Tuesday, April 29, 2008

Dialogue on Housing Deflation - from ArizonaRealEstateNotebook.com

Cbass // Apr 27, 2008 at 7:12 pm

Brian,

So you mean to tell me that prices for goods and services can not increase while our economy stops growing or goes into a recession just becuase there is supply?

en.wikipedia.org/wiki/Stagflation

“Demand-pull stagflation theory explores the idea that stagflation can result exclusively from monetary shocks without any concurrent supply shocks or negative shifts in economic output potential. Demand-pull theory describes a scenario where stagflation can occur following a period of monetary policy implementations that cause inflation. This theory was first proposed in 1999 by Eduardo Loyo of Havard University’s John F. Kennedy School of Government.”

Just an example of some smart dude who agrees my thoughts are possible.

Brian McMorris // Apr 28, 2008 at 9:19 pm

CBass, I don’t think you and I are very far apart on this. I concede the idea of some level of stagflation at a time like this. Today we have “demand shocks” rather than supply shocks. That demand comes from the BRIC nations and is outside our Fed’s control.

I don’t know that residency at Harvard makes this guy smarter than you or me. But yes, anything is possible. But there is no real proof, yet, for this theory that was postulated in 1999 (stagflation that results from loose monetary policy).

The most often cited example of Stagflation came in the 1970s and was the result of supply shocks (in oil and base metals). The supply constraints, accompanied by rapid demand increases in Asia (as Japan and Korea underwent a huge expansion) did result in inflation. But monetary policy probably had little to do with it. A wage inflation spiral was a reaction to the “materials” inflation, but that was in a time of powerful unions that no longer exist. It took Volcker’s interest rate shock therapy in 1980 to break the cycle of wage increases gained by striking unions ending the phenomenon known as “inflationary expectations”.

The “stag” term suggests flattish growth that is behind the rate of inflation. If inflation is at 5% and nominal growth is at 4%, that is stagflation, and not really so bad. It is just important to be invested in hard assets during such a period so that investment earnings beat inflation.

But this scenario is a lot different than the Depression that many are predicting, which requires a Deflation. I say we already have a housing depression (deflation), as compared to the 30s for example. But the other elements of the 30s Great Depression, are not in place and very likely won’t be if the Fed keeps the economy from panicking by pouring on liquidity.

packerbacker // Apr 29, 2008 at 5:52 am

Brian-

I think you are smart. I like what you say, but someone should slap you for this. You say, “we are already in a housing depression-as compared to the 1930’s” A quick google would show you that during the Great Depression, around 25% of people were forclosed on, unemployement was over 20% and household income dropped 40%.

Brian McMorris // Apr 29, 2008 at 6:20 pm

Thank you for the compliment and comments. But see that I limited my statement to “housing depression” which I borrowed from Dr. Shiller himself. He is the greatest authority maybe in the world, on the history of housing pricing, and has lots of historic data to back up his comparisons. So I am comfortable with that statement.

Average national price is down about 15% from its peak now, and more or less in freefall. He concludes, and I have no reason to differ, that it could easily drop another 15% before it bottoms. That will be as big a drop as the 30s. I am not sure the source where 25% of homes were foreclosed in the 30s. I have not seen numbers that high. I don’t necessarily believe everything I read when I google.

As for unemployment and household income dropping, this time is different. I am not saying we are in another Great Depression, just the contrary.

What makes this time different, is we have the lesson of the 30s to teach us how to respond to the housing depression, so problems will not be magnified. We will probably not have 40% foreclosure, because this time, the banks started acting early to deal with their bad loans. The Fed also got into the act early because of Bernanke’s expertise on dealing with conditions that lead to broader economic depressions, including acting aggressively to cut interest rates and simultaneously supply liquidity (in numerous ways) to keep the banking system from imploding.

It did implode in the 30s and that is why foreclosures went so high, the banks could not afford to negotiate with the home owner, do short sales, or hold bad mortgage portfolios. The banks then were S&Ls with no where to go for help (there was a Fed, but it wasn’t ready for the problems it faced).

If you find economics interesting (you can probably tell that I do), I will share with you a very credible source on Depression era statistics, causes and effects: Mr. Ben Bernanke. Here is a speech of his from 2004 (so not colored by the current situation):

http://www.federalreserve.gov/boarddocs/speeches/2004/200403022/default.htm

In it Bernanke quoted a study by economist Milton Friedman, published in 1963, that proves that monetary contraction was the proximate cause of the Great Depression. There are many examples given as evidence, but I will let you read it there rather than fill this space with quotes. This is why we see Bernanke’s Fed has been so dramatically increasing liquidity, much to the consternation of CBass and others. But Bernanke and others are on record saying it is much easier to fight easy-money induced inflation, than contraction-induced deflation. The housing crisis on its own contracts money supply (basically evaporating paper money in the form of mortgage liabilities). Bernanke’s Fed has responded by expanding it in other places, probably for a net zero effect. But we won’t know for a few years.

So, I stand by my earlier positions defending monetary expansion, but appreciate the opportunity to explain why.

Saturday, April 26, 2008

Microsoft is a BUY! and Another Buy Signal? - Consumer Confidence Lowest Since 1982

As Friday's "Prudent Speculator" newsletter suggests, I have bought more Microsoft on Friday (already held some sold puts on Jan 09 at $35), as one of the best values today and also sold some Daylight Energy to capture profits.

The case for Microsoft is very compelling. This is a company with an ROE that is through the roof at over 45% (one of the highest of any stock). The gross margin is also through the roof at 80% (as it has maintained for 20 years). It is a cash machine with revenue growth of 17% YOY. Earnings growth is 25%. Yet, the P/E at today's closing price of 29.83 is only 17.3

This is the best price on Microsoft since the mid 80s, before the launch of Windows, in my estimate. And there is a catalyst in the Yahoo deal. You have to love the way that CEO, Steve Ballmer, is playing his hand with Yahoo directors (and founder Jerry Yang). He is refusing to overpay and throw investor money (Bill Gates' and mine) at Yang. He will get Yahoo for a fair price and that will help MS in its competition with Google. In fact, I won't be surprised if after Yahoo, Ballmer goes after AOL, which Time Warner has on the block (I also own TWX betting AOL gets sold). I think MS will go over $40 by year end as the tech cycle leads us out of recession.

I also have trimmed a little on energy, just to lock in profits. I still think energy is the place to be for the next 10 years, (and have added solar to broaden exposure), but there should be a little pullback as the dollar turns around the next couple months. I will buy back the Daylight I sold when it is around $8. I am not selling any PennWest or PGH at these prices, as they should get back to $40 and $25 respectively, before I consider trimming some.

From April 26 Prudent Speculator: ...The fact that an early decline, one that accelerated after the price of oil spiked following news that U.S. war ships had fired on Iranian vessels in the Persian Gulf, gave way to a broad-based advance that closed near the highs of the day and that the S&P 500 finished above the apparently technically significant 1395 level have to be viewed positively.

The market also had to overcome word that the University of Michigan's consumer confidence survey fell to its lowest level in 26 years. Interestingly, the expectations index component of the Michigan report hit its worst reading since November 1990, while the current conditions gauge plunged to levels last seen in November 1982. Of course, as we have discussed in recent Hotlines and Buckingham Reports, the release of extremely weak economic statistics often marks a major market bottom. Such was certainly the case in 1982 and 1990, as Al Frank's TPS Portfolio gained 123% in 1983 and 55% in 1991.

Sunday, April 20, 2008

Leverage Bank Loans - Great Returns with Limited Risk

In today’s Barrons (I get online a couple days early) there is a good article on commercial bank loan funds, which is the same as floating-rate funds. We have liked these, although I have been early with DWS Dreman Value Fund (DHG). I think you liked a Van Kampen version of this type of investment. The interview is encouraging for the future of this investment. I just checked mine, and though it is paying 11% dividend against today’s price, with my higher cost basis (from purchases last year), I am averaging around 8.5% yield, which is still very good. And there is a lot of market price upside. DHG is trading for 13.35 as of yesterday. But the NAV is almost 16. So it is trading at a 16% discount to NAV. When the market starts liking these investments, that discount will narrow or disappear. The NAV should climb as the market begins pricing up the previously discounted bank loans for the reasons in the article. Bank loans have variable rate interest, so are not exposed to inflation risk (which is why I got into these in the first place).

Note that the TXU debt that Steve Tananbaum likes in the article, is the no. 1 holding of DHG, which is managed by Dan Dreman and his team for DWS.

From Barrons, Monday, April 21, 2008

Leveraged Loans: Ready for Lift-Off
Says Steve Tananbaum of GoldenTree Asset
By LAWRENCE C. STRAUSS



STEVE TANANBAUM'S ROOTS ARE IN HIGH-YIELD BONDS, which he began analyzing at MacKay Shields in 1989. He became head of the department two years later, while still in his mid-20s. Since then his horizons have expanded to all sorts of asset classes, including equities. No surprise, he remains a value investor.

Eager to run his own firm, Tananbaum left the mutual-fund world in 2000 and launched GoldenTree Asset Management. With nearly $14 billion in assets, much of it in hedge funds, the New York firm devotes a lot of its time and energy to alternative assets. One of Tananbaum's favorite investment themes right now is bank loans used to fund leveraged buyouts. Amid the credit crunch, which has caused the spread between yields on high-yield bonds and Treasuries to widen, these loans have come under pressure. This kind of debt isn't widely available to retail investors, though some mutual funds, such as Eaton Vance Floating Rate Fund (ticker: EVBLX) and AIM Floating Rate Fund (AFRAX), specialize in bank loans.



Steve Tananbaum

So-called loan-participation funds haven't done well lately, and are down about 4% year to date through April 14, according to Lipper. But that's better than the broader market's total return of minus 9%. GoldenTree's flagship offering, the $5 billion Master Fund I, which looks for value in equities and bonds, was down 5.39% in this year's first quarter, but more than two percentage points ahead of the Merrill Lynch high-yield credit index that's used as a benchmark. The fund's five-year annual return of 11.34% bests the high-yield index by nearly three percentage points, as of March 31.

Barron's recently caught up with Tananbaum, 42, at his midtown office, which houses a portion of his art collection, including the spacesuits by artist Tom Sachs shown in the photo at right.

Barron's: What is happening in the credit markets, where conditions since August have been very tough?

Tananbaum: The credit problems that started last year, and which were perceived to be isolated, really spread throughout the system. In different pockets of credit, things were mispriced. Right now you're seeing a repricing of credit. Whereas last year you were being underpaid to own credit, now you are being overpaid.

You mean, in terms of much wider spreads?

That's right. Against that backdrop, the investment banks have been damaged. Normally they provide credit to the financial system. But things aren't working the way they normally do. You're seeing the banks' inability to provide credit to a lot of their corporate customers.

Are the banks lending less because they have to put more of assets on their balance sheets?

The banks are playing defense. They are more worried about their current relationships than beginning new relationships.

Are hedge funds paying higher interest rates to borrow from banks?

The terms are different from what they were six months ago. The banks are looking to provide less leverage at wider spreads, and only on larger pools of assets.

How has that impacted GoldenTree?

First of all, most of the money we run isn't levered. We have about $10 billion of alternative assets, of which $7 billion to $8 billion doesn't have any leverage associated with it. Also, we have favorable terms, with four to five years left on our credit facilities, so nothing is coming due right away. Having said that, if you have access to borrowing money, then bank debt, or leveraged loans, is very attractive. That's because the spreads on bank debt have widened considerably, to somewhere around 600 basis points [six percentage points] above Libor [the London interbank offered rate], meaning the prices have come down significantly. Those spreads are as wide as they've ever been. In the next two years, you could see spreads going back down to 400 basis points. That would give you double-digit returns over the next two years.

So this is a good time to be buying?

This is a great opportunity to be buying. It reminds me of earlier credit crises, such as the ones involving Mexico in 1994 and Russia in 1998, and the one that unfolded at the end of 2000. It was clear: The markets correctly predicted that defaults would pick up, and there is usually indiscriminate selling at those points. That's what we have today. But the credit market right now favors those with the money to buy. Earlier in the year, some of the easiest purchases were investment-grade names like American Express [AXP]. It had a new debt issue that was trading 362 basis points, or 3.62 percentage points, over Treasuries. That's what the high-yield index was yielding about a year ago. Now that debt's spread is in the mid-200s above Treasuries, meaning the price has appreciated. But there was definitely a disconnect.

What was driving bond prices to such low levels?

Leverage was a big part of the story. The first phase, as I said, was indiscriminate selling, much of it driven by a lack of liquidity. A lot of people had taken out lines of credit, leveraging up in some cases on bank debt, or loans used to finance buyout deals. When the value of the bonds went down, say 10 points, these investors got margin calls and were forced to liquidate, because they couldn't come up with any equity. It was basically a bunch of margin calls in February, and then in March it became a systemic issue with Bear Stearns [BSC].

What is your take on Bear Stearns' collapse last month, and its pending acquisition for about $10 a share by JPMorgan Chase [JPM]?

The Bear Stearns situation initially was about whether fraud was involved. The market got comfortable that it wasn't about fraud, but more about Bear not having the right capital structure. Then there was a run on the bank. The market has gotten healthier since the Bear episode, and the Fed has done a terrific job providing liquidity and telegraphing they intend to provide more.

What's the next step in the credit markets?

On the debt side, it's about finding companies whose balance sheets work. By that I mean which companies are self-sustaining in the current environment, as opposed to which balance sheets potentially are at risk of defaulting. The debt of Calpine [CPN], which has emerged from bankruptcy protection, was a large holding for the investment banks. Calpine had too much debt. But now, after the restructuring, it's a healthy company. The leveraged loans of Clear Channel Communications [CCU], the radio and entertainment company whose buyout has been stalled, could be a more challenging investment.

Table: Tananbaum's Picks…

Do you hold Calpine bank debt?

Yes. On the bank-loan side, we are focusing much more on companies where we are at the top of the capital structure. Calpine and TXU Energy, the Texas utility taken private last year, are interesting loans.

What does it mean to have a good position in a company's capital structure?

It means you get paid before others if things go wrong. You're first in line, ahead of the common equity holders.

As investment opportunities, how do you view junk bonds versus leveraged loans?

A lot more leverage was used for investing in bank loans. There wasn't as much leverage in high yield. Bank debt had a lot of margin calls at the beginning of this year, creating buying opportunities. And because there was such an overhang from the investment banks that held these loans on their balance sheets, it was a more attractive market.

There was no forced selling in high-yield bonds. Thus, bank debt, which is more senior in a company's capital structure, fared worse than junk bonds that were more junior. Bank debt offers better relative value than high-yield bonds.

What is on the horizon for bank debt?

April is starting off terrific, but there will be twists and turns. At the end of the day, what is going to determine returns, whether for high-yield bonds or leveraged loans, is the performance of the company. When certain companies can't grow into their balance sheets -- they can't, in effect, make their debt payments -- that's going to create opportunities, as well.

Any examples?

First Data, a financial-services company that helps process credit-card transactions, comes to mind. They were taken private last year. They have a big capital structure, and it will be hard for them to pay off debt.

Bank loans aren't readily available to retail investors, though there are some bank-loan mutual funds. Let's talk about some themes that have a wider appeal.

We've always looked at arbitrage between the public and private markets. In equities, there was a big discount to the private-market values of deals. That's opened up some terrific values because there is no private-market value right now. Many companies, including some in the media industry, traditionally were valued off of private bids. Now, in many cases, there is no private- market value because deals can't get done.

Some argue it's still too early to get into bank debt. Should you wait?

It depends on the situation. If you're talking about retailers or home builders, absolutely, it's early. We are avoiding home builders and retailers. The bonds of home builders, particularly the investment-grade issues, look extremely rich. But that's not true of all industries. Some bank loans related to utilities look attractive. For those companies, it depends on the dynamics of the region a utility is operating in.

Tell us about some equity holdings.

The television market in general has very good fundamentals. This is a presidential- election year, and the expectation is this will be the biggest spending year ever for TV broadcasting in terms of advertising. We are long the equity of Sinclair Broadcasting Group [SBGI], which owns a string of television stations around the U.S. It's a well-managed company with strong free-cash flow. And they have been benefiting from retransmission.

Which is?

Basically, getting fees from cable companies for their stations. We also like some cable companies, including Time Warner [TWX]. These companies have always traded at discounts to their private-market values. But we expect them to have high-single-digit cash-flow growth this year. Warner has a catalyst, given that [President and Chief Executive Jeffrey] Bewkes has telegraphed he's going to be splitting up the company. Time Warner trades at a significant discount to what we think its intrinsic value is, and it doesn't have a lot of debt. We believe, whether it's through dividends or buying back shares, they are going to releverage their balance sheet.

Time Warner and other cable companies are pretty much going to deliver the growth rates they've achieved over the last 10 years, yet their valuations are around 40% of what they've been historically. As recently as six months ago, these cable companies had double-digit multiples, based on earnings before interest, taxes, depreciation and amortization. And you can buy them for roughly half that now.

Any other thoughts on the cable industry?

We like international cable a lot. There's less competition overseas and we feel good about earnings. Liberty Global [LBTYA], is our largest holding.

Where else do you see value?

With casinos, take a look at MGM Mirage [MGM] compared to Harrah's Entertainment [HET]. Recently you could buy the debt of Harrah's, which has a better collection of assets, yielding close to 15% and trading at six or seven times cash flow. At the same time, MGM's equity was trading at about 10 times cash flow. We felt Harrah's debt was a better buy. We were short some MGM equity earlier this month, given that growth in Las Vegas is under some pressure in this economic environment, but we covered after the shares went down. MGM is a terrific company, but it turned out to be a good short for us.

Thanks very much, Steve.

Friday, April 18, 2008

Missed it By THAT Much!

Okay, so I missed the breakout by one day. After the great results on Wednesday afternoon and post-market announcements by IBM and EBAY, I thought Thursday would be the BIG DAY. So, what did we get? One measly point on the DOW. Some big breakout day. Maybe just a breather for big things to come.

I have been pointing to today for a couple of weeks. Today is the day for Citibank to announce earnings. It started looking good for Citi a couple days ago as its price starting creaping up. Great insight, or leaked information? Who knows, but good news is usually working into the price before the news is official.

So, this morning the news is out. It isn't stunningly great and was a loss of $1 per sahre, but is apparently good enough. New CEO Viktor Pankrit said the credit markets have become much more liquid and Citi is able to move its paper now. He is confident in their future. Citi is up to over $26 in the pre-market, up from around $20 on March 19 (the BSC bottom day). It can move up with a loss and a small miss because many traders were short figuring that Citi was going to zero.

Google also announced much better than anticipated earnings this AM. GOOG is another market leader, like it or not. It is now considered a metric on the economy since a large percentage of corporate advertising budgets has moved to Google. What is good for GOOG is good for the economy.

These two stories, along with other better news and a generally more positive vibe on Wall Street means a good day is coming (the day I thought would come yesterday!!) The good news is improving the case for the end of the bear. The S&P500 is now above its 50 day moving average. As it continues to move above its 100 and 200 day averages, the price action creates a floor for traders. Averages that at one time were ceilings become foundations. The critical psychological level for S&P is 1400. It could go through that today on a big rally.

We also are now 18 days out from the turn in the VIX signal (breaking below its 100 day moving average on March 31). The further out we go, the stronger that signal is. If you look at charts going back a couple decades, the market never turns on this signal when it is two month long (VIX is below its 100 day average for that length of time).

I think we will all be a lot happier (financially and hopefully otherwise) at the end of today.

Thursday, April 17, 2008

Investing in Canroys for Long Term Success

From Jake:
Brian I am still not fully invested in the oil group, with the commodity bubble expected to bust I have invested lightly in this area. Any suggestions? Maybe short term? I have CANROYS but wanted to invest more before the run up but did not want to be taken out in a couple of months. I know hard to answer but any thoughts.
Otherwise a great day for me positioned well in all areas! Thank you!


My Response:
I think the Canroys will do very well short term and long term. In the mid term (2 mths to 12 mths) I am expecting a commodities correction. I think there is a lot of hot money in commodities that is parked there while the recession worries play out. I think that hot money (traders and hedgies) will move back to U.S. equities once the all-clear is called for the market. I expect that to happen anytime from June this year to March next year, sooner more likely.

Short term (next 2 months) I think Canroys will benefit from the hotness of the energy market. The Canroys hedge some of the product forward, but not all of it. So, they are benefiting from the higher energy prices on a daily basis, as they sell some production into the spot market. Also, as futures contracts expire, they will write new futures contracts at the current higher prices to lock in this level. So, there cash flow will dramatically increase the next 12 months, way above their budget forecasts, which are mostly in the $60s for oil and around $7 for gas (this info is in their annual reports).

Regardless of market concerns over the Canadian tax consequences, eventually, the value of this cash on the books must be rewarded. There could be a large special dividend, an acquisition which would increase future revenue and cash flow per share, or a takeout, which would result in a large premium on the stock price. I expect a 50% increase in price in the stocks if not taken out. If one of the small Canroys, like Daylight or Baytex for example, are taken out, they could double in value over a couple of days.

So, I think this is a great entry point for the Canroys, though it would have been even better a month or two ago (Daylight has gone from $6 in mid-January to $10 today, for example)

Regarding the Long term, 12 months to 10 years or more in the future, oil and gas will get more and more expensive as demand increases and supply stays flat if we are lucky. After 10 years, I expect alternative technologies to began increasing energy supply in general, shifting demand. I think solar will become a much bigger factor as new technology improvements drive production costs down. Wind, geothermal and wave energy will also be increasingly important. As fuel cell and battery technology improves, more vehicles will operate on electricity which can be produced by solar sources (wind and wave energy is indirectly derived from the sun, as is hydro power from rainfall into reservoirs). I expect biofuels like ethanol to become less and less important. They are very inefficient to produce and compete with the food supply.

I think Solar will be the most immediate winner in alternative energy and I am working in this industry, so can keep an eye on it up close. Today I am buying a small tracking position ($1000) in a new ETF for solar energy called TAN. Solar has had a big run and might pull back quite a bit in the likely coming commodity correction. So, I will buy more gradually looking for a better point to add a big position.

Wednesday, April 16, 2008

Intel Showing the Way Up

It has been a few days since I have posted my market moves. Thought I would update you today, April 16.

The market opened strong this morning based on the decent Intel quarterly report after the close last night. Tech is a market lynchpin. There has been a school of thought that Tech can't do well if Financials are hurting, since the banking industry is a heavy consumer of computing, software and data storage. But the Intel quarter disproves that theory.

At the same time, the banks continue to do what is necessary to reposition themselves for a less ebullient economy. I think most market participants are coming to the conclusion that the worst is past, though it may take quite a while for bank growth to get back to where it was in 2006. But a more conservative banking industry is okay by most participants.

Also, more educated observers, including Jack Welch, ex-CEO of GE, this morning. are talking about the great benefits to profits of reversing the mark-to-market of the bank assets. It is likely they have mostly been over-discounted. Those assets will be a source of profits for years to come. Expect savvy bank execs to use those assets to "beat the estimate" for the next several years, which will drive P/Es up on banks.

Here are my moves today: bought more Daylight Energy (DAYYF) for my IRA account, added to FXI, the China index, added to DOW Chemical (DOW).

I am still sitting on my AEM (Agnico Eagle) gold mining shorts. Today it is at $75, so I am in the red on this. But I have more than the same number of AEM May Puts shorted at $65 which just about covers my losses on the stock shorts. I will continue paying for the stock shorts with the close month put shorts, basically averaging up my cost. I am using the AEM shorts to protect my several precious metal mutual fund positions, since this commodity bubble will likely correct significantly as soon as the market believes the bottom is in for the stock market, and that the Fed will start raising rates as the economy begins to improve.

When it does correct, history shows that commodities correct very quickly and aggressively since so much hot money is chasing such a little base of equity.

As for the price of oil: I am just glad I am loaded up on energy stocks, which eases the pain at the pump. The Canroys are finally starting to move. The can go a long way from here in playing catch up to their USA equals. If oil and gas prices hold, I think $40 on PWE is a good possibility in the next 2-3 months and $25 on PGH.

Hope you have a great day in the market.

Saturday, April 12, 2008

GE Crashes: OUCH

So much for the almighty GE. We just talked this week what a good company GE has been and how it was priced relatively attractive. After all, GE is a global infrastructure play, with its jet engine, locomotive, electric power (including solar) and water businesses. But we always new that GE was also loaded with financial assets and had to be exposed to some of the problems of the banks. And the appliance business HAS to be hurting with home sales through the floor.

GE's miss should have been no surprise to anyone, but apparently it was. It is just unacceptable to the market for GE to miss on earnings. This is how earnings season will go (and why volatility will stay relatively high for a while longer). There will be some bad announcements this month with results that were not anticipated. But no one should be surprised if any company with consumer durable or financial industry exposure had problems with earnings in Q1. So, once the shock has worn off, the stock market will be fine. All of this bad news really IS already in the price.

So, I just put my money where my mouth is. I sold 3 GE April 33 Puts for 0.75 with the price right now at 32.75. If I end up with the 300 shares, by cost will be 32.25 with a 4% plus yield. I am fine owning GE at that price.

Friday, April 11, 2008

What do you think about Macquarie Infrastructure?

I should say, Jake, that even though I like the concept of Macquarie Infrastructure (MIC), I don't really understand its fundamentals.

It invests in tollroads and parking garages, which are pretty dependable cash flow sources in all markets. I think it is probably a good anti-inflation play since its yield should always exceed the rate of inflation. It would have pricing power as a monopoly. And the assets of MIC should appreciate along with inflation. This is a little different animal than some of our other investments and I would research it thoroughly before investing in it (by reading their SEC filings, for starters) and maybe checking old news articles online.

There is a big question mark on the 2007 income statement. The SG&A expense is very large for the size of the business at around $194M vs. revenue of $831M. That is way too high. But in the 4th quarter, SG&A was a much more reasonable $6M vs. $264M revenue. That is what you would expect for a company this size. How much "selling" expense can there be in infrastructure? People use your facilities or they don't. There must have been some kind of one-time expense in 2007, but I don't know what it was or why it appears on that line. Normally, big one-time expenses are something like writeoff of goodwill after a big acquisition which is listed under "Other" or "Non-Recurring" expense.

Another concern that may be related to acquisitions last year is the fact that the dividend payout exceeded operating cash flow. You would never want to see that in any company. That means the company has to borrow or issue more stock to pay the dividend, lowering the owner equity per share. Borrowing in this type of company can be a concern if interest rates go way up. But for right now, that is not a concern. Maybe their need for financing for projects is cauing their stock price to go down, since they probably use municipal bonds to finance projects. Muni bonds have had problems recently due to the trouble at the monoline insurers.

You can't use earnings for any guidance in this type of company due to the large amount of depreciation for fixed assets in parking garages and toll roads (the toll booths and the roadways themselves). So, Operating Cash Flow is most important and I would keep a close eye on cash on the balance sheet, return on assets (as opposed to equity, since there will be a lot of borrowing in an infrastructure company like this). There should be some leverage, but I would want to see the debt to equity less than 1:1.

MGU is also interesting as is all of Macquarie Bank. It is an Australian company and has a global infrastructure perspective because of its location in the world and the Australian economy, which is very commodity and infr. related.

The IGF fund does not look that interesting, but I am sure it is fine.

Let me know how it works out.

Thursday, April 10, 2008

Those Overlooked Canroys!

Yesterday it was reported that Apache Petroleum had made a huge new discovery of gas deposits. Its stock price shot up to new all time records. Any where was this big new discovery?

You guessed it, in Canada, in the Northeaster BC shale oil deposits, where all the Canroys already operate and have large lease blocks on their books, along with plenty of current production.

So how is it that Apache, dealing with the same provincial taxes / royalties and a 40% American income tax rate (according to its own documents), but only a 0.6% dividend yield, is shooting up in price, while the Canroys tread water? This is a huge anomaly in the investment world that must be resolved at some point. The Canroys are only paying out 50% of their cash flow currently (on average), and are reinvesting in acquistions and organic growth so that their growth rate is on par with Apache, Chesapeake, XTO, etc.

This development effort is building large tax loss reserves that they can use to offset future income (some are stating they will have no tax affect until 2015 with the reserves that are in place). The development programs create depreciation and tax credits that are available for exploration. Both the development credits and depreciation can be carried forward many years in Canada so that any future tax change can be put off for years into the future.

If anything the Energy E&P Canroys are getting cheaper all the time in comparison to their American counterparts.

Wednesday, April 09, 2008

UYG: an Interesting Financial Options Play

The UYG Sept 08 45 option is now at $15. (UYG is an ETF from Powershares and is leveraged to double the XLF index). Maybe get a couple more contracts to average up? Could also wait a few more days to see if the financials decline some more. It is possible. They have been trading in a range, though I don't see much to drive them down short of some surprise blowup at a big bank.

Thursday, April 03, 2008

Commodity Prices Peaking?

Regarding the commodity price discussion by Stephen Leeb in a recent newsletter, I think we can have it both ways, both the Barrons and WSJ positions. We are in the midst of a "short term" correction in commodity prices. Basically, the price increases got ahead of themselves at a time of weakening demand. The commodities markets are heavily influenced by speculative cash flows in today's market. It has become a favorite play ground of hedge funds and hot money. The size of the commodities markets is relatively small compared to the amount of funds available to chase those commodities, so the prices are easily moved around by speculative money flows. I agree with the 30% correction forecast by Barrons, and we are just about half way there on gold with the price in the upper 800s.

But I also agree with the WSJ article which makes the case for supply constraints as the "long term" problem for commodities pricing. New supplies of natural resources and ag products are hard to bring on line. Demand will not create instant new supply like it might for financial products or electronics, which are very easy to ramp up in terms of production (all financial products require is a paper and pen). New mines or oil wells require land acquisition, permitting, support infrastructure (roads, power, etc), labor in places where it may not be already available (Northern Canada), large capital funding, plant design and engineering, etc. And as the most accessible resources are tapped out, the remaining resources are in harder and harder to develop locations (mining seems to go with mountainous terrain for example).

So, I think we can consider both arguments and invest accordingly. If you like to trade short term, like me, the trade now is to be short the commodities. But if you are more of a buy and hold investor, then the proper trade is long. And the new lower prices make this a decent entry point for gold, copper, iron, etc. Ag commodities will also be a good buy if they pull back a bit more.

Wednesday, April 02, 2008

On Ben Stein and the Demise of His Column

I have always liked Ben Stein. He is quite a renaissance man. Besides being a great investor (and worth many millions) he is an economist, a pretty good actor and a politico. He can come off as a whacko, but there is always good reasoning behind his unique delivery.

His philosophies are a lot like Jim Rogers (who is an even greater investor, and maybe worth a billion or more) who he references in this article. It wouldn't surprise me if they are good friends. Like Ben, Jim Rogers is a goofball, but worth listening too / reading.

I think the gist of this story, buy low (against the grain) and diversify are what we always discuss and the way we invest, too. This message reinforces my thinking, not so much changes it.

I would definitely bookmark anything you can read on Ben Stein. Here is his personal website:

http://www.benstein.com/