China's Obvious Growth Troubles Have Non-Obvious Effects

I haven't had much to say in detail about China's economy so far in 2012.  The accumulated evidence for the end of the Chinese growth miracle is now impossible to ignore.  Overall trade volume growth is slowing.  China's export markets in the U.S. and Europe are tightening their belts and its own domestic consumers are not ready to spend at Western levels.  Curtailing shadow banking will be harmful in the short run as it will force a credit crunch on real estate developers and risk popping the urban real estate bubble.  It will of course benefit China in the long run by putting its capital markets on a more transparent footing so creditors can avoid funding malinvestment.  A trilateral free trade agreement may be in the works.  This would amount to a structural revolution for Japan and Korea, as both grew their economies from state-managed export growth, and a strategic breakout for China.  An alternative to the WTO would appeal to China as a way to exert indirect influence over neighbors who also have strong trade links with the U.S.

The temptation to completely sell out of a long position in Chinese stocks is strong given the country's obvious problems with environmental stewardship and social discontent.  The case that emerging economies eventually re-emerge from any temporary difficulties they experience is also strong.  It is difficult to accumulate wealth by running away from every sign of trouble.  It easier to accumulate wealth by staying invested in an economy with untapped natural resources and an enormous population.  The United States was in a similar position in the 19th century and turned out just fine.

Full disclosure:  Long FXI with covered calls.

The Limerick of Finance for 01/08/12

The German and French plan for growth
Aims to create enough jobs for both
But some Tobin tax
May give EU the axe
Britain will not swear them an oath

The Haiku of Finance for 01/07/12

What's up, Olympus?
Accounting fraud and big fees
Big shots may get sued

Colombia Energy Resources (CERX) Applies Coal Expertise To New Projects

The U.S. is the "Saudi Arabia of coal" with enough proven supply in the ground to last for centuries at present rates of consumption.  One of the main problems in digging it out is the high cost of operating a coal mine in the U.S.  Colombia Energy Resources (CERX) is ready to dig coal in - you guessed it - Colombia, where labor ought to be cheaper.

CERX's four properties in Colombia look attractive, and not just for their deposits.  They are close to viable road and barge links that can handle existing traffic.  The company may have to budget more capex to facilitate barge operations on the Magdalena River if it cannot benefit from the Colombian government's efforts to upgrade infrastructure.  This will help ensure it has the logistics capacity to meet its production targets for 2013.

CERX claims that its cost of production is $50/ton.  Consider that coal prices in many producing locations in the U.S. were under this threshold in 2010, and that the price of coal in the U.S. has rarely been above $70 in the past three years.  The good news is that the export price of coal from the U.S. averaged $120 in 2010.  Perhaps CERX should target export markets other than the U.S.  CERX's advantage is that its deposits contain mid-volatility coal, used to make coking coal.  The price outlook for coking coal is much more attractive, with some forecasts predicting it to sell for $226/ton in 2012.  South Korean steelmakers are willing to pay as much as $235/ton for coking coal.  The company does not yet have funding for the coking facility they plan to install in a wholly-owned energy park (according to their 10-K filed on March 30, 2011) but I give them credit for acknowledging the need to raise capital to do so.

The strongest aspect of this particular company is its management.  It is rare for junior explorers and producers in the resource sector to have an entire top management team with careers exclusively in that sector.  CERX comes closer to an ideal team than any junior coal company I have seen.  I have been skeptical of other resource companies with histories of negative net income, free cash flow, and retained earnings.  Those other companies were almost invariably run by inexperienced teams who didn't understand mining.  I am willing to be more patient with CERX in awaiting improvement.  This one is worth tracking for future developments.

Full disclosure:  No position in CERX at this time.

The Haiku of Finance for 01/05/12

California cuts
Coming if no new taxes
Good for bondholders

The Haiku of Finance for 01/04/12

Consumer watchdog
Topic of elite laughter
Rich folk make the rules

Greece Sets Its Own Hard Deadline For Default

Imagine a homicidal maniac who points a weapon at his neighbor's house and dares the police not to shoot him.  Now imagine a tiny country taking the same approach with an entire continent.  Greece is giving its friends in the eurozone exactly three months to give it more bailout money or it will abandon the euro.  Perhaps the neighborhood maniac analogy is overdrawn.  After all, the worst that could happen to Greece is immediate  forced austerity and a return to a currency with far less buying power, plus a lockout from the international bond market lasting for several years.  The damage to the eurozone would be far greater.

Greece's prospective departure from the eurozone would break a taboo against leaving the currency union.  Larger European economies would follow suit in short order; Italy and Spain are the next leading candidates to return to their native currencies.  The more important result is the immediate 50-70% debt writeoff that Greece's creditors would be forced to swallow.  European banks could no longer kick the can down the road for months on end in the hope that indefinite bailouts will continue.  The daisy chain from a Greek default, to European bank defaults, to insolvency at American banks holding European bank debt, to a failed U.S. Treasury bond auction from capital-starved American banks would be swift.  

This announcement from Greece marks the first hard deadline set by the only party that really matters - the one with its finger on a debt trigger.  The trigger-puller has a target rich environment with U.S. high-yield bonds already expected to see a rise in defaults even when interest rates remain at record lows.  The technocrats running Greece are not couching their threat in language designed to placate local politics.  They are fulfilling their Eurocentric mandate by speaking truth to power in Brussels.  

The Haiku of Finance for 01/03/12

Europe debt wild card
Money center banks at risk
Tighter credit looms

Exxon (XOM) Out Of Venezuela And Out Of Luck

Exxon (XOM) can't catch a break.  An international arbitration panel awarded it a mere $908M judgement for its loss of a $7B investment in Venezuela, and now Venezuela's national petroleum company wants the award reduced further to net out money it claims Exxon owes.  The portion of the claim that represents assets held in the U.S. will be hard to take seriously.

Exxon will most likely end up writing the whole thing off at zero.  It will be lucky to recover a penny from this given the Venezuelan government's attitude towards foreign direct investment.  The $7B represents about 2.3% of Exxon's total assets but as a charge-off it can take a hefty 70% from Exxon's quarterly net income if it hasn't already.  BTW, Exxon's earnings look unusually even for the last four quarters.  I wonder what accounting treatments make it so smooth.  It's worth noting that XOM has a P/E of just over 10, not really a bargain among supermajors when its peers mostly trade at single-digit P/Es.

The other majors who continue to do business in Hugo Chavez's playpen must think that keeping a minority stake in a forced corporate marriage is preferable to a total loss.  Socialism is stupid but Latin American despots find it useful.  Good luck to any oil company that wants to throw good money after bad in Venezuela.

Full disclosure:  No position in XOM at this time.  

Blue Sphere (BLSP) Converts Farm Waste Into Nothing So Far

Prepare yourselves for another penny stock.  Trinity Investment Research sent me a mailer touting Blue Sphere (BLSP), some Israeli company that claims to be doing something in carbon credits and bio-waste.  Claims of launching projects all over the world mean nothing without operational results to back up those claims.

They haven't filed their 10-K for 2011 so it's impossible to tell how well they're doing now.  If the previous three years are any indication, there is plenty of reason to be pessimistic.  Blue Sphere has earned zero revenue since 2008.  Their massive increase in negative retained earnings came entirely from their SGA expenses.  It is unusual for a company with a claimed orientation in a high-tech sector to have such high SGA expenses while spending nothing on R&D.

It makes no sense for a bio-waste conversion startup to pursue small-scale waste sources on farms and landfills in emerging markets.  That's why Blue Sphere's approach isn't scalable.  Large-scale thermal depolymerization plants at big agribusiness installations would work.  This small-scale stuff Blue Sphere is doing is uneconomical.  They announce "discussions" with major farms in the U.S. but have no announcements of firm contracts to operate waste conversion plants.

This turkey traded at a whopping high of $0.90/share on Jan. 21, 2011 and is now at a nickel.  People who bought this stock then have seen their investment destroyed.  This is fitting for a company focused on biological waste.  I could make a joke here but Google probably wouldn't like it.  I watch out for my brand.  That's the difference between Alfidi Capital and Trinity Investment Research.

Full disclosure:  No position in BLSP, ever.

The Haiku of Finance for 01/02/12

Generation X
Started dot-coms that went bust
Now they own nothing

(Did I already use this one?  If so, I apologize.)

Algae.Tec (ALGXY) Growing Algae For Energy

Algae.Tec (ALGXY) has designed a prototype bioreactor that uses carbon dioxide and sunlight to drive algae growth.  The algae is supposed to be harvested for conversion into fuel.  Let's walk through their technology to see if their business model is viable.

One metric ton of algae has an energy content equal to seven barrels of oil, according to this company.  One Algae.Tec 40-foot container can produce 250 tons of algae per year (they claim).  The company's projections envision a configuration of 500 containers producing 125K metric tons algae per year.  That configuration will be difficult to reliably achieve due to the space required for sunlight collection.  Algae.Tec's parabolic solar collection system requires about 1/2 of a hectare to emplace the collectors.  Their business model envisions these container installations adjacent to existing fossil fuel power plants so the carbon dioxide captured from the plant's generation can feed the algae reaction inside the containers.  How many mixed-use power plants in the world have at least 250 hectares of empty real estate around their plants for the assembly of these containers and their solar collectors?  That, and the willingness of utilities to buy adjacent land for expansion, will determine whether Algae.Tec's plan is scalable.

Consider the potential financial returns.  Oil is now priced at about $100/bbl, so one Algae.Tec container can yield (7x250) no more than 1750 bbls/yr, worth $175K/yr in gross revenue.  That's the equivalent of a small oil well.  Algae.Tec claims an all-in cost of production at around $47/bbl (perhaps lower), so one container will yield ($53x1750) about $92,750/yr in net income at current oil prices.  It's important to remember that the oil will probably have to be trucked to refineries because most coal/gas power plants don't have petroleum pipelines leading out from their facility.  Trucking small batches of algae oil to refineries will be costly, unless the company can further refine the algae oil on site directly into biodiesel.  If the final product from these cogeneration facilities is biodiesel, it can be sold directly to local gas station franchises.  The amount of algae each container will yield also depends on regular sunlight and carbon dioxide inputs.  Power plants in cold northern climates will not have year-round sunshine.  Algae.Tec's facilities will thus be most viable in places like the American Southwest.

My analysis does not include the value of other products like animal feed that can come from this process.  That can add to the net income of $92,750/container.  Algae.Tec is thinking big by planning 500-container installations that can produce a net income stream of over $46M/yr by my math, but space requirements are everything.  Their pilot plant in Australia needs to prove that the whole integrated concept can work before they pursue cogeneration and carbon capture agreements with utilities.

This stock is very thinly traded for something with a market cap over $100M, with daily volume in the mere hundreds.  The inventors of their core technology hold 78% of the stock.  That makes it difficult for individual investors to exit a long position.  It appears that their Pink Sheet listing is brand new.

Frankly, I find this stock intriguing.  Most of its initial installations will be small and geographically limited to sunny climates but the income per container is valuable to utilities that need affordable cogeneration options and carbon capture tax credits.  I'm skeptical that the 500-module configuration will work everywhere, but as long as Algae.Tec keeps its costs low and has accurately estimated its production then the concept can attract the interest of utilities.  This one actually has some promise.  Let's see if they deliver.

Full disclosure:  No position in ALGXY at this time.  

Horiyoshi Worldwide (HHWW) Tattoos Investors With Losses

Going through my old pile of Trinity Investment Research teaser mailers is always a joy.  They sent me one about a year ago promoting Horiyoshi Worldwide (HHWW), a clothing company that used to be called Kranti Resources before they rebranded the company in a forward stock split.  A reverse merger with an existing ticker shouldn't be a big deal as long as the new company is successful.

Horiyoshi has yet to experience financial success.  The company's negative net income, free cash flow, and retained earnings since 2008 are obvious for all to see.  This invaluable article from the Vancouver Sun describes the company's dealings with very questionable stock promoters.  I can only add that spending $3000 on a promotional campaign is actually pretty cheap in the penny stock world.  Mailing out these multi-page three-color brochures to tens of thousands of suckers week after week can rack up the bills.

Clothing based on the work of a renowned tattoo artist is a cute concept but positioning this apparel as a premium product may have been a big mistake.  Hoping for movie stars to wear this stuff for publicity . . . well, hope is not a method.  It costs almost nothing to mass produce T-shirts and jeans.  Cutting the price and promoting them in discount retailers might have worked but these people seem to like the glamorous Hollywood route.  It doesn't matter now.  Investors buying in when this thing was pumped have watched it drop from over a buck to around two cents.

Full disclosure:  No position in HHWW, ever.

The Limerick of Finance for 01/01/12

Financial repression may come
It limits investments for some
Debt brings us this fate
Gives us "choices" we'll hate
Failing to prepare just seems dumb

IRA Contributions And Financial Repression

Tax-advantaged retirement accounts have long been a key to building wealth for the professional class and building careers for legions of financial advisers.  The start of a new year brings broker calls from advisers urging their clients to make the maximum contribution to their IRAs for the new tax year.  That would be $5000 for 2012, which hasn't changed since last year.  A traditionalist approach to accumulating wealth emphasizes regular investments in a balanced portfolio of asset classes that are risk-weighted according to an investor's tolerance for volatility.

The problem with this traditionalist thesis is that it breaks down in times of extreme economic upheaval.  U.S. government and household debt-to-income ratios are abnormally high and neither politicians or consumers show any desire to take responsibility for paying debt down.  The capital held in custody for tax-advantaged retirement accounts - IRAs (be they traditional, Roth, SEP/SIMPLE, etc.) and 401(k)s - is a tempting morsel for a debt-addicted governing class.  There is no plan at the current time to confiscate IRA assets or force custodians to offer only government debt as an acceptable investment.  That will be of little importance in a hyperinflationary environment.  There is precedence for sustained financial repression.  Central banks in the developed world held interest rates below inflation for decades after World War II to help their governments accelerate war bond repayment.  

I don't need any financial adviser to tell me what to do.  I made the maximum allowable contribution to my own IRA today, knowing full well that the account exists at the suffrage of a governing class unfamiliar with financial restraint.  IRAs can still help a portfolio survive hyperinflation if government leaves the asset mix alone and the portfolio mix includes hard assets (stocks and funds in mining, energy, commercial real estate, and related sectors).  The good news is that our governing class is subject to Wall Street's constraint thanks to the financial sector's campaign contributions.  Asset management firms and investment banks don't want to lose fee revenue from products in retirement accounts.  Limiting IRA and 401(k) financial choices is a political football that would make Wall Street howl.  Plutocracy isn't all bad.  Mandarins need financial product choices too.