The Haiku of Finance for 03/22/16

Hard asset index
Must be sufficiently broad
Buy global in bulk

The Haiku of Finance for 09/10/15

Hard asset benchmark
One for all commodities
Or pick more than one

Modern Portfolio Theory Before Hyperinflation

Modern portfolio theory (MPT) has been around since Ike was in the White House.  It's old enough to be Generation X's cranky parent, yelling at the neighborhood kids to get off the lawn.  It's also old enough to deserve some improvements.

The authors of MPT and related investment strategies were old enough to have lived through the Great Depression.  Images of people who lost everything from overconcentration in one stock, style, or sector made lasting impressions.  MPT's emphasis on diversification is a natural result.  Most investment theorists in the Anglo-West have not lived through a hyperinflating economy.  Using MPT to rebalance portfolios during hyperinflation poses hidden risks.

Fixed income investments comprise a significant allocation of many MPT models in the real world.  Bonds, notes, cash instruments, and other things denominated in a face amount of currency will rapidly turn worthless in a hyperinflationary economy.  Ask anyone who invested in Zimbabwe, Argentina, or Venezuela in the last decade.  MPT investors in those countries could be heard howling all the way across the Atlantic, if anyone listened.

Hyperinflation turns MPT inside out.  Asset allocations that include hard assets are far more likely to survive a hyperinflating economy than anything with fixed income.  Hard asset sectors like energy, agriculture, mining, and now infrastructure as an emerging theme will hold their worth through inflation because they produce output that can be valued in any currency.  They may even experience strong valuation growth during hyperinflation as investors rush to convert the declining power of their currencies into hard goods that will retain utility.  The end of hyperinflation will also end such rushed growth, but a productive farm will still be a farm.  A bond won't be the same at all.

Updating MPT for a highly inflationary economy does not require adjustments in risk-return calculations.  It does require the inclusion of other asset classes that do not behave like fixed income.  Consider that oil drillers and metal miners have been hit particularly hard in recent months by oversupply and declining world prices.  Consider also that lengthy monetary stimulus has pumped an unsustainable global bond market bubble.  Rebalancing means a rotation away from overconcentration in fixed income is due any time.  Underpriced hard assets are ready for any MPT-based portfolio manager with enough foresight to prepare for inflation.

Financial Sarcasm Roundup for 06/02/14

Read my words and discover the contempt I have for humanity.  Stupid losers are everywhere.  They deserve nothing but my sarcasm.

Pimco's Total Return Fund is watching investor withdrawals whittle away its flagship product.  The trickles will turn to a deluge as investors realize the air is leaking out of the bond market bubble.  Chair Yellen can keep the plates spinning a while longer if the Fed has to restart QE purchases.  Everyone in the fixed income universe forgot about mean reversion while the fixed income party was going full steam.

The Administration's emission rules are going to put the coal sector in a world of hurt.  Climate change advocates have a religious fervor for reengineering our society, with or without a scientific basis.  The only thing dumber than blind faith in weak science is forcing others to pay for those beliefs.  Renewable energy stocks may get a small push from new rules on power plant emissions.  I doubt the Administration's push to convince other polluting countries in the developed world will bear fruit.  US coal companies will just export to China and India if the coal can't be burned domestically, and those nations will have no incentive to cooperate with US climate goals if they would otherwise lose access to our coal.  Way to go, Washington.

Ecuador is swapping gold for liquid assets, presumably some instruments denominated in US dollars.  Goldman Sachs took them to the cleaners and all the Ecuadoreans can do is lie about the deal.  It's obviously an asset swap but Ecuador's finance ministry and central bank both refer to it as an investment.  They must think the global financial community is as stupid as their own citizenry.  This swap only works for them if the US dollar retains its value for three years, a highly doubtful prospect if the US experiences hyperinflation.  A dollar devaluation means they'll only get back a fraction of the gold they're swapping out.  Goldman and other banks now have a case study they can use to liberate hard assets from other dollar-dependent countries before the party ends.  I'll remember that the next time I'm stocking up on stuff.

Humans run around like chickens with their heads cut off.  I exist to collect up the headless chickens and cook them for supper.  The brainless losers who don't read my blog might as well be headless.

The Haiku of Finance for 04/29/14

Big bank bad bond bet
Exposure to inflation
No hard asset hedge

Brief Notes on Asia and Hard Assets in Hyperinflation

I'm adapting this brief commentary from a conversation I had today with another private investor.  We discussed the possibility of dollar devaluation as a response to America's continuing debt funding problems.  Hedging against devaluation is not difficult with a broad mix of non-dollar assets.

There's more to hard assets than gold.  Anything I consume - - food, energy, basic materials - becomes very desirable in a currency crunch.  Advanced purchases of raw materials become "secondary" stuff as additional inventory kept for future needs.

The need for hard assets as a hedge against the potential devaluation of the US dollar begs the question of where to obtain said assets.  Why buy stuff in China?  I think the renminbi is as likely to have high inflation as the US dollar.  On the other hand, Australia, Canada, New Zealand, and Switzerland have well-managed currencies.  China is the least transparent of the G-20 economies.  I believe all of that country's official economic statistics have been falsified for years.

My longtime readers know that I own John T. Reed's book on hyperinflation and depression.  I have implemented many of his ideas at little cost.  His free articles on inflation are worth my time.  Hedging my net worth with a hard asset component of my portfolio gives me peace of mind that I will survive a hyperinflationary depression in the US.  Consumers will have a difficult time shopping for necessities if our currency becomes worthless as a store of value.

Currencies do have value as units of trade, so the yuan may gain some temporary acceptance as a dollar alternative among China's trading partners.  The problem for those who hold yuan will be the same as for those who hold US dollars.  Inflation in China will make the yuan (renminbi outside of China) worth less in that local economy.  Malaysians, Indonesians, etc. will then dump remminbi because they want to preserve their ability to buy things locally.

The secondary effects of simultaneous US and Chinese hyperinflation on Pacific Rim economies are too complex to predict.  Countries that peg their currencies to the dollar will have to de-link immediately or follow through with their own hyperinflation.  Countries that have significant hard asset sectors - mining, energy, agribusiness, timber - and sectors that service hard assets (specifically pipelines, railroads, and barges) are hedged for a currency crisis.

I remember being in South Korea in 1999 just after the Asian currency crisis had passed.  South Koreans donated their private gold holdings to the government so its currency could regain value.  The US dollar traded at a very beneficial exchange rate for Yankees like me who spent money in the local economy.  South Korea suffered because its main sectors were automobiles, semiconductors, and shipbuilding.  Those sectors were fully exposed to export markets.  I don't want any exposure at all to dollar-denominated fixed income during US hyperinflation.  The Fed under Janet Yellen will keep is foot on the QE gas pedal.  

The Haiku of Finance for 09/26/13

Hard asset income

Cash flow from raw resources

Hedging inflation

Alfidi Capital at MoneyShow San Francisco 2013

I had to attend the annual MoneyShow San Francisco last week.  This was more than just another conference for me.  I presented my first MoneyShow seminar ever.  This was something I've wanted to do ever since I attended my first MoneyShow in 2001 during my MBA program.  I spoke this year about my small-cap stock evaluation methodology on the first day of this year's show.  If you want to hear my thinking, you have to invite me to speak at your high-powered conference.  I paraphrase what a few other speakers said below.  My thinking in response to the presenters is noted in italics below, as per my usual style of commenting on major public events.

Thank you to Kim Githler and Charles Githler for allowing me time on your show's calendar.  Kim kicked off the conference in her usual way by covering her basic philosophies:  capital preservation, the big picture, and adapting to change.  She noted that strategies for handling inflation and deflation are different and that long-term stock market investors are rewarded.  Her take on an old adage was a classic:  "Finish your homework.  People in India and China are starving - for your job."  Charles spoke next; he thinks the US is at major risk of deflation (hence the Fed's QE goal of asset appreciation).  He interprets rising real 10-year yields as the result of investors demanding more reward for the risk they take.  Referring to the "2020 scenario" of energy independence for North America, Charles thinks materials and energy may outperform.  I appreciated his mention of GDX and GDXJ (the gold mining ETF tickers) as beaten-down value plays that may also be useful as inflation hedges.  There may be some life in my GDX holdings yet if other luminaries come around.

The first keynoter from TD Ameritrade covered his firm's Investor Movement Index (IMX), which I take to be a Big Data compilation of their clients' aggregate trade activity that measures market sentiment.  I don't use sentiment indicators because I consider most retail investors to be reactive rather than contemplative.  Some hedge fund somewhere can probably throw the IMX into one of their algorithms and measure its signal strength.

The keynoter from S+P Capital IQ said that bullish market action in January and February usually signals a positive twelve month total return, but I'm skeptical.  Ask anyone who was in the markets from late 2008 to early 2009 how the crisis impacted their annual returns.  He noted that the number of "all-time high days" in this bull market are below historical averages; once again, I'm skeptical that this is anything other than random noise.  He noted that narrow yield differentials between the S&P 500 and the 10-year Treasury are generally good for bull markets but I must caveat that with some kind of adjustment for risk.  Only in recent years have investors ignored risk and focused exclusively on total return, and that's only because QE has driven them out of cash and savings accounts.  IHS Global Insight believes that most developed countries have passed the troughs in their business cycles.  I'd like to see IHS's track record in forecasting economic turning points; it's not obvious from their product page.

Roger McNamee from Elevation Partners (and let's not forget his rock band, Moonalice, whom I've heard live) had ten hypotheses about tech that probably went over the heads of most MoneyShow attendees.  I think MoneyShow attendees are much more intelligent than the average American, but not all of them are the type of innovators who would launch or fund a tech startup.  He thinks there's no income overlap between mobile apps and the web, partly because apps are the search engines for mobile.  He thinks Apple should pivot to the cloud and the Google's Android has spawned incompatible systems that degrade app experiences.  He continued to pound Android, saying its OEMs often lose money on hardware.  I'd take a look at Samsung's sales before I count out Android makers.  Roger likes that HTML5 incorporates Flash, which gives it more design flexibility and makes monetization easier.  He predicts that "home cloud" architecture offering remote access to lifestyle devices is coming.  I see that as another manifestation of VCs going for IoT as the next funding trend, something I've blogged about this year.  He also predicts that content providers will have to move to broadband distribution to survive given the decline of cable and satellite channels.  His most alarming hypothesis is that the "sharing economy" allows consumers to imitate corporations' capital efficiency techniques (like outsourcing), his evidence being that Millennials are renting capital goods for short periods via Airbnb and Zipcar.  I hope he knows what's driving this phenomenon.  Millennials' income is constrained by student loan debt and lack of upward mobility.  They must rent cars because they can't afford to own them.  They must lease out their homes and apartments because they really need the extra income.  Check out Roger's slide show on Elevation Partners' mission page.

Steve Forbes was the next keynoter.  He's still pretty sharp but sooner or late the next generation of handsome, intelligent keynoters will have to replace the old guard, and that's exactly why I'm appearing at these conferences.  Steve noted that middle class incomes are still declining after four years of so-called economic recovery, similar to a pattern in the 1930s.  The MoneyShow audience applauded his prediction that the Democratic Party would lose the US Senate due to the Affordable Care Act's implosion.  I'm sad to note that such a reversal is probably a pipe dream.  Americans are addicted to entitlements at all levels of our society.  These programs and their political sponsors will remain in place until a hyperinflationary depression eliminates their funding sources.  Steve thinks fixing federal spending to a percentage of GDP is a more effective budgeting tool than a legislated debt ceiling.  I don't think that is going to work.  Government statistics are already significantly altered, gamed, adjusted, and otherwise misused as to be unreliable, according to Shadow Government Statistics.  Targeting GDP will just incentivize the policy apparatus to artificially inflate GDP so the government can collect more revenue.  The best guide for targeting federal revenue collection and spending IMHO is Hauser's Law.  Steve went back to his advocacy for the gold standard, another impossibility because it's too inflexible as a rule.  The Rentenmark is a better example because it was backed by a broad range of hard assets.  

Jim Rogers was the final keynoter.  He's still pretty sharp but he was starting to show his age while wandering all over the stage.  He's proud of his young daughters for speaking Mandarin and showed off their videos from a speech exhibition.  The guy has been a relentless China bull for something like forever.  Someone needs to tell him that China's most important economic figures are falsified and that English is the international language of business.  I could beat the ground about how China will get old before it will get rich, its resource shortages and little arable land, its economy's fixation on the pork cycle, and the insolvency of its shadow banking system.  I do concur with the rest of his general advocacy of mining, energy, and agriculture.  Jim set up his family's bank accounts in Asia because he doesn't trust the US dollar.  I hope he calculated those banks' Basel capital adequacy ratios first.  He noted that simultaneous monetary stimulus in the largest developed economies is unprecedented and that we should prepare for that to end.  I've been saying that too but I don't think Jim reads my blog.  He's shorting junk bonds.  I'm not, because I don't want to pay the bonds' interest to a counterparty in addition to the margin interest I'd have to pay.  He's still bullish on agriculture because a dearth of farmers will make farming careers more lucrative.  Jim likes Canada's economy and currency but doesn't like US TIPS due to their tax consequences at maturity.  He then rolled into a rambling Q&A and was very friendly with Asian women in the audience.

The vendor booths on the expo floor had more representation from hard assets companies and investment projects than I've ever seen at a MoneyShow.  Big Oil (supermajors), Little Oil (prospectors), pipeline MLPs, timber, REITs, BDCs, and non-US agriculture were all there.  I'll cover these selectively, in pretty broad swaths, working backwards.

Let's consider farmland.  I can understand investing in agribusiness stocks with an international presence because they must publish detailed financial statements.  A pure-play deal in Latin America or the Baltics requires a different kind of due diligence.  Investors would have to physically travel to the country in question to see the land, meet the farmers, and examine the title document in the native language.  That's more effort than I can make just for one potential investment.  Please don't pitch me on the ability of coconut oil to treat Alzheimer's disease.  Please don't tell me that a bunch of neem trees are a miracle without explaining the plan to cultivate them outside their native habitat.  Plants have natural pests and predators.  I'd say investors have natural predators too.  I'd much rather invest in permaculture, which I can do right here at home.

Let's talk about business development companies (BDCs).  I picked up flyers for a couple of these at the MoneyShow.  In normal times BDCs are useful additions to a fixed income portfolio.  These are not normal times.  The likelihood of hyperinflation in the US means any security based on fixed income flows is the kiss of death.  Too many BDCs have portfolios structured as loan funds.  The companies owing those loans to the BDCs will pay them off with worthless dollars in hyperinflation.  Structuring the loans as secured with liens on assets won't matter; the indebted companies will end hyperinflation much healthier as their liabilities are inflated away.  BDCs that structure their investments as convertible debt or project equity might fare better in hyperinflation for a little while.

Let's mention REITs.  John T. Reed's anticipation of nationwide rent control laws puts the kibosh on whatever refuge I might have found in commercial REITs.  Residential REITs are similarly out of my consideration.  The remaining option would be storage REITs, and I found a suitable candidate for my own money in my blog article earlier this week.

Let's check out timber.  I sat through one timber pitch recently.  It was (of course) for a project outside the US.  No thanks.  Timber is a hard asset and thus a potential inflation hedge but it must be structured correctly if it wants my respect.  I suspect that much of the infatuation with timber in recent years is the result of timber's correlation with the housing market.  Housing booms drive demand for lumber and pulp.  The financial sector started to take timber seriously when the Harvard Management Company hired a lumberjack to evaluate timber farms all over the world.  The strikes me as analytical overkill.  There are simpler and cheaper tools around for evaluating timber.  The NCREIF Timberland Index shows the return history for timber investments.  The index's declines since the housing bust are a contraindicator to contemporary claims that the housing sector is strong, but those declines may also indicate that the timber sector is underpriced.  Institutional investors hire timber investment management organizations (TIMOs) to care for their trees but those structures aren't available to ordinary retail investors.  The best the rest of us can do is evaluate timber REITs like Rayonier (RYN), Potlatch Corp. (PCH), and Plum Creek Timber (PCL).  Compare them to the timber REIT ETFs with the adorable tickers CUT and WOOD.

Let's look at pipeline MLPs.  The only thing preventing me from going long one of these babies (aside from finding one at a decent bargain) is the unresolved question of whether they can raise their rates at will or are limited by FERC to rate increases at set intervals.  Pricing power counts for everything in hyperinflation.  I'm still digging for the answer.

Let's wrap up my digression by mentioning oil and gas.  You've heard me talk about energy many times already on this blog.  I've discovered that there's a specialized part of the finance sector called "oil and gas lease banks" that provide capital specifically to drillers.  Even oil and gas royalty trusts need access to capital because wells will mechanically fail over time.  They must spend capex on maintenance and restoration of production.  I don't invest in these tiny little well plays or their lease banks but some people just love the tax advantages.  The IRS has an entire handbook devoted oil and gas, and there's a cottage industry of accountants and attorneys devoted to figuring it out.  There's also a cottage industry of community banks with internal offices devoted to helping oil and gas royalty owners manage their income streams.

Okay, enough of my fixation with oddball asset plays.  I'm switching back to the MoneyShow speakers.  There were so many talks that I couldn't possibly cover them all, so I only attended those that mattered for my own portfolio or professional development.

Serial entrepreneur Bill Harris of Personal Capital explained how money meets tech in financial services.  His three requirements for a money management service are that it should be virtual, secure, and personal.  Virtualization should be a disruptive force in a sector that has four times as many bank branches now as it did before the ATM, especially now that digitization has transformed financial projects into intangibles. The security of vaults and access can now be delivered with smartphone 3-factor authentication (password / phone activation / voiceprint).  Technology now allows for mass personalization that obliterates the old crasftsperson model of wealth advisory.  Much of his talk hit the strengths of his finance startup, Personal Capital, without being a blatant sales pitch.  Great presentation, Bill!

The MoneyShow promoters displayed their own proprietary investment sentiment indicator, collated from attendee responses.  Attendees still expect a rising S&P 500 in 2013 and a steady unemployment rate at 7%.  They plan on buying more stocks.  Okay folks, but your due diligence needs to be as robust as mine.  My own seminar presented a detailed due diligence checklist that I've spent years developing.

The Everbank folks think we're paused at a crossroads.  They presented a FRED chart of nominal GDP growing, but to me that's more an indicator of inflation than economic growth.  Their stats on just how little money most Americans have were depressing, like the median figure for financial holdings at $6000.  I'm not in the top 1% but I feel like I should be compared to people at that level.  Everbank noted that the only real job growth in the 2000s was defense-related.  Manufacturing is no longer a job creating sector because it isn't labor intensive.

Legendary stock analyst Laszlo Birinyi spoke on inefficiency in the stock market.  He had a couple of truisms, like "don't sell into strength," which I didn't quite grok.  Maybe this WSJ data set is what he meant.  He thinks money flows are the best tools for understanding the stock market but he didn't mention any sources.  Maybe he means data like this money flows report in the WSJ's Market Data Center.  It seems like a pretty raw supply/demand technique but I'll have more to say about it after I've studied Birinyi's own money flow methodology.  He also uses a cyclically adjusted P/E to make buy/sell decisions and call market turning points.  I've been wrong when I've tried to call market turning points so I'll check out his system.  I agree with him that technical analysis doesn't work, but some speakers here will swear by it.  Laszlo lamented that investors today are on their own because institutional money managers don't read, think, study, or practice.  He said other money managers never asked him how he outperformed because they thought he was just lucky.  I witnessed all of that behavior inside investment firms where I worked.  I want nothing to do with those people.  

Next up was Doug Roberts' Channel Capital Research speaking on the QE-driven rally.  Follow the Fed to Investment Success lays out Doug's thesis.  The Fed has driven down bond yields and boosted bond valuations, forcing investors to take on more risk.  QE3 is different from previous rounds because of its indefinite size and duration.  Hew drew a brilliant analogy with markets in the 1930s, where low to negative real interest rates and violent bear markets in equities destroyed investors.  The oil shocks of the 1970s had similar effects, where inflation rose and equities dropped.  Accommodative Fed policy can last longer than rational investors can expect.  Crises and shocks can always surprise policymakers.  Mean regression will penalize long-term returns.  I asked Doug what could cause a run on the US dollar by foreign investors.  He answered that a Middle East conflict could cause autocratic leaders to take power, or that China's internal conflict between its military leaders and its Western-educated business elite could become a power grab that sparks open military conflict.  His basic analogy was with political turmoil in Germany in the 1930s.

Ronald Muhlenkamp, the patriarch of Muhlenkamp, gave his first talk on natural gas an an energy game changer.  I'll cover his second talk farther down this article.  He noted that natural gas at $3/mcf equals coal's price.  Natural gas has always been a local commodity because it can't be shipped economically without being compressed into LNG or constructing pipelines.  He gave an example of how the shale gas boom is lowering consumers' commodity charges on home heating bills.  The cost spread of crude oil versus natural gas is currently too wide to be sustained.  Changing the fuel mix of over-the-road trucks to NG will lower the price of diesel fuel.  Steel plants now use NG as a feedstock.  Comparing NG to other energy sources reveals that it takes seven or eight wind turbines to equal the energy output of one typical NG well.  He also noted that NG wells have a much lower acreage footprint that solar or wind installations.  Ron said that coal has gotten a lot cleaner and US carbon emissions are now below the levels specified in the Kyoto Protocols even though we never ratified that treaty.  Other Kyoto signatories are still above the limits.  Ron said that the concerns about water use in NG fracking are overblown because using 1M gallons on 40 acres is the equivalent of less than an inch of rain on said property.  He mentioned that T. Boone Pickens' Clean Energy Fuels is building coast-to-coast NG filling stations for long-haul trucks.  I asked Ron if the Henry Hub price is a decent proxy for world NG prices.  He said not necessarily because NG prices really are discrete by region.  Ron closed by saying that he likes Sam Walton's book on retailing because that's how the guy got rich as a middleman; as a purchasing agent, he delivered goods to markets more cheaply.  I guess that's the analogy with NG distribution.

I listened briefly to a presentation on managed futures but departed because I'd heard the main points before, and I even gave a pitch like this once when I was a licensed broker at a large firm trying to sell a managed futures product.  The CFTC has regulations governing futures commission merchants (FCMs) and introducing brokers.  Alfidi Capital doesn't fall into either of those categories.  The CME Group is a popular market for futures traders.  I don't trade futures.  I believe futures are only relevant for businesses that want to hedge against adverse price movements for commodities they produce or transport.  Turning the futures market into just another casino for retail investors is IMHO an exercise in futility.  How deep is a given futures market's liquidity?  Can an investor really unwind positions instantly?  What is the counterparty risk?  I'll look for answers to these questions in a future blog article, with the sad case histories of Long Term Capital Management and MF Global as examples of what can go wrong.  Oh yeah, one more thing on managed futures.  Reg FD on selective disclosure pretty much eliminated the ability of actively managed futures to generate alpha.

The Forbes columnist roundtable was a fun panel, primarily because bond guru Marilyn Cohen was on it.  The panel seemed to hold a consensus that the Fed's tapering is inevitable.  IMHO the Fed is already losing control of the long end of the yield curve.  The panel hinted that this is happening by noting big drops in the value of long term bonds and mortgage REITs.  Every panelist had their own approach to ideal portfolio construction but Marilyn likes split-rated bonds (i.e. bonds where rating agencies differ on the ultimate rating, implying the bond may be undervalued) and individual junk bonds from firms that have pricing power.  She also thinks the Detroit bankruptcy will be a seminal event for the muni bond market, predicting the case will go to the US Supreme Court and contagion coming to other states' bonds.  The stock picking columnists on this panel mentioned stocks that are driven by consumers' disposable income.  Those are stocks I avoid.  They also mentioned some new spinoff ETF (maybe Guggenheim's CSD, I didn't catch the ticker), which is another thing I'll avoid because spinoffs are the result of active decision rules and don't belong in a passive index.  One panelist said that some large gold miners tie their dividends to the price of gold.  I didn't know that, but it makes some sense because the price of gold determines how much cash miners can get for their metal.  The panelists discussed their sell disciplines.  They all have price level rules except Marilyn.  Her sell rule for a bond is to sell upon discovering any accounting discrepancy in the issuer, any private equity buyout attempt of an issuer (because the target issues new bonds that denigrate the existing bondholders' interest coverage), and any denigration of yield when rolling down the yield curve.  Marilyn Cohen is brilliant, and I told her so after the panel was over.  I heard her speak at the first MoneyShow I attended in 2001 and she's as sharp as ever.  I respect her because she understands fundamental drivers of a bond's value.  Marilyn shared a couple of her corporate bond picks and said bondholders don't like share repurchases because those actions divert cash flow from potential bond interest payments.  The panel let the audience chew on the arbitrage potential between GDX and GLD by going long miners and short paper bullion.  It's not a perfect arbitrage because it's an apples-to-oranges comparison, but it's a useful mental exercise in demonstrating that the price of gold has outrun the profitability of gold miners.  Marilyn's final zinger was to say that I Savings Bonds are a bomb due to lack of inflation, but even she is skeptical of the US government's reported inflation numbers.  Just wait, Marilyn, because when hyperinflation really takes off those I-Bonds will be even worse bombs.

I got to hear more from Marilyn Cohen when she held her own seminar on remedies for situations when management disregards bondholders.  Check out her work at Envision Capital Management.  Marilyn reiterated that M&A and spinoffs affect bonds, and that accounting improprieties are sell triggers for corporate bonds.  Acquirers issue bonds to fund their takeovers, but a failed acquisition makes these newer bonds less desirable than older bonds.  Private equity buyouts hurt existing bondholders if they don't have covenants with change of control provisions in their bonds.  She said the median equity in private equity buyouts is 40%, and any less means existing bondholders suffer.  She warned us all to stay away from covenant-light bonds and to read prospectuses for covenants.  Bond indentures with change of control provisions ensure that your bonds are taken out at a premium to par.  High coupon bonds deserve attention in buyouts; she sells them upon a buyout's announcement.  Bond clawbacks can happen if an issuer has the right to buy back a percentage of bonds issued.  A clawback action is more typical of junk bonds and not so much for investment grade bonds.  Buyout targets take on the acquirer's bond rating.  The bond indenture will describe the make-whole provision of any potential clawback offer.  Bond buyers must beware of these clawback provisions!  Marilyn also advised us all not to buy bonds in private equity companies themselves, because they use those bond issues to pay themselves dividends.  She also told us not to buy pension obligation bonds, because they're taxable.  She wants us to stay away from general obligation munis issued in problem areas (I'm thinking Detroit, Stockton, etc.) or that need appropriations.  She really likes senior lien airport revenue bonds, personal income tax (PIT) bonds, sales tax revenue bonds, and water/sewer bonds.  She also likes bonds of companies that just emerged from bankruptcy because they have clean balance sheets.  Way to go, Marilyn!

I attended Ron Muhlenkamp's second seminar on the squeeze effects of taxes and interest rates.  When someone impresses me, I elect to learn everything I can from them.  He noted that government has never collected more than 20% of GDP as taxes; please refer to Hauser's Law for confirmation.  If the federal deficit grows less than GDP, the debt-to-GDP ratio gets healthier.  Ron also gave us a hint on how frugal lifestyles beget wealth.  He said buying used cars helps you get rich, and one should never borrow to buy a depreciating asset.  I'd caveat that by saying that a depreciating asset that generates cash flow may be worth the debt needed to buy it.  Entrepreneurs who buy taxi cabs, dump trucks, limousines, or hearses should at least calculate the NPV including the periodic negative outlays for debt repayments.  Ron noted that higher taxes won't cure the federal deficit because people will just work less.  Defined benefit pension plans will bankrupt employers.  I'm pretty sure I blogged about that at some point and that's why I read balance sheets to identify underfunded pension liabilities.

I attended Marilyn Cohen's second seminar on how the bond crisis is moving at glacial speed.  Like I said before, I pay attention to people who know what they're talking about.  She borrowed the term "Global Thermonuclear Devaluation" from finance guru Mark Grant to describe what happens after QE.  The best thing Marilyn did for her audience today was to share a method for minimizing taxes.  The Affordable Care Act's tax on capital gains from high earners is unpopular but bondholders can amortize premiums to avoid it.  Amortize the premium of a taxable bond by taking it as an annual deduction on your income tax returns, rather than using it as a capital loss at maturity or sale.  The Form 1099 from a brokerage will show the adjusted cost and premium only for the last year an investor owned a bond.  Amortizing it annually will reduce the ACA's tax.  Competent CPAs know how to calculate this amortization.  I think the risk in this approach lies in the ability of the IRS to change allowable amortization on a whim.  Marilyn thinks it's unique that all new bond issues are at premiums now because ZIRP keeps short term rates at zero.  You'll never find bonds at par or discount anymore because of ZIRP.  She thinks Payment-In-Kind (PIK) bonds are horrible because the issuer (usually distressed) can keep paying in PIKs like an eternal Ponzi.  She noted that even private equity firms are now issuing PIKs.  Which ones?!  I don't think I want to find out.  She admonished us to get more selective on munis, because Detroit really has changed everything.  Many other muni issuers are just as troubled.  Investors in general obligation (GO) bonds may become unsecured creditors.  She said any bonds whose revenues rest partly on federal grants are risky, with Build America Bonds (BABs) as a prime example.  The BAB indentures state that they can be called at par if the federal government cuts its subsidy.  Sequestration puts all grants and subsidies at risk.  She thought GARVEE bonds for highways were usually safe, until now.  The Treasury Offset Program (TOP) can withhold money from these bonds' repayments.  The federal assistance built into some munis is part of Marilyn's glacial crisis picture.  She disparages "yield hogs," investors who just chase high yields with no concern for covenant risks.  I saw a variant of the yield hog breed in some writers who extolled the value of high-interest savings accounts in Cyprus before that country's banking system went into lockdown.  Marilyn thinks California's high speed rail project is a boondoggle and that's part of the reason she now prefers revenue bonds; GO issues are funding useless projects.  She likes "intercept bonds" but I don't think those originate with California issuers.  Marilyn uses Investing In Bonds for research and thinks everyone should use it too.  Okay, I sure will.

That's the exhaustive summary, with pithy italicized Alfidi Capital commentary, of all the seminars I attended.  I already blogged about John T. Reed's MoneyShow seminar because it was too good to delay.

I want to impart a few more random but related Alfidi Capital observations before I wrap up this report.

#1) I am really starting to suspect that oil and gas royalty trusts belong in tax advantaged accounts but I need to look into some rules to be sure.  The payouts from a royalty trust include both return of principal and additional yield.  Eventually the principal will be zero as wells deplete.

#2) IMHO rising real interest rates will eventually crash the value of bonds (particularly Treasuries) that banks hold on their balance sheets, destroying their capital adequacy ratios.

#3) Pension liability analysis must be part of any public company valuation.

#4) The normal interest rate for a 10-year Treasury may very well be its average since 1962, which is 6.58%.  The impact of a mean reversion to this figure from where we are now will be hugely adverse for stocks, bonds, and housing.

These four observations, plus everything else I learned at the MoneyShow San Francisco 2013, play a huge role in how I invest my own money.  I'm totally convinced that the investing public is better off for reading my synopses of investment conferences and that my own seminar added tremendous value to MoneyShow 2013.  I'll see you again next year.  

The Haiku of Finance for 07/28/13

Hard asset basket
Multi-prong inflation hedge
Never out of style

The Limerick of Finance for 07/17/13

Fed can't keep inflation away
Spike in real rates can't be kept at bay
Debt investors beware
So much risk is out there
Hard assets await their big day

Fixed Income Facts and Fancy When Staring Down Inflation

An acquaintance got me thinking about the fixed-income universe.  I haven't thought about it much lately for good reason.  Fixed-income investments are wiped out in high-inflation economies and the Federal Reserve's implied policy of monetizing US sovereign debt dramatically increases the chances of high inflation.  The fixed-income universe is much broader than sovereign debt.  I ought to see if any income-generating instrument can survive high inflation.

The Dividend Yield Hunter lists multiple categories of fixed-income instruments that go way beyond bonds.  I was not aware that exchange-traded debt existed in forms other than preferred stock (not really debt, but acts like it) and funds.  The Tennessee Valley Authority, for example, lists its bonds on exchanges for the public to trade (TVC and TVE are examples).  The usual cast of characters like MLPs, royalty trusts, and REITs round out exchange-listed offerings.  I've never considered business development companies (BDCs) as fixed-income investments because they are unique ways to invest in undercapitalized small companies, sort of like VC firms but publicly traded.  Dividend Yield Hunter lists BDCs as fixed-income, presumably because they must pay out their earnings like other pass-through entities.  BDCs are also searchable over at QuantumOnline, and that site also lists exotic things like income deposit securities.

Fixed-income investing is a fine stabilizing element for a diversified portfolio in normal times when interest rates are at their long-term historical average and the national debt-to-GDP ratio is manageable.  Americans are not living in normal times any longer.  Most fixed-income investments will see their principal destroyed when high inflation reduces the dollar's value to nothing.

These are the types of fixed-income investments I have decided to avoid due to their vulnerability to inflation.
US sovereign debt of any kind.  The Fed is going to swallow these things whole when foreign central banks sell them in a panic.  The QE needed to absorb the world's outstanding stash of Treasuries will have to be monstrously huge.
Coupon debt of any kind.  This includes any corporate debt or municipal bonds that pay a fixed coupon based on the bond's face amount.  That face amount will be worth less than nothing after hyperinflation ends.  Say goodnight, internotes.
BDCs.  I don't care how generous the cash flow from repaid loans looks right now.  BDCs are highly sensitive to short-term interest rates and real rates will skyrocket at the onset of high inflation.  Their funding is unsecured, which means investors have little recourse to recover assets after bankruptcy.  No thanks.  Finally, their assets are loan portfolios.  High inflation is a debtor's dream come true because it allows them to pay existing debts with future dollars that are worth less than current dollars.  Inflation will destroy BDC loan portfolios.  These are the crucial differences between BDCs and other private equity vehicles.
High yield debt.  No way, ho-say.  This was the first debt category to crack when the market turbulence of 2007 became the crisis of 2008.  Junk bonds are always the first to be wiped out in any market downturn because their issuers have weak earnings or troubled business models.

These are the types of fixed-income investments I am open to considering, given the caveats mentioned.  Their common denominator is their basis in a hard asset sector.
MLPs.  I like pipeline MLPs as a play on hard asset servicing.  Oil and gas are energy hard assets whose demand will be price inelastic during high inflation.  My concern is whether FERC regulations will prove to be so onerous during hyperinflation that they destroy the pricing power of MLPs and their pipeline operating companies.  I cannot rule out regulatory risk with pipeline MLPs.  I may have to wait until renewable MLPs are active.
Royalty trusts.  These are collections of orphaned oil and gas wells whose owners do not need to spend capex to upgrade them.  They pass their earnings through to trust holders as the wells' reserves run down.
REITs.  These are the trickiest to consider.  Some residential REITs will fair poorly during hyperinflation if their holdings are concentrated in urban areas that are hostages to rent control ordinances.  Those will not retain their pricing power during hyperinflation.  Commercial REITs will fare better but many REITs own a mix of properties.  The best sector bet for me may be iShares Dow Jones US Real Estate (IYR), an ETF of REITs, but based on its dividends it's currently trading more than twice what it should be worth.

I feel like restating my enmity for actively managed funds of any kind, including fixed-income.  Bond mutual funds are no longer needed now that index funds and ETFs exist.  Active management of fixed income portfolios is for institutional investors and corporations who must immunize their portfolios against interest rate moves or match durations to liabilities.  They have specific goals in liability-driven investing.  The larger investing world doesn't need to constantly fine-tune a fixed-income portfolio.

I must also reiterate my disdain for the superficial analysis some fixed-income investors use to evaluate the attractiveness of securities.  I've heard some investors claim that MLPs and REITs trading for less than book value are bargains, but if those same entities have low ROEs then there's a reason they trade at such discounts.  The market is discounting their ability to generate cash flow because a low ROE indicates they use capital inefficiently.  They may be paying too much for debt because of past negative credit events or committing capital to operating payouts (like lawsuit settlements or regulatory fines) instead of facilities maintenance or improvements.

Finally, it's worth noting that rising volatility hurts the valuations of fixed-income investments.  The VIX is currently trading below its historical average of about 20.  Any rise in the VIX hurts fixed-income securities, with or without hyperinflation.

I'm staying the heck away from fixed-income investments.  I'll keep my eye on only those few types that generate cash flow from hard assets like commodities or real estate.  

The Haiku of Finance for 02/23/13

Currency warfare
Hard asset economy
Likely victory

The Haiku of Finance for 02/05/13

Inflation trap set
No exit as prices rise
See scarce hard asset

Just How Lame is Wall Street on Hard Assets?

I see it day after day.  Financial headlines talk up money managers who plan to rotate from bonds back into stocks.  The eventual end of the bond bubble means the easy money for fixed income managers demands a career re-think but the quality of Wall Street thinking leaves much to be desired.

Stocks are high partly because low borrowing costs enable easy corporate credit for capital spending, but too much expansion will be poisonous when the recession hits again.  Stocks are also high because low interest rates encourage American consumers to charge more unnecessary purchases onto credit cards they'll never pay off.  The same factor driving the bond bubble has also inflated stocks.  Exchanging one bubble for another isn't very bright.

Smarter portfolio managers would look for value in hard assets but I don't see much of that happening.  I periodically meet with representatives of a few family offices and private partnerships at San Francisco investment gatherings and they seem to be the only ones thinking outside of the box on asset class selection.  This is why I don't give advice on investments; no one ever listens to me anyway and most people aren't worth the time it would take to speak a couple of words.

The lack of general interest in hard asset plays means beaten-down stock prices will finally give me the entry points I need.

Updating The Alpha-D for 12/26/12

The stock market was on a reduced hours schedule on Monday and I didn't make any portfolio adjustments until today.  I figured even my brokerage's computers need a break for a few microseconds.  Here's what I did with my money today.

My short covered calls on GDX expired unexercised, so I renewed them.  I'm willing to risk seeing that long position sell off if it breaches the strike price.  Gold of any kind will prove to be a poor hedge by itself against the inflation we'll see at some point in the U.S.  A position in gold stocks is probably okay as a cash-generating hard asset position, but I am considering other hard assets to add to my holdings.

I also sold short some cash-covered puts under GDX.  Given that security's recent decline in price, I wouldn't mind picking up some more near its 52-week low.

I made no changes at all to my positions in FXA, FXC, and FXF.  I will continue to hold the currencies of countries with well-managed fiscal policies and non-inflationary central bank monetary policies.  I am particularly encouraged by recent public statements of the central banks of Australia and Canada.  Those countries will probably stay on their low-inflation courses while the euro and U.S. dollar fall apart.

I am not at all interested in dollar-denominated fixed income holdings.  Inflation will destroy cash, CDs, and bonds but that's what the Bernanke Fed is trying very hard to do.  I will commit cash to equities in energy, resources, and related hard asset sectors when I see some bargain prices.  That's all for this month.

The Haiku of Finance for 11/26/12

Hard asset wisdom
More than debt and equities
Real things over cash

Alpha-D Update for 09/24/12

Let's make this as quick as possible.  My GDX holdings rose through the strike price of the covered call options I wrote last month.  I bought some back and let some go.  Gold stocks are rising again thanks to QE3 hurting the dollar so I'll be trimming my position as it rises.  Remember, gold and other precious metals  respond positively to the beginning of hyperinflationary periods but they are poor long-term hedges against the entirety of a hyperinflationary period.  That means I'll be looking to buy other hard asset equities pretty soon.

I sold off the last of my FXI, just as I said I would do for the past few weeks or so.  My FXI holdings have greatly diminished since I opened the position a couple of years ago, and they did quite well much of that time.  I have since come to my senses on the China story now that their economic figures are pretty much known to be fabrications.  I won't return to any more non-U.S. indexed equity investments for the foreseeable future.  The world's biggest economies have not decoupled and they'll all head down the slope together, at some point.

Here's how the Alpha-D looks right now.  I'm long GDX, FXA, and FXC.  I tried to renew the short option positions that expired for those two currency ETFs (and also FXF, which I'm not holding right now) but the orders wouldn't execute.  I couldn't even write short options on GDX.  What is up with that?  I'll try again tomorrow.

My pile of cash awaits deployment after the inevitable crash.  If I'm lucky, and the market crashes before the Fed and Uncle Sam launch their coordinated wage-price spiral, I may be able to buy U.S. equities at lifetime low prices.  If I'm unlucky, and hyperinflation hits first, I'll buy a basket of hard asset equities I've been tracking and hang on for the ride.

BTW, you may have seen an excess of haiku and a dearth of analysis on my blog for the past few months.  I am heavily engaged with several other projects that have come to dominate a huge amount of my time.  You'll just have to deal with what I publish until I'm finished doing some important work.  I'll tell you all about it when I'm done.  I promise.  

Alpha-D Update for May 2012

Here it is again.  My options from last month all expired unexercised.  It's always nice to hang onto cash earned from conservative hedges.  I have renewed my covered calls on FXI and GDX to expire next month.  I also renewed a short cash-covered put position under GDX, which I am increasingly likely to do as the price of GDX keeps dropping.  I realize I'm risking having more shares of GDX put to me but I don't mind doing so if they're getting cheaper.  A bigger pile of a hard asset ETF is one thing I wouldn't mind holding as the U.S. approaches hyperinflation.

I mentioned recently that I'm strongly interested in adding natural resource MLPs to my portfolio as a hard asset hedge against future hyperinflation.  I still plan to do so at some point but I'm much more skeptical now that using ETFs of MLPs is a viable way for me to do so.  Those ETFs have some odd ways of recalculating their daily NAVs that have the same effect as using leverage.  I hate leveraged ETFs and want to stay as far away from them as possible.  I may just go for a few reasonably priced MLPs and their associated operating companies (i.e., pipelines).

I'm also still looking for long positions in currencies of countries with low debt/GDP ratios and high transparency.  If I can't find correspondent banks in countries such as Australia, New Zealand, and Canada then I will need to look at currency ETFs.

I also wonder whether an agribusiness stock will perform adequately as a hard asset hedge.  People still need to eat even if the domestic currency they use to buy groceries is depreciating.  Maybe owning a farm or  even a backyard greenhouse is a substitute for such a stock; the big difference is that I would literally eat the yield.

My remaining California muni bonds mature in about a month.  I will not replace them with any fixed income instruments at all, although I would consider the sovereign debt of the three countries I mentioned above if those bonds were available to U.S. investors in their pure individual forms.  I am still not sure whether an ETF of TIPS will keep up with a hyperinflating U.S. dollar until I finish analyzing the fine print.  I do give myself a lot of homework but it's worth my time if it protects my net worth from chaos in the U.S. economy.

Nota bene:  I am not a financial adviser, planner, or counselor.  Please bear in mind that the above discussion is not any kind of financial advice for investors.  Like I've said in my legal disclaimers, nothing I say in any of my materials constitutes investing advice.  I do not tell other people what to do with their own money.  Enjoy my discussions as a form of entertainment.  

The Haiku of Finance for 04/28/12

Seeking MLPs
Hard asset pools with a yield
Can grow with prices

Updating the Alpha-D for April 2012

Here's my quick update.  My covered calls on FXI and GDX expired unexercised.  I renewed them.  My short puts under GDX hit their strike price and were exercised; I'm now the proud owner of more GDX.  I'm trying to keep my gold (GDX) allocation at about 7% of my net worth.

A couple of my California muni bonds are maturing soon and a couple more mature later this summer.  I will not replace them with more munis.  Like I've said before, things related to hard assets and forex are probably more suitable for me as asset protection tools.

I still have plenty of cash.  I am watching the renewed recessions in Spain and the UK with interest, wondering when their troubles will trigger the end of both the eurozone and the global equity bull market.