A Sign in the Times

This story in the FT sounds like the beginning of the end for the great commodities bubble as insiders seek new capital from greater fools. 

Why would you abandon years of broking commodities and earning a nice little spread in your alpine tax haven for very little risk and start vertically integrating with the mines who take all the risk in some godforsaken desert?

"“We, like others, are looking to invest in the whole supply chain,” said Ian Taylor, chief executive of Vitol, the world’s largest oil trading house."

The reason is a fatal attraction to returns. During an up-cycle the mines make higher ROEs as the price of commodities starts to rise far above the marginal cost of production. As one trading house gets sucked into doing this so do the others in much the same way that Citi’s former Prince Chief said “As long as the music is playing, you’ve got to get up and dance.”

That is quite an apt quote. This is of course absolute folly and exactly the same as happened to the Investment Banks who transmogrifying into mortgage lending behemoths hungry to feed on the excess of profits of the housing bubble era. You stop your riskless broking and start taking risk on your capital because the winnings in the casino look better than the running thereof. However for the managers of these trading houses it's much, much worse. No government is going to consider them of systematic importance so they don’t even get a classy TBTF put option when this blows up.

Now that the worlds dumbest investors (Asian sovereign wealth funds) are getting on board it must be high time to find the exits. With European banks pulling the funding the issue is where is all the cheap cash going to come from to prop up the commodity markets. The issue is not who is going to fund the expansions these guys want to undertake. Perhaps the commodity houses know this too and hence they want to flog some of their shares to these sovereign wealth fools. But this sounds like primary issuance so I guess the commodity houses really do believe the hype in which case the bible actually does have some modern relevance;

"What has been will be again,

what has been done will be done again;

there is nothing new under the sun."

-          Ecclesiastes 1:9

The core, the core

“Basil Fawlty: “Well, I'll just get your hors d'oeuvres.”
Basil Fawlty: “Hors d'oeuvres... vich must be obeyed at all times vitout qvestion!””

Fawlty Towers – “The Germans”

Something in the Eurozone is becoming increasingly obvious. The meaning of the core has changed. As the Dutch look set to reject the fiscal suicide pact it may leave a core of just one; Germany.

What do you call a core of one. I call it a periphery. So really what the Eurozoners should be doing is calling a timeout huddle and concluding that what they need to do is kick out the Germans from the Eurozone. Then the new core can at least agree on one key policy which is that they need to print a lot of money. The Germans can have back their beloved DM and enjoy the subsequent deflation and depression and thus stop feeding at the exporters trough of a devalued currency.

Any other policy is madness because no other country follows the rules like the Germans. In Greece, Italy, Spain or France the rules are there for other people not for one’s self. In Germany the rules are there for all and they abide by them. This subtle distinction is not about to be dissolved in the crucible of greater integration.

The only other people who really take the rules at face value are we Britons. Foolishly we actually listen to the judgments of the European court of human rights or the EU directives on the use of ladders. This is why Cameron was a fool to walk out of the EU fiscal death compact. He should have seen that the only people who thought the compact and its rules would work were the Germans. Everybody else was playing the European solidarity game in full knowledge that they could declare ‘force majeure’ later when they put the bill if front of their parliaments.

In some ways it makes you proud to have a leader like Cameron. Naïve and gullible though he may be he does seem to have an ounce of humanity in him which he couldn’t subvert fully to the game of abstract politics played in Brussels. Perhaps he doesn’t have to because with our own currency we can still print as much money as we want to buoy our debt markets whilst calling it fiscal virtue.

Where does kicking the Germans out of the EU get you? Back at square one of European integration regressing sixty years to arrive at the uncomfortable truth that Germany is just too big and effective for the rest of Europe.

You always pays

The problem or benefit of low interest rates continues to distort previous norms in the economy. Today pensioners have a tasty tit bit of complaining on the merrygoround of faux sympathy known commonly in the UK as the BBC.

I find it surprising that people really believe that they should be guaranteed a risk free return on their savings. A team of our finest budget geniuses (MPs) have determined that inflation is damaging to those on fixed incomes.

"We recommend that the government consider whether there are any measures that should be taken to mitigate the redistributional effects of quantitative easing, and if appropriate consult on them at the time of the Autumn Statement,"

Hold the press. Is this news? Surely it is the objective of QE to create inflation as a means to avoid a depression. Old people would probably vote for a depression given their fixed incomes and floating expenditures. Inflation erodes your fixed income, but so what? Pensioners aren’t living in perpetuity even if they want to plan for it.

The money has to come from somewhere and there have to be losers. At the moment the winners are all those with highly leveraged homes especially those on interest only mortgages who are paying a pittance to 'own' a home which might cost triple the monthly mortage interest to rent.

What most people can't do is connect the dots. Ok you want higher interest rates. Fine then we will see banks charge higher mortgage rates. Oh look the housing market collapsed and now pensioners are moaning because the equity in their home was meant to fund their retirement is shrinking. Or they were about to retire but all the bonds in their portfolio just tanked. Enjoy your higher annuity rate on your smaller pension pot.

There is a financial version of “murder will out” and I call it “one way or another you always pays.”

Portfolio Update

I thought I might take some time today give an update and talk my own book on my current personal positions and the why I hold them. I try and run a kind of long/short strategy to avoid being totally market directional and I look for a hurdle rate which is basically a return better than cash with maximum capital preservation.

SCOP: It has been a long haul with this one what with Copper futures treading water for the last 2 months at $3.90/ib or so just waiting for me to capitulate before they drop off a cliff. Still holding out on this one and the past few days have seen a positive move downwards. This remains my biggest short because the fundamentals are stacked against the inflation hedgers who have driven the correlation to other financial assets way up. At some point I believe this trade will break down but it is going to take a seismic shift in the viewpoint of investors or the reporting of Chinese inventories.


SAP3: Another position not working out so well but it is coming back. I saw this as quick buck and should have exited after I made one and now I feel kind of stuck with this position underwater.  Break even is around 1.56AUD/GBP so this was suffering during the Q1 risk rally. I still believe in this position long term but it is probably too similar to my copper position to add a lot of value. Australia looks a real mess when China starts slowing down its effort to relieve the Aussies of their natural resources.

SBRY: Still holding the Sainsburys shares and these have certainly proved a better bet than Tesco although they are still underwater. The stock had a nice bounce due to great Q4 results only to have it slaughtered following the Tesco results which dragged on the whole sector. The UK suffers from overcapacity of stores and declining sales in real terms. However with a 5% yield compounding, a solid franchise (Note: I base this solely on the fact that I shop there and I like it) and potential upside if the Qataris come back to the table this still looks a good deal. Prospects for real capital growth however are limited given the ongoing consumer squeeze in the UK.

Pandora A/S: This stock was a real surprisein Q1 as it started to rally and must have shook out all kinds of shorts. It shot up from 60Dkk to touch 100Dkk in just 3 weeks in January. I sold down some shares into the rally at around 67Dkk and then more at 92Dkk leaving me with around 1/5 of the shares I purchased last year and a tidy return of ~70% across all sales. Looking back it was obvious that with so many big holders having dumped the name and such high short interest the stock could become highly undervalued (4x a conservative forward P/E at its trough). A classic example of a fat pitch.

I am holding onto the remaining shares to see how the business pans out longer term. The jewellery is certainly yesterdays news but there could be value here and I enjoyed collecting my 8% dividend yield although the stock has come off the boil since January and now trades around the 65Dkk mark which is still a tidy return on my average in price of around 45Dkk.

RSA: This is a new one for me which I acquired this week. The stock is trading way down on 5 year lows despite a very limited exposure to euro peripheral bonds, decent underwriting performance and a great yield. With solid dividend growth over the past 5 years and a yield of around 9% the compounding effect of reinvesting dividends makes the stock attractive by itself assuming further capital losses are limited. Certainly one for my tax free account if I want to capture the dividend reinvestment argument properly.

Risks for this are obvious; it is a european financial so could get blown around by further chatter regarding the glacial unfolding of the euro area collapse. It is also a global insurer so all kinds of catastrophes pose a risk to medium term underwriting results.

Caveat: Clearly I have a financial interest in these investments and this post relates solely to my personal investment positions. It is in no way a solicitation to buy or sell these investments nor does it constitute advice to do so.

Cuba - Freedom

"Those who have been once intoxicated with power, and have derived any kind of emolument from it, even though but for one year, never can willingly abandon it. They may be distressed in the midst of all their power; but they will never look to anything but power for their relief."

 

- Edmund Burke

A lot has been said about the political system in Cuba and the lack of basic freedoms for many Cubans so I wanted to give my brief observations on the topic.

One of the first things one notices in Cuba is the prominence placed on Che Guevara as a national hero. Visting the monument to Che in Santa Clara they pipe the song "Hasta Siempre, Comandante" out around the site. In Cuba you do not see any statues or monuments to Fidel. Despite being effectively a dictator he does not seem to share the same bizarre egotism as say Saparmurat Niyazov. Che is however celebrated everywhere.

Guevara therefore is used by the regime as a kind of talisman alongside selected works of Jose Marti to reinforce the propagandised view of the Cuban state as being the ultimate expression of a great impulse for freedom and equality. Driving along the roads one never sees the find of advertising billboards that blight the rural landscapes of America. Rather one finds the odd ‘Socialism’ mural depicting soviet style art of workers in fields with slogans like “Defendiendo Socialismo.”

What struck me most about Cuba was the irony of the revolution. Perhaps at the time it was really necessary to topple Batista and deliver the Cubans from foreign control and Castro really did want to provide a better system for the people. In some ways Castro succeeded given the strong healthcare and educational system. However the irony is that Cuba under Castro has ended up just as vulnerable to outside influence as it always was first the Soviets and since 1994 international tourists. As a tourist you have more rights in Cuba than as a Cuban. The double currency further exacerbates the gulf between tourists and those who work with them and all other Cubans. Either way Cuba is so detached for the wider world now it needs to liberalise slowly rather than all at once. Ordinary people have built their lives around this system and to bin it suddenly and completely would be a disaster for them.

Cuba feels like a place that isn’t being allowed to move on and evolve from its revolution. It’s as if the revolution was Castro’s one defining moment and he lives forever in 1959 cracking down on any counterrevolutionary movements which want to continue the process of societal evolution.

For a country of ironies I’ll quote its leader;

"I think that a man should not live beyond the age when he begins to deteriorate, when the flame that lighted the brightest moment of his life has weakened."
- Fidel Castro, 1953