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December 2007

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12

Dave Barry New Year's Laugh

December 31, 2007 – Comments (2)

I came across Dave Barry in my reading list this morning and it was great for a laugh,  [more]

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4

Which "Losers" To End?

December 31, 2007 – Comments (2)

I am looking at my in-the-red picks again.  I often look at a few and I seem to rarely end them...  [more]

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7

Local Economies

December 30, 2007 – Comments (2)

To what degree has your local economy changed?  [more]

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6

Make a Wish

December 29, 2007 – Comments (0)

Get your dictionary out and look up schadenfreude. 

My feelings towards walls street are increasingly "schadenfreude" when I read something like this, More Toxic Waste Bagholders Found, This Time it is Children.

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7

Payment Delinquencies Spanning All Industries

December 29, 2007 – Comments (3)

Mish had a link to the titled report which I think is worth having a look at.  [more]

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9

2007 Housing Predictions Norman vs Schiller

December 29, 2007 – Comments (6)

 I picked this up off Calculated Risk, a look at predictions from last year. Someone did a edit to add in what happened over the year.  Atkins is from Dumb and Dumber, listen to Schiller, Stein would put you in the poor house, Norman must have also been on Dumb and Dumber, Pallin is seeing a mild correction.  [more]

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7

Dealing with "in-the-red" picks.

December 27, 2007 – Comments (4) | RELATED TICKERS: MIL.DL

In real life I don't hold on to loser, but in CAPS I seem to be hanging on to lots.  A few I have looked back, reassessed what I know and ended the pick.  My most common reason for ending a pick has been bad data, what is reported on common sites for information is quite different than what is in the financial reports.     [more]

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5

My Poor Sister

December 27, 2007 – Comments (3)

So, how do you ruin a good name?  Well in John Crapper's case he invented a toilet...

It seems this subprime mess has now been code named Norma...

My poor sister.  I think Merrill or Prince might be more deserving.

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8

Go First Solar Go!

December 26, 2007 – Comments (3)

I was working on a post about why I choose to not end losers, or what does promote me to end them, as I have quite a few right now, when my computer locked up, which happens to me quite a bit with CAPS.  [more]

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6

CAPS is Resource Pig

December 26, 2007 – Comments (4)

One thing I have to say about the programming for the Motley Fool site is that it is a total resource pig of both bandwidth and computing power.    [more]

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13

Battle of Economists - Inflation or Deflation

December 24, 2007 – Comments (23)

My vote is that by the time the credit crisis finishes unwinding we will see some deflation.  The causes of the hyper-inflation of assets was the loose lending standards and possibly fraud the way they were rated AAA and sold to investors to further hyper-inflate the money supply.  Enough people and funds have been burned that, for example, there were no buyers for the $32 billion that Canadian funds are known to be stuck with.  These things are not selling anymore and investor have wised up and better understand the enormous risk these things presented.  [more]

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9

Shame on the News Media

December 24, 2007 – Comments (6)

Today I caught the clip of a news story about repayment of this mortgage asset backed paper.  It was something to the effect about investors will get their money back.    [more]

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8

The Politically Correct Congratulations

December 23, 2007 – Comments (8)

I have taken an extensive look at how the price of housing and the low interest rates are creating debt slaves for life and my advice to anyone who would listen who is interested in entering the housing market has been to look for the top and wait 4 to 7 years.    [more]

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6

Six Degrees of Leverage: Part VII

December 22, 2007 – Comments (2)

The summary of this series is Part I looks a the leverage of debt on a 10 year utility type bond, M2 and M3 money supply and the ratio of M2/M1 (which should be flat to reflect uniform risk).  [more]

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8

My Xmas List

December 21, 2007 – Comments (0)

I just saw a book I want for Xmas, The Greenspan's Bubbles, The Age of Recklessness at the Federal Reserve by Bill Fleckenstein.

I saw the book mentioned here, "While Humpty Dumpty Sat on a Fence." 

If you haven't read Bill Fleckenstein's stuff before, do a search on him, his stuff is good. 

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12

Credit Default Swaps - Derivatives

December 21, 2007 – Comments (4) | RELATED TICKERS: CM

My reading list this morning gave a very good write-up on Credit Default Swaps and then a real-life example of what happens when there is a default on these contracts.  It is a fairly long read, but a very good read.  You have to scroll down about half a page to get to the article.  [more]

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14

The Glory of Ignorance

December 20, 2007 – Comments (9)

We ought to be able to go about our lives blissfully ignorant about many things.  For example, I was blissfully ignorant about serious home design problems which in Vancouver led to what we called our "condo rot" problems.    [more]

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11

Equity Earning - Harmony Gold (HMY), Goldcorp (GG)

December 19, 2007 – Comments (3) | RELATED TICKERS: HMY , GG

Harmony Gold is selling a uranium asset for $252 million.    [more]

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6

Taxing battles

December 19, 2007 – Comments (5)

There is a very good article outlining some of the issues with respect to property taxes and local budgets.  [more]

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10

Japan Doesn't Want to Play

December 17, 2007 – Comments (13)

Last when I read that the US was trying to get Japan to buy $15 billion of subprime paper to help the liquidity of the market it crossed my mind that that wasn't going to go over well.  After all, Japan and done nothing but languish since their housing bubble burst in 1989.  [more]

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8

Georg Tells the Truth

December 16, 2007 – Comments (7)

What experience and history teach is this -- that people and governments never have learned anything from history, or acted on principles deduced from it - Georg Wilhelm Hegel, 1770 - 1831  [more]

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10

Petri Dish Planet

December 16, 2007 – Comments (10)

How much have you factored population growth into your economic beliefs?

In first year biology one of the items of study was contrasting world population to bacteria population in a petri dish.

The lesson went something like, this is a graph of the world population:

Photo Sharing and Video Hosting at Photobucket  [more]

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11

BHP - RIO -- Merging Bubbles

December 15, 2007 – Comments (13) | RELATED TICKERS: BHP , RIO

I am losing on my BHP call and barely holding on my RIO call.  I believe both these companies to be highly bubled values and BHP is courting RIO.

BHP has a market cap of about $190 billion and I believe BHP has been artificially sending its share price higher with its share buy back program. I simply see no value for long term shareholders, as I have previously written.

I think share buy back programs are gross violations of shareholder interests as ultimately they tend to line the pocket of the executives with stock options at the detriment of the company and shareholders.  A share buyback creates a temporary increase in demand which increases price.  Mish has a very good example of a share buy back that fell apart.  I can't see the BHP buyback being much different.

Ouch, this isn't going to be good,  look at some of the largest shareholders:

                                                                                                                                                             
Company
Citicorp Nominees    Pty Ltd
Shares
440,460,280
%
13.12
HSBC Australia Nominees Pty Ltd377,638,51911.25
J P Morgan Nominees Australia Limited372,983,70011.11
UBS Nominees Pty Ltd20,861,6210.62
HSBC Custody Nominees (Australia)    Limited18,369,7300.55
ARGO Investments Limited6,422,4110.19


Aren't those companies related to companies already in trouble because of subprime?

So, BHP has been making record profits, but when you look at their liabilities, they have increased from $17 to $28.5 billion.  There is no question that equity has increased nicely, from $12.8 to $29.7 billion, but price to book is over 7x.  Additionally, P/E is around 17-18.  Say earning cut in half, then the P/E is about 35, and earnings cutting in half is highly realistic.

The problem is that many commodity prices have gone down and with weakening demand, and they are likely to decline further.

Take a look at BHP's earnings over the past six years:

 
Year Total Income
(billions)
2002 $1.25
2003 $1.58
2004 $2.72
2005 $6.32
2006 $9.75
2007 $13.16


BHP's business segments (and relative share of 2007 profit) are petroleum (16.4%), aluminium (9.9%), base metals (31.5%), diamonds and specialty products (1%), stainless steel (20.1%), iron ore (14.6%), manganese (1.4%), metal-lurgical coal (6.8%), energy coal (1.4%), and eliminations (-3%).

Take a look at the 5 year spot price for aluminium, some base metals and nickel, of which 60% of segment profits are dependent.

 

             
[Most Recent Quotes from www.kitco.com]


 


[Most Recent Quotes from www.kitco.com]


 

             
[Most Recent Quotes from www.kitco.com]


For Aluminium the profit before taxes was 31%, $1.8 billion out of $5.9 billion.  The year ended in June and spot price graph shows a full year of strong price when the US dollar was on average about 15% stronger.  A rough estimate of where the 2008 price will be with both spot price and currency declines is about 25% less.  That comes off revenue and costs stay relatively the same, so expecting to see revenue decline to about $4.5 billion for 2008 for aluminium is highly realistic.  Well, $4 billion was costs, so the aluminium segment declining to $0.5 billion in earnings isn't unrealistic, or $1.3 billion shaved off earnings.

There are a few base metals, but they all have strong prices so an estimate can be made just by looking at copper.  The revenue was $12.6 billion and profit was $5.8 billion, or 43% of revenue.  Copper had a 2-3 month period for 2007 with a strong price decline in the winter/spring so average copper price for 2007 looks to be around $3.20ish.  Copper is currently 10% less and with the G7 economies all slowing down it is not likely to have the same kind of price support.  So copper revenue down 20% for 2008 is not unrealistic.  That would shave $2.8 billion off earnings.

Steel is nickel and nickel price is indeed scary.  BHP caught the entire unsustainable nickel price spike in 2007.  Whoo-hoo, no wonder it had a race to the bank 310% EBIT increase over the previous year.  It looks like the average 2007 price was about $17-18/lb.  Nickel is under $12/lb and there is about a 15% currency decline to consider.  Expecting to see 2008 revenues will be down in the range of 40% is not unrealistic.  That would be $2.8 billion off revenue and would take profit from $4 billion to $1.2 billion.

Looking at just 60% of the market segments of BHP and considering commodity and currency declines there is a feasible estimate of $7 billion decline in operating profit, or about 37% gone.  For this year the energy earnings look sustainable, and could be up, but I would expect energy to decline as the gross over supply of housing used a lot of energy and that part of the demand is already declining as manufactures that supplied the housing boom are finding their inventories increasing and are cutting production.

For the merger with RIO they need $70 billion, $40 billion to restructure Rio's debt and another $30 billion for a share buy back.  Their existing long term debt is about $9.3 billion, so they are looking to increase debt about 9-fold.  They had $13 billion in earnings for 2007 and Rio had $7 billion.  Wouldn't it be reasonable to expect debt servicing costs on $80 billion to be about $8 billion?  With the kind of unsustainable record earnings of the past 5 years wouldn't you expect zero debt on the books?

This is the wrong time to increase debt.  With $80 billion in debt, and say earnings go down 25% overall, would result in increased costs by about $7 billion and decrease income by $5 billion, and combined $20 billion in earnings would decline to $8 billion.  Scraping the share buyback would reduced the debt burden by $3 billion so earnings would only decline to $11 billion.

But, overall, I would anticipate more like a 50% decline in earnings by the time the next year or two play out.

   [more]

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7

An Implosion

December 14, 2007 – Comments (4)

I was just looking at Calculated risk and a graph they plotted....  [more]

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7

Sensible Lending Laws

December 14, 2007 – Comments (2)

I have written previously that with lower interest rates mortgage terms should be reduced and I have given sketchy guidelines for debate., I have even calculated some differences in what I would have qualified for compared to what I actually borrow and what a reasonable guideline would allow.  [more]

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9

Debtor Nation

December 13, 2007 – Comments (4)

 In "Biggest Sucker of All Nations" in the comments Craig, aka TMFspreadsheet, mentions that he has read that the non-deductibility of interest payments on a mortgage is one of the reasons other nations have higher savings rates.   [more]

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4

Biggest Sucker of All Nations

December 12, 2007 – Comments (5)

So, the Bank of Canada is putting money in the markets to increase liquidity.     [more]

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5

Faulty Mortgage Data

December 12, 2007 – Comments (3)

A friend of mine was telling me about the challenges of getting a mortgage with good credit and equity during the credit crunch of the summer.  I don't remember exactly how many different financial institutions he ended up applying to, but after the first deal fell through, it was many.  [more]

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12

Six Degrees of Leverage: Part VI

December 11, 2007 – Comments (5)

The first 5 parts can be found here.   [more]

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6

Six Degrees of Leverage: Part V

December 11, 2007 – Comments (0)

 The first 4 parts can be found here.   [more]

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Six Degrees of Leverage: Part IV

December 11, 2007 – Comments (0)

You can find the first 3 parts here.  [more]

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7

Six Degrees of Leverage: Part III

December 11, 2007 – Comments (0)

This is the third in a series.  The first look at how leverage can change a rate of return on a bond and the dramatically increasing M2 money supply.

The second looked at the leverage of how mortgage terms dramatically change with changing the rate and the amount of income that can be used on debt.  [more]

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6

Margin Squeeze

December 10, 2007 – Comments (2)

I'll post my part III on leverage later, but this interested me.  Revenue growth for the last quarter was up, by 7.4%.    [more]

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12

Six Degrees of Leverage: Part II

December 10, 2007 – Comments (4)

In  Part I I looked  how a 10-year bond can be leveraged and the increased leverage of the money supply because of banks and I suggest that this increased leverage comes with substantial increased risk.   [more]

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9

Six Degrees of Leverage: Part I

December 09, 2007 – Comments (4)

My little look at the implications of pricing-to-market a rate of return for long-term debt in “Milkmaid Investments” really shocked me.    [more]

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7

Student Loan Bonds

December 08, 2007 – Comments (13)

They have student loan bonds?

Sheesh...

It appears that student loan default rates are increasing and now student loan bonds are being down graded...

 

 

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6

Spam Blocker or Market Forces?

December 07, 2007 – Comments (5)

It has been ages since I got one of those "we have a mortgage deal for you" emails. 

Is it my spam blocker working better or are those emails drying up? 

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9

Milkmaid Investments

December 07, 2007 – Comments (6)

 ... The milkmaid was carrying her milk in a pail on her head, daydreaming about how much butter she can make with the milk. She thinks that when she sells the butter, she can buy a lot of eggs. The eggs will then hatch into chickens. And the chickens will bring even more money, so she can buy a new dress...  While daydreaming she tossed her head scornfully, and down fell the pail of milk to the ground. And all the milk flowed out, and with it vanished butter and eggs and chicks and new dress and all the milkmaid’s pride.  Never count your chicks before they are hatched...   [more]

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6

Lady President?

December 06, 2007 – Comments (3)

Economic Briefing is saying Hilary Clinton gets it on the dollar.  No kidding she gets it.  The Clintons moved 100% out of the market in the spring I believe with the "story" that that way she wouldn't be in any conflict during her presidential campaign.  [more]

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4

"Moral Hazard" bailout?

December 06, 2007 – Comments (3)

In a post on Economics Briefing quotes Mark Kiesel at Pacific Investment Management:  [more]

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10

Just Who Is Getting Bailed Out?

December 06, 2007 – Comments (3)

I was reading comments on a blog about the "bailout" for home owners with interest rates due to reset which would freeze the interest rates.  [more]

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11

Fraud Probe - International Relations

December 05, 2007 – Comments (3)

I was thinking about the implications in a broader sense of what Wall Street and the banks have done in terms of working relations with other nations.  Right now we are seeing losses to different levels of government, pension plans, money markets and the US subprime mortgage losses are limited to the US, but are around the world.  These things were rated triple AAA by US firms.  [more]

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6

Northern Birthday Welcome

December 05, 2007 – Comments (11)

Well, Dec 4th was my birthday.  I have discovered doors freeze up to the point that I can't open them in the cold, I had to get my house mate from work to open the door for me...  [more]

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18

Debt Slaves and the Slug Economy

December 04, 2007 – Comments (13)

In university I was required to take any first year economic course as a pre-requisite for second year economics.  At the time I took the course I went on and on questioning the use of studying serf and slave economies in the economic history course I had chosen.  [more]

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15

Will Base Metal Demand Fall Off a Cliff?

December 02, 2007 – Comments (7)

A year ago I was highly uncertain about where I thought base metal demand might go.  As an investor I examined both the bull and the bear arguments.  

As technology improves costs generally decline and there has been an overall downward trend in base metal price over the past century and probably longer if one was to research it.  In recent years the evidence suggests that the cost for mining base metals has gone up and the ability for prices to further decline through technology gains or cheaper labour no longer exceeds the rate of cost increases.  There do seem to be price supports based on costs.

However, metals can end up being sold for a loss should supply end up ahead of demand.  World demand has been increasing and in the past few years the increase in supply has not kept up with the increase in demand, resulting in an enormous boom in base metals at unsustainable high prices.  

But how and where did all that demand come from?  The bulls suggest that we are at the beginning of a boom in a long term cycle for base metals due to the emerging economies.  The bears suggest that over investment will result in massive supply that will slaughter metal prices.  The question doesn't have an easy answer, nor is it one that I can accurately answer, but I can look at where some of the demand came from and consider it in my investment decisions.

The US has had a housing boom.  Last April housing starts were 2.1 million.  At about 400 pounds of copper per home, that's an enormous source of demand for copper.  Indeed, spending some time searching the internet I found that home construction accounts for about 40% of US demand for copper.  It seems to me that homes that were only starting to be built last April would have been using copper that has been sold in recent months.  Fast forward to now and housing starts in the US have declined to about 700,000, roughly 1/3rd.

A simple extrapolation suggests that the US demand for copper could decline by 25% in the coming months from the decline in housing alone.  With US consumption around 15% of world supply, well that would result in almost a 4% decline in world copper consumption from the US alone.

This very simple look at copper got my attention.  The enormity of the decline in the US housing starts will not easily be off set by increases elsewhere, if there are indeed increases elsewhere.  I did a search on housing starts in other countries.  In Japan housing starts fell 35% in October from a year earlier.  

India is supposed to be an emerging economy and one of the places that demand for metals is supposed to be increasing, at least that's the impression I get with all the hype.  Imagine my surprise when I wasn't even doing research on India, but steel, and an article about the stock piling of steel rods due to a slump in apartment construction came up.  Copper goes into apartments as well.

Australia seems flat, which is better than down.

I also looked at news about copper demand and I found an article about projections of copper usage.  The article has nothing in it to satisfy me that the projections are reasonable.  It points out that demand from China drove the growth in 2007, but go back a year to 2006 and that was when copper peaked at over $4/lb and China was not replenishing its warehouse stores of copper.  After the price of copper dropped in early 2007 China was a buyer so it is no surprise that the market was in a deficit in the first 8 months of this year.  I have seen no evidence that China has grossly diminished storage levels of copper now.  It seems to me that replenishing storage levels would have resulted in more demand for copper in 2007 then what is actually being used, which isn't good for outlook for demand for 2008.

If I look further at industry growth, the news suggest the mining industry is going full steam in their efforts to increase supply.

Copper demand seems highly dependent on home construction and the evidence that I see is that the level of housing starts are declining beyond what most people would have guessed, and this has enormous negative implications for copper.  Supply is still being ramped up and demand is falling, and it seems probable to me that supply will exceed demand, and by more than what many people expect.  I personally will sit out and watch copper rather than be vested in it.

I remain uncertain about where I think demand with other metals will go.  They are not as dependent on housing.  Pipelines, for example, do need replacing.  There was one that failed just this past week in Eastern Canada.  But the question is will the money be there to replace pipelines?  With the high level of uncertainty and the nature of price leverage due to supply, for me it is time to exercise caution for investments and watch the market rather than participate.

Happy investing.  [more]

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