Diary Archives

Europe?s Big Problem

Europe has a big problem. No, it is not the continuing sovereign debt crisis, the lack of leadership, or the possible departure of up to a quarter of its membership, although these are all major worries.? Nor is it the Euro, the currency that everyone loves that has been declining for the last two years. No, the problem I am talking about is much worse than that. It is in fact so extreme that the union may not survive unless it is dealt with soon.

A Big Mac hamburger in Milan, Italy?s downtown Galleria cost me $7.50 on Monday. No, that is not for the entire meal, which includes the supersized Coke and French fries. That is just for the burger alone. This compares to $3.50 back home in the USA and only $3.00 in China.

And I can tell you that there is absolutely no difference between these three heart attacks on a plate, because I have eaten all three of them over the past year. The only real benefit of buying the Italian version is that they also had this cool espresso machine so you could wash down your lunch with a cappuccino or caf? latte.

I have written many times in the past about the Big Mac?s usefulness in measuring the relative value of foreign currencies using the theory of purchasing power parity. It is, after all, one of the few products sold in almost every country in the world which is uniformly identical. Thank American management for that, along with the world?s largest food logistics operation.

I have followed this indicator in earnest since my old employer, The Economist magazine in London, wrote it up as an April 1 spoof during the 1970?s. To their shock, their own arguments carried some merit and achieved a life of their own.

Last week, The Economist updated their closely watched indicator. It showed that the Norwegian kroner is 60% overvalued, fueled by its huge oil exports. The Hong Kong dollar sits at the bottom with a 50% undervaluation, gaining an edge from the cheap cost of labor and a low tax regime.

In the good old days, Italy could simply devalue the lira to make its Big Macs, and everything else it produces, internationally competitive. But since 1999, it has been trapped inside the European Monetary System, making this kind of instant cost cutting impossible. As long as Italy is pricing its Big Macs in Euro?s, it might as well be pricing them in in the old Deutchemarks. The same is true for Spain, Portugal, Ireland, and Greece. This does not bode well for the future of Europe.

Of course, if the Euro continues to fall, Italy might get some respite. But even if the Euro plunges to its old all-time low of 88 cents, down 28% from here, it would still have one of the world?s most expensive hamburgers. Maybe it?s time for Italians to become vegetarians. Maybe that is what is knocking the stuffing out of McDonalds (MCD) shares today.

Musings of a Dinosaur

Diary

I often get accused by readers of being a dinosaur, of being insensitive to the feelings of others, and of living as a relic from a previous age. Well, you all may be right. So it is with some amusement I run a piece that I have lifted from my friend, Dennis Gartman?s, The Gartman Letter, on the difference between going to school in 1957 and 2010:

Scenario 1:
Jack goes quail hunting before school and then pulls
into the school parking lot with his shotgun in his
truck's gun rack.
1957 - Vice Principal comes over, looks at Jack's
shotgun, goes to his car and gets his shotgun to show
Jack.
2010 - School goes into lock down, FBI called, Jack
hauled off to jail and never sees his truck or gun again.
Counselors called in for traumatized students and
teachers.

Scenario 2:
Johnny and Mark get into a fist fight after school.
1957 - Crowd gathers. Mark wins. Johnny and Mark
shake hands and end up buddies.
2010 - Police called and SWAT team arrives -- they
arrest both Johnny and Mark. They are both charged with
assault and both expelled even though Johnny started it.

Scenario 3:
Jeffrey will not be still in class, he disrupts other
students.
1957 - Jeffrey sent to the Principal's office and given a
good paddling by the Principal. He then returns to class,
sits still and does not disrupt class again.
2010 - Jeffrey is given huge doses of Ritalin. He
becomes a zombie. He is then tested for ADD. The family
gets extra money (SSI) from the government because
Jeffrey has a disability.

Scenario 4:
Billy breaks a window in his neighbor's car and his
Dad gives him a whipping with his belt.
1957 - Billy is more careful next time, grows up normal,
goes to college and becomes a successful businessman.
2010 - Billy's dad is arrested for child abuse, Billy is
removed to foster care and joins a gang. The state
psychologist is told by Billy's sister that she remembers
being abused herself and their dad goes to prison. Billy's
mom has an affair with the psychologist.

Scenario 5:
Mark gets a headache and takes some aspirin to
school.
1957 - Mark shares his aspirin with the Principal out on
the smoking dock.
2010 - The police are called and Mark is expelled from
school for drug violations. His car is then searched for
drugs and weapons.

Scenario 6:
Johnny takes apart leftover firecrackers from the
Fourth of July, puts them in a model airplane paint
bottle and blows up a red ant bed.
1957 - Ants die.
2010 - ATF, Homeland Security and the FBI are all
called. Johnny is charged with domestic terrorism. The
FBI investigates his parents - and all siblings are
removed from their home and all computers are
confiscated. Johnny's dad is placed on a terror watch list
and is never allowed to fly again.

Scenario 7:
Johnny falls while running during recess and
scrapes his knee. He is found crying by his teacher,
Mary. Mary hugs him to comfort him.
1957 - In a short time, Johnny feels better and goes on
playing.
2010 - Mary is accused of being a sexual predator and
loses her job. She faces 3 years in State Prison. Johnny
undergoes 5 years of therapy.

So True!

Our Leaders Hard at Work Solving Nation?s Problems

The One Bright Spot in Real Estate

Diary

After my weekly dump on residential real estate, I feel obliged to reveal one corner of this beleaguered market that might actually make sense.

By 2050 the population of California will soar from 37 million to 50 million, and that of the US from 300 million to 400 million, according to data released by the US Census Bureau and the CIA fact Book (check out the population pyramid below).

That means enormous demand for the low end of the housing market?apartments in multi-family dwellings. Many of our new citizens will be cash short immigrants. They will be joined by generational demand for limited rental housing by 65 million Gen Xer?s and 85 million Millennials enduring a lower standard of living than their parents and grandparents. These people aren?t going to be living in cardboard boxes under freeway overpasses.

The trend towards apartments also fits neatly with the downsizing needs of 80 million retiring Baby Boomers. As they age, boomers are moving from an average home size of 2,500 sq. ft. down to 1,000 sq ft condos and eventually 100 sq. ft. rooms in assisted living facilities. The cumulative shrinkage in demand for housing amounts to about 4 billion sq. ft. a year, the equivalent of a city the size of San Francisco.

Four years after our economic collapse, rents are one of the few areas in real estate that have been consistently rising in price. Fannie and Freddie financing is still abundantly available at the lowest interest rates on record. Institutions combing the landscape for low volatility cash flows and limited risk are starting to pour money in.

In Your Future?

The Muni Bond Myth

Diary

Some 18 months ago, bank research analyst Meredith Whitney is predicted that the dire straits of state and local finances would trigger a collapse of the municipal bond market that would resemble the Sack of Rome. She believed that total defaults could hit 2,000 issues and reach $100 billion in value. Those sharp edged comments caused the main muni bond ETF (MUB) to plunge from $106 to $97.

So how did that forecast do? Since then, muni bonds have been one of the top performing asset classes in the financial market. (MUB) has soared from 92 to 113, a gain of 23%. As for the number of defaults? The amounted to a handful worth only a few million dollars. Try again Meredith!

I didn?t buy it for a second. States are looking at debt to GDP ratios of 4% compared to nearly 100% for the federal government, which still maintains its triple ?A? rating. They are miles away from the 130% of GDP that triggered defaults and emerging refinancing?s by Greece, Portugal, and Ireland.

The default risk of muni paper is vastly exaggerated. I have read the prospectii of several California issues and found them at the absolute top of the seniority scale in the state?s obligations. Teachers will starve, police and firemen will go on strike, and there will be rioting in the streets before a single interest payment is missed to bond holders.

How many municipal defaults have we actually seen in the last 20 years? The nearby City of Vallejo, where policemen earn $140,000 a year, is one of the worst run organizations on the planet. And Orange County got its knickers in a twist betting their entire treasury on a complex derivatives strategy that they clearly didn?t understand sold by, guess who, Goldman Sachs. They were recently joined by the city of Stockton, California. To find municipal defaults in any real numbers you have to go back 80 years to the Great Depression.

My guess is that we will see a rise in muni bond defaults. But it will be from two to only 20, not the hundreds that Whitney is forecasting. Let me preface my call here that I don?t know anything about the muni bond market. It has long been a boring, quiet backwater of the debt markets. At Morgan Stanley, this is where you sent the new recruit with the ?C? average from a second tier school who you had to hire because his dad was a major client. I have spent most of my life working with hedge funds, major offshore institutions, and foreign governments for whom the tax advantages of owning munis have no value.

However, I do know how to use a calculator. Top quality ?AAA? muni bonds now carry 3% yields. If you buy bonds from you local issuer, you can duck the city, state, and federal tax due on equivalent grade corporate paper. That gives you a pre tax yield as high as 6%, depending on where you live. While the market has gotten a little thin, prices from here are going to get huge support from these coupons.

Since the tax advantages of these arcane instruments are highly local, sometimes depending on what neighborhood you live in, I suggest talking to a financial adviser to obtain some tailor made recommendations. There is no trade for me here. I just get irritated when conflicted analysts give bad advice to my readers and laugh all the way to the bank. Thought you should know.

There is another factor that will support this market. When taxes go up, and they almost certainly will no matter who wins the presidential election, the tax free aspect of muni bonds also increases. That makes them a ?buy? in my book. But only a buy and hold. They way to play it safe here is to only invest in maturities that match your cash flow needs. They way you can ignore the market gyrations and hold everything to maturity. For most investors, that means limited maturities to 10 years or less.

This is Not the Muni Bond Market

Report From Milan

Diary

Milan, Italy appears to be a city entirely populated by fashion models riding bicycles on the city?s frenetic streets. That is one?s first impression coming out of the monolithic Milano Centrale train station, built by Mussolini to reaffirm faith in his state. Despite years of allied bombing during WWII, the building is as imposing as the day it was built.

You Think It?s Easy Fitting into a Size 0?

I came to this medieval city to speak at another strategy luncheon, which was attended by readers from throughout Europe, from the surgeon hailing from Trondheim, Norway, to the Hungarian hedge fund manager. The Westin Hotel provided a spectacular lunch, as only the Italians can.

We discussed various breakup scenarios for the EC which come into vogue every time Greek debt gets downgraded, which is often. This is unlikely, given the modern European?s dislike for open conflict. Bring nationalism into the equation, and things could deteriorate quickly. Germany could bail, unwilling to refinance the debt of lazy, tax avoiding, garlic eaters. Southern Europe could do a disappearing act, unwilling to pay their debts to the sauerkraut eaters up North.

Yes, I Can Be Bribed

In either case, the European currency bloc shrinks, or disappears completely. It is just a matter of time before an opportunistic political party rides this fast track into power. The Germans will tell you from hard earned experience that this always ends badly.

I had exactly one free afternoon to spend in this amazing city. I visited Da Vinci's The Last Supper at Santa Maria della Grazie monastery, looking for evidence of the conspiracy theories long ascribed to this masterpiece. I did a quick run through the Galleria and stepped on the bull?s balls, conducting three clockwise rotations to bring good luck. Looking at my performance since then, it obviously worked. The impact of the fashion industry on Milan is enormous, with every conceivable brand imaginable on show.

I managed to duck into the main Brioni store just before closing. There, I watched two Russian Mafia types in their thirties buy a half dozen exquisitely tailored, 200 thread count suits each for $6,000 apiece. That?s $72,000 worth of clothes?. for guys!

Alas, they don?t carry an American size 48 long in stock, it would have to be a custom order, so I left with only a couple of Leonardo ties in hand. It turns out that Brioni doesn?t manufacture suits for big guys anymore. The company has downsized production to fit Chinese and Russian customers off the rack, where the big money is these days. In any case, I happen to know that I can get the identical suit at the Brioni shop Caesar?s Palace in Las Vegas for a third less, plus they likely have my size. And I will be there in two months for a strategy luncheon.

The next morning found me in a mad dash back to the train station, my taxi driver artfully weaving in and out of traffic, where I boarded a first class Eurostar train. The engine powered North towards the Italian Alps, passing through the Milan slums. Retracing the route seen in the classic Frank Sinatra war flick, Von Ryan?s Express.

Is Food the New Distressed Asset?

Diary

After my entertaining repast with the head of our nation?s intelligence service, I had to ask myself this question.

During the sixties, new dwarf varieties, irrigation, fertilizer, and heavy duty pesticides tripled crop yields, unleashing a green revolution. But guess what? The world population has doubled from 3.5 to 7 billion since then, eating up surpluses, and is expected to rise to 9 billion by 2050.

Now we are running out of water in key areas like the American West and Northern India, droughts are hitting Australia, Africa, and China, soil is exhausted, and global warming is shriveling yields. Water supplies are so polluted with toxic pesticide residues that rural cancer rates are soaring.

Food reserves are now at 20 year lows. Rising emerging market standards of living are consuming more and better food, with Chinese pork demand rising 45% from 1993 to 2005. The problem is that meat is an incredibly inefficient calorie transmission mechanism, creating demand for five times more grain than just eating the grain alone.

To produce one pound of beef, you need 16 pounds of grain and over 2,000 gallons of water! I won?t even mention the strain the politically inspired ethanol and biofuel programs have placed on the food supply. Burning food so you can drive your GM Suburban to Wal-Mart on the weekends while millions are starving never made much sense to me.

It is possible that genetic engineering, sustainable farming, and smart irrigation could lead to a second green revolution, but the burden is on scientists to deliver.

The amount of arable land per person has fallen precipitously since 1960, from 1.1 acres to 0.6 acres, and that could halve again by 2050. Water is about to become even more scarce than land. Productivity gains from new seed types are hitting a wall.

China, especially, is in a pickle because it has 20% of the world?s population, but only 7% of the arable land. It has committed $5 billion to develop agricultural land in Africa. There are now thought to be over one million Chinese agricultural workers on the Dark Continent. Similarly, South Korea has leased half the arable land in Madagascar to insure their own food supplies.

An impending global famine has not escaped the notice of major hedge funds. George Soros has snatched up 650,000 acres of land in Argentina and Brazil on the cheap, an area half the size of Rhode Island, Others are getting into the game, quietly building portfolios of farms in the Midwest and the South.

This year promises to deliver one of the greatest US crop yields in history, brought on by the warmest winter in 100 years. The US Dept. of Agricultural January crop report then predicted huge surpluses, slamming prices once again, and delivering limit down moves in the futures markets. But the weather may not cooperate, as it did last year.

The net net of all of this is that food prices are going up, a lot. Use this year?s expected weakness in prices to build core long positions in corn, wheat, and soybeans, as well as in the second derivative plays like Potash (POT), Agrium (AGU) and Monsanto (MON). You might also look at the PowerShares Multi Sector Agricultural ETF (DBA) and the Market Vectors Agribusiness ETF (MOO).

A ?BUY? SIGNAL?

Please Use My Free Data Base Search

Diary

The original purpose of this letter was to build a database of ideas to draw on in the management of my hedge fund. When a certain trade comes into play, I merely type in the symbol, name, currency, or commodity into the search box, and the entire fundamental argument in favor of that position pops up. With a link chain to older stories.

You can do the same. Just type anything into the search box with the little magnifying glass in the upper right hand corner of my homepage and a cornucopia of data, charts, and opinion will appear. Even the price of camels in India (to find out why they?re going up, click here). As of today, the database goes back to February 2008, and comprises some 2 million words, or triple the length of Tolstoy?s epic novel, War and Peace.

Watching the traffic over time, I can tell you how the database is being used, and the implications are fascinating:

1) Small hedge funds want to see what the large hedge funds are doing.
2) Large hedge funds look to see what they have missed, which is usually nothing.
3) Midwestern advisors to find out what is happening in New York and Chicago.
4) American investors to find out if there are any opportunities overseas (there are lots).
5) Foreign investors wish to find out what the hell is happening in the US (about 1,000 inquiries a day come in through Google?s translation software in a multitude of languages).
6) Specialist traders in stocks, bonds, currencies, commodities, and precious metals are looking for cross market insights which will give them a trading advantage with their own book.
7) High net worth individuals managing their own portfolios so they don?t get screwed on management fees.
8) Low net worth individuals, students, and the military looking to expand their knowledge of financial markets (lots of free online time in the Navy).
9) People at the Treasury and the Fed trying to find out what the private sector is doing.
10) Staff at the SEC and the CFTC to see if there is anything new they should be regulating.
11) More staff at the Congress and the Senate looking for new hot button issue to distort and obfuscate.
12) Yet, even more staff in Obama?s office gauging his popularity and the reception of his policies.
13) As far as I know, no justices at the Supreme Court read my letter. They?re all closet indexers.
14) Potential investors/subscribers attempting to ascertain if I have the slightest idea of what I am talking about.
15) Me trying to remember trades which I recommended, but have forgotten.
16) Me looking for trades that worked so I can say ?I told you so.?
It?s there, it?s free, so please use it.

The One Economic Indicator You Can Rely On

Diary

There is no end to which I am willing to go to understand the future direction of the world economy. So when I learned that the price of Brazilian bikini waxes was going through the roof, I had to sit up and take note. Last month, the price of the popular beauty treatment soared by 16.6% to 35 Reals, about $22.

This is no joke. The Brazilian government includes the removal of body hair in the most strategic of places in a basket of consumer services that it uses in calculating the country?s inflation rate, now estimated at 6.5%. An economist in Rio de Janeiro assured me that this has nothing to do with the opposite sex. It is one of the few measures they track which can?t be clouded through the surreptitious altering of its quantity or quality. You either get it, or you don?t.

The big picture here is that inflation is worsening, not only in Brazil, but other emerging markets, like China, India, and Vietnam. This is why the yields on one year Brazilian debt are at sky high double digits, a hedge fund favorite. It is also why the People?s Bank of China?s efforts to stanch inflation through higher interest rates and tightened bank reserve requirements are likely to get worse before are gets better.

What can I say? An economic indicator in the hand is worth two in the bush? And I won?t even get into the implications of ?Stealth? inflation.

Your Portfolio and the Population Boom

Diary

Long time readers of this letter know that demographic issues will be one of the most important drivers of all asset prices for the rest of our lives (click here). Researchers expect that the global population will reach 9 billion by 2045, the earliest date that I have seen so far. Can the planet take the strain? Early religious leaders often cast Armageddon and Revelations in terms of an exploding population exhausting all resources, leaving the living to envy the dead. They may not be far wrong.

A number of developments have postponed the final day of reckoning, including the development of antibiotics, the green revolution, DDT, and birth control pills. Since 1952, life expectancy in India has expanded from 38 years to 64. In China, it has ratcheted up from 41 years to 73. These miracles of modern science explain how our population has soared from 3 billion in a mere 40 years.

The education of the masses may be our only salvation. Leave a married woman at home, and she has eight kids, as our great grandparents did, half of which lived. Educate her, and she goes out and gets a job to raise her family?s standard of living, limiting her child bearing to one or two. This is known as the ?demographic transition.? While it occurred over four generations in the developed world, it is happening today in a single generation in much of Asia and Latin America. As a result, fertility around the world is crashing. The US is hovering at just below the replacement rate of 2.1 children per family, thanks to immigration. But China has plummeted to 1.5, Europe is at 1.4, and South Korea has plunged as low as 1.15.

Population pressures are expected to lead to increasing civil strife and resource wars, according to my friends at the CIS. Some attribute the genocide in Rwanda in 1999, which killed 800,000, as the bloody result of overpopulation. If you want to get a first class foundation in the demographic issue along with a lot of cool graphics and charts, read the story in full by clicking here. I?ll be the one to tell you which stocks to buy to capitalize on these trends.

Will There be Room For Us All?

The World?s Worst Investor

Diary

My grandfather was an immigrant from Sicily who joined the army during WWI to attain US citizenship, lost an eye when he was mustard gassed on the Western Front, and settled down in the Bay Ridge section of Brooklyn after the war.

He bought a three bedroom brick home on 76th street for $3,000, eventually raising four kids. Back then, there was a dairy farm across the street, and horse drawn wagons delivered ice blocks door to door. During the roaring twenties an assortment of relatives chided him for avoiding the stock boom where easy fortunes were made trading on margin. When the 1929 crash came, all of them lost their homes. Grandpa finished off the basement, creating space for two entire families to move in. He never bought a stock in his entire life.

Because dad contracted malaria with the Marines on Guadalcanal during WWII, the old man moved the family to Los Angeles in 1947 for the dry, sunny weather. Unfortunately, the train stopped long enough in Las Vegas for a flim flam man to sell him five acres of land for $500. Ten years later my dad drove out to check out the investment. It was a tumbleweed blown, jack rabbit and rattlesnake ridden piece of land so far out of town that it was worthless. You couldn?t see downtown, even if you stood on the rusted out model ?T? that occupied the land. After that, the parcel became the family joke, and grandpa was ridiculed as the world?s worst investor.

Grandpa died of emphysema in 1977 at the age of 78. Chateau Thierry and Belleau Wood finally caught up with him. What German shrapnel and gas failed to accomplish, 60 years of smoking two packs a day of Marlboro?s did. His estate executor put the long despised plot in Sin City up for sale. Although the final price was never disclosed, it was thought to be well into eight figures. In the intervening 30 years the city of Las Vegas had marched steadily Southward towards Los Angeles, eventually encompassing it, sending its value through the roof. The deal triggered a big fight among the heirs, those claiming he was the stupidest demanding the greatest share of the proceeds, the bad blood generated continuing to this day. It turns out the world?s worst investor was really the best, we just didn?t know it.

What was the address of this fabled piece of real estate? Why, it is 3325 Las Vegas Blvd. South, the site today of the Venetian and Palazzo Hotels, home to the Dal Toro restaurant, the venue for the Mad Hedge Fund Trader?s last Las Vegas strategy luncheon. I?m sure grandpa is laughing in his grave.

Bought for $500 in 1947