Porterian

This is my personal blog. Travel, financial and political observations. Notes to myself and my friends. Content development for my monthly newsletter, Porter Stansberry's Investment Advisory (www.stansberryresearch.com).

Monday, May 08, 2006

GILDER’S MISTAKE – NOT OURS







When I launched Stansberry Research in 1999 with the financial backing of Agora Inc. and the organizational support of The Oxford Club, George Gilder was the number one, most influential commentator on stocks.

Gilder had an Ivy-league pedigree. His father was David Rockefeller’s roommate at Harvard. When Gilder’s dad died in WWII, Rockefeller assumed the role of father figure, watching over George and helping him get ahead in the world.

When Gilder dropped out of Harvard, Rockefeller helped him get on board with the Nixon administration, where he was a copywriter (they call it a speech writer in politics.) Later he found employment with think tanks. Ronald Regan quoted him frequently. Forbes hired him as a columnist for its tech centric magazine, ASAP. And, behind this exposure he started his own newsletter firm, with several partners.

As the tech bubble took off, so did Gilder’s newsletter. By 2000 he was getting paid $70,000 to give a speech. And he could move stocks from $5 to $125 with a recommendation in his newsletter.

You could tell which stock he’d picked just by watching the ticker on CNBC. It would soar. He drew investment lemmings like rotting meat draws flies. Once a Gilder subscriber posted a recommendation of AT&T on the Gilder message board, as a joke, using Gilder’s digital signature “GG.” Everyone should have known it was a gag, as Gilder based AT&T management regularly, but some poor shmucks bought the stock anyways and threatened to sue.

Even corporate managements fell under Gilder’s spell. Motorola, for example, paid $400 million just for the right to manufacture a piece of communications equipment (“Terabeam”) that Gilder proclaimed was the Holy Grail of all of his “telecosmic” predictions. Too bad Terabeam was a flop and Motorola wrote off the entire $400 million.

In fact, all of Gilder’s predictions led to disaster. He heralded the WorldCom acquisition of MCI as the deal of the decade the wrote that WorldCom had “won” the race to the “Telecosm.” What happened in fact is that WorldCom paid far more than it could afford for MCI. The only race it won was the race to bankruptcy.

But this was all in the future when I launched Stansberry Research in 1999. Back then Gilder wasn’t a target for mockery; he was the most successful new publisher in our business.

I read Gilder’s books on economics: Wealth and Poverty and Recapturing the Spirit of Enterprise. I also read his book about Silicon Valley, Microcosm. I attended several of Gilder’s conferences, which cost $5,000 for attendees and which garnered millions of dollars in sponsorships from corporations hoping to catch Gilder’s eye and be added to his list of recommended companies. I thought Gilder’s ideas about wealth creation were right on, even if I had serious doubts about his economics and his stock picking (see below.). And I knew he’d learned a lot about silicon technologies by taking classes with famed Caltech professor Carver Mead.

I was so impressed with Gilder’s ideas and writing, I modeled my newsletters on Gilder’s. Our letters were story based and built around grand visions of the future. But…as the market changed…so did we. We cut our losses on the stocks that fell. And we wrote bear market warnings when we began to see the writing on the wall for the tech bubble in late 2000. The next year we launched a new letter, built on safe investing:  True Wealth. It’s now our biggest and best letter.

Gilder wasn’t my only intellectual mentor. Steve Sjuggerud taught me the importance of valuation when considering securities. Bill Bonner introduced me to the Austrian school of economics, whose ideas about the risks and dangers of debt were anathema to the supply side ideas of George Gilder. In 1998 I spent a day with Kurt Richebacher, the best living Austrian economist discussing the boom in stocks. In 1999 I went to China for two weeks with Doug Casey, a speculator who’d been in the market for thirty years. He told me the end was near for the NASDAQ bubble because the same gold-stock promoters he’d avoided for years were changing the names of their shell companies from “Gold Sham” to “Sham.com.” Doug and I sat and listened to a half-crazed Vancouver promoter trying to sell us on the idea of investing in his Bike.com business, where you could buy everything you’d need for cycling. We were sitting in the lobby of an old, grand hotel in Shanghai. It was unreal. And destined to end badly.

The Wall Street Journal did a follow-up story on Gilder today “Where Are They Now: George Gilder.”

According to the Journal, Gilder’s newsletter, at its peak, had 75,000 subscribers paying $295 per year. That’s over $22 million in newsletter revenues. And I know his conferences, which pulled over 3,000 people paying $5,000 each, made millions too. According to the newsletter industry scuttlebutt, at its peak, Gilder Publishing was making close to $20 million in profits per year. It had 50 employees.

Today Gilder Publishing has three full time employees and less than 5,000 subscribers. The subscription price has fallen too, to $99. As George told WSJ: “The typical Gilder subscriber lost all his money and that made it very hard for me to market the newsletter.”

Gilder himself was rendered insolvent after he decided to buyout his partners in the publishing company, in March of 2000, at the very top of the market.  As the stocks he’d touted to absurd valuations crashed, his subscribers canceled. And, as a result, he didn’t have the money to pay his former partners.  Says Gilder, “I was as close to bankruptcy as you can get without filing.”  Gilder avoided personal bankruptcy only because his creditors were also his friends. They put a lien on house.

George Gilder went from being a multimillionaire and the single most influential commentator on stocks, to being financially destitute – all in a matter of months. His reputation has been so badly tarnished that he can’t even sell books. His latest, “Silicon Eye,” was a flop.

I think about what happened to Gilder frequently. What happened to him could have easily happened to us. Why didn’t it?

  1. We, luckily, had access to better ideas. I wasn’t Rockefeller’s godson. The Republican Party didn’t indoctrinate me; its messianic, religious view of economics never made any sense. (See the letter below that I wrote to George on his message board in August of 1999. On his website I became a “gadfly” character, pointing out the fallacies of his economic thinking. He responded to my posts regularly.)

  2. Likewise, thanks to Steve Sjuggerud training, I knew cutting losses was the key to successful investing. After the bubble, we worked hard to expand our knowledge of stock picking and finance. Today Gilder still doesn’t understand how to value on equity. In this business, you must be a genuine financial expert, or else you will eventually blow up all of your subscribers.

  3. We expanded our titles as quickly as possible, building new publications that were in demand. Gilder only had one niche: new technology. In the stock market, tech comes in out of fashion regularly. You have to base your publishing business around bigger themes – like safe investing, income investing, value investing, global investing, etc.

  4. Because of Julia’s experience at the Oxford Club with the Chairman’s Circle, we understood the potential of lifetime subscriptions. Locking in your customers by getting them to invest $5,000 or more in your business means they won’t leave you when the market inevitably stumbles.

  5. Likewise, because of our experience with Agora, we knew the profits from the newsletter business would come mostly from the “backend.” Gilder’s only backend was his conference business, which by its nature is low margin. I invited Gilder to participate in our Diligence product…but he never understood why charging more for more specialized information was such a good business decision.

  6. We avoided being too closely associated with any one stock. Gilder was synonymous with WorldCom, JDSU and Global Crossing. Two of the three went out of business. Gilder was blamed. We didn’t let our editors continue to re-recommend the same stocks, month after month. We required that they cut their losses when they hit their trailing stop losses. And…where we broke these rules…it cost us dearly (VaxGen)…so we learned not to break those rules, ever.

  7. We never held ourselves out as visionaries or gurus. We made it clear, in almost every issue, that we were human and fallible. We demonstrated that our edge was merely our willingness to work hard, to uncover all the facts and to understand simple financial rules – it wasn’t our genius. By being humble, we did not set ourselves up to fall from Mt. Olympus.

  8. We worked hard on writing great marketing packages. Gilder’s success in the mail came straight from his track record and reputation. With both of those tarnished, he didn’t know how to get new readers.

  9. We understood the power of email and frequent communication. Gilder didn’t add a regular eletter until 2003. His newsletter was never published on any consistent schedule.

  10. We’ve never made any risky financial choices. Whenever I’ve had the opportunity to risk a large sum of money in pursuit of more money, I’ve declined. My philosophy is taken from Warren Buffett: “Never risk money you cannot afford to lose in pursuit of money you don’t need.”

**************************

A posting from “Aegis” (aka Porter Stansberry) to George Gilder
August 1999

Mr. GilderYes, your fans are correct.  It is very kind of you to humor me with your replies.  I certainly appreciate the opportunity to match wits.  And I'd really like to back away from the personal attacks, as I seem to provoke more than most.  I strongly disagree with your views on credit, but I have the highest regard for you personally and professionally.  (Please, don’t call me an economist…that really hurts.)You are quite correct to say that credit can lead to real advances.  Let's consider the 1920s.  A credit bubble was intentionally built by Ben Strong of the New York Fed and his counterpart at the Bank of England.  I doubt you would dispute this.  The discount rate went as low as 3.5%.  Business boomed.  The automobile was in abundant supply and radio was fast on its way.  The 1920s were a period of spectacular gains in wealth for all Americans.  Women especially made great advances.  Technology was ascendant.OK, so we know the good side of credit.  You can point to much of the same in today's economy.  The problems are more difficult to see, but just as real.  If you're looking for both evidence and effect, consider prices.  The 1920s, like today, were a period of tremendous productivity growth.  Wages and prices should have fallen, the latter much faster than the former.  But they didn't.  Credit inflation caused prices to remain steady, through the manipulation of interest rates.  The same thing has happened today and will always happen when politicians control interest rates. The fact that prices were distorted meant that information didn't reach producers.  See Sowell's excellent work on this topic.  Goods, such as cars, were overproduced because their prices were kept artificially high.The result was that tremendous claims were built upon assets whose value was inflated.  Profits and yields slowly disappeared.  After the bank of England was put back on the gold standard, the credit expansion ceased (1928).  The economy stopped growing in April 1929.  The crash came six months later.Mr. Gilder and many people on this board probably wish that I would go away.  They say that I bring nothing of value to the table.  Remarkably some people have even muttered that I must have missed the boom.  Some day when I reveal my identity, these doubts will be put to rest.  For now, let me ask you this:Mr. Gilder says that because we always progress, the credit cycle is meaningless.  And yet twice in this century investors have gone 26 years without any real return in the stock market (if you bought in ‘29 or in ‘66, you made nothing in real terms for 26 years.)   He wants you to believe that the Great Depression and the 1970s energy crisis were no problem.  Maybe for him it wasn’t a problem…
I say that more money doesn't create more value.  If we’ve become productive (and I think we have), then why haven’t prices and wages fallen?  Ask Greenspan.  

I say that credit bubbles are dangerous because they distort the economy.  

I say that sound money and banking should be part of our constitution: that property rights are human rights.

Most importantly, perhaps, I say that you can’t judge the distortions in our economy by measuring the current prices of assets because those assets are measured only in paper dollars whose value is controlled by the same man who is promoting this credit bubble.

-- Aegis

Wednesday, April 12, 2006

WHAT THE WSJ DOESN'T KNOW ABOUT GOLD

Gold is the only major commodity that isn’t produced primarily to be consumed in the economy – like iron, copper, pork bellies, or oranges – but simply to be owned and admired. It is too heavy, soft and rare to have many practical uses outside of electronics and dentistry. Yet it is one of the earth’s most prized objects, valued mostly because it is considered valuable.”


  • E.S. Browning, The Wall Street Journal page A1 April 12, 2006


Did you notice the circular logic? Gold is valued because it’s valuable.

How insightful...

There’s no other way Browning and his editors at The Wall Street Journal can describe gold’s utility. They look at the metal curiously, the way a dog looks at a carrot.

Mmmnnn, they ponder.

They describe gold’s unique attributes – the things that make it perfectly suited for use as money – without acknowledging any of them. In fact, to the Journal, these attributes are weaknesses. It’s too rare they say. It's too soft they say. It isn't consumed by industry they say.

They don't mention that its softness means it can be divided easily. They forget to mention entirely that it never tarnishes, which makes it a unique store of value. And, that gold doesn’t have any industrial uses means it's also in ready supply: all the gold that's ever been mined is still on the market...at some price. It’s timeless, eternal, and isn't someone else's liability, much unlike today’s paper money.

The Journal doesn’t mention any of this; in fact, the Journal doesn’t even reference the historical role of gold in the economy (as money) at all. Not once.

Late last year I met with about a dozen of the top private equity firms in New York, Boston and D.C. I was trying to buy another, large publishing company. I needed to borrow $70 million. It's funny. I had a hard time getting a $300,000 mortgage to buy a brand-new home on a piece of water-view property in downtown Baltimore that's easily worth far more than $300,000. But private equity firms were ready to hand me $70 million, to buy a business with no earnings and little tangible assets. Go figure. Our deal fell through, by the way, as the target company's share price ran away from us. Still, I have a feeling private equity investors are going to get what that deserve from these firms...not what they expect.

Case in point: gold.

During each meeting I usually made a point of mentioning that we publish research about gold and that we consider gold to be the only real money. I’d show them a promotional letter we published three years ago about the “secret currency” – which is rare gold coins. Each time gold came up in our meetings, these highly educated extremely polished money managers couldn’t hide their smirks or stifle their guffaws. Most of them openly laughed out loud. They certainly didn’t have any investments in gold mines, gold bullion or rare gold coins.

They will. Soon. And they won’t be laughing about gold anymore.

******

Epilogue: I distributed an earlier draft of this post to a close circle of friends and business contacts. Rick Rule, who has been the leading investment banker to the resource industry for more than thirty years, replied with the following comments about private equity managers.

"Wall Street hubris leads these morons to believe that they can master or hire the expertise appropriate to a wide variety of tasks, despite a historical track record unblemished by success. The set of circumstances that make me think exposure to bullion is neccessary, economic slowdown, monetary instability, political and social corruption, will decimate the cosy, mundane world of private equity, particularly given the balance sheets of the resultant entities.The Wall Street guys are very wise to ignore the gold and gold equity markets; those markets devour the uninitiated. These same Wall Street guys will become involved, to their clients chagrin, eventually [at the top of the market]."

Friday, April 07, 2006

FRAUD OR STUPIDITY

Here’s what’s troubled me about some (not all) of the prosecutions following the great bull market of the 1990s…

When someone commits a financial crime or a civil fraud, it’s usually easy to spot. Take the former CFO of Patterson Energy. Living in Synder, Texas and working for the only big company in town made it pretty easy to spot the extra $60 million or so he embezzled from Patterson. You can also see the clear link between his criminal intent (to steal), the actions he took (creating dummy corporations) and the benefits he gained (temporarily).

Likewise, when someone commits fraud, they end up with things they had no right to – usually profits.

So… what did Bernie Ebbers end up with? Nothing, he went bankrupt. What about Ken Lay? Likewise, nothing: he sold all of his Enron stock on the way down to cover margin calls. He was wiped out financially and his reputation has been destroyed. What about Martha Stewart? If she hadn’t sold the stock when she did, it would have been worth more money later. By taking Sam Waksal’s “tip” she probably lost money, not to mention losing her freedom for six months.

Other way I like to judge the amount of Federal grandstanding in these cases is to think about what would have happened if these “criminals” hadn’t been caught. If Bernie Ebber’s WorldCom hadn’t gone out of business, the way the company handled its accounting for local line access would have never been considered a crime. AOL did essentially the same thing for years during the late 1990s – the capitalized their marketing costs. Also, it’s important to note that the company’s accounting had nothing to do with its bankruptcy. The company went broke because it paid way too much money for MCI and it couldn’t afford the corresponding debt obligations. Bernie’s decision couldn’t have been criminal because who would intentionally bankrupt their own company and go broke in the process… It doesn’t make any sense.

Obviously, some of the era’s fraudsters don’t pass the “what if they didn’t get caught” test. Take the Solamon Brothers telecom analyst, Jack Grubman, who upgraded his rating on AT&T so that his firm would get part of the IPO business on the AT&T spin-off, AT&T Wireless. Emails show pretty clearly part of the reason Jack Grumman changed his rating on the stock was so that Citigroup Chairman Sandy Weil would help get Grubman’s twin boys into a prestigious kindergarten. If Grubman had never been caught -- if the telecom bubble hadn’t burst bringing him down with it -- he still would be guilty of accepting benefits in exchange for touting an investment he knew was actually low quality. He would have still committed a fraud.

What about Ken Lay? If Enron hadn’t gone bankrupt, would he be guilty of any crimes? He is charged with defrauding investors by telling them Enron’s finances were sound and that the company’s prospects were bright. Why would he have said those things if he didn’t believe them to be true? How did these “fraudulent” statements benefit Ken Lay? They didn’t. He was being forced to liquidate his Enron holdings because of margin calls. At the very worst, Ken was trying to save his company by rallying his employees in the midst of a terrible crisis. If he had succeeded, he would have been applauded. But, because he failed…should he be convicted of fraud…?

THE TOP OF THE BOND

Last week (on April 1st) in The Wall Street Journal, Edward Chancellor suggested the U.S. sell undated zero-coupon bonds.

“How about issuing an undated zero-coupon bond? Such a bond would have several attractions. Since it pays no interest and never redeems, it would save the Federal government a packet. It would also satisfy the apparent willingness of global investors to snap up low-yield, risky paper. Last, but not least, an undated zero-coupon security would be the ultimate expression of U.S. financial hegemony.”

I’ve tried repeatedly to contact both Edward and his editors to verify that this suggestion was not an April Fool’s day gag. If it was, WSJ was unaware that it was publishing humor.

That it’s even possible to posit as a joke that the U.S. government could sell a bond that will never be repaid and that carries no coupon tells me the top is in.

Thursday, March 23, 2006

INTER-NOTS

The myth, if you’ll recall, began in 1995 with the Netscape IPO.

The first Internet software stock to go public priced at $28 per share in August 1995, closed at $59 on its first day of trading and reached $171 per share by December, sporting a market capitalization over $1 billion.

By the top of the mania in 2000, Yahoo! had achieved a market cap of $150 billion.

The myth was that the Internet would change everything because the Internet would produce new levels of productivity and efficiency. Buying things from Amazon.com would cost less, allowing Amazon to sell at lower prices. Investors buying Internet stocks were told to throw out the old ways of valuing a business because, in the new economy, capital efficiency would make a mockery of low P/E ratios.

The Internet has changed some industries. Newspapers, in particular, have seen their revenues cannibalized by net advertising, which offers specific customer targeting and tracking and which, generally, costs much less. Internet advertising revenues reached $10 billion in 2004. According to Price Waterhouse Coopers (PWC), in the first six months of 2005, total ad revenue for websites reached $5.8 billion, 25% higher than for the same period in 2004. I personally know of financial websites that were able to raise their ad rates by 60% in 2005.

Meanwhile, newspapers have seen large single digit revenue declines.

So…the Internet did change everything in the print ad business. And, I bet, in time it destroys TV advertising too, with an assist from Tivo.

But what about the other stuff – the promise of far great capital efficiency? What about the promise that the Internet would make our lives easier, cheaper and vastly more profitable…?

It’s not happening.

While companies like Amazon and Google have offered users discounts and lots of free services (free shipping, free email, free data storage), the costs haven’t truly been removed – or even lowered – for any of these services. Who’s paying for them? Shareholders.

In early March Google announced it would have to spend 19% of net sales on capital investments – mostly the services and data warehouses required to give essentially free unlimited storage to email users who pay nothing (directly) for the privilege. These costs are the manifest result of the web’s low switching costs – something that’s always made it a troubling medium for business. When the Froogle search engine can tell you where on the web to buy that hot new widget at the lowest possible price, how can widget venders earn a profit? Only by spending huge amounts of money on user perks like free shipping and free email storage.

The result is that investors continue to subsidize Internet businesses in the same way they subsidized Netscape. The only difference is that the damage is hidden from the income statement because the required spending is put in the capital budget, where they hope you won’t see it.

Alas, I looked.

To make the study more interesting, I didn’t just look at the major internet stocks (Yahoo, Ebay, Amazon, Google), I also threw in smaller Internet businesses I know well (Digital Insight, Akamai) and I looked at another handful of stocks that are either very well-know (MSFT, GM, Dell) or have been recommended in my newsletters (BL, NOK, BUD).


[All $ figures below are in millions. Capex% refers to the percentage of capital spending, as measured against cashflow. "FCF Mult." refers to the companies market cap as a multiple of free cash flow.]

Cashflow Capex Capex% FCF Mult. '05 Rev. Growth
MSFT $16,605 $812 5% 18 9%
RTN $2,515 $338 13% 10 9%
NOK $4,900 $718 15% 22 13%
DELL $4,839 $728 15% 17 13%
BL $48 $8 17% 4 -7%
EBAY $2,000 $338 17% 31 42%
YHOO $1,700 $408 24% 35 40%
AMZN $733 $204 28% 28 17%
DGIN $57 $18 32% 31 16%
AKAM $83 $27 33% 77 44%
LXK $576 $201 35% 11 -12%
GOOG $658 $245 37% 245 86%
BUD $2,800 $1,100 39% 19 -1%
GM $13,000 $7,700 59% 2 -1%
VZ $22,000 $15,000 68% 14 6%



Some interesting things pop out right away.

First, the Internet companies aren't very efficient with their capital spending. Second, there are manufacturing companies that are surprisingly efficient -- Raytheon (RTN) and Nokia (NOK). Third, lots of capital spending doesn't ensure revenue growth (BUD). And fourth, telecommunications (Verizon, VZ) is incredibly capital intense. You have to wonder what that will mean in the future, as more and more businesses compete for the same home connection. Telecoms could end up in the same situation as the airlines. It's probably better to own the equipment makers.

Now...about those Internots...

In almost all respects except for its medium, Amazon.com is a catalog retailer, the Sears Roebuck of our day. There are many other companies in the direct sales retail space. Two I know well are Dell and Blair (BL). Both Blair and Dell (despite their enormous respect size differences) have a website business and a catalog presence. And both spend around 15% of their free cash flow on capital investment each year. Amazon on the other hand spends 28% of the cash its produces each year on investments. That’s a lot of spending to produce only marginally more growth. (Dell grew sales at 13% last year; Amazon 17%).

But the Google example is much more startling. Google, like Microsoft, is a software company. It sells access to its software through its Internet site (Google.com), which generates advertising revenue through tracked sales links and paid-for search results. You would think that a totally centralized software operation, based completely on Internet connectivity would prove to be a far more capital efficient business than Microsoft, with its multiple products, multiple versions and its mix of hardware devices (the Xbox.) But you’d be wrong…

Microsoft only spends 5% of its free cash flow on capital investments, while Google is spending 37% -- putting Google on par with one of the huge industrial stocks in our survey, Budweiser. Is Google’s outstanding growth rate (86%) worth this rate of investment? I can’t imagine how. Not when switching to another search engine provider is as simple as forwarding a few of your favorite email files to someone else’s server.

Tuesday, March 14, 2006

WHO PROFITS FROM OBSCENE EXECUTIVE COMPENSATION?

The top three executives at North Fork Bancorp…stand to receive $288 million from the large New York Regional Bank’s $14.6 billion acquisition by Capital One Financial.”
-- WSJ, March 14, 2006


These payments to the executives of North Fork Bancorp are obscene.

There are 475 million shares outstanding of North Fork Bancorp stock. So, each shareholder will give about $0.60 to the top three executives, just for selling the company. That’s more than half a year’s dividend!

A small shareholder, say a 1,000 share round lot buyer, will give $60 directly to the top three executives – just for selling the company!

These payments come mostly in the form of accelerated stock option vesting and cash payments to cover the tax burdens of such equity grants. The IRS requires people to pay taxes on all compensation. So, when ten years worth of stock options get vested all at once, there is a big tax bill. Covering these tax payments has become a regular executive benefit, although such payments are expected to occur over the life of the executives’ employment, not all at once. In any case, North Fork Bancorp’s CEO, John Kanas, will receive $111 million in cash, just to cover his tax bill, when the deal closes.

Why should some employees have their taxes paid by the corporation? They justify it by explaining that if the CEO had to pay his own taxes, he’d have to sell half the shares he earns and that selling might negatively impact share price. But that, of course, is a retarded argument. It assumes that a temporarily depressed share price is a bad thing – it’s not. A weak share price for a week or ten days is a blessing for other shareholders, who could buy more at a better price.

The real explanation for the obscene payments being made each year to executives is a corporate governance system that’s still completely broken – because it’s dominated by third party, institutional shareholders who have deeply conflicted interests.

Board members have to approve executive compensation deals. Board members also have to approve mergers. Shareholders vote on who gets on the board. Therefore, board members check in with big shareholders, to make sure their interests are being represented.

So, who are the large shareholders of North Fork Bancorp…? Whose interests are being rewarded by this merger…? And whose interests are served by paying the top three executives more than a quarter billion dollars…?

In this case, it’s JP Morgan, which owns 4.42% of North Fork Bancorp (a little more than 21 million shares). JP Morgan is also the world’s largest derivatives trader and has a large, proprietary trading group. Is it possible that JP Morgan encouraged this deal in order to prop up its own trading account? JP Morgan’s share of the executive compensation bill for the top three North Fork Bancorp executives comes to nearly $13 million.

Would JP Morgan agree to spend $13 million for nothing…?

Thursday, March 09, 2006

OIL HEADING LOWER

I was in a meeting with Matt Baldiali, our oil analyst on Monday and I had to confess to him that I think the current high price of oil is both unsustainable and something of a bubble.

Here are my reasons –

1. The oil to gold price ratio is still completely out of whack. Normally it takes about 20 barrels of oil to buy an ounce of gold. The ratio is surprisingly stable, as both oil and gold respond to world political events and inflationary pressures. But, last August the ratio fell to a record low level – 7. This can’t last: either oil has to fall, gold as to rise or both have to happen to some degree. (I should have a chart of this up by tomorrow.)

2. Wall Street believes in “peak oil” – the idea that oil prices must forever go higher because there is no more oil. The oil sector analysts are the most wildly bullish group on Wall Street: 73% of all oil service stocks are rated “buys” and 61% of oil stocks are rated “buys” – the two highest buy-rated groups. Gold is the lowest. I can tell you from experience that pro investors still think gold is a joke. I met with a dozen top private equity firms last fall, in a failed attempt to buy a large publicly traded publishing company. At each meeting I would make a point of telling the assembled “stars” that we published reports about rare gold coins. The groups laughed every single time. At some point the speculators that have bought oil as an inflation hedge will buy gold instead.

3. Individual investors have full committed to oil: assets in the Rydex Energy Services Sector Fund (RYVAX - 41.94), when adjusted for net-asset value changes, swelled by 94% during the past two months. Total assets in the fund reached a new historical high last week.

4. Norwegian billionaire John Fredriksen is at it again. He is part of a group of financiers that are building 40 new floating deep-water rigs. They cost about $600 million each, or between $15 and $20 billion altogether. I say Fredriksen is “at it again” because at the previous top in the market (1997) he raised money (Northern Offshore) to build rigs too. That company went bankrupt about a year later when oil plunged below $10 a barrel. Fredriksen’s new company, SeaDrill, raised over $800 million on claims to become the world’s fifth largest offshore drilling company. It has already committed to spend over $1 billion on new rigs.

5. A big, wildly overpriced merger. Think TimeWarner/AOL. In the oil boom, the biggest, most overpriced deal happened in December when ConocoPhillips bought Burlington Resources for $35 billion. Judged in terms of proven reserves, ConocoPhillips paid $17.50 per barrel. That’s about twice as much on a per barrel basis as Chevron paid for Unocal five months earlier.

6. Nature abhors a bubble and it won’t cooperate: too much oil is coming out of the ground. U.S. crude-oil inventories jumped 4.5 percent to 335.1 million in the four weeks ended March 3, leaving supplies at the highest since May 1999. Last week's gain was the biggest since Oct. 29, 2004, the report showed. The increase left supplies 14 percent above the five-year average.

SMART GUYS BUY ARGENTINA

Lots of “smarter” money seems to be heading into Argentina.

Some of the smartest guys I know – Doug Casey (caseyresearch.com) and Bill Bonner (dailyreckoning.com) have been buying up thousands and thousands of acres of ranch land in northwest Argentina.

It’s difficult for most investors to invest in Argentina this way. Are you going to spend $20 million dollars buying up dozens of individual ranches, some of which are more than 100,000 acres in size? I doubt it.

But, there’s a publicly traded company, Cresud (CRESY) that owns million of acres in the same area, plus a big stake in IRSA (NYSE: IRS), which owns top office properties in Buenos Aires. My friend Steve Sjuggerud, editor of our True Wealth newsletter recommended Cresud a few years ago, based on the value of its land holdings and on the savvy of its CEO, Eduardo Elzstain. Elzstain has good relations with many of New York cities top financiers – Soros was once his partner. I’ve met Elzstain. Steve and I had lunch with him in BA two years ago and we took a group of subscribers with us. Eduardo would meet with us – but not with any of Wall Street’s analysts – because we wanted to talk to him right after the crash when Wall Street wouldn’t return his calls.

It pays to build relationships

I’ve been researching Leucadia (LUK) – billionaire investor Joseph Steinberg’s investment vehicle -- for an upcoming sales letter about the world’s best investment holding companies.

Turns out great minds think alike about Argentina…

Leucadia recently became a top holder of Cresud. A Leucadia subsidiary, Nead, bought a bunch of Cresud warrants, some of which were sold back to Elzstain, but some of which were held and will convert into stock – more than 17% of all Cresud shares outstanding.

Here’s a link to Leucadia’s SEC filing about the position:

http://yahoo.brand.edgar-online.com/fetchFilingFrameset.aspx?FilingID=4232790&Type=HTML

MORE ABOUT "DEADSUMERS"
AND THE HOUSING BUBBLE

Paul Kasriel, the top economist at Northern Trust, and one of the very best data hounds out there now, wrote about the housing bubble in John Mauldin's latest ezine (http://www.investorsinsight.com/otb_va_print.aspx?EditionID=289).

You'll recall that my thesis is that while housing prices may not collapse, real estate sales volumes are likely to contract and the ability of consumers to "refi" and draw equity out of their homes is likely to end -- which would have a seriously negative effect on consumer spending. That's bad news for our economy, because consumer spending and the housing market are the main contributors currently to economic activity.

Kasriel points out that the last time there was a correction in home prices, consumer spending wasn't directly hit because back then people still thought paying off the mortgage was a good idea. Back then, people didn't use the equity in their homes as an ATM machine. Here are the relevant figures (from Kasriel): "in the third quarter of last year, households extracted equity at an annual rate of $633 billion, representing 7.0% of their after-tax income, from their houses. In 1989, home-equity extraction totaled only $82 billion, or 2.0% of after-tax income."

And here's a chart that shows equity extraction since about 1980...as you can see, most of the time it's near $0. But since 2000, it has soared.

When the economy crashed after the tech bubble in 2001/2002, most of the experienced investment writers I follow noted that equity valuations should have fallen to much lower levels and dividend yields should have reached new highs. In the past, extreme bear markets have always fallend extreme bull market and no bull market was longer or more extreme than the bull of '81-2000.

But the expected correction in stocks never came. We didn't see the Dow trading at 8 times earnings and yielding 6.5%. High quality tech stocks, like Amgen, for example, never even traded below 30 times earnings! Why not? Why didn't the economy contract more...why didn't assets become cheaper...

Mmmnn.... I wonder.

Wednesday, March 08, 2006

ELAN SOARS... AGAIN!


The first time I "bought" Elan was in December of 2002.

The company was a mess, trading for around $2.00, and reeling from what amounted to an Enron-like scandal. Under Irish management, the firm had sold-off stakes in its best products to outside investment groups. It was also lending money to start-up biotech firms and then booking the same funds back as revenue for "joint venture" partnerships. Worst of all, it was borrowing the money it was lending out, operating as a kind of biotech hedge fund. The whole thing was a big house of cards. When biotech stocks crashed in 2002, it came toubling down.

It was Garo Armen's job to fix it, as the company's new chairman of the board.

In 2001, before Elan collapsed, I'd gotten to know Garo Armen by studying his cancer technology company closely -- he's the CEO of Antigenics. I greatly admire Garo's brains and ambition. Because I had gotten to know him, I knew he had the highest standards of personal integrity. I knew he was telling the truth when I spoke with him about Elan. And in a situation like Enron, or WorldCom or Elan, knowing the guy in the middle of it all, and knowing that he's totally honest is the most valuable information you can ever have in the stock market.

Garo told me Elan was worth saving because of its excellent science -- in particular the company's new drug for MS. This drug would be worth $10-$20 billion in the market, but Elan was trading for less than $1 billion at the time because most investors thought the company would go bankrupt and nobody trusted its managers. But I did.

I wrote that Elan would be the best stock on the NYSE in 2003 ("Investing in Garo" PSIA December 2002). Unfortunately, we got stopped out in March, at $3.00, up a bit from where we'd bought....but not the big gains I was expecting. A few months later, in September of 2003, after checking in with Garo and seeing additional clinical trial results on its MS drug (Tysrabri), I re-recommened it -- this time at $6.00. We made a killing this time, riding the stock to around $18.00.

Then everything fell apart. The company hit a huge landmine in early 2005, shortly after we sold. Its MS drug was pulled from the market, over safety concerns. I reviewed the data -- only 3 out of several thousand patients developed a rare brain disease. I believed the drug would be reinstated by the FDA after further study. I re-recommended the shares in July 2005, for around $7.00.

Today all 12 members of a FDA advisory board voted to urge the FDA to allow the drug back on the market. (See the Reuters story here: http://biz.yahoo.com/rb/060308/tysabri.html?.v=11 ) The stock rose 24% on the news, to close near $16.00 per share, up more than 100% from my most recent recommendation.

Three recommendations. Profits each time. In total, several hundred percentage points of profit.
All the Elan profits my subscribers made stem from one relationship I cultivated in biotech -- Garo Armen. When young editors join our group, I always tell them the most important thing to do for your career as a newsletter writer is to build good relationships with the smart guys you meet.

Thanks Garo.

Gran Pacifica Looks GREAT

Plus, Wad O’ Cash



*** ROADS! ***

I’m fired up today... about roads!

I got a JPEG picture in an email from my friend Mike Cobb. Mike is the CEO of Gran Pacifica, a real estate development company with beachfront projects in Nicaragua and Costa Rica. The picture Mike sent me is of newly paved cobblestone streets! It was taken in Nicaragua, at the Gran Pacifica development. The roads even have curbs and a sidewalk! There’s nothing else like this in all of Nicaragua.

Steve Sjuggerud and I bought a beachfront lot in Gran Pacifica about six months ago – before there were roads of any kind. The roads look nice – as nice as any you’d find in America. Maybe nicer. And that’s a wonderful surprise. We bought for the beach, the surf, the people and the price. That the developers (our friends, Mike and Joel) are doing a first class job is icing on the cake.

Take a look for yourself. The folks standing in the photo are my future neighbors. They all came down for a party and shareholders meeting in January. The roads look great, don’t they? Holy cow. I’m sure it’s hard for you to understand why it’s such a big deal…but basically nothing else in the whole country looks this nice…

By the way, Gran Pacifica will soon be selling “turnkey” casitas (with two bedrooms) for less than $100,000. If you’re looking for a very low cost second home in a very low cost destination…you should check out Gran Pacifica (http://www.granpacifica.com/). If I wasn’t in the midst of a buying a new home for my family in Baltimore, I’d scoop up as many of those casitas as I could afford. In a few years (3-5) I bet they’ll sell for $200,000 or more. Full disclosure: My wife and I own a tiny stake in the development company.


*** WAD O CASH ***

I found about $10,000 in cash ($100 bills) in my camera bag two weeks ago.

I was sitting in the airport in Managua, digging around in my camera bag for a cable to upload pictures onto my laptop. What’s this envelop…? I cracked it open and $100 dollars bills started pouring out.

Holy cow – I’d just found a huge wad o’ cash in my bag!

Of course, I didn’t really think I’d found $10,000, I thought I'd re-discovered a stash of my own "travel money.” I'd taken out for one of my past trips and then forgotten about. I tend to do that from time to time, because I'm always afraid of running out of money. I have this never ending fear that my American Express card will simply stop working one day and I won’t be able to pay my hotel bill. So, before I travel, I take out $10,000 in 100s and hide them in my luggage, in case I ever need "get away money."

It's funny...finding $10,000 that you didn't know you had feels better than earning $100,000 investing.

Anyway...I was so freakin' excited. I thought about what I could do with the money -- go to New York, buy a new mountain bike...get a few really nice new suits, etc. Maybe a case a great wine...
Then I remembered: a colleague of mine, Lief, gave me this money to deliver to another colleague. I’d spent the night with Lief at an apartment in Buenos Aires six months ago. I was supposed to deliver the money months and months ago, when I flew to back to Miami. But I’d completely forgotten. I'd hidden the cash in my camera bag, in a pocket I never use, so that it would be safe. I knew my camera bag would be "on me" at all times during the trip, so the money couldn't get stolen...but by the time I got home I'd completely forgotten about it.

I was so depressed...