- Reserves deplete faster than oil (in general)
- Oil/natural gas ratio: the price of oil divided by the price of natural gas is at an all-time high (or close). This ratio stands at 17 (historically it has been at about an 8 or so), Natural gas prices will go up, oil will decline, or both. Also, natural gas is not a good hedge against the declining dollar (it is for the most part a domestic commodity) and storage capacity is more limited, thus not as admired by speculators as oil. This explains in part why it lagged the the spectacular performance of oil of late.
- At $4, natural gas it is uneconomical to develop and look for new reserves.
- No OPEC competition, LNG (liquid natural gas) imports are uneconomical at these prices.
- Politically more favorable than coal.
- After emission caps are implemented natural gas will become a cheaper alternative than politically and environmentally unfriendly coal.
The arguments for why one should sell the cat, pawn the mother-in-law and use the proceeds to buy gold are well known: The Fed is printing money faster than you can read this, which will result in inflation; the government is borrowing like a drunken monkey, so the dollar will be devalued; this will debase all currencies, so the only thing that will save you is the shiny metal. However, here are some arguments why one should think twice before jumping in bed with gold bugs.
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Gold is an important but very different asset class that competes with stocks and bonds. Unlike stocks and bonds, its main attractions are scarcity, durability and resistance to oxidation - it simply never stops shining.
In fact, most of the gold ever mined is around today. It is exhibited in museums, worn as jewelry and buried deep in the vaults of the central banks. Peter Bernstein, in The Power of Gold, wrote:
“Despite the complex obsession it created, gold is wonderfully simple in essence. Its chemical symbol AU derives from aurora, which means “shining dawn,” but despite the glamorous suggestion of AU, gold is chemically inert. That explains why the radiance is forever. In Cairo, you’ll find a tooth bridge made of gold for an Egyptian 4,500 years ago; its condition is good enough to go into your mouth today. . . . Stubborn resistance to oxidation, unusual density, and ready malleability-these simple natural attributes explain all there is to the romance of gold.”
Despite its unique properties, gold has not been a good investment. Over the past 200 years, its returns have barely kept up with inflation. Its value has a low correlation with stocks (prices of gold and stocks move independently of each other most of the time), which is a big positive from the portfolio construction perspective; diversifying with gold can reduce a portfolio’s fluctuations(volatility). But the diversification benefit comes at a large cost: Once added to the portfolio, gold substantially reduces that portfolio’s risk-adjusted returns. Its dismal returns negate any benefit the portfolio receives from reduced volatility.
I spent my youth in Murmansk, a city in the northwest part of Russia, located right above the Arctic Circle. Murmansk owes its existence to the port that, due to the warm Gulf Stream, doesn’t freeze during the long winters, providing unique access to Russia from the north. During the Cold War, Murmansk’s coordinates must have been on the speed dial of the U.S. military, as it is the headquarters of the Russian Northern Navy Fleet. Fans of Tom Clancy’s The Hunt for Red October may remember Murmansk as the home base for the submarine Red October
The city revolves around its port, and its academic institutions are geared toward producing a workforce for the fishing and merchant marine industries. It was always assumed that I’d attend either the Marine College or the Marine Academy. Both were semi-military schools where the students (cadets) had to reside in dormitories, wear navy uniforms, follow strict military-like rules, and take orders from navy officers (and ask no questions).
We often talk about how developments in the economy will impact the stock market, but we rarely discuss the other side of the relationship: how the market impacts the real economy.
It does, and the current run-up in stocks is very positive for the economy. Here’s are three reasons why:
Call it the wishful thinking of the guy who owns Microsoft (MSFT) stock, but the news flow from the company this week was excellent:
MSFT did something very uncharacteristic. It did not push back the release of Windows 7, which will be released on Oct. 22.
Bing is excellent. I played with it for a couple of days, and it’s an “un-Microsoft-like” search engine. It is very good. Type for instance “flight from NYC to Denver“, and it will tell you that fares are predicted to rise in the next 30 days. Click on the green arrow and it will tell you everything you want to know about fares.
- The Rain in Rome by Naum Katsenelson
When I think of Microsoft stock, images of Susan Boyle in “Britain’s Got Talent” come to mind. The Scottish woman appeared — middle aged, awkwardly dressed, unsure of herself, unattractive by conventional (stereotypical) standards — and expectations of her singing were in line with her appearance. As long as she did not fall off the stage, the audience would have concluded that her performance was a success.
If Susan Boyle was a stock, I’d call her a deep value stock with very low expectations, and thus a great margin of safety, selling at a discount to its fair value.
Then she opened her mouth, and to everyone’s shock, this duckling had a beautiful swan of a voice. She became an overnight sensation. The video of her performance was YouTubed more than President Obama’s inauguration.
Then here comes Microsoft (MSFT). The company’s name doesn’t have the luster it once had. It’s seen as middle-aged, overweight and slow, and it is believed by many that creativity retired with Bill Gates.
I updated my Active Value Investing presentation and added new slides. This file opens Power Point – better for viewing on the screen, this file opens PDF – better for printing.
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Slide 17 - new slide on Japanese secular bear market
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Slide 18,19,20,21 - updated valuation data for recent stock market rise, added a new 10 year trailing P/E chart, and new reported and operating earnings expectations
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Slide 20 - brand new discussion on the role interest rates play in stock market cycles
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Slide 24 – new slide, are we still in range-bound market?
A friend asked: What do you make of this rally? Is this May 2003 [beginning of four year cyclical bull market], or May 2008? [beginning of dramatic stock market declines]
- Colorado Autumn by Naum Katsenelson
The May 2003 rally turned into a cyclical bull because the economy started to recover, but more importantly earnings growth started to outpace GDP growth (margins expanded). Today’s rally is predicated on the fact that the US is not going out of business – which is great news, but not good enough for this to turn into a sustained cyclical bull.
Investors soon will realize that the growth prospects going forward are not 2003-2007-like. We are going through the consumer deleveraging that will depress the economic growth rate for quite awhile. I am not betting on much margin expansion for the corporate sector as a whole. Though cost cutting helps, sales growth is not there to exert economies of scale. Also, investors are still looking at past earnings as a guide for stocks’ earnings power. The cold shower of reality is that the past has passed and should force them to revalue their stocks.
The Golden Sea by Naum Katsenelson
Be careful about investing your hard-earned dollars in the latest Chinese five-year economic miracle. One should not confuse China’s latest economic growth — retail sales up 14.8 percent, industrial production up 7.3 percent and car production ahead 18 percent — with sustainable growth.
Now that the US consumer is de-leveraging and the global appetite for goods is declining, Chinese exports dropped 22.6 percent in April.
But this raises a question: How can China, a mainly export economy, continue to thrive when its exports are falling? The answer is that today’s China is a story of two competing economies: the real economy, producing goods and services for mostly external consumption, which is declining at a tremendous rate and the government-spending stimulated economy, which is currently expanding on steroids.
The latter one is clearly winning, for now. Here is why:
The Western Wall by Naum Katsenelson
As a follow up to a recent article, I had a very interesting conversation with a reader. He argued that there is something very important and intangible that economists cannot measure.
The will of people.
That public will becomes even stronger when a country’s past is ridden with political and economic misery. Think of Germany and Japan after World War II; their economies were in shambles. Human capital and ingenuity played much larger roles in their recovery than what we traditionally think of as capital.
In other words, economic models at the time would have predicted that those economies would not recover as quickly or as well as they did, as the models would not have accounted for the key human factor — the raw (and very selfish) drive to succeed.
The reader was making the argument that because of their poverty-stricken past, the Chinese people’s ingenuity will put their economy on a tremendous growth trajectory – just as the drive of the Germans and Japanese did for their countries after WWII. Continue Reading…
Sun and Shadow by Naum Katsenelson
I never write about politics. First of all, it bores me. Second, its guaranteed to upset about 53% of my readers, which normally I would not mind, but since I won’t be able to change their mind why bother. Third, and most importantly, my writing is a byproduct of my investment process – I am an investor who thinks through writing, not a writer who invests. The following article is not meant to be a political one, though I am sure it has turned out as such, but was written to defend free markets.
By shafting bondholders and undermining the bankruptcy system, the Obama administration may change the way investors view risk.
On May 1, the United States took a drastic step toward becoming Russia. Not Russia at its best, not the motherland of Dostoevsky, Tolstoy, Rachmaninoff…
Instead, Russia at its worst, the one that in 1917 took from the bourgeois and gave to the working class; the one that signed contracts with western oil companies in the 1990s when oil prices were low and then — in 2007 when oil prices skyrocketed – blatantly and unilaterally “renegotiated” those contracts.
Wielding the public’s empathy as a weapon, President Obama took Chrysler from its rightful owners: secured loan holders (a.k.a. TARP-tainted banks, the “evil” hedge funds, faceless pension funds). And he gave it to struggling, very sympathetic, $40-an-hour earning (including benefits, this is not a typo), blue collar workers — Chrysler’s employees and the United Auto Workers union. Chrysler, simply, was stolen from its rightful owners.
Israel Old Ruins by Naum Katsenelson
There is a tremendous misconception that leveraged (double, triple, long or short) ETFs are to be used as long-term investments. On the surface they make a lot of sense. You want to hedge your stock portfolio, for instance, you buy a double short ETF of the market SDS (double short of S&P 500) or QID (double short of Nasdaq 100) and for each 1% decline of the market you make 2%. It does sound like a great deal. Leveraged ETFs have been sold as panacea to this market volatility, but panacea they are not. If used as investment (not trading) vehicles they may cause a lot of harm to your portfolio even if you were “right” on their use. They should not be used as a long term investment, but only for short-term trading (i.e. days not months).
Got a letter from Bank of America (BAC) today that informed me that I am a great customer and also mentioned that B of A will be raising fees and canceling rewards on my credit card. Maybe this is the time to own well-run bank stocks with solid balance sheets. They’ve got incredible pricing power. Though I would not touch B of A - too complex and the CEO is…, works for the government not for shareholders.
I own Microsoft (MSFT) stock, and I do believe it is one of the steals of the century. But when I read that the code name for a phone, that is supposed to capture the days of glory from Apple’s (AAPL) iPhone, is “Pink,” I lose some of my faith in the company.
I know it is not the name of the final product, and I am probably reading too much into it. But “Pink” doesn’t inspire employees to create a product that will challenge a market leader.
Three Colors of Life by Naum Katsenelson
Mr. President is facing the first econ lesson of his presidency. According to a New York Times article Mr. President is trying to figure out what to do with shortage of doctors. He said “we are not producing enough primary care physicians”.
Education is expensive, consumes a lot of time and the payoff is not worth the trouble. This is a very early wake up call on socializing medical care in the US.
The econ lesson? When you lower the price you get less of it. This is a good preview of what will happen to little chemical compounds we call legal drugs that save millions of lives every day if you start instituting price controls to “protect” people from “evil” pharmaceutical companies.
- After the Rain by Naum Katsenelson
One more bubble, please.
After the bubbles in technology, housing, and commodities, we saw the mother of all bubbles: the one in global liquidity. The world economy seemed to require bubbles for its continued functioning.
I get the distinct feeling that investors’ prayers are now being answered: There’s a new bubble now - or an old one is being re-inflated, depending on your perspective even as I type this. I’d like to call it the Troubled China Revival Program (TCRP).
Why start reserving bubble-naming rights? Well, I recently received an email from a friend that had the following subject line: “China … Record Loan Addition, Record Money Supply, Record Auto Sales, Record Imports of Copper, Iron Ore, and Coal, Strong Property Sales.”
I checked every figure (the hyperlinks above are mine), and every single one checked out. I couldn’t quite believe what I was reading. I had thought China was in a spiraling-down recession. But even the decline in electricity consumption — a true gauge of economic growth — decelerated from 3.7% in January and February to a mere 0.7% in March.
When I was invited to give a presentation in March about my book to South African CFA Society members in Cape Town and Johannesburg, to say that my expectations for South Africa were low is a tremendous understatement. Click here to see pictures from this trip (opens PDF).
Preparations included a visit to my doctor where I paid $285 for three vaccinations against hepatitis, tetanus and typhoid. My wife packed me antibacterial wipes and gave me clear instructions: “Wipe your hands every time you touch anything.”
Images of dirt roads, AIDS, food-deprived kids, militants with AK-47s, and general lawlessness were circulating in my head, and on some very subconscious level I was saying final goodbyes to my wife and kids. I was going to South Africa.
Banks opened a dirty, ugly Pandora’s box when they destroyed their balance sheets to the point that the Federal government HAD to bail them out. Unfortunately now they’ll be paying for it, dearly. President Obama is going after their credit card fees and will likely not stop there. Our government will start setting interest rates banks can charge and thus will be effectively determining banks’ profitability.
I am sure this will be a very popular with voters, but it is horrible for banks, the economy, and the population whom Mr. Obama is trying to “defend.” When you lower the price of something you’ll have less of it. But maybe all this won’t matter in the short-run as consumers are deleveraging and paying off their debts.
If you thought banks like Citigroup (C) made money in the first quarter, think again. Its business just deteriorated and bonds declined so much, but ironically that was one of the biggest moneymakers for Citi.
The lesson is: if you screw up, screw up big, drive your bond prices into the ground and voila your profitability increases. Seriously, that is what happened to Citi last quarter.
“It gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.” - Warren Buffett
Blossoming Lilac by Naum Katsenelson
After muting CNBC for years, I turned it on by accident yesterday and learned something very interesting. The gold ETF (GLD) is the 6th largest holder of gold in the world - the whole world, even ahead of China. When investors buy GLD they have to go out and buy gold driving up the prices. This raises a little question - who will be buying this gold from GLD when investors will decide to sell it?
Gold is one of those weird assets where nobody knows what it is really worth. You cannot run discounted cash flow analysis to value it - it has no cash flows. It is an asset where perception and reality are deeply intertwined.
Investors buying the gold ETF (GLD) are influencing the price of gold which is fair for the most part as otherwise they’d be buying the real thing. Though of course the ease of buying GLD creates a slightly higher artificial demand, but still it is fair game. The violent sell off in GLD will drive the prices of gold down dramatically unless a real buyer steps in (like another government sick of owning the US debt for instance) and the gold price could get cut in half overnight. Suddenly perception of not being a store of value will create a reality of gold not being a store of value. The gold game will be over.
The economic picture has changed dramatically since Active Value Investing came out. Over the last six months I’ve been getting a lot of questions from readers that have the same theme in common - now what?
This made me think that I should either update the book (write a second edition) or write a series of articles to address the following two questions: Are we still in the range-bound market I described in the book? How should investors change/readjust strategy investing in this environment?
In the mean time I wanted to ask you this: what would you like to see in the second edition of my book. Tell me what you think. Don’t hold anything back. If you think I should shut up and stop writing, tell me this too.
I’ll not make a prediction if this latest rally in stocks is sustainable or not. I don’t know. But it is self-fulfilling. Rising stock prices improve consumer confidence, and more importantly send a signal to CEOs and other executives that maybe there is a light at the end of the tunnel, and maybe that light is not another oncoming train.
CEOs, who despite the appearances, are as human as everyone else may decide to postpone or at least reduce the speed of job cuts as they start taking cues from the stock market.
Thus this stock market rally (if not followed by a sharp decline) may actually help the economy, at least in the short run.
- Israel Old Ruins by Naum Katsenelson
I’ll be attending Berkshire Hathaway’s annual meeting at the beginning of May. After attending it last year, I had serious doubts about returning. The Q&A session, which is really the reason to attend and consumes three quarters of the meeting, was not very fruitful. Questions asked by attendees were “dumb” - Charlie Munger’s words, not mine. The majority of questions had nothing to do with Berkshire and addressed important investment topics like Buffett’s “relationship with Jesus” (no kidding) and tips on how to look for a job. Buffett is great, brilliant, we love him but he is not God. I was surprised last year’s questions did not ask him for advice of how he would do brain surgery. I’ll stop here…. However, Buffett, being a smart fellow and all, changed the format of Q&A this year. This year questions will be submitted ahead of time to three reporters and thus will go through the process of un-natural selection, which in this case is a good thing.
The BRK annual meeting turned into a value investing social gathering. It does provide a great opportunity to meet, debate, learn from, and, this year, sympathize with other value investors. I’ll have a couple of free hours on Friday. You are invited to join me and couple of friends for cheap talk (we are value investors after all) and drinks (mostly water with no ice - value investors cannot afford anything else in this market). We’ll be at the Double Tree hotel bar area on Friday, May 1st, from 1:30 to 4pm. Nothing formal, just like-minded folks getting together for a chat.
In the Barn by Naum Katsenelson
It is amazing what companies will do to cut costs during recession. We know that demand for oil will decline during a global economic slowdown. Basically, global consumption of goods decline, fewer goods manufactured, and fewer ships are needed to cross the Atlantic. Simply, less petrochemicals used. Today’s
article in the WSJ discusses how Maersk a large shipping company is trying to save $1 billion a year.
“Eugen Maersk has left Rotterdam, the Netherlands, on the tail end of a journey from Shanghai. But the giant freighter is cruising at 10 knots, well shy of her 26-knot top speed… At about half speed, fuel consumption drops to 100-150 tons of fuel a day from 350 tons, saving as much as $5,000 an hour.”
I am sure this strategy was unthinkable only a year ago, consumers wanted goods and wanted them NOW. But now that inventories are piling up, car companies are probably finding it cheaper and safer to store cars on slow moving ship than in ports or parking lots.
This is just one, though very large, company trying to survive in a very tough environment. Imagine what other companies worldwide are doing to survive. The point: oil consumption may drop a lot more than we may expect.
I am back from South Africa where I spoke about my range-bound market thesis to South African Society of CFA in both Johannesburg and Cape Town. I’ve visited many countries over last few years, but none have amazed as much as South Africa. I hope to write my thoughts about South Africa soon. It is truly an amazing country.
”Gas use in Europe’s largest economies fell as much as 16% this winter despite unusually cold conditions, according to IHS Global Insight.” WSJ, April 6, 2009
It is hard to be bullish on commodities after reading these types of statistical data bits, especially when you consider that Europe is not the producer of things in the world (China is), and thus a predominant consumption of natural gas goes to heat homes. Of course there is another side to this story - Gazprom will be cutting capital expenditures to cope with lower demand and lower gas prices that it is about to face (natural gas prices lag oil prices).
Gazprom, despite being government controlled, is not a unique case. Oil and gas companies are facing lower demand, sharper lower prices, and thus much lower free cash flows are causing them to slash production and capital expenditures. Capital expenditures are easier to cut out of the two - those are the future revenues and thus future problems which at least from today’s perch pail in relevance to management.
Lowering production is a bit trickier for both oil and gas companies as that impacts current revenues. Oil and gas rich nations like Russia, countries in the Middle East, and Venezuela all face a similar problem. They stand on one leg - petrochemicals – and that leg is being undermined by global decline.
However, their social obligations have ballooned during time of prosperity – cutting productions lowers already declining revenues, while social obligation costs don’t decline. What does this all mean? Lower demand for petrochemicals in the short-run is becoming a certainty. Lower production in the short-term is not certain, though very possible (OPEC to my surprise did reduce production so far, but will it be able to maintain it?) In the longer run, supply of petrochemicals will not be robust; it will decline. It will take high oil and gas prices to cure that problem. As it does every time.
My love for investing, writing and educating is only superseded by the enjoyment I receive doing them concurrently. I hope you find this site informative, educational and maybe even fun. - Vitaliy
You are not as smart as you think you are
By Vitaliy KatsenelsonSun and Shadow by Naum Katsenelson
Our emotions are our biggest enemy, at least when it comes to investing. We should all know this. If you don’t, stop making your own investment decisions right now.
Our emotions lead us to do the opposite of what we should be doing. They lead us to buy high and sell low. They make us excited when we should be scared, and scared when we should be excited. They make us slaves to the stock market; they let the market become our master.
The market is there to serve us, and not the other way around. It is okay to have emotions; we’re human, after all. But what we really need is an investment process. This is system of rules that we follow that keeps emotion in check.
Now, I hate republishing old articles. But a few, the ones that focus on the process, I’ll recycle (and improve upon) for a long, long time. I wrote the following article, in 2007. I included it in my book. I’ve shared it with readers in the past. And I even wrote the flip side of it in October 2008, addressing the impact of a cyclical bear market on out psyche by cyclical bear market.
I’m not offering it now to provide a hidden message that I think the current (cyclical) bull market is over. I don’t know that. I just want to remind you (and me) that a rising market has an impact on our psyche, our analysis and our decisions, and we need to be aware of it.
Continue Reading…