Archive for April, 2007

Aussie non-conforming loan IPO: fools rush where angels fear to tread

Saturday, April 14th, 2007

Today, we read with disbelief at this news article: Liberty may seek $350m in float:

ONE of the most prominent lenders in Australia’s non-conforming loan market could seek to raise about $350 million in a public float.

The Australian non-conforming loan is the equivalent of the US sub-prime loan. As we said before in How did the US sub-prime lenders get into trouble?, ?it does not take a genius to see that sub-prime lending is a fundamentally bad business.?

Buying stocks in that company?s public float would be like a fool rushing to where angels even fear to tread.

US sub-prime woes?witch hunt begins

Friday, April 13th, 2007

Today, from this article: Rules to deter risky mortgage sales, we read about what we foresaw before. We can always trust some politicians in a democracy, who cannot see beyond the next election, to bow to popular will, which often turns out to be a mistake. As we said before in A painful cleansing or pain avoidance at all cost?, which clearly illustrates this point,

… the Fed will have no choice but to acquiesce to the desire of the mob, whose aim is to avoid immediate pain as much as possible.

Please do not misunderstand our point?we abhor dictatorships immensely?our conviction is that the quality of a democracy lies in the quality of its politicians and electorate. If mob rule takes over the electorate, we can only pray and hope for the best. Other than hope and prayer, the next best thing to do is to educate the mob through the promotion of debate and discourse, which is what we are hoping to achieve with our miniscule effort. Anyway, back to the main point of this article…

In that above-mentioned article, it says that

US politicians are drawing up a bill that could make it less attractive for Wall Street investment banks and other financiers to repackage risky mortgages into securities and then sell them to investors around the world.

The question to ask is this: how did Wall Street becomes so reckless in the first place? We believe the fault lies in Alan Greenspan. Having slashed interest rates to a recklessly low of 1% at the beginning of this century, the US was embarking on an extremely loose monetary policy (see What makes monetary policy ?loose? or ?tight??). With the economy flushed with a massive sea of money and credit in the financial system, do you expect money not to be reckless lent? Imagine yourself being a banker who is crammed with a glut of fiat cash. What will you do with it? You will have to get rid of it by lending it out. What if you run out of borrowers? Easy! Just lower the credit standards! This is what is happening in the US.

Unwisely, as the article mentioned, the mob laid the blame on the ?greedy? financiers and lenders:

Politicians and consumer groups blame such flows for the lax lending practices that developed in the sub-prime market in recent years.

So, if this bill gets through and becomes law, what will be the consequences? Definitely, credit will tighten enormously. What follows will have serious effects. Our previous article, Marc Faber on why further correction is coming?Part 2, will elaborate more on the consequences.

Elsewhere in the article, it said,

Lawmakers said they would summon stakeholders to a crisis summit, while the Bank of America responded to the political pressure with an announcement yesterday that the two largest US banks would make $US1 billion of loans available on favourable terms to borrowers on the verge of losing their homes.

This is what we foresaw before in Inflation or deflation first?,

Now, faced with the threat of a deflationary recession, what can the Fed do? Politically, it is impossible for them to allow a recession run its full course in order to clean up the prior excesses of the bubble. They will do anything and everything to ?prevent? another recession. The only way for them to do that is to do what they always did?pump even more liquidity into the economy (a.k.a ?print? money).

That is the power of the printing press! Buy gold.

Smart money in alternative energy?Part 4: avoiding the duds using EROEI

Thursday, April 12th, 2007

Continuing from yesterday?s article, Smart money in alternative energy?Part 3: centralised or distributed power?, today we will look at a very simple but very important concept for evaluating alternative energy businesses?Energy Return On Energy Investment (EROEI). Understanding of this idea is certainly helpful to prevent you from wasting your time by even considering outright bad investments.

According to the Wikipedia, EROEI is the

… ratio between the amount of energy expended to obtain a resource, compared with the amount of energy obtained from that resource.

Simply put, if in order to produce one unit of energy, more than one unit of it is expended, then this process is an energy sink. That is, that process is unviable as an energy source.

A very good way to illustrate this concept is via an example of a real life alternative energy business. There is a company in Australia that is in the business of producing electricity through the burning of garbage as fuel. Is this a viable energy business? Well, consider this: in order to burn garbage as fuel, you need to assemble vast quantities of garbage from all around town and transport them to the power plant. This means garbage trucks are required to drive to each household to collect the garbage. What does garbage truck run on? Petrol. Thus, by the time all the garbage is put together at the power plant, a lot of energy is already consumed in the form of petrol consumption by the garbage trucks. Obviously, the energy produced through the burning of the garbage is less than the energy that had been previously consumed. In this case, the EROEI tells us that this process is an energy sink and is unviable as an alternative energy business in the long run!

So, watch the EROEI!

Smart money in alternative energy?Part 3: centralised or distributed power?

Thursday, April 12th, 2007

Today, continuing from Smart money in alternative energy?Part 2: the solution or solutions configuration?, we will look at just one tiny facet within the complex energy problem?the generation of power. Assuming that in the long run, the generation of electricity through conventional fossil-fuel burning power stations is unsustainable due to environmental and fuel supply issues, what can be done? We do not really know for sure because we are not scientists and engineers. But we have some worthwhile ideas to offer.

Before we go into that, let us review the present conventional arrangements in power generation. Currently in most countries, electricity is generated centrally in power stations and then distributed to the rest. Let us call this the ?centralised power generation? model. One of the problems we can think of with this model is that a lot of energy is lost in the transmission of electricity from the power station to the destination.

There is an alternative (and more radical) model that we believe may possibly be a better idea for a world of scarcer energy and global warming. Instead of having power generated centrally, why not distribute the generation of power into a network of nodes? Let us call this the ?distributed power generation? model. The advantage of this model is that with locally generated power at the nodes (even homes can be nodes), there is no wastage of energy from the transmission of electricity. Also, from a security point of view, this model is not vulnerable to a single terrorist strike.

You have to understand that these two alternative models are not mutually exclusive. Think of them as a spectrum, with each end as one of the models. Now, the question is, which end of the spectrum will the future be likely to be? Those thinking in terms of the centralised power generation model will concentrate on technologies like nuclear power, clean coal, ethanol and so on. Those thinking in terms of the distributed power generation model will concentrate on technologies like solar, fuel cell, wind and so on. Therefore, your vision of the future will determine which alternative energy investments you are more likely to evaluate.

Which model do you think the future is likely to be?

Zimbabwe: Best Performing Stock Market in 2007?

Wednesday, April 11th, 2007

In Are stocks good value?, we mentioned that,

You can make the Dow climb as high as you want as long as you print enough money (that is, provide enough liquidity). In fact, if you run the printing press hot enough, anything that you ?invest? in will increase in price… with Zimbabwe?s inflation rate in the order of thousands of per cent (in May 2006), almost anything you buy in Zimbabwe will increase in price by 100-fold after a year has gone by. But are you better off by a 100-fold if you do that? Of course not! In Zimbabwe?s case, all it meant was that the money had become worthless!

Take a read of this article from the Mises Institute regarding Zimbabwe’s ?roaring? and ?booming? stock market.

Smart money in alternative energy?Part 2: the solution or solutions configuration?

Tuesday, April 10th, 2007

Yesterday, in Smart money in alternative energy?Part 1: current energy quandary, we mentioned that:

Hence, the world is now facing a mounting energy problem, which if not solved, will sooner or later lead to a crisis. The good news is, opportunities are found where crisis are. As investors, we have to train our mind to see such opportunities.

Nowadays, as you keep your eyes and ears open, you will easily notice that energy seems to be a hot topic in the business world. Buzzwords including ?alternative energy,? ?renewable energy,? ?bio-fuels,? ?ethanol,? ?nuclear energy,? ?clean coal,? ?conservation,? ?solar energy,? ?wind energy,? ?geothermal energy,? ?hydro-energy,? etc are often mentioned in the press. No doubt, a lot of hot money are pouring into energy related projects and businesses. Therefore, when you see this, you should be under no illusion that we are still basking in a world of forever readily available and plentiful energy.

We (along with the above-mentioned hot money) believe that in the long run, with everything else being equal, energy is going to be more costly. This will have an impact on our current way of life. To put it simply, the problem is that there is not going to be enough environmentally friendly energy to satisfy everyone in the planet. For those who believe in the theory of Peak Oil, their views will be even bleaker indeed.

At this point in time, the world?s energy problem has yet to filter down into the consciousness of the average layperson on the street. When that day comes, it means that this issue is finally making an impact (whether positive, negative or neutral) so real and visible that its effects can be felt in everyday life. As investors striving after atypical excellence, it will be too late to do anything by then. Thus, now is the time to take action.

Now that we understand the problem, what about the solution? This is the tricky part.

Before we plunge into it, the next step is to understand the nature of the solution. Now, we wish to impress upon you one very important concept that you should remember if you cannot recall anything else in this article. That is, this problem is not simply the problem requiring the solution. It is a multifaceted configuration of problems (e.g. Peak Oil, supply constraints, geopolitical instability, environmental concerns, global warming, skyrocketing demand, costs, etc) that require a complementary multifaceted configuration of solutions. Thus, its complexity is not something we (nor anyone else, we believe) can fully understand, let alone address.

In the following articles, we will look further at the energy issue from the perspective of an investor. Stay tuned!

Telstra entering the media business

Monday, April 9th, 2007

In our previous article, Is the Telstra T3 offering worth a buy?, we said that,

Will Telstra remain just a telecommunication company in the future? This is a very interesting question. If the answer is ?yes?, we would not be keen in investing in Telstra because there are much more lucrative opportunities elsewhere. We suspect the answer will be ?no? because if we were Sol Trujillo, we would have taken the strategic path to transform Telstra to one that is more than a telecommunication company. We believe this strategy is the key to Telstra?s future.

In this article, See like an entrepreneur… how will Telstra be like in 2010?, we quoted Sol Trujillo,

By 2010, Telstra wouldn?t any longer be called just a telecom business. It?s going to be a media-comms business, which means our revenue profile [will] change.

Today we saw this article in the news media: Telstra’s net bid for $1bn in ads.

Smart money in alternative energy?Part 1: current energy quandary

Monday, April 9th, 2007

If you have followed us for a while, you will know that we are generally cautious about investing in stocks right now. As we said in Another sign of the business cycle top:

In a business cycle peak, company profits as a whole are as good as it can get. If you expect the profit trend to continue and pay a premium price for stocks in anticipation for higher earnings next year, chances are, you will be disappointed.

Therefore, if you intend to invest in stocks, you have to be very selective in your choices of businesses to invest in. To do that, you cannot merely extrapolate the status quo into the indefinite future and base your decision on that. Instead, you will have to look beyond the current state of affairs and understand the underlying forces that are driving today?s current macro trends. Only then will you be able to anticipate the coming changes for tomorrow and invest accordingly.

Today, we will talk about one of the macro trends?energy.

The most important ingredient that drives the efficiencies, comforts, automation and wonders of today?s modern way of life is energy. The trains, cars, ships and aeroplanes that transport massive quantities of people and goods over vast distances quickly require energy in the form of fuel. The heavy machines that do heavy physical work far beyond the scope of human labour require energy too. The powerful computers that process and store vast amount of data and information as well as automate mental labour requires energy in the form of electricity. The heating in winter and cooling in summer of our abode requires energy too. Take energy away and our modern way of life will very much grind to a halt and bring us back to the hard life of our ancestors. In fact, contemporary life rests on the premise of abundant and cheap energy. Therefore, whoever controls the supply and provision of energy controls power and wealth.

Currently, most of the world?s energy exists in the form of oil, coal and natural gas reserves, of which oil is the most notable. There are two significant issues with regards to these forms of energy: (1) availability and security, which are applicable to oil and (2) global warming, which is most applicable to coal. We will tackle each one of them in this article.

There are growing worries that given the growing competitive demand for oil from emerging nations (e.g. China and India), there would not be enough supply of it to satisfy everyone (see Analysing recent falls in oil prices?real vs investment demand). To compound this problem, according to some respected scientists and geologists, today?s global oil productions are at or near permanent decline (i.e. Peak Oil). Thus, whether you believe in the theory of Peak Oil or not, there is growing consensus that given everything else being equal, oil is going to be more expensive in the long run (see Is oil going to be more expensive?). Since oil is a major manifestation of energy, which in turn is the most important ingredient for our modern way of life, it implies that if nothing is being done with regards to this issue, then the quality of life that we currently know and enjoy will be significantly eroded in the future. Worse still, a significant portion of the world?s oil resides in the most politically and militarily volatile regions (i.e. Middle East), which puts a serious doubt to the security of oil supplies.

The cheapest alternative to oil will be to use coal in which the world has plentiful supply of and are not located in regions that can result in its supply being held hostage to military and political situations. Unfortunately, the world is facing another serious challenge that makes it highly unwise to burn coal for its growing energy needs?global warming. Scientists are still cracking their heads to think of ways to extract energy from coal without damaging the environment seriously.

Hence, the world is now facing a mounting energy problem, which if not solved, will sooner or later lead to a crisis. The good news is, opportunities are found where crisis are. As investors, we have to train our mind to see such opportunities.

US shooting own foot with tariff on Chinese goods

Thursday, April 5th, 2007

At present, the US Congress is simmering in antagonism against China for her trade surplus against the US. They see China as a convenient scapegoat for America?s economic woes, accusing her of misconducts that includes currency ?manipulation,? unfair trade practices and so on.

Regarding Congress temptation to label China as a currency manipulator, we find this the case of the pot calling the kettle black. As we said before in How does the US export inflation?, the US, which arguably having the world?s reserve currency, can print its own dollars to pay for foreign imports. This gives the US the enviable power to expropriate resources from foreign countries and exporting inflation to them. Now, is this currency manipulation on the part of the US? China, on the other hand, refuses to play along this game?by not letting her currency float freely, she had turned the tables against the US. In a sense, both the US and China are ?manipulating? their currencies. Both of them are locked in a downward spiral of devaluing their currencies against each other. As the US print their money to pay for China?s goods, the Chinese print theirs to prevent their RMB from appreciating too much against the US dollar (see Why is China printing so much money?). Both China and the US are locked in an embrace of unhealthy co-dependency with each other.

But recently, the US was about to fire the first shot. As the New York times said in In Big Shift, U.S. Imposes Tariffs on Chinese Paper, ?The Bush administration, in a major escalation of trade pressure on China, said Friday that it would reverse more than 20 years of American policy and impose potentially steep tariffs on Chinese manufactured goods on the ground that China is illegally subsidizing some of its exports.? This could set the precedent for more tariffs to come, which if eventuate, will result in a trade war between China and the US. Should this happen, the US will be shooting their own foot. As we said before in What can we expect in a US dollar decline?, the ?reason why monetary inflation had not led to severe price inflation is because of the disinflation effect of cheap Chinese imports.? If the US would be foolish enough to use tariffs to ?solve? their trade deficit problem, their consumers and by extension, their economy will suffer. The Chinese can retaliate by dumping their holdings of US Treasuries, which will result in the nightmare situation that we mentioned in China unwilling to hoard US dollars?what?s the implication?.

We doubt either side will be stupid enough to sabotage each other.

More pain for Australia

Wednesday, April 4th, 2007

By the time you read this, the interest rate decision by the Reserve Bank of Australia (RBA) would have been announced. For us, we were writing this article before the announcement. Therefore, we were not in the position to know RBA?s decision. Nevertheless, our opinion is that the timing of interest rate rise is not important. What are more important are the underlying economic forces that make a rise inevitable.

From our observation of the market, we find something rather amusing. Before the RBA?s decision, the market was embroiled in a flurry of tealeaves examination activities in its attempt to divine what the RBA would do with the interest rates (see Economists punt on Aussie interest rates). The funny thing is, the RBA probably did not know what its decision would be until it was made. That was the purpose of having the meeting in the first place?to decide on something that had not been decided yet! If the RBA did not know what its decision would be, how on earth can the others know for sure? That is why we called any of such ?prediction? a punt.

Anyway, let us go back to the main point of this article. What will be the outlook for interest rates in Australia? To answer this question, we need to have an opinion on the outlook for price inflation in Australia. This is because one of the major mandates of the RBA is to achieve ?low and stable inflation over the medium term? (see the RBA?s web site). The main tool that the RBA is using to achieve its mandate is the setting of interest rates.

What is our view on price inflation in Australia? As we have said before more than a month ago in Have we escaped from the dangers of inflation?, we doubt it is a problem that can go away quietly. At this stage of the business cycle, Australia?s productive capacity is already at its peak (see Where are we in the business cycle?). Also, despite the interest rates rise since 2003, Australia?s monetary policy is still ?loose? (see What makes monetary policy ?loose? or ?tight??). If you look at the RBA?s financial aggregate figures, all measures of money supply are still expanding in the vicinity of around 12% to 14% year-on-year since 2006. From June 2003 till February 2007, Australia?s broad money supply has increased by almost 50%! This tells us that as long as Australia?s economy is ?strong,? its price inflation problems are not going to go away. Therefore, there is going to be pressure on the RBA to raise interest rates in order to truly ?tighten? liquidity in the economy.

However, there is another issue that complicates the whole thing. The risk is that with so much debt in Australia, interest rate rise can burst the debt-driven asset bubble, hurtling Australia down into a deflationary recession. But we believe it is better to burst the bubble earlier than later because any delay will result in the unavoidable burst having a more painful impact. Unfortunately, the RBA does not have the mandate to prick dangerous bubbles.

What is the implication of this?

It means that given the mandate constraint imposed on the RBA, it can only raise interest rates to ?fight? price inflation (the idea of a central bank ‘fighting’ inflation is flawed- see Cause of inflation: Shanghai bubble case study). Consequently, asset price bubbles will be allowed to balloon further (i.e. ?loose? money) as long as price inflation seems to be under control. When the inevitable bursting of the bubble happens, Australian household will bear the brunt of a severe recession.

We encourage you to read this article about this warning from Ian Macfarlane, the former RBA governor: Next economic dip will hit households.