Critiquing Some "Sovereign Investing" Concepts

A fellow private investor asked me today for my assessment of the following portfolio ideas for a hyperinflating economy:

- Physical gold and silver
- Agricultural commodities
- Cash-rich large-cap stocks

Those ideas were mentioned in today's edition of "The Sovereign Investor" email from Eric Roseman.  Here's my critique. Physical gold and silver don't come in small denominations.  They will be quickly depleted in a barter economy.  Try dividing a gold brick into spare change at the grocery store and you'll see what I mean.  Gold and silver have to produce some kind of yield - like dividends from mining stocks - to be practically useful. 

Foodstuffs make excellent stockpiles of hard assets for hard times.  I have many shelves full of canned goods and will keep adding to my pile.  I would have to take a serious look at agriculture-related stocks' fundamentals (five year ROE, etc.) to complete this part of the portfolio. 

Cash-rich large cap stocks can be deceptive; it all depends on what the balance sheet is hiding.  GE was cash-rich in 2008 but took TARP money to avoid a bailout.  Investors would have to sift through a cash-rich company's financials to figure out just how quickly that cash would be depleted if hyperinflation pushed up raw material costs faster than the firm can raise prices. 

It's not bad advice in general because it covers several asset classes that are mostly non-correlated.  The key is to translate these things into forms that are fungible and allow investors to pay for their daily existence without depleting their portfolios. John T. Reed's book on hyperinflation is a much better guide to assembling a portfolio. 

Full disclosure:  Long GDX with covered calls. 

The Haiku of Finance for 07/12/11

Irish bonds are junk
Moody's keeps it negative
Crunch time on the isle

U.S. Won't Take IMF's Medicine

The IMF is notorious for requiring recipients of its aid packages to undergo draconian austerity measures.  Imposing similar measures upon the U.S. might actually be effective in reducing the country's debt.  Alas, the U.S. has little appetite for anything but political theater and empty gestures.  Would-be debt reducers are unwilling to tell the American people that their debt-driven party is over.  They'd rather just pretend to cut deficit spending and push their luck to see just how much uncertainty the bond market will tolerate. 

My fellow Americans need to know that delaying their inevitable reduction in living standards will only make said reduction more harsh and sudden when it comes.  European leaders are finally coming to terms with the inevitable consequences of delaying Greece's insolvency and debt restructuring.  The sooner we come to terms with our own country's need to quit the debt binge, the faster our prosperity can return. 

The Limerick of Finance for 07/10/11

Both sides want to make a debt deal
Resolving this does have appeal
But without massive cuts
Any deal would be nuts
Phony "savings" will never be real

IMF Wants U.S. To Extend And Pretend

Mme. Lagarde is wasting no time settling into her new job as head of the IMF.  She wasted no time unpacking her office move-in before brokering Greece's adhesive bandage version of a bailout.  Now she does her part to endorse the mounting elite chorus singing the siren song of sovereign debt.  She wants the U.S. to get its debt deal done so it can keep borrowing into bankruptcy.

Her concerns are well-founded, at least in mainstream elite thinking.  The U.S. sovereign credit rating is currently the most stable in the world, so any uncertainty over its ability to pay its national bills will destroy the global bond market's confidence in any and all sovereign debt.  The short term impact of a bond market crash would be an immediate spike in interest rates, including LIBOR.  Mme. Lagarde is probably well-aware of the number of European banks that would be destroyed by an interest rate spike.

Their is no escaping contagion in global bond markets.  Any sovereign default anywhere will knock over dominoes on both sides of the Atlantic.  The crash is inevitable.  Timing it is impossible.

Just Say No To Groupon's IPO

The Web 2.0 phenomenon is approaching its apotheosis.  Sometime between now and the next eurozone debt crisis - like another two months or so - a bunch more  Web commerce businesses are likely to go IPO or get bought out.  Groupon is one of them.  They remind me of Netscape in 1995, which had a hot IPO based on first-mover advantage but had no durable competitive advantage that could keep competitors away.  Groupon's competitors see a similar opportunity and are lining up to be the next big thing in merchant services. 

The new competition is a boon to merchants, who will now have multiple channels for reaching out to customers with shopping incentives.  It's ultimately bad for Groupon and all of its copycats because they'll end up copying each other's "services" to seek differentiation.  That means they'll end up competing on price, because there's no way they can build brand loyalty without an emotional component in their customer service.  That emotional hook is how all of those worthless Wall Street wealth management firms survive despite the universal similarity of their product lines. 

Here's a prediction.  The IPOs of these online coupon aggregators will tempt larger online megaportals like Yahoo and Google to buy them out at unwarranted premiums just to get a "presence" in this "space."  You have to love the lingo these kids use nowadays.  The whole trend will turn out the way GeoCities did for Yahoo.  Remember GeoCities?  I sure do, because I built my first website there in 1998.  It cost me nothing, and that's ultimately what GeoCities' business model was worth.  Nothing.  Yahoo bought GeoCities for $3.57B in 1999 and shut it down ten years later.  The same fate awaits most of these online enablers of merchant gizmos.  The founders will do quite well; hence the scramble for media attention at this stage. 

People desparate to make a quick buck will line up to buy hot Web stocks.  Just a few headlines in investment magazines targeting the harried middle class will do the trick every time.  Mutual fund managers chase the same hot trends.  Nothing has changed since the dot-com era. 

France Defeats Itself With Stupid Fracking Ban

Frenchies are hilarious.  Their banks bought billions of euros worth of worthless Greek debt and can't admit the massive losses they're about to take.  Meanwhile their government is very concerned about the mostly imaginary environmental hazards of fracking in oil exploration.  France's new ban on hydraulic fracturing ensures that Frenchies' energy needs will be held hostage to instability in Libya and elsewhere indefinitely.  This is just too darn bad.  The Paris Basin's geology resembles that of the U.S.'s oil-rich Bakken Formation and may hold very large amounts of shale oil.  Frenchies are handcuffing themselves by eliminating a very successful exploration method. 

The U.S. isn't that dumb (not yet anyway, although arguably we can give the rest of the world a run for its money in other categories of stupidity).  The Niobrara Formation has plenty of shale oil and natural gas.  Fracking is the only way to get at it.  Explorers are plenty busy in Wyoming to bring this trapped energy to you and me.  If I owned some shale-rich land I'd love to let wildcatters go fracking all over it in search of oil. 

Futures ETNs Have No Future With VZZ

One of my previous employers, Barclays, had to learn the hard way that there are limits to financial innovations.  The firm had to redeem an iPath ETN based on index futures because its market price fell below a predetermined share redemption barrier.  The thing about constructing a passive note around futures contracts is that they have to be constantly refreshed to keep the note's holdings consistent with its prospectus.  Equity and bond ETFs need refreshing too, but futures notes require leverage, and that's what kills them. 

The note's symbol VZZ is appropriate for the fizzing sound this product made as its price declined.  It also represents the sound escaping the lips of an investor who gets increasingly angry watching this product's performance.  The good news is that ticker VZZ will soon be available for use.  Perhaps another enterprising asset management firm with know-it-all quants will come up with a snazzy new product that will lose money. 

The Haiku of Finance for 07/06/11

China dries up loans
With more junk bonds in Europe
Bad time to borrow

LTL Rate Hikes Become Self-Fulfilling Prophecy

The mainstream analyst community gets it almost right on the upward trend in LTL trucking freight rates.  Sure, it's easy to forecast freight rate hikes when an industry leader like UPS raises its rates by 6.9%.  It's intriguing to note that competitor ABF Freight Systems just raised its rates by the exact same amount.  I disagree with the analyst community consensus that rate increases are due to tightening capacity.  They're missing a few things. 

In ABFS's case, the UPS rate increase gives them the cover they need to try to return to profitability.  ABFS has had negative net income since 2009 and this rate increase may be their best shot at a positive quarter for a while.  The U.S. trucking industry as a whole will soon feel the effects of a slowdown in goods orders; read my last blog post on shipping for a prelude of what's coming.  LTL truckers who raise rates are trying to squeeze whatever extra dollars they can out of this economy before GDP growth slows markedly in Q3 2011.  I can't say I blame them. 

Full disclosure:  No position in UPS or ABFS. 

Ocean Rates Falling, Falling, And Falling

The hard ride up in commodity prices is very probably going to turn into a hard ride back down (until long-term scarcity forces them back up, of course).  Thank the Fed's quantitative easing for pushing hedge funds to chase yield in hard assets.  Anyway, slackening industry demand for commodities is already prompting forecasters to lower their outlook for the economy.  The jumps in shipping rates earlier this year are likely to be as short-lived as the non-recovery that spawned them.  Shippers added capacity too quickly and will soon pay a huge price for their misallocation as rates drop.  We don't have to wait for these pessimistic forecasts to pan out.  Shipping lines on the Asia-Mediterranean route are already cutting back service as lower rates make them less profitable. 

I can't wait for the next downturn to hit the shipping industry.  It will give me the chance to buy some shipping stocks I've wanted for years.  I'm willing to wait a very long time for the right entry point. 

Deep Sea Rare Earth Extraction From Mud - Improbable, But Possible

China's monopoly on the production of most rare earth metals leaves the rest of the world wondering about alternatives.  Any news of big finds or revolutionary extraction methods are bound to bring early investor attention.  The latest such news is a Japanese academic study of rare earth metal extraction from the deep seabed. 

The technical feasibility of deep sea mining is not in question.  Offshore industry has been able to extend drills, scoops, and other processing equipment to the sea floor since the 1970s.  Even the former Glomar Explorer is still in use.  Technical capability to drill an ocean floor deposit is not an indication of whether such an effort is economically feasible.    One big difference between deep sea oil drilling and metal drilling is the ability of colocated natural gas deposits to force oil through a bore hole to the surface in a confined pipe.  Any offshore driller looking to turn those rare earth drill sites into profitable mines will have to consider the energy costs of sucking tons of silt from the ocean floor through at least 11,000 feet of water.  Scooping it up is certainly an alternative, but compare lifting a scoop through miles of water versus traversing a much smaller distance on land.  Miners can build conveyor systems to carry ore out of land-based mines; building a conveyor system to go vertical from the sea bed would be a huge undertaking with a host of unknowns (like stabilizing it against ocean currents).  Engineers may be up to the challenge right up until a driller's finance department figures out how much it will all cost.

Consider the environmental implications of the Japanese research project's findings.  If the silt is processed on a surface ship, where will the processor dispose of the slag?  Simply dumping it overboard is not a viable option, especially if it's been acid-leached (as the Japanese researchers claim to be the ideal technique).  Whichever country ends up granting drilling permits will undoubtedly want to enforce its environmental laws on the seabed.  The EPA will probably require slag to be brought down to the seabed with controlled action.  Operators should thus plan on doubling their estimates for an energy budget. 

Add it all up and filtering through deep sea silt looks like a lot more trouble and expense than prospecting for rare earths on land.  It's not impossible, but it needs to be profitable. 

The Limerick of Finance for 07/03/11

Stock buybacks sure look really hot
But really, they don't do a lot
They do pump the price
In the short term, that's nice
A long term plan?  That's what they're not

The Haiku of Finance for 07/02/11

Euro aid approved
First package set, second comes
I guess PIIGS can fly

YRCW Coverage Dropping Like . . . Flies On A Unionized Truck

Publicly traded companies like the attention they get from research analysts who give them formal coverage.  The thing is, you have to be a solidly profitable company with a bright future to warrant coverage.  Sadly, YRC Worldwide no longer meets that description, which is why research coverage of the firm is drying up.  Don't worry, YRCW, I'm still tracking your every move. 

Maybe the Teamster monthly newsletter can initiate coverage of the stock.  The union is already giving it a shot with media puff pieces, but they need to try harder for Wall Street to take them seriously.  The union would first have to find members eager to put down the donut box long enough to pick up a YRCW annual report.  They'd also have to start reading the business section of the daily paper instead of the comics page so they can understand why lame stocks like YRCW can experience a massive one-day run based on nothing at all. 

Here's my theory as to how this trading anomaly may have occurred.  Perhaps some hedge fund algorithm mined the market for low-priced stocks with an extremely high short interest (over 20% of float for YRCW right now).  Then maybe the fund took outsized positions in YRCW options (which surged over 1200%) in the hope of driving a short squeeze that would force up the share price for some quick gains.  Come on, I'm just guessing here.  I don't have time to look for confirmation of large institutional long positions placed into YRCW or its options chains this week, but it's just fun to wonder which hedge fund on Wall Street is dumb enough to play this game.  If Teamsters really want to be taken seriously on Wall Street, they should start their own hedge fund and try to come up with even dumber trading strategies.  It's not hard at all to be dumber than the Street. 

Full disclosure:  No position in YRCW.