather, or pressed fruit rolls). I smell a sweet deal.

Credit rating agencies are still messed up. It's about time regulators squeezed these people until they squeal. Selling ratings for MBS and other garbage helped cause the 2008 financial crisis. Dumb money does not perform due diligence even one level deep, let alone for the two or three levels needed to understand securitized products. Continued problems will bring another chance to short every falsely rated financial product in sight.

The corporate debt mountain is ready to topple. Bring on the implosion. Publicly held companies that can't service their debt will get wiped from indexes and bring shorting opportunities to patient investors like me. Defaulted corporate bonds and bankrupt ETF prospectuses will make nice art projects.

I can really get used to a daily sarcasm habit. I will enjoy force-feeding this diet to my regular readers. Eat it, people.

Tuesday, January 26, 2016

The Haiku of Finance for 01/26/16

Eat bread in a tweet
Diet stock jumps on the news
Tasty fat profit

Regulatory Risks Of Leveraging Federal Lab Innovation

The Federal Laboratory Consortium is a gold mine begging for exploration. Technology gathering dust in lab basements and filing cabinets needs entrepreneurs to make it economically viable. The regulatory landscape has holes at the federal level that beg to be filled. Here are some Alfidi Capital tips for small and medium-sized businesses (SMBs) looking to make tech innovation work while avoiding regulatory traps.

The Brookings Institution published "Going Local" in 2014 about how DOE's labs should support regional economic growth. White papers are full of ideas that gather dust, just like great tech ideas without people implementing them. The lead time for processing a cooperative research and development agreement (CRADA) or a work for other agreement (WFO) may be too long for specific product development but just right for a basic tech demonstration. The SMB moving a tech concept out of the lab's basement may be suited for small-scale funding typical of the NREL's technical and analytical service agreements.

The President's Council of Advisors on Science and Technology (PCAST) report "Big Data: A Technological Perspective" from 2014 will set federal policy on data privacy for years. Government regulations crossing multiple agencies' jurisdictions has a way of guaranteeing a market for products. Large firms faced with the regulatory risk of meeting Big Data privacy mandates will need solutions. Small firms should factor privacy compliance into their product development milestones.

The American Academy of Arts and Sciences report "Restoring the Foundation" in 2014 recommended permanent Presidential attention to R+D spending. Federal tech funding as a GDP percentage cannot stagnate forever. Its eventual recovery will provide funding opportunities for SMBs ready to jump into grants and contracts.

Watching the slow progress in implementing all of these reports' recommendations is disheartening. Untangling the jumble of federal advisory committees shepherding regulatory reform is outside the private sector's control, unless the President appoints business-friendly people to run the process. American SMBs cannot wait for reform. They should master the funding application system now and gain experience working through the system.

Financial Sarcasm Roundup for 01/26/16

The Beatles once sang about having "A Hard Day's Night." That's unintentionally sarcastic. If your hard day continues into the night, you may have a lifestyle problem.

JP Morgan Chase wants to turn your smartphone into an ATM. People need to think hard about this very risky approach. Tapping a smartphone to an ATM means anyone who holds the phone can get your cash. It will be a boon for pickpockets and armed robbers. JP Morgan's IT people need to code some hard-core biometric identification tools into their ATM app before it goes live. I think a saliva sample would work nicely. Just lick your smartphone's screen before you tap for that cash.

Apple's iPhone sales are slipping. Here's the latest evidence that a long-term bet on endless China growth is the corporate strategy of five years ago, not today. The inevitable US sales peak will come when Apple's too-stupid early adopter segment finally realizes that they can do without spending $800 every eighteen months for an incremental improvement in camera resolution. Oh yeah, the Apple Watch looks like the company's first dud since the Newton scratchpad. I knew the Watch was useless as soon as I saw it. Watches cannot be scaled down versions of smartphones due to their display size but nobody at Apple was thinking about biometrics. Tech marketers fall for their own hype at the tops of market bubbles.

Oil producers that cut costs can survive earnings season. The ones who drilled $60/boe wells expecting to make $100/boe forever are toast. I was really getting sick of hearing from unproven junior E+P companies tout their shale wells. They can have their remaining employees take turns sucking the oil out through big straws if they can't afford fracking fluids anymore.

I usually have a great day's night, unlike the Beatles. I studiously avoid the Notre Dame Club of San Francisco because those people used to ruin both my days and nights when I met them. No one can ever ruin me now.

Monday, January 25, 2016

The Haiku of Finance for 01/25/16

Private mortgage deals
Real estate notes and trust deeds
Weird and hard to do

Amateur Private Real Estate Finance Includes Notes And Trust Deeds

Private lending has been around for property developers ever since those ancient Pharaohs built their pyramids. Our capital markets today allow for much more public participation and transparency. Bank depositors provide capital for secured mortgages. Real estate investment trust (REIT) investors provide capital for property developers, augmenting the capital available from syndicated bank loans. The private capital market for small-scale real estate investors is now fragmented with boutique solutions. Many such creative real estate investing solutions are complex and not intended for amateurs. They are even fertile grounds for scams.

The assignment of a contract for the purchase of real estate sounds to me like brokering a transaction without being a properly licensed Realtor. I would not want to be in the shoes of an assignor or assignee if a property they're flipping was on some Realtor's multiple listing service and the Realtor files a complaint with their state's regulatory body. Private parties who are not licensed and do not adhere to government regulations or the National Association of Realtors' code of ethics open themselves up to serious risks if they can't complete an assignment deal.

Hard money loans are more expensive for borrowers than bank mortgages. These loans do not conform to standard credit guidelines and default at higher rates. Inexperienced hard money lenders can easily become suckers for a fast-talking sales pitch. Even experienced lenders can be stuck with a non-performing loan book in a significant market downturn, and they may not always have recourse to a bank that can help them offload troubled properties.

Seller financing strikes me as being just plain dumb. A borrower who cannot get a mortgage from a conventional source probably should not qualify for any loan at all, even from a private source. A seller willing to trust such a person's creditworthiness is trading the speed of an easy title transfer for the huge risk of non-payment. The advantages of this deal type all skew towards an unethical buyer: easy money, fast ownership, and rent-free living space if they never intended to pay up. Perhaps a desperate seller would do such a deal just to get rid of a very bad property, which would be just as unethical if the property had serious deficiencies.

The so-called "subject to" real estate deal sounds unbelievably complex for anyone who is not an experienced real estate attorney. The paperwork needed to get iron-clad agreements looks daunting. I looked for authoritative sources in my "subject to" Web search and found mostly amateurish promotions for this deal category that did not adequately describe risks.

Mortgage assumption is possible in some situations where the FHA or VA is involved. The good news is that banks and government regulators have rules for this quasi-official process. Buyers meeting conventional mortgage standards can use assumable mortgages if they meet lending standards and have enough cash to make any needed down payments.

These types of deals can lead investors to participation in real estate notes and trust deeds. Mortgage notes are a form of securitization paralleling the real estate sector's whole-hog embrace of mortgage-backed securities. Real estate trust deeds serve as security for loans that avoid third party participation. Notes and trust deeds are small-scale versions of the financing that mortgage REITs and trust deed investment companies (TDICs) provide. I will never understand why amateur investors would spend their precious time pursuing small lot notes and single trust deeds when professionally managed REITs and TDICs are diversified, well-capitalized alternatives.

Modern finance has tamed what used to be the wild world of real estate finance. Investing in real estate today is as easy as selecting REITs in a brokerage account. REITs come in multiple flavors: commercial, residential, mortgage-only, ETFs, you name it. The publicly traded ones all have prospectuses and histories of SEC filings for transparency. Privately originated notes, trust deeds, and other financing methods are less liquid and transparent than publicly traded securities. Some amateur investors will insist on biting off more risk than they can chew, just to fulfill their fantasies of becoming real estate moguls from their living rooms.

Sunday, January 24, 2016

The Limerick of Finance for 01/24/16

Twitter shake-up comes into our view
Different leaders must bring something new
Independence at stake
User growth hit a brake
Radical change is long overdue

Saturday, January 23, 2016

The Haiku of Finance for 01/23/16

Bad money choices
Spend now what could grow later
Losers waste it all

Thursday, January 21, 2016

The Haiku of Finance for 01/21/16

Demand oil meeting
OPEC members are crying
Tiring of low price

Ultimate Lessons From JP Morgan Healthcare Conference 2016

The end of the JP Morgan Healthcare Conference invites reflection on lessons for investing. The legions of investors populating the Union Square hotels - almost all white, male, and wearing pale blue neckties - will face challenges finding value in the health care sector's long bull market. Bears have already come out of hibernation in the larger US stock market's first two weeks of 2016. They wait to pounce on the health care sector.

Investors could have thrown a dart at the universe of stocks and funds in the large-cap health care sector after 2010 and come away winners. The bull case made sense up until mid-2015. Consider the price trajectory of one very broad health care ETF, iShares Nasdaq Biotechnology ETF (ticker IBB).

iShares Nasdaq Biotechnology ETF (IBB) from Yahoo Finance

Here we see the 5-year price chart for IBB from Yahoo Finance as of January 19, 2016. Its valuation peaked in July 2015. Note that Amgen (ticker AMGN) is one of the top ten holdings. That one stock is off its 52-week high by about 17% even though Motley Fool reports that Amgen had phenomenal things to say about itself at the JP Morgan Healthcare Conference. Of course, a sector's performance is more than the financial health (pun intended) of one of its widely-held leaders.

The health care sector's long-term performance is very much dependent on the Affordable Care Act (ACA). FactCheck noted in 2014 that the ACA may be contributing to a moderation in the growth rate of per-capita health care spending. The per-capita growth since at least the 1990s has driven the profitability of drug makers and insurers, so any moderation means the sector's companies must seek more customers (i.e., plan enrollees) to sustain their earnings growth. The Economist noted in 2015 that more people are enrolled in health insurance plans even as costs per patient decline. The tradeoff of more customers for less costly coverage was always the grand bargain that the health care sector expected from the ACA to maintain its financial success.

Several CBO reports note that federal health spending continues to grow. We can find one cause for this hidden in FactCheck's 2012 discussion of cuts to growth in Medicare spending. The estimated $716B in growth savings designed to prolong the Medicare trust fund's life covers the issuance of Treasury bonds the trust fund will own. The Treasury's borrowing through such bond issuance will subsidize the ACA health plan exchanges for years. The CBO's March 2015 baseline update on the ACA's fiscal effects shows just how expensive those subsidies will become. The estimated net cost of ACA coverage, including exchange subsidies, totals over $1.2T by 2025. That total more than overtakes the original estimate of $716B Medicare savings. The ACA's effects on health care affordability are an unsustainable burden on the federal government's finances.

The ACA exchanges themselves are facing financial trouble. Premiums from healthier people are not offsetting the tax credits for poorer and sicker people. Twelve of the ACA cooperative health plans have now closed. Insolvent entities cannot continue to operate, and their closure means the surviving eleven co-ops will face more financial stress as sicker people enter their risk pools. The ACA risk corridors are underfunded. Insurers' premiums did not keep up with cost increases for those risk corridors, so either a federal bailout replenishes them or insurers raise their premiums even more. Insurers participating in ACA exchanges are facing unprofitable growth. The ACA's rules and structures force every participant in the health care sector's revenue chain - individual plan subscribers, insurers, and government transfer payment programs - to participate in an increasingly insolvent regime. The financial implications of a collapse in support for the health care sector's revenues would be disastrous for investors.

Watching The Big Short before the JP Morgan conference began offered an indirect lesson in the warning signs of an overheated sector. Only a handful of major investors anticipated the housing market's crash through 2008 by watching how adjustable-rate mortgage rates destroyed the value of pooled securities. The canary in the coal mine to watch is always whether a payment stream is sufficient to support asset valuations. Health care payments are a convoluted jumble of insurance premiums and government reimbursements. Collapsing intermediaries will obstruct such payment streams and endanger the valuation of any security tied to the health care sector. Investors will eventually have an opportunity to make their own big short in health care, much like the home mortgage big short. Analysts can someday decide which short is bigger.

Full disclosure: No positions in any securities mentioned.

Tuesday, January 19, 2016

The Haiku of Finance for 01/19/16

Trust in modern life
Perverse change from ancient world
Time to change it back

A Post-Modern Interpretation Of Trustworthiness

I made my usual rounds through San Francisco's intellectual circles of influence today. One aspiring philosopher claimed that trustworthiness is the fulfillment of a promise, especially one that is in accord with publicly professed values. The naivete in that expression was striking. Life would be so much kinder if only the modern world worked that way. The real world has a different definition of trustworthiness than the one held in the effete imagination of progressives.

The classical age's virtues gave the Judeo-Christian West a baseline for understanding trustworthiness. The baseline disappeared in the modern era as a semblance of material prosperity became accessible to the uneducated, unenlightened lower classes. The most postmodern definition of trustworthiness has a different formulation from the classical understanding. In antiquity, moral actors earned trust by fulfilling duties, especially civic ones. Today, amoral actors earn trust by providing economic advantages, regardless of how said benefits are attained. Demonstrating integrity by keeping promises is not part of that equation.

Consider how modern politicians typically earn trust. Election winners promise to give their constituents free things. Greedy, selfish, stupid voters flock to the polls and hand them victories purely from self-interest. The question of trustworthiness becomes "What will you do for me?" The answer is some variation of "I will make you prosperous." How the prosperity comes is irrelevant. Voters tend not to link their personal prosperity to abstractions like the rule of law, property rights, enforceable contracts, and incorruptible regulatory bodies. The modern electorate prefers cold, hard cash. It cuts out the middleperson that way. Benefits and bailouts are the order of the day. Politicians who try to do honorable things like balance budgets, end wasteful programs, curtail entitlements, and enforce accountability are the kinds of politicians that voters simply will not trust.

I have always tried to earn trust the old-fashioned way by telling the truth, showing loyalty, and sharing my work. I always fail because my personal values are out of step with the times. Feel free to scold me for my own naivete. My colleagues in financial services lacked personal integrity but outperformed me anyway, and their clients rewarded them for their exertions. Bernard Madoff lied and cheated all the way to prison, while the SEC and his well-heeled clients could not have cared less. In a perverse sense, vile people earn a kind of trust by violating values a philosopher from antiquity would have held dear. The Alfidi Capital solution is to be a lone voice in the wilderness raging against the onrushing dark age.

Trustworthiness is no longer earned in post-modern America. It is a commodity to be traded rather than a virtue to be demonstrated. It is highly ironic that a nation founded by serious intellectual students of the English Enlightenment and ancient Rome has devolved to this state. A reset to pre-modern definitions of trustworthiness and virtue is a pressing national need. Resetting national values is always an election year issue, whether we realize it or not.

I am Anthony James Alfidi, and I approve this message.

Monday, January 18, 2016

Inca One Gold Turns Its Wheels

Inca One Gold Corp. (US ticker INCAF) is yet another one of those tiny stocks milling around in precious metals mining. It trades under other tickers but the US listed one is the only one I need to see. There isn't much to see here anyway.

The CEO's bio describes precisely zero experience in mineral processing. Some of these people appear to have mining backgrounds, so maybe they found their way down a hole once in a while. A couple of the people listed here also have zero experience in metallurgy and their bios don't even describe their jobs at Inca One Gold. That just about takes the cake. Investors have cast their lot with people who don't tell the public what they do all day.

Inca One Gold's unaudited quarterly financial statements dated July 31, 2015 show CAD$236K cash on hand and a net loss of -$581K. They burn through the equivalent of their cash reserves in less than a month at that rate. The company does have revenue but COGS eats up a high percentage, and corporate expenses are almost three times their gross margin. This is one very poorly run turkey. Read their own choice of words "material uncertainty" in Note 1 about their going concern prospects in case you don't believe it's a turkey. The shareholders' equity deficit of $15.5M means it has always been a turkey.

The stock's EPS is a negative, losing -US$0.06/share LTM. The closing share price for INCAF on January 18, 2016 was $0.06/share at zero traded volume. That means the company loses the equivalent of its entire public value for an investor who buys now and expects to hold for a year. Some sucker who owns it now and can't sell would love to find someone even dumber. Any trading volume higher than zero means another sucker is born.

Full disclosure: No position in INCAF at this time.

The Haiku of Finance for 01/18/16

Oil Slump Leads To Shale 2.0, The Great Crew Change, And COP21

The oil sector's bear attack shows no signs of abating. OPEC's Saudi-led push for huge overproduction is driving the US shale sector to the brink of collapse. The post-crash survivors can benefit from "Shale 2.0" technologies that keep their costs down. They will need every advantage they can get when the "Great Crew Change" makes finding human talent harder and the UN's COP21 protocols make hydrocarbon production less desirable.

High-sulfur US crude varieties are now so uneconomical that they command prices near zero or even negative in refining. You know your sector is in trouble when you have to pay customers to take your worst product away. Large US banks are strengthening their loss reserve allowances as loans to oil producers reach default thresholds. Thank the Federal Reserve for increasing required capital cushions. Some financial players tracking the oil sector have begun clamoring for a federal bailout. The energy sector's financiers did not get the memo that bailouts are political non-starters. Miscellaneous regulatory changes in Washington may make it easier for surviving drillers to market their product. Financial backstops for the entire sector are very unlikely now that regulators have learned lessons from the 2008 systemic crisis.

Oil drillers who survive the slump will contend with more favorable economics, and not just from an eventual rise in market prices. The Manhattan Institute's "Shale 2.0" study argues that Big Data will bring a revolution to oil drilling that dramatically reduces its cost structure. The think tank's longer study is worth reading for technical insights. Lower production costs across North America will make the continent's production less responsive to OPEC production changes.

Another factor working in the oil sector's long-term favor is the need for a "Great Crew Change" replacing the sector's retiring experts. OGFJ's coverage of the Great Crew Change reveals that hiring to replace experts is less of a priority when oil prices are low and producers shut rigs down. Hiring younger Big Data experts will bring the Shale 2.0 cost benefits to financially healthy producers first, giving them market power as they restart exploration. Only the financially healthiest producers can afford to both replace retired talent with new STEM hires and replace depleted fields with new exploration.

One other complicating factor facing oil shale producers is the finalization of the UN's Paris COP21 climate change protocols. The new regime will use both regulatory and financial incentives to discourage hydrocarbon production and favor renewable energy generation. The regime includes financial support for developing nations whose energy exports will suffer as their oil production is rendered uneconomic. US oil drillers who can afford to comply with COP21's controls may have a window of opportunity if some OPEC producers are deterred from production.

The oil sector's pain will pass at some point. US producers who are currently sour on crude (pun intended) will relish the economic advantages they can reap by being first to implement Shale 2.0 tech, first to hire younger engineers in the Great Crew Change, and firs to adapt to COP21 controls. The largest and least leveraged US oil producers should be first in line when the race begins again.

Full disclosure: Long position in USO.

Sunday, January 17, 2016

The Haiku of Finance for 01/17/16

Send me to Davos
Elites find me impressive
I could bring a date

The Limerick of Finance for 01/17/16

Davos gathering is on edge
Market turmoil is harder to hedge
Some elites are in shock
Populists broke the lock
Long-held notions are tossed off the ledge

Saturday, January 16, 2016

The Haiku of Finance for 01/16/16

Howling bear market
Investors face hard headwinds
Winter should be cold

Winter Bear Markets Start Off 2016

Investors are watching wealth evaporate in the first month of 2016. Major market indexes are down and the CBOE's volatility measure is up. Sleepwalking to easy wealth is no longer the order of the day. Hard winters come with howling winds. Serious macroeconomic headwinds are howling at markets.

Did you think markets would go up forever? Think again. A few decades of consumer overindulgence left developed countries with bloated debt loads. Central bank stimulus was the co-dependent enabler that encouraged consumers, businesses, and governments to load up on cheap credit. Try digging out from under an unmanageable debt load. It's like digging out of a winter snowdrift.

China's economic fictions are now laid bare. Forget the forged official numbers. Australia's declining metal exports to China are real enough. The obvious Chinese recession will become a depression as state-owned funds liquidate shadow holdings and real estate creditors throw urban speculators out of their apartments. The only possible remaining stimulus in a Fourth Turning Crisis era is military spending. Expect Beijing's mandarins to ramp up militarism after a few years of bear market pain become unbearable for China's former middle class.

Live bears hibernate through the winter. Bear markets wake up whenever they feel the urge. Winter is coming, according to people who quote the Game of Thrones saga. Investors' winter is already here.

Friday, January 15, 2016

The Haiku of Finance for 01/15/16

Small cap stock focus
No time to waste with shell games
Growth is the one way

Wellness Center USA In The Pennies

Wellness Center USA (ticker WCUI) is one of those micro-cap companies that only deserves a look long enough to move along. It reminds me of why I am always so skeptical of penny stocks. The company occupies several verticals related to health care that should theoretically cross-sell products and services. Theory is different from reality.

It is strange to see such a small-cap company organize its primary product lines as stand-alone corporate subsidiaries. It would be cheaper and easier to focus on one thing and spin off whatever isn't working. The company states on its website that it seeks to acquire other health care companies. They should really try to grow what they already have before buying something else. Too many different products will distract management's attention from scaling, because each thing scales into a slightly different vertical.

The current management bios made me chuckle while shaking my head. I certainly did not expect to see the same two bios listed twice on a single-page website. I am not interested in leaders who took previous companies through reverse mergers in unrelated industries. I have seen such maneuvers before and they rarely add the kind of value that comes from organic growth. It's really funny to hear an executive bio mention numerous publications and inventions under development. Yeah, I've got plenty of ideas in development too, but it won't drive revenue to my Web properties until I actually publish the stuff.

The company's Psoria-Shield is some kind of UV treatment for skin conditions. Independent sources can tell us whether UV treatment is effective. The National Eczema Association thinks UV therapies are somewhat helpful in remittive therapy, but the treatments require frequent outpatient visits that may not always be covered by insurance. The National Psoriasis Foundation thinks UVB works well with other therapies, but then again so does natural sunlight all by itself. The NCBI archived an article on narrowband UVB's apparent effectiveness in nonpsoriatic conditions. The science behind this therapy type is somewhat encouraging but not conclusive enough for some insurance companies' reimbursement methods. Read Aetna's positions on various UV therapies to see the difficulty of building a business model on therapies still considered experimental in many cases..

Wellness Center USA's unaudited 10-Q SEC filing dated August 25, 2015 showed cash on hand of US$126K and current liabilities of over $959K. They had better earn some serious income ASAP to pay that off, but that will be difficult with a net loss for the quarter of over -$525K. The financial statements also showed an enormous amount of goodwill from their acquired companies. I am usually disappointed to see small companies portray intangible assets so optimistically before they have successfully monetized their primary products. Read what the company says in its own 10-Q about how it must continually raise new capital because of its burn rate. Shareholders will see further dilution.

I don't know why the "investment professionals" who sent me information about this company still have me on their contact list. They should know by now that I don't invest in penny stocks with difficult earnings histories.

Full disclosure: No position in WCUI at this time.

Thursday, January 14, 2016

The Haiku of Finance for 01/14/16

Non-dilutive funds
Pay for early-stage startup
Save the founders' stakes

Non-Dilutive Funding Summits Offer Free Insights

I attend as many local finance events as possible. The week's JP Morgan Healthcare Conference 2016 brought out lots of supporting events to keep me busy. I attended the FreeMind 11th Annual Non-Dilutive Funding Summit because I need to know how startups can raise money without giving up eventual riches. I have no badge selfie this time so you'll just have to imagine me there. The speakers were tailored for a life science audience given JPM's presence this week. I'll share my own thoughts below based on what I learned.

The federal government's SBIR and STTR programs are big funders of projects that meet the government's program requirements. The Milken Institute's report “Estimating Long-term Economic Returns of NIH on Output in the Biosciences” shows how the NIH's non-dilutive funding has tremendous leverage on future funding and economic output. I don't know why some federal agencies cluster their awards in certain parts of the fiscal calendar. Maybe they just don't get enough interested applicants for a regular award cycle, or maybe they just procrastinate. It's good to know that small businesses owned by private investment funds are eligible for SBIR/STTR funding.

The US government is not necessarily the ideal target market for most pharma startups. The government's niche drug needs for low-volume doses do not offer the same scalability of a high-ROI commercial market. Furthermore, I suspect that the government's need to stockpile even large doses of drugs for emergency use requires only periodic replenishment every few years as stocks expire. Contracts for definite delivery of definite quantities do not offer private companies the same quality of earnings as regular sales through commercial channels. Startups targeting a government or military customer should use that non-dilutive funding to enable penetration of a larger commercial market if their solution has more than one application. Realistic startups will not get rich on DOD's need for bio/chem war countermeasures, but will instead recognize the useful partnership and validation that comes with DOD research funding.

I am pleasantly surprised to learn that FDA priority review vouchers can be sold in private transactions. Netting a few hundred million dollars for a voucher is a sweet deal. Perusing the FDA's Center for Drug Evaluation and Research (CDER) Small Business and Industry Assistance (SBIA) webpages reveals a whole bunch of tax credits and other incentives for drug developers addressing special situations. Here's a legal path to riches in drugs, kids. Stay away from the ghetto street dealers, earn your MD or PhD, and get Uncle Sam to fund your commercial drug lab.

The NIH's NIAID funds Phase I efforts and helps companies find a transition partner for Phase II. Centers of Excellence for Translational Research (CETR) are NIAID's academic research partners offering subject matter expertise for medical tech under review. The Bayh-Dole Act's procedures for determining exceptional circumstances (DEC) apply to tech transfer in the life sciences, just as they do to other government tech commercialization efforts. Small companies can use Bayh-Dole's leverage in a DEC to get funding if they commit to accelerating a technology's development.

Salespeople know that more frequent contact in highly targeted campaigns gets better results. Raising capital is a lot like selling a product. I will not listen to self-proclaimed experts who sell exorbitantly priced marketing solutions. Cheap or free marketing efforts are best. Scientists who have never left an academic research lab need a business partner who can sell. Just ask the Google founders. Startups staying in stealth mode longer than needed miss out on publicity and fundraising that they need to accelerate. The stealth aficionados need to get out more to see that tech ideas are more common than execution ability.

I want to see good definitions of the clinical research phases that describe the value-added things entrepreneurs can do before Phase I. Some private funders in venture philanthropy break down pre-Phase I tasks in different ways. Entrepreneurs need those things so they can leave stealth mode quickly. They also need good data on unmet needs in medical conditions to guide assessments of viable markets. I found some basic unmet needs descriptions of Parkinson's disease and multiple sclerosis with a Google search. The truth is out there.

It's really great to see the NIH National Cancer Institute's SBIR program offer an I-Corps pilot program. The popular biotech forums like BIO Innovation Zone and AdvaMed's MedTech Showcase are the kinds of places where life science researchers cam meet entrepreneurs. Once they start hanging out together, they can start commercializing government research and jump into I-Corps training. They can start by exploring NIBIB's Biomedical Technology Resource Centers (BTRCs) for data at the BTR Portal that supports a technology's commercial prospects.

Greedy business people can forget about buying influence with the US government. The interest of a powerful government patron means nothing at all in funding tech. Government program managers must follow rigorous guidelines and scientific evaluation criteria when awarding grants and research contracts. Contact with a senior government official may get a private company some feedback on the government's procurement interests, and nothing else. I have to laugh at companies like Theranos who stuff their advisory boards with prestigious former government people. Lobbying for influence is a waste of money.

The Milken Institute / FasterCures report "Fixes in Financing" from April 2012 is a much better guide to funding success than what any retired political hack could offer. It would be more useful for a life sciences startup to have an advisory board of grant experts, government contracting experts, and NIH subject matter expert reviewers than some Theranos-type board of clueless celebrities. Startups should also read NCBI's 2013 article "Estimating Return on Investment in Translational Research: Methods and Protocols" to appreciate how some government funding reviews incorporate ROI calculations into awards.

It's worth noting that SBIRs can have slightly less stringent requirements than STTRs. The SBIRs can also have broader objectives in socioeconomic development and keeping the industrial base warm. Government managers may just offer SBIR grants to generate some random innovation even if the result doesn't completely meet a procurement requirement.

I suspect that private companies seeking non-dilutive capital may have no clue how to describe a minimum viable product (MVP) using technology readiness levels (TRLs). I want any startup in my private equity portfolio to use those TRL milestones when they submit SBIR/STTR applications or develop cooperative research and development agreement (CRADAs).

Non-dilutive funding saves small company founders from giving away ownership too early in the life of their big idea. Only private industry can do large-scale manufacturing and distribution, so late-stage companies will have to seek dilutive funding for final commercialization. Taking the free money up front from government agencies and non-profit venture philanthropists is always a smart move.

Wednesday, January 13, 2016

The Haiku of Finance for 01/13/16

Paying for health care
Usage divorced from billing
Patient unaware

Tuesday, January 12, 2016

The Haiku of Finance for 01/12/16

Reception venue
Deal makers get drunk all night
Really immature

Mentor-Protege Relationships Now Include Mentees

I always try to use language properly. Words adapt when dictionaries catch up to real world descriptions. One way to describe working relationships in the real world has always included connections between mentors and their proteges. In recent years, some business writers have gotten sloppy by referring to the junior person as a "mentee" rather than a protege. I shake my head at this unfortunate trend.

The word "mentee" is of recent vintage, according to Merriam-Webster. It appears to modify the word "mentor" when no such modification is necessary. Read the dictionary definition of "mentor." The word originates with a Greek character and defines a teacher. Read the dictionary definition of "protege." It originates from French and defines a learner. Read the Wikipedia description of mentorship. It clearly describes the relationship between mentors and proteges. There is no need to create a new word for protege that modifies the word mentor.

I prefer to use traditional language. I lament such changes to the English business lexicon. Calling someone a protege worked perfectly fine for a long time until some writers decided not to pay attention anymore. I have mentored people in the past and may do so again. I do not need to be anyone's protege; if I were for some reason, I would never call myself a mentee.

Monday, January 11, 2016

The Haiku of Finance for 01/11/16

Patient care data
Saving lives and health care costs
Big hospital cash

First Insights From JP Morgan Healthcare Conference 2016

The JP Morgan Healthcare Conference 2016 is happening all this week here in San Francisco. I could not get access to the main conference, so whoever was supposed to confirm me for front-row VIP seating must have really messed up. Seriously, I'm not as much of a die-hard healthcare fan as the other attendees. There's a lot for me to learn by attending the adjunct events. I've picked up a few insights already, straight from the boardroom.

All of the investment bank and private equity people I've seen here so far are in the top 5% of the population in physical looks. This observation holds for both genders. They were hired partly for their looks and pedigrees because those are markers of superior breeding that attract clients and intimidate rivals. One private equity woman sitting near me at an event carried a very showy handbag. I searched the bag's brand online and it cost over $2000 retail. Elite brands may impress people whose upbringing taught them that throwing away money is a sign of success. I just think it's a sign of stupidity to pay two grand for something when a $50 Wal-Mart knockoff gets the job done. Any financial professional who is that irresponsible with their own money is probably even less considerate when handling someone else's money.

Enhancing primary care with "digital health" is a big trend. Information density will increase as more hospitals and HMOs want systems that track patient care history. Patients with chronic ailments have more touch points and will have denser data records. Such detailed use cases will be the reference lodestones as insurers seek ways to reduce costs in their most expensive populations. I bet behavioral finance concepts adapt to healthcare consumption, just like analytics can adapt across sectors. Large data sets on how patients use drugs and devices will make delivery more effective.

I am beginning to understand the healthcare value chain. The chains for both drugs and devices should theoretically be quite simple, running from manufacturer to distributor (i.e., hospitals and pharmacies) to user. Nothing in life is ever so simple. The wrinkle comes from the distinction between users and final payers, who are not the same thanks to insurance coverage and government spending. Insurers have grown accustomed to Medicare and Medicaid reimbursement policies. The Affordable Care Act's complexities are making business untenable for some insurers. The final detonation of government mandates for collective health care payments will severely disrupt the heath care value chain in the next few years. The return of user payments for small services and traditional insurance for high-risk catastrophic events will be an inflection point in the healthcare sector's financial trend. The inflection point will bring opportunities for market short-sellers before it occurs and low-cost providers after it passes. You heard it here first at Alfidi Capital.

SaaS financial analytic tech is apparently useful when re-configured for adaptation to healthcare's Big Data. Financial tech startups have the opportunity to address another vertical, or to pivot to healthcare if they have the sector expertise. Analytics that improve labor productivity would also be a winner in healthcare if it lowers costs. The per hour charges of employing doctors and nurses in high-touch conditions (emergency room, intensive care units) may be severe hospital pain points. I would like to see a typical hospital's KPIs to be sure that an analytics suite gives them a viable Cloudonomics solution.

I think regulatory barriers for healthcare informatics devices and systems are lower than those for drugs and care devices. HIPAA may be a lower barrier than FDA treatment protocols because data doesn't enter a human body's living systems. Startups have an implied faster and easier path to a monetized exit if they offer Big Data informatics and analytics.

A healthcare business solution's success depends on both clinical viability and a reimbursement savings path. Investors are used to seeing predictable but high growth in this sector. I was surprised to hear that frequent turnover of an insured population is a concern. If an insured person changes plan providers every two years on average, as someone claimed, it shouldn't make much difference for companies making drugs or devices because the end user still pays, either out-of-pocket or through Medicare/Medicaid. The only party that should be concerned with turnover are the insurers who need new covered policyholders to replace their cancellations.

Ecosystems matter in healthcare solutions, just like in enterprise software. I wonder who are healthcare's equivalents of software's systems integrators and consultants. Testing labs, outpatient clinics, and occupational therapists spring to mind as secondary markets, but I don't know their roles in implementing product solutions. A drug maker's ecosystem depends on its delivery modality; for example, a drug requiring subcutaneous injection needs syringe makers in its partner ecosystem, while an oral drug maker does not need a device partner. The health care sector's inherent conservatism means a strong ecosystem presents entry barriers to new competitors and imposes switching costs on existing marketing channels.

Actively managed mutual funds are late-stage investors in health care, just like Silicon Valley's other tech sectors. The late investors are still just as dumb. Mutual fund analysts are classic Dunning-Kruger effect cases. The biotech bubble makes this worse by attracting the least capable analysts and portfolio managers.

Product pricing at the patient level seems to be more art than science, partly due to a lack of data on patient efficacy. The Affordable Care Act defines payment methodologies, which IMHO demands data-centric assessments that should determine product pricing. Data privacy may be a roadblock to collecting data on patient efficacy. Privacy builds trust. Data collection must be an aggregate effort that protects privacy.

I had to silently mouth "holy canole" when one startup executive said his company filed way over 100 patents to protect their IP. Their rationale is that they needed multi-level IP protection to avoid competitors' potential prior art claims. Wow, their attorneys must love that concept. I think their legal firm took them to the cleaners with unnecessary strategies. I say Customer Development use case data plus experiential knowledge is all the trade secret protection they need in addition to their core patents. Trade secrets are probably more solid IP protection because they are unique to a specific company's processes.

Single-vertical products usually have smaller total addressable markets (TAMs) than multi-vertical ones. Adding new tech to a single-silo product (i.e., ingestible tracking mechanisms) means the tech can cross silos and find multiple TAMs. Consider virtual reality (VR) as one such tech. Using VR telemedicine will probably greatly reduce healthcare costs once Medicare/Medicaid reimbursement methodologies catch up to the market's reality. The US Department of Health and Human Services (HHS) will have to include telemedicine in outpatient care categories to make those savings real.

I am ready for my one-on-on meetings with the healthcare sector's big shots. You know where to reach me if you have room in the penthouse receptions around Union Square.

Sunday, January 10, 2016

The Haiku of Finance for 01/10/16

Waiting for meeting
Big shots are last to arrive
They waste so much time

Saturday, January 09, 2016

The Haiku of Finance for 01/09/16

Stronger currency
Imports are less expensive
Exports must cost more

Friday, January 08, 2016

The Haiku of Finance for 01/08/16

Cascading oil price
Energy sector ruin
More high-yield bursting

China Eats Into Its Foreign Exchange Reserves

China's government and central bankers should worry about running out of money. More specifically, it is running down its reserves of other countries' currencies stored up after years of current account surpluses. December's monthly drawdown was the biggest ever. Continued reserve declines reflect an increasingly futile campaign to support the yuan's value. China's private sector takes note and reduces its US dollar-based liabilities. Private companies do not wish to be stuck with debt denominated in US dollars that will be more costly to repay as the yuan sinks.

The yuan's membership in the IMF's list of reserve currencies is a privilege for economically successful countries. It is not an entitlement based on a country's share of the globe's human population or land area. Beijing secured the yuan's status with the IMF after years of publishing very questionable economic statistics that inflated its national track record. Sustaining the yuan's new status requires spending forex reserves to stall its depreciation. Beijing is now in a race against time it cannot win. Its currency reserves will probably run out before it can build both honest statistics and truly consumer-driven economic growth.

The People's Bank of China is now learning the same painful lesson its Swiss counterpart learned in recent years. The difference is that the Swiss tried to drive their currency's value down while the Chinese are holding their own currency up. Switzerland's attempt to suppress the Swiss franc's value was not worth the effort of buying other currencies. Currency market interventions have ruinous effects on central bank balance sheets. Central banks only have so much ammunition to expend in currency wars, and they now fight losing battles against the rest of the world.

Thursday, January 07, 2016

The Haiku of Finance for 01/07/16

China selloff wave
Markets down both there and here
More stock pain coming

China Triggers US Stock Avalanche

Any stock market watchers who peeked out of their caves this week noticed that the economic slowdown in China is triggering a stock market selloff there, which in turn triggered a market selloff here in the US. Collapsing world commodity prices indicated that stock markets had overestimated basic industrial demand. The Baltic Dry Index's massive decline in 2015 should have told people what was coming.

I read through some financial news headlines this week. Wall Street's court stenographers quoted the usual mutual fund managers' nonsense about how this is expected, and how it's a buying opportunity, and of course how US stocks are poised for success. What a pile of baloney. The sociopaths and trust fund kids running those active management strategies are privately kicking themselves. A slew of hedge funds, distressed debt funds, and multi-strategy fund shops are doomed to close. Leverage is going to bite these idiots hard.

The only sane voice this week was George Soros, who repeated an oft-heard warning that central bank policies have endangered the world's financial systems. No one listened to me when I gave this warning many times in the past few years. Hardly anyone listened to the few other financial experts who gave the same warning. Someone may listen to George Soros now. Everyone who doesn't listen will be on the wrong side of some seriously winning market trades.

I would very much like this stock market avalanche to continue until the DJIA is under 3000. Many stupid investment professionals deserve to buried under their losses. The bloom coming off Wall Street's rose will be gone for a decade after the dust settles. Watch out below.

Wednesday, January 06, 2016

The Haiku of Finance for 01/06/16

Endless exploring
Excuse to throw cash away
Mine that never pays

Nevada Copper Corporation Languishes Under One Dollar

I first noticed Nevada Copper Corporation (Canadian ticker NCU.TO, US ticker NEVDF) back in mid-2014 when its stock was headed up to over two bucks a share. It looked for a while like there was something here besides a typical penny stock run-up. Let's take another look to see if there's anything still in this story.

Just look at these management biographies. Here we've got an accountant as CEO, forcing me to wonder what operational role the dude ever had in pulling ore out of the ground. Other folks on the team have been geologists and engineers, doing stuff that equates somehow to mining. The least I can say is that their headshots look nice. Maybe that's the most I can say without directly asking them whether they have personally run a profitable mine.

The one project they have is Pumpkin Hollow in Nevada. Admitting the preexisting surveys by other mining companies begs the question as to why those earlier explorers elected not to develop the property themselves. Sometimes that happens when larger, more successful mining companies realize they found a property that won't meet their investment criteria when they have more viable properties in hand. These Nevada Copper people have NI 43-101 reports on their website going back to 2006 and they are still drilling exploratory holes. Whenever I see a junior resource company taking that long to gather evidence, I have to wonder if there will ever be a final decision on production.

I had to suppress laughter when I saw that Nevada Copper's feasibility study kept the price assumptions for gold at $1200/oz and silver at $18/oz while they adjusted the copper price from their base case. I didn't even need to read their NI 43-101 report dated July 9, 2015 because they put those numbers right on the project's "feasibility studies" Web page. I realize the gold and silver are expected to be byproducts of this project's copper lode, but the least they could have done was run separate economic scenarios for each metal type. If I had turned in a sensitivity analysis like that as academic work, my MBA professors would have given me poor marks for sloppiness.

I looked through their unaudited quarterly financial statements for the period ending September 30, 2015. They had US$6.3M in cash on hand and showed a net loss of -$2M. The company must continue to raise capital so they can pay off more than $20M in short-term liabilities. Reading Note 5 on the details of their bridge loan facility is crucial. Nothing focuses the mind quite like a deadline. Compare the numbers in that note to the Current Liabilities numbers in the balance sheet. Just do it.

I never get tired of examining the entrails of such "opportunities" as Nevada Copper. I used to see plenty of junior resource companies at San Francisco investment conferences. They always had great stories about undeveloped properties that major companies had abandoned. Management was always raising capital to fund endless exploration, and they always paid themselves well. Investors in these types of companies must ask themselves why they keep paying up. The story never ends.

Full disclosure: No position in Nevada Copper Corporation at this time.

Caledonia Mining Corporation Goes Full Bore Into Zimbabwe

Caledonia Mining Corporation (Canadian ticker CAL.TO, US ticker CALVF) is optimistic about its prospects in Zimbabwe. That country ranks 156th out of 174 on Transparency International's Corruption Perceptions Index and 175th out of 178 on the Heritage Foundation's Index of Economic Freedom. It's a bad country for any kind of business. Caledonia Mining had recent success in spite of such geopolitical risk.

The current CEO is an accountant, not a geologist. It's surprising to see such a background in a profitable mining company. It's also surprising to see a geology PhD whose biography leans more on financial analytical work than on successful project discovery. I have more respect for applied competence than I do for luck. A mining company can rely on production from a good ore body for a long time while management teams come and go.

The Blanket mine's ownership structure is unique to the Zimbabwean government's requirements for indigenous participation in foreign direct investment. Caledonia still owns a stake in Blanket after accounting for a partial sale supporting a local participation requirement. The complex governance and financing of this agreement is typical of countries with high geopolitical risk. Suffice it to say that success with such a corporate structure requires investors to heavily discount any new discoveries or operational improvements in such a jurisdiction.

I looked through Blanket's latest NI 43-101 technical report dated July 9, 2015. The total P2 reserves of 2.9M oz Au at 3.67 g/t grade look really good. Those are some of the best numbers I've seen in a junior mining company's project in recent memory. The mine finances its own infrastructure maintenance. It's too bad the report used a gold price estimate of US$1250/oz in its DCF valuation; the world gold price is now under $1100/oz. Consider how further declines in the gold price will reduce the project's estimated valuation. A more appropriate forecast would use gold's long-term historic average price of about $640/oz since 1968. Caledonia's cash cost of production is $513/oz, but its AISC is certainly higher.

Caledonia's gold recovery rate at Blanket is 93%, which is remarkably high. The company is doing the best it can given the political requirements of its local hosts. Good grades and plentiful reserves can make any management team look brilliant even after surrendering ownership of half the project. The company's 43-101 report predicts mine production will start to decline after 2019. Caledonia must then replace production with new discoveries or additional engineering to maintain the company's valuation. The stock currently trades under a dollar because the market recognizes the difficulty of operating a good project in a bad country. It's tough to live in a good house in a bad neighborhood.

Full disclosure: No position in Caledonia Mining Corporation at this time.

Tuesday, January 05, 2016

The Haiku of Finance for 01/05/16

Dumb executive
No clue how the business works
Find a new job quick

Clueless CEOs Irritate Investors

Studying the ancient Stoic philosophers has taught me to take life's complications in stride. Things that used to irritate me don't bother me so much anymore. I am still morally obligated to identify sources of irritation so other investors, who are not as mature or brilliant as I am, can avoid them. Executive pitches to the investing public are one prime source of bother.

Reviewing my notes from financial events I attended in 2015 reminds me of how clueless some CEOs can be. One junior mining company guy was totally guessing at his company's timelines for project development. Where the heck were his updated NI 43-101 reports? I couldn't find them and he didn't have them. He also cluelessly claimed a silver mining credit would reduce the cash costs of production, which is not entirely accurate. Credits may in fact offset cash costs when calculating all-in sustaining costs (AISC), but only process improvements or cheaper inputs (water, power, etc.) can truly reduce cash costs in mining. Changing accounting terms does not make a physical process cheaper or more efficient. Sheesh, that's what happens when anyone other than a geologist runs a mining company. Truly competent mining CEOs understand these nuances.

Inexperienced CEOs think throwing around names of powerful supporters will matter. Those corporate backers and industry legends may have little to no involvement in running the company. They sure do make for nice presentation filler when a company has no earnings, patents, or serial entrepreneur leadership. A prominent corporate partner is useless if they offer weak financial backing or incidental strategic value. Putting an industry legend on a board of directors works when that director is personally advising the CEO every day, not when they drop in once a quarter to review executive compensation.

Aspiring CEOs should have academic and career experience relevant to their company's industry. Geologists should run exploration companies. Computer scientists should run software companies. Medical doctors and biochemists should run drug companies. All of this should be obvious but many investors don't seem to care. Presenting CEOs who can't speak with confidence, or who mumble at crucial discussion points for particulars that drive project success, are really telling me they don't know how to be CEOs.

Presenting a corporate story that depends on someone else's theoretical action just falls flat with me. I have listened to CEOs who claim their business will succeed if only some other government builds phantom infrastructure that does not exist. I hear that all the time in the resource sector. I'll believe the project is viable when the road, power line, or port facility is finished.

I could warn investors to stay away from clueless CEOs until the cows come home. Only a few people will listen. The rest of the investing public craves the seduction of an entertaining story, even if its parts are stitched together from fiction. I'm on the hunt for CEOs who openly lie about their corporate finances so I can turn them in for a regulator's bounty. I have to ignore the others who just want to waste my time.

Kaizen Discovery And Japan

Kaizen Discovery (Canadian ticker KZD.V, US ticker CCNCF) is another junior resource development company. It touts its connection to major Japanese trading house ITOCHU Corporation as validation for its project generator model. Strategic support for a raw material supply chain is nice to have but it cannot be a dominant factor in a company's valuation. Corporate customers can only buy what a resource company can produce. Only economically attractive properties go into production or get acquired because industry will never overpay for any globally available commodity.

The current CEO trained as a lawyer, not a geologist. Folks, a mining company must have a geologist at the helm if it wants my respect. Geologists are people who find valuable ore in rocks. Lawyers argue about what the word "rock" means in a lawsuit. It's nice that their exploration EVP has a doctorate in geology. I hope lawyers don't overrule his exploration plans. Hope is not a method but it's all some junior resource companies own sometimes.

This company has over half a dozen projects currently under exploration in different parts of the world. I can't call any of them successful until they demonstrate discovered ore grades an acquirer would find attractive. That is the whole point of a project generator business model. The grades discovered on those projects so far, even with NI 43-101 reports, aren't getting me all excited about future mine viability.

I checked out their most recent unaudited quarterly financial statements dated September 30, 2015. They had CAD$2.5M in cash on hand and a net loss of -$3M, so they need to keep raising new capital pretty much every quarter with such a burn rate. That's probably why they have an accumulated capital deficit of almost -$23M. American accountants would call that the equivalent of negative retained earnings. Maybe ITOCHU could pony up the cash to keep this thing afloat. Yeah, sure, whatever.

Project generator models are always neat ideas. I have yet to find one that fits my own preference for solid earnings from a history of successful acquisitions and spinoffs. Markets currently price Kaizen's shares in the pennies; they traded over a buck in early 2013 and have since fallen into the pink sheet basement. Kaizen expects its minerals to feed Japan's industrial appetite. Japan's economy has enough problems getting away from two decades of stagnation. I look for better strategies, and I don't need to look at Kaizen again.

Full disclosure: No position in Kaizen Discovery at this time.

Monday, January 04, 2016

The Haiku of Finance for 01/04/16

High hope for startup
Investors blind to prospects
Tiny unicorn

Helius Medical Technologies Targets Brain Trauma

I have to examine Helius Medical Technologies (US ticker HSDT) just to wonder what this medical device company is all about. Here's another small company that went public before it became profitable. Startups often use reverse mergers to raise capital. The successful ones have a minimum viable product ready for regulatory review prior to said merger.

The company's core offering is some kind of tech that facilitates neurological rehabilitation. Their PoNS device electrically stimulates the tongue to prompt brain functions in patients undergoing different forms of rehabilitative activity. It's a cool concept and getting CRADA funding is also cool. I respect anyone who tries to ameliorate mTBI suffering. Doing it outside a research lab means making a product someone actually buys.

The market for mTBI treatments alone makes pursuing any solution a calculated risk rather than just a wild gamble. The NIH's NCBI cites a literature review from 2013 citing a wide range of estimates for the societal cost of TBI. The range of $25,174 to $81,153 for moderate TBI matters most for the types of solutions that will attract US government CRADA funding. Any device seeking market share must be available at a price point far below the low-end TBI cost estimate of $25K. A total addressable market anywhere from $2-4B is worth chasing.

The one data set that jumped in my face was the executive compensation on their Yahoo Finance profile page. I looked at their most recent 10-Q dated November 16, 2015 and it looks like the compensation is stock-based. That's appropriate if they're spending cash on R+D. Cash on hand as of September 30, 2015 was $192K while their net loss was just over $1M for the quarter. A burn rate of over $330K or so per month means Helius must regularly raise new capital. Shareholders can expect dilution after a successful $2M raise in late 2015. The drawdown of a $5M credit facility noted in the 8-K dated December 31, 2015 will also dilute shareholders.

Medical device makers cannot sell a product until the FDA grants approval for distribution. Helius must survive on invested capital until their product has complete regulatory approval. It's too early to tell whether Helius can match its tech's promise to market reality. Patients with mTBI can keep their fingers crossed.

Full disclosure: No position in Helius Medical Technologies at this time.