Agricultural Opportunities
September 23, 2009 by Vagabond Investors · 1 Comment
I have previously pointed out that the monetary and fiscal policy, which has been going on for decades, creates inflation. Aside from asset price inflation, which - if we are being completely honest - the richest 1% of population is after, consumer price inflation severely stresses the most vulnerable groups of the globe. The rich elite is hardly concerned about rising fuel and food prices, but the average person on the street may feel differently.
Today, I wish to address certain underlying causes of high food prices. Frequent readers will detect investment opportunities although I am not providing any investment advice.
World cereal stocks have been falling over the past few years. The current stocks for rice, wheat and corn are estimated to have fallen by 40% between 2002 and 2008. As to cyclical factors, depreciation of the US dollar against currencies of major Asian rice exporters has had the effect of raising dollar prices. The decline in US dollar has contributed to increase in the prices of soft commodities, whose prices are denominated in US dollars.
As to structural factors, rising energy prices and energy intensity of the agricultural sector have increased the cost of critical inputs like fertilizer, fuel and power. Both fertilizers and irrigation are critical inputs to the production of food. These are very energy intensive.
The diversion of cereal use from food to produce biofuel is increasing as oil prices become higher. Annually 100 million tons of food grains are being converted into biofuel. Since 2000, cereal use for food and feed increased by 4% and 7% respectively, while cereal demand for industrial purposes like biofuels jumped by more than 25%.
Moreover, since the 1990s the growth of yields have slowed significantly. In most countries, the yield gap between actual and potential is high. One reason for low food grains productivity is the low rate of capital accumulation in agriculture. However, I should wish to stress that this trend could reverse, if the bull cycle in commodities continues as Mr. Bernanke’s freshly printed dollars look for ways to making profits to their owners.
Then there are the coming economic powerhouses in Asia. Rising incomes in Asia have driven up food consumption significantly over the past decade. The demand for meat, milk, eggs and other livestock products have increased dramatically.
Food prices are expected to moderate somewhat later due to supply responses. However, presently farmers cannot get loans to even buy a fertilizer. At the same time, central banks and their agencies around the world are printing money to combat the financial crisis (which, in my opinion, they created exactly with the same measures that they are using to fight the crisis now). This increase in money supply along with out-of-balance in supply and demand should indicate classic investment opportunities in agricultural commodities in the coming decade.
I have to confess that I have no idea how long the crisis will last, but I am 100% certain that it will end up in inflation. Inflation can be created, if fiscal and monetary planners so decide. Presently, Mr. Bernanke is sowing the seeds of the next crisis. I wonder if they hired him because of his abilities to destroy the dollar or instead it.
I encourage everybody reading this post to be on the cutting edge instead of the bleeding edge of it. One of the ways to respond to his insanity may be to invest in agricultural commodities. As always, the choice is yours.
Jaakko
The Birth Of State Capitalism
July 20, 2009 by Vagabond Investors · 1 Comment
Just a year ago some of our readers were sending skeptical emails to us about our then ultra bearish (now overly optimistic) views. Today nobody is denying the on-going crisis. It seems that people have divided into two camps: the other terrified of deflation and the other arguing that inflation is the greatest danger after all.
The Way It Was Supposed To Work
Capitalism is a system where people are allowed to fail. Corporate destruction is creative in a way that the ashes of dead corporations give rise to new and better ones. Corporations and investors who over-reach themselves suffer from the consequences. Then the cycle begins again.
At least so it was supposed to be.
In reality we are witnessing the birth of state capitalism in the once-dynamic West. This is not so far from the system in China, where state-controlled banks have just raised their lending targets. The only difference is that in the West banks have ended up on top.
So Where Are We Heading?
As I have previously pointed out, inflation and deflation are not mutually exclusive scenarios. We can have inflation in some asset classes and deflation in others. Furthermore, inflation can touch different asset classes at different times. One year it could be gold and collectibles, second real estate and third stocks and wages. Highly inflationary investment environments can be very tricky.
What I find remarkable is that we are already seeing deflation in many asset classes and inflation in necessities. Just look at how much transportation, insurance, electricity, food and water cost today compared to two years ago. You’ll get the picture.
What is even more significant is that all governments are throwing money into the system. This is attractive as is burning your furniture to get heat. Initially you feel warm. Eventually the fire runs out and things get even worse. In general in crisis such as this there is a demand shortage and large overcapacity, which leads to deflation. Now the governmental natural disasters are running their money-printers at full speed with little concern to the future.
Many markets have rebounded enormously. It is healthy to recognize that the recent surge in markets was caused by excess liquidity coming from banks. Skillful traders are in a position to make sound profits now. When money is pumped into the system and large deficits are created (politicians, note) the result is volatility.
Mr. Bernanke and Mr. Geithner are not completely useless people. The people who got the money from the US government must be feeling better now. Still, it pays to remember that all that money has to come from somewhere. As Marc Faber points out, you have to borrow it, tax it or print it.
Inflation Shifts Wealth To The Rich
How long can we afford to continue doing this? Tomorrow always comes, at least up to today, and eventually the deadly consequences of heavy inflation start to show up. I’m afraid that it will be very painful to the average person out there.
The problem I have with creating inflation is that it favors special groups and further shifts wealth from the poor and the middle class to the rich. This has been the case for many decades now. I am absolutely certain that Mr. Bernanke has no intention to keep inflation away. In fact, if S&P 500 starts to go south, I’m convinced that he will step up to the gas pedal and pump even more money into the system. Only history will tell how these ultra expansionary policies will be judged. As an investor, I have to invest somewhere, so I will take advantage of it (as I advise you to do as well). As a citizen, I cringe.
The old rules of capitalism where saving was a virtue no longer apply. The new rules favor speculators and groups close to the government. For average people like you and me, it may be easier to just play by the new rules than change the whole world. The choice is ours.
It always has been.
Jaakko
Passing The Bottom Of The Stock Market?
April 20, 2009 by Vagabond Investors · Leave a Comment
Have we finally seen the bottom of the stock market? We will know better by the end of this earning season. If the news continue to get worse, but the stock market refuses to make new lows, we will clearly see the foundation of a solid bottom.
So, if you are investing for the long term and you are not interested in the movement of the following months, by all means by the index and close your eyes for six months or so. Your investment could very well deliver its promise on a long time perspective.
As we look at the charts on a weekly basis, we clearly see how the price has moved from a significantly under-valued zone to the value zone. Note that the MACD histogram, which expresses the power of the uptrend, has reached a 10 year high! This tells how the market has been wildly optimistic and willing to buy. However, the wilder the party becomes, the more likely it is that there will be a hangover. It is very possible to see the index take some breath on the following weeks. It would be a healthy to retreat to around 740 points in order to gather strength to a new marvelous rally.
The daily chart shows how the index bounced from the bottom to tingle the upper level of the channel. In order to create a positive mood for the future, the bounce would have to reach the significant level around 870 and close above it. At present, the index is clearly above the value zone, where it tends to retreat to gather momentum. The rallies of the past days have not reached new short term highs.
Even the MACD histogram, which measures the power of previous power, has failed to make new highs. Instead it has fallen whenever there is a higher new high compared to the previous ones. This simply means the deceleration of the rising power. The struggle of the upcoming weeks shall be seen between 740 and 870. The result of that will show if there is basis for further bounce. Patience in timing purchases is no sign of being a sissy. It is simply sensible thinking.
It strongly seems that the longer trend is changing, but we could experience violent volatility during the upcoming weeks when new earnings are announced and the market gathers strength on slightly lower levels. If you are a short term trader, keep your stops tight and practice very prudent risk management.
The ride will be bumpy and it will offer tickly opportunities both on the short and long side. If you are planning a long term investment, it is desirable to make multiple enters to the market over time as this strategy will calm the mind.
I wish you pleasant investing. As always, let’s plan our moves carefully before we do anything.
Best,
Matias
The Architects of Re-Inflation
March 5, 2009 by Vagabond Investors · 1 Comment
It has become a somewhat popular sport to bash the European Central Bank for not acting fast enough to save the system. Many say that the ECB should take similar actions as the Fed has. That, at least, is the common viewpoint.
What Caused the Crisis?
The widespread view is that the cause of the current crisis is this. The people and the government do not borrow and spend enough on consumer goods. Therefore the government must force us all to borrow and spend more. This is as ridiculous as it sounds. It seems that today’s best comedians are not found in the theaters anymore. They are in the economic and financial arena and, for some logic that evades me, are taken as honest people. After all, a smiling central banker should scare you at least a little.
Let us not forget that it was exactly the government and their agencies around the world who constructed the crisis in the first place. It is these people that did not know how to prevent the current crisis. Instead they provided a massive credit bubble and allowed the asset bubble to get out of hand. Now we advocate the same people who caused this mess to fix it - with the same tools they created the mess!
The Free Market Did Not Fail
It is important to recognize that it wasn’t the free market that failed. The root cause of the current crisis is the same as it has been for decades: massive credit creation and government intervention. The architects of the current crisis are found where political and monetary powers bind together today. That is in the Treasury and the Federal Reserve. I should like to point out that central bankers aren’t completely useless people. Especially in times like this, we require what only they can provide: their absence.
The Fed and the US government seem to think that the way to solve the problem, which was caused by printing too much money, is to print more money. In case it should not work out as planned, their backup plan is to print even more money.
The point is, while money creation may help on the short term, they will indisputably overdo it. While many economists see light at the end of the tunnel, it may only be the headlamp of the upcoming train.
Even every ordinary person could immediately see that when debt growth enormously exceeds nominal GDP growth, sooner or later the party will come to an end. Yet even more massive money creation is the road the government and central banks have taken to combat the problem. I suspect that it will lead to even greater problems in the future.
The Road to Ruin
I believe that most people, including Mr. Bernanke and Mr. Geithner, do not fully realize what gigantic money printing will cause. The problem will be especially acute and severe in the US because of its colossal debt burden. Since half of US federal debt is held by foreigners, what happens when they realize that the US government has no intention to pay back? You see, the US is about to repay debt with the issuance of new debt. I suppose these gentlemen do not suffer from insanity, but enjoy every minute of it.
This is as hilarious and as frightful as it sounds. I would like to stress that now is the time to take care of proper asset allocation in your portfolio. Personally I continue to like gold as Mr. Bernanke is flooding the system with money (Mr. Geithner is doing his share by using taxpayers’ money to help out his friends on Wall Street). It could be wise to protect oneself from these financial predators. To do that, it is best to keep an eye on the macro data.
You Have To Do Your Share
I am doing my best to provide you occasional insights and investment considerations. Despite that, you have to make your own financial decisions. Instead of waiting for anybody to save you, I suggest you get educated and leave gentlemen like Mr. Bernanke and Mr. Geithner do their tricks. Luckily, it is easier to adapt to and take advantage from the circumstances than it is to change the whole world.
Jaakko
(C) Copyright Vagabond Investors 2009
The Dow Is Not Normal: Here Is Why
February 18, 2009 by Vagabond Investors · 1 Comment
For those of you that like the stock market (as I do) I will ll give you a nut to crack. Many of you already know this, but those of you that are just starting out your investing career will find this interesting.
Many of you consider investing in Dow Jones. The market says that the Dow did this and The Dow did that. It is as if The Dow was a synonym for the overall stock market. If you think that that is a fairly accurate statement, hang on.
Why is it that The Dow is outperforming on the downside?
What is driving the index?
I will quote Mr. Bianco, CEO of Bianco Research LLC. In his excellent blog post entitled The Dow Is Distorted he made the following points.
The Dow Jones Industrial Average (DJIA) is a price weighted index. The divisor for the DJIA is 7.964782. That means that every $1 a DJIA stock loses, the index loses 7.96 points, regardless of the company’s market capitalization.
Dow Jones, the keeper of the DJIA, has an unwritten rule that any DJIA stock that gets below $10 gets tossed out. As of last night’s close (January 20), The DJIA had the following stocks less than $10.
Citi (C) = $2.80
GM (GM) = $3.50
B of A (BAC) = $5.10
Alcoa (AA) = $8.35If all four of these stocks went to zero on today’s open, the DJIA would lose only 157.3 points. The financials in the DJIA are
Citi (C) = $2.80
B of A (BAC) = $5.10
Amex (AXP) = 15.60
JP Morgan (JPM) = $18.09If every financial stock in the DJIA went to zero on today’s open, it would only lose 331.25 points, less than it lost yesterday (332.13 points).
If you want to add GE into the financial sector, a debatable proposition, then:
GE (GE) = $12.93
If the four financial stocks above and GE opened at zero today, the DJIA would only lose 434.24 points.
The reason the DJIA is outperforming on the downside is the index committee is not doing its job [emphasis added] and replacing sub-$10 stocks and the financials are so beaten up that they cannot push the index much lower.
So what is driving the index? [emphasis added] The highest priced stocks:
IBM (IBM) = $81.98
Exxon (XOM) = $76.29
Chevron (CHV) = $68.31
P&G (PG) = $57.34
McDonalds (MCD) = $57.07
J&J (JNJ) = $56.75
3M (MMM) = $53.92
Wal-Mart (WMT) = $50.56For instance if all the sub-$10 stocks listed above, all the financials listed above and GE opened at zero, the DJIA loses 528.63 points. To repeat if C, BAC, GM, AA, JPM, AXP and GE all open at zero, the DJIA loses 528.63 points.
If IBM opens at zero, it loses 652.95 points. So, the DJIA says that IBM has more influence on the index than all the financials, autos, GE and Alcoa combined.
The DJIA is not normal as the Index committee is not doing their job during this crisis, possibly because of the political fallout of kicking out a Citi or GM [emphasis added]. As a result, this index is now severely distorted as it has a tiny weighting in financials and autos.
Now that is something for you to think about. We have talked extensively about the impact of politics on the market as well as the bailout plan with its shortcomings. The stock market, if let alone, is one of the freest markets there are. However, everything is subject to manipulation by central bankers, politicians and the like who are easily mistaken as honest people.
I will thank Mr. Bianco for his excellent comment and give a direct URL to his article if any of you should be interested: http://www.ritholtz.com/blog/2009/01/bianco-the-dow-is-distorted/
See you guys!
Jaakko
An Inconvenient Truth: I.O.U.S.A.
November 18, 2008 by Vagabond Investors · Leave a Comment
As our frequent readers know, one of our central themes is responsibility over finances. This applies to both individuals and governments (and their agencies). While many politicians are touting fiscal responsibility, the truth of the matter is, many governments are not acting responsibly.
Many mistakes have been made on the side of central bankers, namely Dr. Greenspan and Dr. Bernanke. The most important mark of the 21st century economic history is likely to be the demise of the dollar. Such is has been their response to the cycles of economy.
This time instead of us shouting about fiscal and monetary responsibility, we let Addison Wiggin from Agora Financial explain in simple terms what is going on in the USA these days. He and his colleagues do an excellent job in their free 30 min video entitled “I.O.U.S.A.”.
We highly recommend you take 30 minutes of your life and watch it. We know, we’re the first people to tell you to be frugal about your finite time. Trust us, this is well worth it! Reuters called it “To the US economy what ‘An Inconvenient Truth’ was to the environment”. We think it’s amazing for average people like you and us.
Matias & Jaakko
The Likely Outcome Of The Crisis (Plus: Tools For Future Prediction)
November 6, 2008 by Vagabond Investors · 1 Comment
Insights are part facts and part opinions. The opinion part has to be based on facts, but an insight always has uncertainty. Despite that many people state their insights as facts, even though the future is very difficult to predict.
How is it possible to have a relatively accurate insight despite uncertainty? It helps to realize that there are two things we can use to estimate the future:
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The direction of change
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The speed of change
In our speed-addicted society most people are good at recognizing quick changes. When change happens gradually, even most experts do not see it. This is because they are still watching the daily or monthly charts. They are too close. They recognize changes in speed but they don’t identify changes in direction, when it happens slowly.
For example, what is the likely outcome of the current credit meltdown? Most academics are keen to point out that it is deflation. Prices will fall, they say. Central banks around the world are lowering key interest rates and pumping money to the market. Nobody invests in commodity production anymore. The price of oil has come down. Deflation it is, they say. We’re heading down. Right?
Hold on! Let’s back pedal. The speed of recent changes indicates just that. Asset prices have come down. What about the big picture? What about the direction of change? Let’s think about this for a while and ignore that prices may come down for a year or two.
Think five years in the future. Imagine the economy was up. China is still the largest commodity importer of the world. Picture you only knew five years ago these were the facts: decreasing supply of commodities, low interest rates, and massive money creation. What is the likely outcome?
You guessed it. It’s massive inflation! Considering what the central banks are doing now and how out of range supply and demand are with most commodities, that’s exactly what’s going to happen! I don’t care if there’s some deflation along the road. Eventually we are going to see a massive inflation wave.
The fact is that history shows that this has always been the case when money is printed at will. The fact is that supply and demand are out of whack. The opinion is that this will happen again. How valid is the opinion? Unless the law of causality is not cancelled, I would say it’s very valid.
This is my opinion of the likely outcome of this crisis. The speed may be slow at first, but the direction is clear. Hard assets are likely to come out as winners in this crisis. Personally, I believe in commodities (such as oil and agriculture) and solid cash flow based real estate with low fixed interest rates. While oil is low now, by 2015 it is likely to hit incredible new highs. On the other hand, increases is rent are mainly due to inflation.
I don’t mind high inflation. I feel for the little guy on the street who is told to save money and keep it on their bank account. While this may seem valid at first, in the end it will prove bad advice.
That’s my insight. I may be wrong. But if I’m right, will you suffer or profit?
Jaakko
PS. I would have everyone look at the comments of a legendary investor Jim Rogers.
Introducing BIG Change, Part 2: Announcing The Rules Of Tomorrow
October 17, 2008 by Vagabond Investors · 1 Comment
What did you spend money on today?
A big part of Gross Domestic Product is consumption. It means simply that you and I spend money. As people retire, they have less money to spend. This has a big impact on our GDP.
Americans may not like the sound of that, but the US may not be able to maintain the economic dynamism of the late 20th century in the 21st century. Sooner or later, wishful thinking is going to crash into financial reality. In a few years the biggest baby boom generation in history begins to retire all over the world. Do not think that you are entitled to a secure life.
Let’s think about the US. The fact is that 75 million baby boomers start to retire. Suppose each of them need $1,000 in terms of Social Security and Medicare. That becomes 75 billion dollars a month. That’s approximately the annual cost of one Iraq war – every month.
Most governments don’t have financial resources to keep their promises. Mr. Paulson will no doubt call the Fed chairman. Then in the dens of Federal Reserve Mr. Bernanke will fuel his helicopter, which he will then fly over the cities to drop money from. That is both insane and dangerous. Of course the Fed can always print money and give it to people, but it would only lead to hyperinflation and eventually the average person’s savings would be wiped out.
The fact that baby boomers around the world are reaching retirement age is a MEGA challenge for our countries and economies. It is one of the most overlooked gradual changes. The fact that it will come about in an acute way is highly predictable. It is likely to lead to higher taxes in many countries.
Politicians have reluctant to take the bull by the horns on their terms. The politicians that ultimately have to deal with this problem will take action but it will be all too late by then. They are likely to run in to desperate solutions, because nothing was done when there still was time.
Still, we as individuals are 100% responsible for our futures. As much as we would like to blame for the government, it doesn’t help. Some people have started building wealth. Some have made smart choices. Others have merely bought what their financial advisor has sold them. That is usually a 401(k), IRA or something of the kind.
It is estimated that 401(k) plans will not adequate for 80% of people who have it. In addition, inflation is eating the purchasing power of their 401(k) all the time. The plan is on the mercy of market forces. It is a very risky investment. A single market crash near their retirement could wipe it out. They may not have time to wait for the recovery.
What happens when people realize that their 401(k) has become a 201(k)?
As entrepreneurs and investors, it’s not our job to predict the future. But as always, your response to the future is on your hands. Becoming financially intelligent so that you can become financially independent is optional. You can choose to become a victor, rather than victim. Remember, to every move there is a counter.
The ONLY functional way to respond is to increase our financial IQ. There is no time to wait for the future. It’s time to learn before it’s too late.
There is a recipe to wealth. It’s easier than it sounds. We are here to help you. Help us by commenting and sharing these posts. We have held seminars, written books and taught hundreds of people the principles that we have learned. Help us share this message.
It’s not too late.
Jaakko
Introducing BIG Change, Part 1: What Is Already Here?
September 28, 2008 by Vagabond Investors · 2 Comments
Big changes do happen.
They happen very gradually. They go unnoticed. They are missed by most people who focus on weekly performance results. They are hardly noticeable until the symptoms become acute. As big changes happen, the rules of the game change. A new set of threats and opportunities arise.
Between 1998 and 2000 oil prices tripled, but nobody paid attention to it even though it outperformed Nasdaq index. Why should they? It was the New Era. Right?
The crisis in the banking sector was gradually becoming evident before it hit the markets. When Northern Rock had a bank run, not many people reacted. Even when Bear Sterns was bailed out, most people didn’t get it. Even when Fannie Mae and Freddie Mac were nationalized some people still didn’t take it seriously. It was only after Lehman Brothers went bankrupt that it really hit the last one of investors.
“What the BLEEP, the financial sector is toast!”
Yes, it has been for a long time. Don’t expect a quick rebound either.
As investors, we have to adjust our thinking. When the rules change, we have to change our thinking and actions. The best part is that big changes provide huge opportunities to become wealthy! It’s not only about surviving. It is about profiting from that change, too. To every market move there is a counter.
For example, just a few hundred dollars on put options on banking sector would have made you a load of money by now. That’s the power of seeing patterns and the courage to act on it. I admit that on this particular case it didn’t take that much visionary skills to that, but many people still didn’t do it.
Every time the rules of the game change superior opportunities to become wealthy are presented. We, the US government, central bankers or anybody else can’t stop it. There is no more powerful force than an idea, whose time has come. The waves are going to come no matter what we do. Instead of blaming, I suggest we learn to SURF the waves. It’s a low-risk idea.
We can’t control what happens in the market, but we have absolute control over our response to what happens. To every market move there is a counter. To every counter there is a counter.
So What Is Here Already?
The brief financial history of the 21st century could be summarized as follows:
1. The bursting of Nasdaq bubble in March 2000
2. Commodities bottomed out in 2001
3. The great housing boom, and the end of it
4. The end of a 20 year global equity boom
5. Credit bubble collapses
How many of these did you capitalize on? I doubt that anyone got them all. I know people who have made millions with the changes listed above, but none of them utilized them all. Still, if you’re a professional investor, don’t tell me you didn’t get any of them 
Some of these changes are under suspicion by some parts of the investor community. Many will fight hard and long before they admit that the equity boom came to an end. As to us, for you and me, it would seem to be true.
The most overlooked and misunderstood big change is the bursting of the credit bubble. It was very clearly signaled by the market when the total collapse of financial firms happened. It has changed the rules of the game big time. In my opinion, it is as important as the crash of 1929.
The old rules said that in the United States credit growth can outpace GDP growth. Under the old rules, for 20 years, three forces boosted asset prices:
1. Strong credit growth
2. Falling commodity prices
3. Low interest rates
The crisis is not nearly over yet. What we have seen is the first wave. More waves will come. The US is hit. Rest assured, Euro are will be hit too. So will the emerging markets. Many people will be stunned by the outcomes of this change. I believe that those who believe strongly in emerging economies will be staggered within a year. As a surfer would say, the ultimate wave is upon us, let’s surf!
To every market move there is a counter. To every counter there is a counter. Let’s keep our eyes open now! Judging from the blood on the streets, somebody is making a killing.
Let’s join the party!-)
Jaakko
Update - Comment on Forecast: Oil $60, Recession
September 15, 2008 by Vagabond Investors · 5 Comments
Dear Readers,
You can rest assured that the credit bubble has burst. I don’t think anybody is trying to deny that anymore. The reward of a correct bearish forecast is questionable. One can feel intellectual satisfaction for that, but the true test of one’s character is if he can refrain from saying “I told you that was going to happen!”
The r-word is on everybody’s lips. The financial sector is not keen on saying it aloud. Let’s just face the facts that we’re in the middle of an unusually large meltdown.
Mr. Edwards had a highly bearish forecast on the market. I have some reservations about his forecast. I think that if S&P 500 would approach that 500 points level, US bond yields would be far from 2%. This is because the US Government and the Fed would probably arrange large bail outs. This would boost the US budget deficit, which I believe would put the dollar under significant downward pressure. US bonds would likely go down to BBB or CCC rating. Under that scenario, I don’t think that 2% yields are very realistic.
So the global liquitity is tightening.
Do I believe that it’s going to lead to a recession? Yes. I think the result of this mess is a global slump with all asset markets hit one way or another. I would even say that the USA is in recession already, although traditional Slump-o-Meters don’t show that. For the average person, though, rising unemployment is recession. It gets very personal and very negative when you lose your income streams no matter what the GDP figures say. In my opinion, it might be time to check if traditional ways to measure recession are up to date anymore.
So what’s new? Lehman Brothers faced bankruptcy less than one week after the video post. Bank of America announced that it would buy Merrill Lynch. American International Group is in big trouble. Rumors of Washington Post bank run shake confidence. Central banks and the market have reacted accordingly – making the show even more exciting and hilarious!
Movement is lovely for the technical momentum investor. I can’t say that a put option play on banking sector was a bad idea. I hope our fellow readers profit from this volatility. It may take time before we see such great opportunities in such a short period of time again. Not to worry, though, it’s not even nearly over yet. The results of this mess are yet to be seen and are likely to surprise many people.
Now let’s see what Mr. Bernanke and Mr. Paulson are up to. I’m sure it’s a blast! As the song from Pointer Sisters says “I’m so excited and I just can’t hide it!”
Let’s keep an eye on the market. Now is the time of great wealth transfers. The collapse of the banking sector was without a doubt The-Biggest-Investment-Opportunity-Of-The-Year.
Successful investing!
Jaakko
On Oil $300, Recession, Fed (Plus: Q&A Session)
August 19, 2008 by Vagabond Investors · 4 Comments
This video on YouTube caused a flow of critical questions to me. I thought I’d answer them all here so that everyone can see the answers. Consider it another FAQ :o)
Question: Why such a critical attitude towards America?
Answer: In fact, no criticism towards American people at all. Many of the people I respect deeply are from the USA. I’m bullish on America, but I’m bearish on the dollar.
It makes me feel sick when I see certain people, namely Mr. Bernanke in the Federal Reserve, abuse their position. He’s not playing by the rules of capitalism. Instead the man is promoting socialism for the rich. He was never elected by the simple person on the street, yet the average person has to pay for that. Take the case of Bear Sterns on the video.
Question: Without bail-outs the economy would have gone into recession and that would have been bad! What do you have to say about that?
Answer: First of all, the world economy may already be in recession. The worst of this crisis is yet to be seen both (especially in the USA banking sector) and in the EU. That’s my opinion.
Secondly, the Fed is over-reacting. A five percent correction in the stock market made him lower the interest rate. What happens if the market falls by 35%?
Thirdly, in 1907 everybody on Wall Street was bankrupt. After that America emerged as a dominant player in the world economy. In the 60s almost all Japanese bankers were bankrupt. Yet after that Japan became an economical powerhouse. Let’s just accept the fact that banks tend to run into problems like this and the financial sector too can have recessions. It’s not the end of the world. It’s painful - very painful! - but it’s better to have serious dips than witness a total wipeout of the system! Right now it seems that Mr. Bernanke is deliberately destroying the US Dollar.
Question: That prediction on oil at $100 / $300 per barrel is ridiculous. What were you thinking???
Answer: Many commodities have experienced serious corrections from their peaks on this commodity boom. I would not be surprised to see oil do the same at $100 per barrel. Just watch the world economy slow down and oil prices fall.
On the long run, I believe that oil prices will go much higher. No major (elephant) discoveries have been made in 40 years. There will be a day that oil demand picks pace again. 3 billion people now want to buy cars. There could be a war on some key areas. On times like that, oil prices could hit $300 per barrel.
Question: You’re not a central banker, analyst, government official or economist. What do you think you know about these things anyway?
Answer: That’s a valid point. Fair enough. I can be wrong. I have made colossal mistakes in the past. That can happen again. The real question is not whether I’m right or wrong. The true question is, what are you going to do, if things turn out as I said? Will it be good or bad for your portfolio? I’m just asking you to think!
Question: What makes you think that the Fed would go down someday???
Answer: Just read economic history and you’ll see why. I believe history tends to repeat itself especially if same mistakes are being made over and over again.
The last one is my favorite one!
Question: Why are you speaking English? It’s obvious that it’s not your mother-tongue.
Answer: Well, simply because most of you would not understand if I made my point in Finnish. You’re right, I don’t speak 100% correct English, heck it’s not even 80% correct! Then again, most of the readers of this blog don’t either. Despite all the progress in the world, many people still speak in foreign languages :o)
There you have it.
Kiitos että luitte tämän kirjoituksen. Nähdään ensi kerralla!
(Didn’t get it? ”Thanks for reading this post. See you next time!”)
Jaakko
The Scapegoat Game: Why Speculators Are Not to Blame for Rising Commodity Prices
July 11, 2008 by Vagabond Investors · 14 Comments
I am astonished that many finance ministers and “experts” blame speculators for the rise in commodity prices – especially oil. Italy’s finance minister believes that there is a “magnum of speculative champagne” included in the price of each oil barrel. Some EU members want the union to impose tax and regulation on speculation.
It’s a shame that economic discussion has disintegrated into such disinformation and manipulation of facts. Any attempt to curtail speculation is likely to make oil even more expensive. Speculators do play an important role in setting the price of commodities. However, if they had somehow managed to push prices to unjustified heights, then demand would contract and unsold oil would be left on the market. At the moment, there is little sign of that. All big exporters are pumping as fast as they can.
The reason for the rise in oil price is elsewhere. It’s always easy to blame somebody and speculators have become the most appealing scapegoat. There is little evidence to support such blaming statements.
It should be obvious that speculators do not buy physical oil. Instead, they buy futures and options which they settle with a cash payment when they fall due. The real currency of these contracts is cash and not oil barrels. There’s no limit to the number of bets that can be made. No oil is ever held back from the market. All positions are closed out in a futures market. The impact of speculators is essentially market neutral. These bets do not affect the price of oil any more than bets on a horse race affect the result.
The market for nickel provides a good illustration of this. Speculative investment in the metal has been growing over the past year. Still nickel prices have come down by some 50% of their peak. At the same time, the prices of many other commodities have been rising almost as fast as oil even though they are not traded on any exchanges. Iron and rice are two good examples of this.
It’s not long ago that all asset classes were inflating. As I have pointed out in my other posts, now the credit supply is contracting and lending standards are tightening despite the fact that the Fed has lowered the Fed Fund rate. Over the long term, there has been a close relationship between M3 money supply growth and oil prices.
The public invests in those sectors of the economy that provide superior profit opportunities. If short-term interest rates are set below the rate of consumer price increases, paper money is no longer a store of value. What then is the difference between a hedger and a speculator is not clear to me. Under constant growth of M3, it was acceptable for people to hedge the loss of purchasing power by buying into the Nasdaq until the burst of the tech bubble. There were no complaints when the public bought homes between 2002 and 2007. Some “experts” even believed it created wealth, (although I think this is one of the most stupid statements one can make: rising equity in homes might be a good at first but the inevitable correction is usually too painful!) However, when the public moves into commodities, it’s not considered acceptable. Such are the double standards.
Excessive speculation is a direct result to the easy monetary policies by central banks. They are eroding the purchasing power of their currency and undermining the working classes for the benefit of the elite. The easy monetary conditions have hit the consumers with a commodity price surge. At the same time, it is causing a global flight from dollar assets. Since oil prices follow the growth of M3, who would you say is the biggest speculator of them all if not the Federal Reserve itself?
However, I should like to congratulate the Federal Reserve and especially Mr. Bernanke for an amazing cover story. It seems that there are academics who know a lot more about monetary theory and too little about currency markets and price signals in the real world. They are doing a proper job blaming other people for their mistakes with the easy money experiment. At the same time, I hope more people would pay attention to the real causes of bubbles and changes in the investment environment.
Jaakko
Changes in the Investment Environment, Part 1 June 19th 2008
June 19, 2008 by Vagabond Investors · 25 Comments
Dear fellow Vagabond Investors,
We have made some market and investment observations that we would like to share with you. Over the past few weeks there has been a significant change in the investment environment, which could have important consequences for the near future. Let’s take a look.
As some of you know, US mortgages are no-recourse loans. This means that lenders have no recourse to the house’s owner beyond the value of the house. Therefore, individuals with negative equity (loan amount exceeds value of the house) have an incentive to default.
A downward spiral in the house prices would cause a fall in household wealth and in the capital of financial institutions. This could lead to a deeper and longer recession than those seen in the past several decades. Many people are just becoming to realize this.
The current crisis is of course the result of governments and their agencies around the world that have created asset bubbles by keeping interest rates artificially low. This has encouraged the purchase of all sorts of assets – not just real estate and not just in the US – with high leverage. In inflated asset markets, it is expensive and difficult for first-time buyers to purchase assets without leverage. We presume that over time, the housing market, S&P 500 and other asset markets will adjust to the downside and become affordable again, or that inflation will increase earnings significantly.
The Fed fund rate was increased between June 2004 and August 2006 from 1% to 5.25%. It seems that no actual tightening of monetary conditions really occurred. Lending standards were eased and leverage increased in all asset classes. On the other hand, when the Fed cuts its fund rate since September 2007 from 5.25% to 2%, the impact of the interest rate cut was limited because of tighter lending standards from the private sector.
In inflation-adjusted terms, the sharp decline in home prices is likely to negatively affect the commercial real estate market because of tighter lending standards and declining consumption. It is our observation that whereas in the past residential and commercial real estate booms were usually local or in a specific market, at the present there seems to be a construction boom on a global scale. If this construction activity slows down meaningfully, prices could come down everywhere, although with different intensities.
Both commercial and residential property prices could be vulnerable to a significant downturn in the financial sector. This holds true in other financial centers than US as well. It is our view, though, that these changes are problematic primarily in the West, but less so in Asia.
We are concerned that investors haven’t paid sufficient attention to the problems that could arise if asset classes should decline meaningfully. This is exactly why proper asset allocation is so important. Please see our Financial IQ section for further advice and specific strategies.
We would like to underline that at the moment it would seem that both the US trade deficit and the US current account deficit are now contracting. The US current account deficit was the primary source of global excess liquidity, and it is now contracting because the US trade deficit is contracting. This is the result of weakening domestic consumption. Therefore the US dollar may have some upside potential from its current level. We are expecting global economic growth to slow down and commodity prices to disappoint in the near term.
Nothing goes down in a straight line, though. Intermediate strong rallies should be expected to interrupt the downtrends. The question then becomes, which assets would gain the most if commodity prices (especially oil) declined?
A significant slowdown in economic growth would be negative for currencies of countries that have benefited from rising commodity prices (i.e. Australia, Canada, New Zealand). Therefore, for the next few months, US and perhaps Japanese equities could outperform the emerging stock markets in commodity-rich countries. Yet we believe that the S&P 500 is somewhat overbought at the moment. Therefore significant gains should not be expected.
Declining oil prices could be beneficial for airline companies’ shares. You might want to consider Singapore Airlines, Lufthansa and Thai International. Lower oil prices are generally perceived to be a good thing in the investment community. It is our view that declining oil prices through economic weakness would hurt the entire material and metal sector. Therefore we believe that stocks like US Steel have significant downside potential.
What about the bond market? If commodity prices were to decline due to a weak global economy, it would seem rational to expect bond yields to decline. However, this is not certain. Economic weakness would be an incentive for central banks around the world to ease their monetary policy. The bond market might not like it and sell off. Of course, higher bond yields would be supportive for the US dollar.
The only reason we think that commodity prices could significantly decline is a widespread economic weakness. This is not just in the US but where the demand is the strongest, that is, in the emerging economies. Therefore, we suggest you pay close attention to the US housing market and its ripple effects on the global economy.
Happy asset allocation and, as always, successful investing!
Jaakko
An astonishing 24% annualized return since 1998
June 5, 2008 by Vagabond Investors · 1 Comment
I’m a big fan of Ken Heebner. That’s the man behind Capital Growth Management. Heebner is definitely one of the very best mutual fund managers on this planet. It’s not just the hefty returns that get me going. It’s his true contrarian style that gets my unshared attention and deep respect. I’m truly madly deeply in love with this guy’s way of investing. He has placed some of the same bets I did back in 2004-2005. Despite that, I really adore Heebner’s incredible capability to see things coming before anybody else.
So how well has he performed compared to the other big names in the industry? Let’s compare his results to a well-known, now-retired money manager Peter Lynch. Lynch’s 14-year tenure at Fidelity Magellan fund has long been the benchmark for mutual fund excellence. During his best ten years from August 1997 to August 1987 he recorded an average annual return of 36 points. That’s am amazing achievement. Over the same period, the S&P 500 returned a remarkable 19 % per annum. So what? So, he over-performed the market by 17 points a year. Not a bad job at all! That’s something to pay for!
What about Heebner? Ken Heebner’s Focus fund has beaten the market by 20 points a year during his glamorous period. This was from May 1998 to May 2008.
It’s characteristic for Heebner’s style to find emerging trends and play big games with them. He’s open to all new ideas, the kind of possibilities that the masses aren’t even aware of. He seems to be the happiest when everyone else thinks he’s nuts. He is a happy-finger-trader so his positions can change in a heart-beat from long to short.
I lively remember the time when I got a wakeup call for commodities in 2004 after reading Jim Rogers’ fabulous book entitled Hot Commodities. I tried to rush into the commodities market with little hope. The only way for me was to buy commodities-related stocks and some emerging market funds. I finally ended up trading PCU (Southern Copper Corporation). What started as a channeling game became a momentum leap trade. Soon after came APA (Oil Producers Apache), NOV (National Oil Well Varco), and MRO (Marathon Oil) which I enjoyed playing with covered calls, deep in-the-money leaps and calendar spreads along with some marginal equity placements. So far my only uranium bet has been CCJ (Cameco Corporation) since 2004. I also put some of my eggs to mutual funds like FIM Russia Fund , which is under Glitnir bank today.
At the time most money managers burst out laughing when I mentioned my (stolen) ideas of a rising bull in commodities. Heck did I let their comments hurt me at the time. Well, I don’t have to argue about that opportunity anymore. I have to admit, though, that I totally missed the big gold train that my dear brother Vagabond Investor Jaakko was happily riding back then. I thought it was somewhat unorthodox but what the hell – can’t blame him for that ride, can I?
As I said, I really admire Heebner’s capability to see the upcoming trends. I give him enormous credit for seeing the fertilized and agricultural trend (which I had doubts on and didn’t invest in). His philosophy is to simply find a trend and place big bets on it. That has brought enormous success for his funds and the courage to sell short doomed trends.
I wanted to share my enthusiasm of this guy because I think it would be beneficial for you to be interested in his philosophy and actions. Study his moves and try to learn his way of thinking. He is such a brilliant trader in so many ways.
Trade with passion!
Matias
The Hall of Shame: King Kong, Godzilla, The Subprime Six…
May 19, 2008 by Vagabond Investors · 3 Comments
I’m happily surprised. I have known for a couple of years that banking will become hilarious some day. What I did not know back then was how obnoxious the entire financial world would turn out to be.
I have had great fun reading the scary news about the bursting of the credit bubble. It’s a bit like watching horror movies from the 70s. You see a monster’s head fall off but you can’t help laughing at the poorly made visual illusions. I have no doubt that is exactly what the professionals of the future will feel like about the banking practices of today.
It’s always a surprise to the market - and especially to newspapers - that something terrible happens in the banking sector. The blow-up of Long-Term Capital Management in 1998, the bursting of leveraged buy-out bubble in the early 1990s, the Nordic banking crisis and the Japanese experience in the same decade… The list goes on and on way back to the bankers’ panic in 1907 and beyond. Let’s just agree that it is characteristic of banks to get into mess like this.
I must admit that there is something good about the ignorance of the masses. If people knew how retail banks work, the society as we know it today would be history overnight. That would make a lot of things awfully difficult. I accept that the masses don’t realize the nature of banks, but I have yet to figure out why most professionals have a hard time getting the point.
I am especially amused of the debate on the timing of risk. Regulatory regimes that are based on market prices implicitly assume that risk goes down when the markets do well. The value-at-risk measure is the most obvious example. It demands less capital from banks when the data show a longer period of calm, and more capital when markets have become volatile. But that (ass)umption makes very little sense. Up until today, busts follow booms like day follows night.
Financial crashes are not that random. In fact, they occur just after the top of the economic cycle. I bet that market participants were all well aware that too much credit was being created too cheaply. Yet models showed that risk-weighted capital ratios were healthy.
It’s nice to see that financial houses rely on mathematical models. The results are amazing indeed. Right at the top of the hall of shame is Citigroup with write-downs of some $40 bn since January 2007. Right behind are UBS (some $38 bn) and Merrill Lynch (some $32 bn).
When the news of Northern Rock arrived I was immediately with a popcorn can ready to watch the show on TV. I was keenly expecting a series of bank failures to entertain me. I certainly hoped for some banks to fail in order to teach the market some discipline. What followed was the tragicomic news: even the smallest investment bank on Wall Street was too entangled to fail. Bear Sterns just had to saved!
Now don’t you think that it sounds like an invitation to moral hazard? If investment banks have access to the same central-bank funding as commercial banks and represent just as much of a threat to the stability of the financial system, shouldn’t they be subject to the same prudential and capital standards? You might think so. Guess again.
It is questionable if re-regulation helps. I believe that the outcome of this mess will be a more stringent approach to liquidity and capital. That makes credit more expensive. Still, higher capital charges should not be used to make up for the deficiencies in market discipline.
It would be healthy to let some banks fail. Line the banks up and shoot the dog. The rest will quickly learn the lesson. However, I’m confident that Mr. Bernanke will get his hands on that somehow and postpone the horror show to a later date. It’s like eventually showing King Kong 1-3 all at once. You might want to have a crap load of popcorn when that happens. It will be a long show.
See you guys!
Jaakko
Market Conclusions May 12th 2008
May 12, 2008 by Vagabond Investors · 5 Comments
The following thoughts of recent market movements and economic conditions might be helpful for you. First, we play with the idea of Fed’s two possible strategies and their consequences. Second, we take a look at some investment considerations. We try to keep this short and easy to follow. So let’s begin.
We think the Fed now have two options.
1) They could continue to pursue their interventionist policy that is obviously designed to support the suffering US housing and equity markets. That will happen at the expense of further sharp decline in the value of US dollar. You can read more about this in WSJ April-14-2008 entitled “The Inflation Solution to the Housing Mess”. That is a staggering article.
A sharply declining dollar would leas the US to suffer from rapidly increasing import prices (appreciating currencies) and inflation. Overseas particularly the EU would suffer from the further weakening of the dollar. We can’t highlight enough that a total of 31 % of the S&P earnings come from overseas. This will easily lead to disappointing corporate profits and nasty surprises in valuations and future guidance. This scenario makes us seriously think about shorting US long-term Treasuries. No doubt that would be the short of the century.
We would like to warn fellow Vagabond Investors not to be overly bearish about US equities in dollar terms. You can find many cases that show that stocks have rallied strongly in local currency even if the country’s economy is going through its darkest era. At the same time, of course, their currency has collapsed. Keep that in mind. You might still find some opportunities out there. We believe that oil and energy related stocks might offset the weakness in other sectors of the stock market in the near and midterm future. Some of you might remember that this was the case in the energy sector in the 1970s.
2) The second alternative is to tighten the monetary policy to support the US dollar. We think that this is not likely, though. Tightening would lead to weaker US asset markets. If it were the case, we wouldn’t be surprised to see the US stock market slide 20-40 %.
The US dollar would be more stable in this scenario than the first one. A stronger dollar would lead to an increasing cost of living in the US. Would that be beneficial for the median US household? Who knows?
Both of these alternatives sound very unattractive for global economy and asset markets. In both scenarios the US stock market is in a great danger to move even lower in dollar and euro terms. The Fed may have run out of right choices.
The rate cuts since September 2007 have set a furious fire under commodities. We have been very bullish on commodities since 2004. However, a weak US consumption means weaker global liquidity and would consequently hurt most asset markets. This includes real estate, equities, art and most commodities.
At the moment, at least for the short run, we are especially looking forward to the end of this liquidity-driven strength in commodities including gold. However, we are looking for gold to correct around $800 before its bull market resumes. We see this level of $800 a very attractive buying opportunity. We would also add our positions in the future weakness in gold.
We really do not see very much upside room for the US dollar under current US monetary policies. The case with Asian currencies is quite the opposite. Most Asian still look very attractive. They have gained strength against the US dollar, but they remain depressed against the euro. You might want to have a look at the Singapore dollar. It looks like a fun future play for us.
Be careful out there. It’s going to be a bumpy ride. With the right knowledge, you can make great investment decisions. Feel free to share them with us!
Victorious investing!
Matias
Markets Are Not Rational
May 5, 2008 by Vagabond Investors · 5 Comments
Every now and then newspapers argue that markets have changed. Over the past decades massive structural changes have taken place in terms of credit creation, regulation and deregulation, the development of derivative markets and the value of currencies. Leverage and liquidity have led to a bubbly economy with capital flowing from one asset class to another, creating volatility and turbulence.
While massive changes have taken place, there are some things that have not been affected in 100 years. One particular about markets has remained the same. That is the human factor, which is the wildcard of financial markets. It is specifically because of this factor that one should not think investing as a hard science. In fact, it is perhaps closer to art than science. The difference is obvious. One can heat a pot of water in 100 ºC (272 ºF respectively) and it will boil every time, assuming constant pressure. On the other hand, put a human under pressure and it is anybody’s guess what will happen. He/she is unpredictable, irrational and acts in bizarre ways.
It is useless to try to understand an irrational creature with logic. It is vain to expect financial markets to act in a rational way. Humans operate the markets, and the last time the author of this article checked most people were human.
One can tell the where the market is by listening to people’s opinions. At the height of boom, mobs and media invent explanations to why prices are high and will continue to rise. People tend to make personal relationships with their investments and fail to realize that money is nothing more than a commodity.
Tomorrow always comes, at least up until now, and eventually booms turn to busts. Newspapers declare that certain asset classes are dead (Business Week ran an infamous cover in 1979 entitled Equities Are Dead). Amusingly, financial salesmen are busy calling their customers to tell that it is only a momentarily correction. Prices will rise, they say, so investors should diversify and invest for the long term.
Long term is a flexible concept in inflation-adjusted terms. It is easy to be deluded by nominal figures. Yet in real terms, the S&P 500 at its 1990 low of 460 was radically below its real high of 647 in 1968. Moreover, it was just 20% above its inflation-adjusted 1929 peak.
A rational person would avoid the apparent manias at the end of bull markets. Sadly, the masses get blinded by their own thinking and feel that the rainy day will never come. Most people are ill prepared to meet financial shocks. Many are merely relying on the central banks or the government to bail them out. This creates an obvious moral hazard to the market and encourages excessive risk-taking.
As to the people pointing out the rationality of traditional long term strategies in US equities, it is enlightening to realize that US equities have grossly underperformed any other asset class since 2002. In a world of very high credit growth, a rational investor needs to look at asset price movements in inflation-adjusted terms. The long term value of any paper currency is zero. The same law holds true with humans. The mean for human beings is non-existence or death.
In times of irrational exuberance, human strengths morph into weaknesses. One can have too much of a good thing. In excess, most actions take on the characteristics of their opposite. Pacifists become militants, blessings become curses, and help becomes hindrance. Even National Socialism in Germany was initially promoting peace, but it became the most militaristic creed on the planet. More becomes less.
Time and again this is apparent in the markets, which are supposed to be efficient and rational. In reality, the unpredictable human factor is always present. Coupled with mounting and increasingly more complex leverage, left alone the market is liable of over-extending itself and eventually breaking systems down. For example, several countries have experienced two or more banking crises since 1980: Argentina, Indonesia, Malaysia, Philippines, Thailand and Turkey.
Systemic banking crises typically accompany the implosion of economic bubbles. When economic cycles turn, it seems the masses are revoltingly blind to the changes at hand. As to the public’s need to feel right about their opinions, most people get dead right.
Jaakko
