Jim Rogers FT interview

I have to say I've learned more over the years from Rogers' take on the markets than from anyone else.

So here's a four-part interview with the original gnome of Zurich investor.

"Lynch Rebates"

Most people today who write about value investing emphasize discounted cash flow valuations and various other techniques that rely on projections of future earnings or cash flow in determining the intrinsic value of a stock.

That's fine. But if you read the beginning of Graham and Dodd's 1940 edition of Security Analysis you find that Graham's entire argument for asset-based investing is that projection of current earnings trends into the future is inherently an unreliable exercise. Anticipating today's behavioral economists, Graham understood far better than most (with the help of being bankrupted by the Great Depression) that we as investors are not nearly as accurate in predicting the future as we think we are.

To fight this bias, Graham argued for investment in stocks that had share prices trading at less than two-thirds of their net current asset value. Buying cheaply in this sense, or at any other deep discount to readily ascertainable corporate value, meant that an investor didn't have to predict anything to make money.

Many extremely literal readers of Graham and Dodd (we could call these "value fundamentalists") took this advice to mean that investors must only buy Graham's "net-nets." So they sat around through the second half of the twentieth century with their hands in their pockets as the population of always-rare net-nets thinned out further and further.

Peter Lynch introduced a brilliant solution to this problem in One Up on Wall Street, a book that is far too often caricatured as a simplistic "buy what you know" manifesto. Lynch's technique is to take the net cash of a company--that is, cash on the books net of long-term debt, and apply that figure to the share price as a "rebate" of sorts.

Here's an example of how this works . . .

Take 4Kids Entertainment (NYSE:KDE), which licenses the rights to use Pokemon and several other children's entertainment franchises that may or may not have value.

The stock closed today at $16.85. According to the most recent balance sheet, the company has 105.64 million of cash and liquid short-term investments, along with no long-term debt. For the sake of simplicity, this is assuming that there are no substantial lease obligations or other obligations that are not readily ascertainable from the balance sheet. That gives us a figure of about $9 a share in cash or assets readily convertible to cash.

So you subtract that $9 from the share price of $16.85, leaving you an effective share price of $7.85, since you're getting paid 9 bucks to hold each share. So you're buying the business at about a 53% discount.

You then compare that $7.85 to the value of each share of the business to see whether the business is worth that discounted price. I don't know if the business at 4Kids is attractive at that price, but it's clear that it's considerably more attractive than it would appear without getting this sort of discount.

In my experience, this technique is a terrific way to find businesses at extremely attractive values.

Disclosure: I do not own shares of KDE.

China Goes Parabolic . . .

See for yourself.


I believe China is headed for a 1929-style wipeout, which will be bad news in the short term for them, but good news in the long term as they implement a range of market and economic controls that mirror those imposed in the US depression era.

China now has the financial clout of a world power, but the market infrastructure of an emerging country. This is great for them on the upside (the above chart) as it accelerates the boom, but is going to make the bust equally ugly.

And unlike Japan in the 1980s, I don't believe China has a stable, coordinated-enough banking system to prop its equities up indefinitely.

We're likely to see some great opportunities in China over the next 5-7 years--I mean the exact same companies now, but at PEs of 3-5.

Keep your powder dry.

Reading Berkshire's Chart

I've found that Berkshire Hathaway (BRK-A), run by a man with no use for technical analysis, is more technically driven than just about any stock I deal with.

That may not be the definition of irony, but it's not far off.

I guess this is because 1) there are not many traders who want to swing 115K chunks of stock around and 2) the stock attracts people who are thinking in the long term anyway.

Look at how BRK has struggled to clear each major round number, then usually dutifully held above it.

I'm holding the B-shares, which basically mirror the performance of the A-shares. Are we about to see a break above 120K?

Quiet Booms

Those of us who live in commodity-producing areas have noticed something recently that many others haven't: the commodity boom is beginning to make its way into the broader economies of these areas throughout the US and Canada.

Cash generated by high prices for tangibles is trickling out into banks, real estate, luxury purchases, and capital investment of every part of North America that has an economy reliant on production or distribution of "stuff."

Minyanville's Ryan Krueger, for example, sees a petrodollar-driven boom unfolding in the oil-refining region of Port Arthur, Texas.

There has been some scattered coverage in the national media about this. Both New York Times and the Los Angeles Times have noted Houston's boom-town characteristics over the past year.

By the time it's all said and done, Houston will prove to have been just the first (and probably the biggest) of many of these kinds of booms.

Dallas, Denver, Kansas City, Oklahoma City (where I live) and other centers of commodity production and distribution will experience similar effects on capital investment, luxury spending, and high-end real estate as oil, grains, livestock, and metals prices remain high.

Maybe it's some facet of this boom-time mentality that has rich OKC oil execs barely able to disguise their lust for other cities' sports teams.

The point I would take from this whole phenomenon of quiet booms, as illustrated by Mr. Krueger's observation, is to avoid letting a blanket conviction obscure the potentially profitable subtleties of a situation.

You don't want to let the idea, for example, that "all real estate is going down" lead you astray any more than the thought that "all real estate is going up" led many investors astray several years ago.

Gross national figures can be illusory: there's no reason an economy or an asset market has to correspond to a national boundary.

They say "all real estate is local." Well, all economics is local, too . . . and it's worth it for an investor to pay very close attention to what's really driving the economy of a particular area before those numbers get folded into GDP.

An Emerging Consensus

Recently, more and more investors and journalists have begun to argue that the center of world financial gravity is shifting decisively away from the US.

There's an emerging consensus that emerging markets are the place to be for the near future, and potentially for longer.

This author points to the fact that increased accumulation of foreign reserves has put many emerging market countries in the position of being net creditors, describing emerging markets as being in a "golden age."

The Washington Post has a piece that is even more eyebrow-raising, showing how hot money is pushing further and further out along the risk curve by investing in "frontiers" around the world. For a potential target, the piece even points to the hyperinflationary disaster that is Zimbabwe, once one of Africa's most promising states before the tyrannical Robert Mugabe (pictured) single-handedly ran it into the ground.

Past performance, of course, doesn't necessarily have any bearing on what's going to happen in the future. It's worth looking at the explosive growth these markets have already experienced over the last five years, though.


All the "golden age" talk has me skeptical. Emerging markets' expansion has run in lockstep with the unprecedented credit expansion in the developed world beginning in 2001-2002, and as we know, a rising tide lifts all boats.

We have yet to see how these countries will respond to slowing growth in their primary export markets, or if they truly are as immune to the need to access credit markets as the bulls contend.

My opinion is that the emerging market talk is evidence that the longtime market advance is probably picking up speed as we enter a euphoric phase. Viable investment opportunities are saturated with capital, so creative investors are moving to places that aren't really viable, as they assume that the bull market will continue forever.

Speculators should see this as an opportunity to ride a sector that is beginning to go parabolic, and may have already begun to do so.

Long-term investors, however, should tread lightly. All of this stuff should be available in the future much more cheaply, after these countries have proven that they can thrive when credit is not so plentiful.

A Bubble in Retrospect

Barry Ritholtz's excellent summary of the housing market's woes got me thinking as he discussed David Lereah, the former chief economist for the National Association of Realtors. Lereah wrote a number of ill-advised and ill-timed investment books, ranging from tech stocks to real estate.

In 2005, Lereah published Why the Real Estate Boom Will Not Bust, which looks fated to become an inadvertent classic of bubble-market psychology, taking its place alongside James Glassman's Dow 36,000 and the South Sea Bubble-era launch of "an undertaking of great advantage, but no one to know what it is."

I was curious about what people said about the book when it was published, so I looked back at the oldest reader comments from Amazon, circa 2005.

What I found was interesting. The first thing that jumped out was that a few people recognized that following the book's bullish advice would be dangerous.

But at the same time, the emotional momentum remained with the bulls. As you move from older to newer comments, you can see the bulls disappear and the bears gain confidence as the comments shift from optimistic to dismissive.

I think this little exercise shows that--contrary to the views of Alan Greenspan and others--it's entirely possible to identify financial bubbles as they are going on.

The trick is having the stomach to resist the crowd. I have to say that it does gets easier, though, as you experience and read about more historical bubbles.

Here are a couple of books that will help out by giving you indigestion at stories of monks who day trade:

• Edward Chancellor, Devil Take the Hindmost: A History of Financial Speculation
  
• John Kenneth Galbraith, A Short History of Financial Euphoria
• Charles Kindleberger, Manias, Panics, and Crashes
  

The Gnome's 10 Most Valuable Financial Reads: Honorable Mentions

Before I start on the top 10 Most Valuable Financial Reads, here are the honorable mentions, divided by category:

Fundamental Investing:

• Philip Fisher, Common Stocks and Uncommon Profits: why sell a quality business? This book is the most cogent defense of buying great companies and hanging on as long as they stay that way.
• Joel Greenblatt, You Can Be a Stock Market Genius: A silly title, but the content is sound. Don't believe that there could be a book explaining bankruptcy investing to a middle-schooler? Well, here you go.
• Robert Hagstrom, The Warren Buffett Way: The best place to start learning about Buffett. New readers should be aware, though, that the Buffett bag of tricks is quite a bit deeper than this book lets on.
• John Neff, Neff on Investing: A very humble and matter-of-fact introduction to what Neff calls his "low P/E shooter" investing style. It blends biography and investing strategy seamlessly, showing the stomach it took to stick to his guns, particularly in the rough-and-tumble 1970s.

Technical/Trading:

• Nicholas Darvas, How I Made $2,000,000 in the Stock Market: The title is ridiculous, Darvas's risk management leaves much to be desired, and some have questioned if any of this ever really happened. But this is still probably the best introduction to how stock prices work. Plus, you can read it on a Saturday afternoon.
• Edwards and Magee, Technical Analysis of Stock Trends: The Bible of technical analysis. The sections explaining the logic behind support and resistance work are unmatched, anticipating by more than half a century much of what modern behavioral finance is only starting to discover about how people think about and act toward their stocks.
• William O'Neil, How To Make Money in Stocks: Great investment book or cross-promotion machine for Investor's Business Daily? Well, a little of both. Clearly O'Neil hit on something with his CANSLIM strategy. The problem for the serious investor is that it's difficult to integrate the CANSLIM method with other approaches (let me know if you've done this successfully). The problem for the serious reader is the incessant IBD trolling.
  
• John Train, The Money Masters: A group biography of highly successful investors, this is one of the best ways to gain quick exposure to a variety of fundamentally based investing styles. The chapter on Robert Wilson's harrowing Resorts International short is classic.
  

Macro/Other:

• Jim Rogers, Investment Biker: Primarily a travelogue, the parts of this book on macro investing are among the most useful material any investor can read, and aren't really duplicated anywhere else. Really understanding Rogers's approach to global investing is one of the most valuable investments you can make with your time. Now if he would just write a book that focused purely on his investment style. Are you listening, Jim?
• Victor Sperandeo, Trader Vic: Methods of a Wall Street Master: This eclectic read provides a great introduction to Austrian economics suitable for investors, very helpful definitions of a trend and a trend break, and deals with the emotional side of trading to boot.
• Nassim Taleb, Fooled By Randomness: An excellent discussion on how randomness, by definition, cannot be controlled for, and how we frequently ascribe to skill much that is in fact produced by variance.
  

Next installment: Most Valuable Financial Read #10.

Links of Fury

• The Economist wonders if the global age of stable growth is over
• Returns around the globe since the start of the bull market I didn't realize how high the P/Es were in China. Good thing those stocks always go up . . . as the day trading monks have already informed us.
  
• Investing with the stars--literally
• Oil's not made of dead dinosaurs? The Russians have what you could call a contrarian opinion on the nature of so-called "fossil fuels" . . .
  
• Goodbye, Age of Agriculture . . . It's been a great 10,000 years.
• The Kirk Report's link post is the daddy of them all

Napoleon on Investing

A quote that applies well to finance, courtesy of Napoleon Bonaparte, of all people:

"The whole art of war consists in a well-reasoned and extremely circumspect defensive, followed by rapid and audacious attack."

Replace "war" with "investing" or "trading" and you have a pretty succinct blueprint for doing well.

The point, of course, is to obsess over covering your tail. . . but to strike quickly and decisively when the situation warrants it. I could think of worse advice to follow.

How Deep Is Your Value?

Here's a deep value screen I run from time to time. It's been lighting up recently, for whatever reason--many more results than normal.

It uses the following criteria:

Current P/E less than 10, Forward P/E less than current P/E, Debt/Equity Ratio less than 1, Quick (Acid Test) ratio greater than 1.

This is not a screen for quality by any stretch (although I'll run some of those later on). The idea is to find very inexpensive companies that are not crushed by debt and are liquid enough to stay afloat long enough for that value to be recognized.

If you're interested in getting quality as well, you'll want to screen for return on equity or invested capital. But you're going to have to make some substantial concessions on price.

These are not exactly Ben Graham's net-nets (which would sell at a 33% discount to net current assets), but it's roughly the same idea. These are "cigar butts," as Buffett would put it, generally good for one puff.


(Scroll way down) . . .

Deep Value Screen

Symbol	Company Name	Current P/E	Forward P/E	Quick Ratio
IMMR	Immersion Corp	3.60	3.50	9.50
ASPV	Aspreva Pharmaceuticals Corp	5.70	4.80	10.10
HSOA	Home Solutions Of America Inc	6.00	5.00	2.70
AVCI	Avici Systems Inc	6.20	3.00	3.80
MTEX	Mannatech, Inc	6.80	5.10	1.10
VLO	Valero Energy Ord Shs	7.20	7.20	1.00
TX	Ternium SA	7.30	7.00	1.10
GNA	Gerdau AmeriSteel Corp	7.80	7.10	1.80
CPX	Complete Production Services Inc	8.50	8.00	2.50
BRLC	Syntax-Brillian Corp	8.70	6.10	2.00
SIM	Grupo Simec ADR	8.90	6.80	2.80
ZINC	Horsehead Holding Ord Shs	8.90	7.90	1.50
ESV	ENSCO International Inc	9.20	8.10	2.60
MTL	Mechel ADR Rep 3 Ord Shs	9.20	7.90	1.40
VIRC	Virco Manufacturing Corp	9.20	8.60	1.20
KG	King Pharmaceuticals Inc	9.40	6.50	3.20
LMC	Lundin Mining Ord Shs	9.40	8.30	2.90
ZEUS	Olympic Steel Inc	9.80	9.70	1.30

Bear with me on the screwy formatting. If any of you are HTML-inclined and have some thoughts on good ways to present tables, drop me a line at gnomeofzurich1@gmail.com.

Next, I'll give these a closer look and we can see if anything decent turns up.

Uncle!

This week's rate cut does make me wonder what's going to keep the dollar from continuing its decline.

Maybe I'm inadvertently calling a bottom here, but I wonder how much longer it is logical to keep hanging on to the dollar. Is it time to say "uncle"?

My answer has been to hedge pretty thoroughly. I've generally diversified my currency positions out of the dollar, although I retain significant exposure to the dollar through stocks.

The dollar could certainly bounce from here, but a rally would be pretty easy to catch.

I'm all about capital preservation right now until we prove that we can hold above 1500.

The good news for people who like to think about nominal returns is that if the current currency declines against hard and financial assets accelerate, we will definitely see new equity highs. The bad news, of course, is that this will be a paper gain, without meaning in purchasing power terms.

Another Massive Trading Range?

The current S&P 1-year chart doesn't look terrific, and the ugly July decline appears to have come out of almost nowhere to test the March lows.

(BigCharts.com)

Backing up chronologically gives us a little more perspective, though. Look at how significant the 1500 level is: the selling kicked off as soon as we crossed it.

(BigCharts.com)

Clearly we're at a major pivot point. Holding above 1500 would be very bullish. Failing and dropping down again would be equally bearish.

A final chart to provide some historical background:

This is the Dow Jones Industrials in the great bear market of the 1970s (then the most watched index). The Dow had an extremely rough relationship with 1000. It first tested it before this chart begins in the late 60s, then retested it several times before eventually breaking it decisively in 1982.

(Dow Jones)

If the current rally breaks down, does it suggest that we may have just made the second peak of a massive long-term trading range?

Surveying the cut's dollar damage

Because the dollar has been declining against a basket of currencies and of assets recently, whenever there's a rally I like to check the returns of dollar-competitive assets and currencies. I use this to see if the gains are just reflections of a dollar slide, or whether they are outpacing the dollar's decline.














Here's a chart of the nearly 3% S&P return for today (The Nasdaq & DJIA were slightly lower), compared to the return in USD terms of the Swiss
Franc (FXF), the Euro (FXE), and the Gold ETF. Since these are ETFs, the returns are not precisely the same as the underlying assets, but you get the idea.

As you can see, these dollar-competitive currencies and currency alternatives (gold) benefited in dollar terms today, though not nearly enough to compensate for the blowout day in the major averages.

My very unscientific conclusion if that if you were long today, you made money even controlling for the accompanying dollar sell-off.

Whether the returns will continue to be positive in currency-adjusted terms is anybody guess.

Links of Fury

The must-read stories of the last several days . . .

• Enough with the Weimar Germany analogies!
  
• Did what happened have to happen?: Legg Mason gets counterfactual
• How to value cyclicals
• The Fed Funds futures are not taking inflation seriously enough
  
• A dollar collapse could mean the end of US economic dominance

Fire or Ice?

Fire and Ice
by Robert Frost

Some say the world will end in fire
Some say in ice.
From what I've tasted of desire
I hold with those who favor fire.
But if I had to perish twice,
I think I know enough of hate
To say that for destruction ice
Is also great
And would suffice.

I doubt Robert Frost was thinking of the inflation/deflation debate when he wrote this, but he might as well have been.

Will the out-of-control money supply expansion of the last six years result in a credit contraction and ultimately something as bad as a deflationary depression, as Robert Prechter argues? (Ice) That seems to be the fear shared by the world's central bankers, who have collectively shoveled more than $300 billion of liquidity into the system in the wake of the subprime collapse.

Or will Ben Bernanke get into his helicopter to stave this deflation off, madly throwing out bushels of dollars and hyperinflating us all back to Weimar Germany? (Fire)

Neither, of course, would be great. And to paraphrase Frost, for destruction, either would suffice.

I am no permabear, and I am not a gold bug (although I am holding gold currently). But it strikes me as somewhat far-fetched that a US Federal Reserve that has said that the problem with Japan in the 1990s was lack of monetary stimulus can somehow be expected to sit idly by while the US money supply contracts.

Fire, or out-of control inflation, gets my vote as the more likely outcome.

Additionally, I am convinced by the Austrian permabear argument that the bull markets in virtually every asset in the world over the last five years does not indicate a miraculous period of everything getting more valuable, but rather suggests that all global assets are appreciating against all currencies, but especially the US dollar.

Further, global money supply has been increasing at double-digit annualized rates. The US is a relatively mild offender by world standards, rising at "only" 12%.

Still, even though the dollar might be better than other currencies, I frankly don't think it's safe to hold dollars any longer. I've moved into gold on the recent breakout, but if this gold rally fails, I will probably have my hands full of Swiss Francs (FXF).

Every dog gets his day, and the Gold Is Money gang's day is probably going to continue for the foreseeable future. Might as well be along for the ride . . .

WELCOME!

There's plenty to talk about, so let's dive on in . . .

Money's Jason Zweig finds some new investment insights in recent advances in behavioral finance. Among other things, he describes how, for us homo sapiens sapiens, the anticipation of a reward is much greater than the satisfaction of actually getting the reward.
http://money.cnn.com/2007/08/14/pf/zweig.moneymag/index.htm

So we run stocks up to ridiculous levels when something good is over the horizon, and we sell them off when that good thing actually happens.

Apparently, this whole mechanism works in reverse, too, as fears of something bad or dangerous excite more anxiety than the actual arrival of the dreaded event.

Could this be why war scares tend to be such a great time to buy?