Like most people who follow markets, I've spent the past two years vacillating between concerns that inflation will take off again as a result of the easy money being pumped into the economy and between the opposite anxiety that we may in fact slip into deflation because of the depth of the economic slowdown.
Markets themselves have yet to reach consensus on this subject. Bond markets seem to be pricing in a prolonged period of deflation with yields on 10 year government bonds at wafer-thin levels, yet when one looks at the prices of inflation-linked bonds, it also becomes clear that a fair number of investors are buying protection against inflation.
The strongest case I've read so far that we face a prolonged period of deflation comes from a speech by Adam Posen in his capacity as a member of the Bank of England's Monetary Policy Committee (MPC). His talk lays out a compelling argument as to why we are not at risk of inflation at the moment and why more aggressive action is needed from central banks.
In short his main points are:
1) there is little risk of inflation because so much productive capacity (labour and machinery) has been idled but it has not been destroyed. In Britain, for instance, he cites research showing that without the crisis total output (ie the size of the economy) would now be 10% bigger than it currently is. The ability to produce goods and services to that extent is not completely gone. Workers are still able to work and many factories have simply closed a single production line or gone to shorter hours. But they have not scrapped many factories. So the economy could grow at a cracking pace without putting pressure on wages and prices.
2) Central Banks need to do more, but can't do much more with interest rates alone, so they need to start buying assets and keep doing so until they start seeing the economy moving in the right direction (ie focus on the outcome, not the amount spent).
For more detail you really need to read Posen's talk in full. It runs to 38 pages so will take a little while, but makes for compelling reading.
As for the investment conclusion - if you believe as he does that we face prolonged deflation then the assets you want to be holding are government bonds, perhaps even really long term ones. If Central Banks push interest rates down (ie yields) by even a quarter of a percentage point then there is big money to be made. Bonds may be in a bubble, especially if you are thinking of holding them for a very long period of time, but for now with economies slowing, deflation a threat and central banks moving more aggressively it seems that there may still be some legs left in yields.
Wednesday, September 29, 2010
Thursday, August 5, 2010
The BP Share Rally Ride
I've neglected this blog for a while due to other commitments but came back to talk for a moment about market sentiment, behavioural psychology and value investing in the context of BP shares (BP.LON) in the wake of the oil spill.
Now this is not meant to be a crowing session (okay it is) but it struck me during all the panic about BP that the market had over-reacted completely to the extent of the spill. BP is a firm that throws off cash and unless you are expecting a huge double dip recession you have to believe that Chinese oil demand is going to keep driving up the price of oil - not forever mind you as substitutes such as tar sands in Canada become increasingly competitive about $70-$80 a barrel so there is some supply response as well as demand elasticity.
Either way you have to believe that under most scenarios BP will generate about $10 billion in profit each year (after the costs of finding new oil to replace each barrel it sells). This is obviously very geared to oil prices so could be significantly higher.
Now that may look scary in relation to the companies potential liabilites related to the spill, which may hit up to $30 billion - but I find it hard to believe its total liability will get that high. The big bulk of is expected to come from government fines of up to $21 billion. But that depends on whether gross negligence can be proved and my reading of the situation (as a non-lawyer) is that this could be difficult and could take many years. I would expect that a settlement is reached for a far smaller sum to satisfy the government rather than have 10 years of hearings and appeals. BP at this stage has every incentive to hire the best lawyers and get the best scientists to contest the government's estimates and claims. Even if over the longer run the claims were to reach that level were are not talking of 2-3 year's profit swallowed up in one gulp, but more likely an amount that gets paid over many years in nominal terms (ie today's dollars).
The long and short of this is that when the market was selling the shares right down to £3 a share, the lowest in 16 years, I took a small punt in my personal account and moved a few thousand (all I have to play with) out of corporate bonds and into BP, getting the stock at £3.05. I was lucky. A lot of people tried to catch this falling knife on the way down. I guess the fact that I called the bottom exactly was really due to the fact that I came to the party late and only ran the numbers when it seemed everyone else had given up on the stock, which as of this time is now back up to above £4. The final tally on the liabilities could still go higher than I think and this bet could have gone quite wrong. It may yet if BP finds it is unable to drill in American waters again. But it is a useful reminder of the old philosophy that the time to buy is when blood (or in this case oil) is flowing in the streets.
Now this is not meant to be a crowing session (okay it is) but it struck me during all the panic about BP that the market had over-reacted completely to the extent of the spill. BP is a firm that throws off cash and unless you are expecting a huge double dip recession you have to believe that Chinese oil demand is going to keep driving up the price of oil - not forever mind you as substitutes such as tar sands in Canada become increasingly competitive about $70-$80 a barrel so there is some supply response as well as demand elasticity.
Either way you have to believe that under most scenarios BP will generate about $10 billion in profit each year (after the costs of finding new oil to replace each barrel it sells). This is obviously very geared to oil prices so could be significantly higher.
Now that may look scary in relation to the companies potential liabilites related to the spill, which may hit up to $30 billion - but I find it hard to believe its total liability will get that high. The big bulk of is expected to come from government fines of up to $21 billion. But that depends on whether gross negligence can be proved and my reading of the situation (as a non-lawyer) is that this could be difficult and could take many years. I would expect that a settlement is reached for a far smaller sum to satisfy the government rather than have 10 years of hearings and appeals. BP at this stage has every incentive to hire the best lawyers and get the best scientists to contest the government's estimates and claims. Even if over the longer run the claims were to reach that level were are not talking of 2-3 year's profit swallowed up in one gulp, but more likely an amount that gets paid over many years in nominal terms (ie today's dollars).
The long and short of this is that when the market was selling the shares right down to £3 a share, the lowest in 16 years, I took a small punt in my personal account and moved a few thousand (all I have to play with) out of corporate bonds and into BP, getting the stock at £3.05. I was lucky. A lot of people tried to catch this falling knife on the way down. I guess the fact that I called the bottom exactly was really due to the fact that I came to the party late and only ran the numbers when it seemed everyone else had given up on the stock, which as of this time is now back up to above £4. The final tally on the liabilities could still go higher than I think and this bet could have gone quite wrong. It may yet if BP finds it is unable to drill in American waters again. But it is a useful reminder of the old philosophy that the time to buy is when blood (or in this case oil) is flowing in the streets.
Sunday, May 9, 2010
Inside the mind of a short-seller: Bronte Capital and First Solar
Short sellers have been getting pretty bad press lately. The most recent involves politicians in Europe trying to blame them for many of the problems affecting debt markets as the contagion of worry about whether Greece can afford to pay its bills (it probably can’t) spreads to other countries such as Spain (which should be able to) and Portugal (which almost certainly will run into troubled in a prolonged slowdown too). There is sometimes something to be said for the argument that short seller lead to increased market volatility rather than just better liquidity but in general shorts are just the messengers delivering bad news. They do not create it.
And lost in the politics of how terrible they all are is the fact that they often help serve other investors well by helping prevent bubbles. If more people had the opportunity to bet easily against house prices (not just the structured credits that financed them) then there may have been less severe housing bubbles and busts in many developed economies over the past decade. And I have just one example right now of a short seller who is doing me a great service. Not only that, but he is unusually open and transparent on his thinking about why he is selling a stock short. As such his posts make excellent reading and are a great lesson in investing for short sellers and long-only investors alike.
The posts all explain in great detail why Bronte Capital is shorting First Solar.
In a very small nutshell of a nuanced argument (so forgive me if I simply too much) John Hempton lays out why he thinks that First Solar, which is currently the darling of the renewable solar industry, is toast. First Solar has an innovative and low cost method of producing thin film solar modules. These are less efficient than the more conventional silicone ones, but are also much cheaper as they are mostly made of glass. In a long and well reasoned argument, John explains why he thinks that despite their great technology and innovative product, they will still in time be done in by cheap Chinese production of the older sorts of PV modules No matter how great the First Solar product, over time it just won’t be able to compete with cheap Chinese production.
Now the company itself and many analysts argue that First Solar will keep improving and will stay ahead by becoming cheaper itself as well as by making its modules better (more efficient).
Now disagreement is great. There is no right answer here because the future is inherently uncertain so different views of it can coexist. The idea of a market is to set a price on the stock by taking all of those different opinions. Now if John were not allowed to short sell, the most he could do is sell his holding if he had one, or just not buy if he didn’t. In essence you would then have a self-selecting group of optimists setting the price. That might not matter, you could say, since if they are wrong they are the only ones hurt. But in fact First Solar makes up a part of an index that I have bought (the iShares S&P Global Clean Energy index fund) in which First Solar is the biggest holding (5.7%). Now many people, myself included, might own the index because we want a hedge against oil and believe there is something to the longer-term growth story for renewable energy. So it is important for us that the index is priced correctly lest we become innocent victims of other people’s exuberant optimism for the stock. As it happens I agree with John and think that First Solar is pricing in too much growth and optimism, though am not in a position to short the stock Thanks to him my tiny passive stake in the company was bought for just a little less than it might have been without smart and brave people like him who are willing to bet against the crowd.
And lost in the politics of how terrible they all are is the fact that they often help serve other investors well by helping prevent bubbles. If more people had the opportunity to bet easily against house prices (not just the structured credits that financed them) then there may have been less severe housing bubbles and busts in many developed economies over the past decade. And I have just one example right now of a short seller who is doing me a great service. Not only that, but he is unusually open and transparent on his thinking about why he is selling a stock short. As such his posts make excellent reading and are a great lesson in investing for short sellers and long-only investors alike.
The posts all explain in great detail why Bronte Capital is shorting First Solar.
In a very small nutshell of a nuanced argument (so forgive me if I simply too much) John Hempton lays out why he thinks that First Solar, which is currently the darling of the renewable solar industry, is toast. First Solar has an innovative and low cost method of producing thin film solar modules. These are less efficient than the more conventional silicone ones, but are also much cheaper as they are mostly made of glass. In a long and well reasoned argument, John explains why he thinks that despite their great technology and innovative product, they will still in time be done in by cheap Chinese production of the older sorts of PV modules No matter how great the First Solar product, over time it just won’t be able to compete with cheap Chinese production.
Now the company itself and many analysts argue that First Solar will keep improving and will stay ahead by becoming cheaper itself as well as by making its modules better (more efficient).
Now disagreement is great. There is no right answer here because the future is inherently uncertain so different views of it can coexist. The idea of a market is to set a price on the stock by taking all of those different opinions. Now if John were not allowed to short sell, the most he could do is sell his holding if he had one, or just not buy if he didn’t. In essence you would then have a self-selecting group of optimists setting the price. That might not matter, you could say, since if they are wrong they are the only ones hurt. But in fact First Solar makes up a part of an index that I have bought (the iShares S&P Global Clean Energy index fund) in which First Solar is the biggest holding (5.7%). Now many people, myself included, might own the index because we want a hedge against oil and believe there is something to the longer-term growth story for renewable energy. So it is important for us that the index is priced correctly lest we become innocent victims of other people’s exuberant optimism for the stock. As it happens I agree with John and think that First Solar is pricing in too much growth and optimism, though am not in a position to short the stock Thanks to him my tiny passive stake in the company was bought for just a little less than it might have been without smart and brave people like him who are willing to bet against the crowd.
Friday, January 15, 2010
Is Gold a Bubble set to Burst
For those who worry that gold investments are the latest bubble to burst comes some disturbing news from GFMS, a company that gathers data on the gold mining industry as well as on gold investment and consumption.
On the face of it, the outlook for those who are investing in gold this year is good.
Gold Price Forecast
The consultancy reckons that gold will again hit new record highs in 2019. It forecast in a report on January 13 that the price of gold would be $1,175 on average this year. That is quite a lot higher than it was last year at $972 an ounce on average. Its main reason for optimism is that investment demand for gold will probably be strong because of fears of a double dip recession, higher inflation and a weaker dollar. These reasons are often the traditional ones for owning bullion and played a big part in it rising to a record price last year.
Investment purchases of gold (much of it going into dedicated ETFs) doubled last year, according to GFMS, with demand rising to 1,820 tons. It was apparently the first time in three decades that investment demand for the precious metal was greater than the amount of bullion bought for jewellery.
This gives me some worries about the sustainability of the current gold price and think that there are worrying signs that it is becoming a bubble.
Weak demand
My worry, which I've written about in previous posts, is that the high price of gold is driving down demand for jewellery, which is traditionally its biggest use. The great thing about jewellery purchases is that they are sticky. You'd have to be really desperate to melt down your wedding ring, for instance. And if you can afford to keep grandma's rings for their sentimental value then you'll do that to. Although some gold jewellery gets recycled, a lot of it stays on fingers and wrists and dangled from pretty ears. That changes the higher the gold price gets. Not only is less of the metal bought, but more may find its way back onto the market.
Investment demand, on the other hand, is notoriously fickle. Especially when it goes into liquid instruments such as Gold Exchange Traded Funds (ETFs). All of those tons that went into investment flows last year can come back within in twinkling of an eye. So long-term investors in gold should really be looking closely at jewellery demand.
Even GFMS seems a little worried. In an article in the Financial Times, the FT quoted Philip Klapwijk, the executive chairman of GFMS, as saying that he thought the market would become "increasingly vulnerable" to a big correction. According to the news report he said that:
On the face of it, the outlook for those who are investing in gold this year is good.
Gold Price Forecast
The consultancy reckons that gold will again hit new record highs in 2019. It forecast in a report on January 13 that the price of gold would be $1,175 on average this year. That is quite a lot higher than it was last year at $972 an ounce on average. Its main reason for optimism is that investment demand for gold will probably be strong because of fears of a double dip recession, higher inflation and a weaker dollar. These reasons are often the traditional ones for owning bullion and played a big part in it rising to a record price last year.
Investment purchases of gold (much of it going into dedicated ETFs) doubled last year, according to GFMS, with demand rising to 1,820 tons. It was apparently the first time in three decades that investment demand for the precious metal was greater than the amount of bullion bought for jewellery.
This gives me some worries about the sustainability of the current gold price and think that there are worrying signs that it is becoming a bubble.
Weak demand
My worry, which I've written about in previous posts, is that the high price of gold is driving down demand for jewellery, which is traditionally its biggest use. The great thing about jewellery purchases is that they are sticky. You'd have to be really desperate to melt down your wedding ring, for instance. And if you can afford to keep grandma's rings for their sentimental value then you'll do that to. Although some gold jewellery gets recycled, a lot of it stays on fingers and wrists and dangled from pretty ears. That changes the higher the gold price gets. Not only is less of the metal bought, but more may find its way back onto the market.
Investment demand, on the other hand, is notoriously fickle. Especially when it goes into liquid instruments such as Gold Exchange Traded Funds (ETFs). All of those tons that went into investment flows last year can come back within in twinkling of an eye. So long-term investors in gold should really be looking closely at jewellery demand.
Even GFMS seems a little worried. In an article in the Financial Times, the FT quoted Philip Klapwijk, the executive chairman of GFMS, as saying that he thought the market would become "increasingly vulnerable" to a big correction. According to the news report he said that:
"As the macroeconomic environment gradually normalises, the gold market's dependence on investment will become all too apparent with a substantial price retreat at that point on the cards."If that doesn't sound like a bubble warning, I'm not sure what does.
Friday, January 8, 2010
Privacy policy
I have recently installed Google analytics to track traffic on this page. Although I don't get any personal information about you I do get information that is useful to running the site such as the search words used to find it and how people navigate through the site. None of this is tied to a particular person or IP address in the reports I receive from Google.
The following is what Google has to say about the information that they collect.
“This website uses Google Analytics, a web analytics service provided by Google, Inc. (“Google”). Google Analytics uses “cookies”, which are text files placed on your computer, to help the website analyze how users use the site. The information generated by the cookie about your use of the website (including your IP address) will be transmitted to and stored by Google on servers in the United States. Google will use this information for the purpose of evaluating your use of the website, compiling reports on website activity for website operators and providing other services relating to website activity and internet usage. Google may also transfer this information to third parties where required to do so by law, or where such third parties process the information on Google's behalf. Google will not associate your IP address with any other data held by Google. You may refuse the use of cookies by selecting the appropriate settings on your browser, however please note that if you do this you may not be able to use the full functionality of this website. By using this website, you consent to the processing of data about you by Google in the manner and for the purposes set out above.”
The following is what Google has to say about the information that they collect.
“This website uses Google Analytics, a web analytics service provided by Google, Inc. (“Google”). Google Analytics uses “cookies”, which are text files placed on your computer, to help the website analyze how users use the site. The information generated by the cookie about your use of the website (including your IP address) will be transmitted to and stored by Google on servers in the United States. Google will use this information for the purpose of evaluating your use of the website, compiling reports on website activity for website operators and providing other services relating to website activity and internet usage. Google may also transfer this information to third parties where required to do so by law, or where such third parties process the information on Google's behalf. Google will not associate your IP address with any other data held by Google. You may refuse the use of cookies by selecting the appropriate settings on your browser, however please note that if you do this you may not be able to use the full functionality of this website. By using this website, you consent to the processing of data about you by Google in the manner and for the purposes set out above.”
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