Wednesday, November 15, 2006


eee... my micro-small cap babies!
Triple good news today! And in the words of the great Dave Chappelle, I'm Rick James! I'm rich bitch! But long-term greedy, not short... and though this feels good... let's see some risks, and

Let's see if the hike lasts!

ETLT hiked 26% today on earnings due to significant increases from the E-Sea acquisition (that everybody thought was moot). Sales of embryo transfers declined as expected, but offset by increases in sale of meat. This will probably be just another blip on the stock-chart, because the long-term viability of this company is still in question... not to mention... is the 39m cash and no debt real on their balance sheets, and if it is indeed real why do they have an enterprise value that's still below it. It's a nice small bet in the portfolio... due to the tremendous upside potential, but in case everything goes south, it is, after all a smallllll bet (but still profitable!)

GRZ hiked 10% today on news from Crystallex that a forum between the Canadian companies and the Venezuelan government political and commercial entities of MARN. The news wasn't even GRZ's... but I guess investors got a whiff that... hey... now there's more certainty regarding the recovery of the properties. Of course, no one exactly knows what the "agreements" as a condition to getting the Permit to Impact Natural Resources is, but I don't think anybody cares at this point. Now it's just a nice thing to know that their concessions won't be expropriated or forced into 50% joint ventures. Political risk is still there, but I think we can all take a breather at least.

GBN announced new developments in their Hollister joint venture property in Nevada, and man I've never seen Au results so good. As opposed to before, these new holes seem to prove that not only is Ivanhoe a viable project for silver, but the gold is not so bad either--in fact, this is what the company highlighted:

- Hole HDB-045 intersected 9.2 ft (2.7 m) grading 1.12 oz/t (34.8 g/t) Au and 5.85 oz/t (202.3 g/t) Ag from 344.1-355.0 ft (104.9-108.2 m).

- Hole HDB-048 intersected 3.8 ft (1.1 m) grading 1.27 oz/t (43.4 g/t) Au and 6.15 oz/t (212.6 g/t) Ag from 132.4-136.2 ft (38.9-40.1 m).

- Hole HDB-049 intersected 2.7 ft (0.8 m) grading 3.46 oz/t (118.6 g/t) Au and 32.04 oz/t (1098.5 g/t) Ag from 92.2-95.3 ft (27.1-28.0 m).

- Hole HDB-050 intersected 1.9 ft (0.6 m) grading 7.22 oz/t (247.5 g/t) Au and 34.4 oz/t (1179.4 g/t) Ag from 236.8-239.1 (72.2-72.9 m).

- Hole HDB-057 intersected 1.8 ft (0.5 m) grading 4.13 oz/t (141.6 g/t) Au and 23.70 oz/t (815.6 g/t) Ag from 248.2-250.0 ft (73.0-73.5 m).

- Hole HDB-062 intersected 1.8 ft (0.5 m) grading 7.42 oz/t (254.4 g/t) Au and 41.6 oz/t (1426.3 g/t) Ag from 129.2-131.1 ft (39.3-40.0 m) and 1.6 ft (0.5 m) grading 1.30 (42.48 g/t) Au and 3.61 oz/t (123.8 g/t) Ag from 140.8-142.8 ft (42.9-43.5 m).

- Hole HDB-063 intersected 3.8 ft (1.1 m) grading 3.81 oz/t (130.3 g/t) Au and 25.8 oz/t (884.6 g/t) Ag from 126.8-131.4 ft (38.6-40.0 m).

Yeah, they might run into some investor backlash when it comes time to finance, but with Burnstone and this baby, it's now officially 50 cents on the dollar. What could go wrong? Project time lines, gold & silver price fluctuations... still GBN pays off handsomely.

Saturday, November 04, 2006

Alpha/Beta Anemia by the Bond King

A good article by Bill Gross, on "this time its different". Not in the sense that it's really different, but on economic reality that information travels much faster than the old days, and the narrowing of risk/return spreads. It's a very interesting proposal/investor outlook letter on how modern investment instutions must "scale up" good ideas in order to make excess returns in tandem with the double digit alphas of the past. A great essay, and a great perspective on perhaps why hedge-funds and private equity are proliferating, and why there might be a blow-up if enough people actually believe that leverage and scale is the answer (that tidbit on Ponzi finance).

Thursday, November 02, 2006

Goodbye, sweet corporate structure arbitrage... oh Caaaanada

You know, income trusts are pretty sweet--until today that is, when the finance minister of Canada Jim Flaherty took the markets by surprise (if not the market, then definitely little old me) by announcing plans to effectively end the tax-free benefits enjoyed by companies that opt to structure themselves legally as an "income trust status". This move cost me an alpha of 2%... my first reaction was, of course, THAT BASTARD!

You know, it's really funny because this thing happend september of last year too when the guy came out and basically said the same thing that he has said today, except he repudiated it later by saying that the government actually has no intention of revoking the tax-free structure of income trusts (the markets were relieved, but proceeded still with some suspicion still). I bet he only revoked it because his friends begged him to too... haha

"Hey jim, buddy, can you help us out? Can you just tell the market 'nevermind' until next year, at least after we get rid of all of our own income trust holdings?"

Conspiracy theory? I hate politics.

While I still think he's a bastard, this sort of thing was probably too good to be true in the first place. It was a good thing, income trusts, but sometimes all good things must end. I know of no other developed country with a business structure like that of Canadian income trusts--simple, elegant, and sweet sweet cash flow to shareholder absent of tax on the corporate level. Canadian income trusts are like REITs, except they can be virtually any business that any normal company can engage in. From frozen food distribution and medical supplies distribution, to matress manufacturing, or air cargo services... sounds pretty sweet, and yes, it was indeed too good to last.

When a business is structured as an income trust, it usually means that despite inability to reinvest more than 10% of free cash flow to the underlying business and grow organically, it could still take on leverage to grow from acquisitions. When an income trust acquires another entity that have to otherwise pay 35% in tax to the Canadian federal government, and if these acquirees are valued solely on its ability to generate bottom-line to shareholders, then income trusts can effectively pay the market (assuming market price is a function of after-tax earnings) and pocket the spread between free-cash-flow after tax, and free-cash-flow before tax for free... which claims value (at the marginal tax rate) from the government and gives it to investors.

This is a sort of "corporate structure" arbitrage opportunity that has existed for a while... until today. Maybe the government realized that, maybe the government just wanted more tax revenue. Whatever the reason, the conservative government completely broke the election promise of leaving the income trust status alone. 10-15% losses across the board on income trusts today, and the hardest hit were seniors retirement funds.

Shit happens.

Sunday, October 15, 2006

Actually... swap contracts are set to zero because

I am ignorant/stupid. But this sunday afternoon I have seen the light! Thank ya jesus, thank ya lord.

A swap contract is not meant to create an NPV zero exchange throughout the life of the SWAP (otherwise why would anyone ever enter into a swap). It's guided by the principle of expected return, not no-arbitrage spreads. The only time no-arbitrage spreads come into play is the initial pricing of the swap contract, which is determined by the value of a floating rate bond (initially worth par), and the fixed rate set to make the stream of payments worth par, otherwise, the long swap position would profit risklessly 6-months from now with a coupon determined completely above par. The fixed rate paid must equal a coupon rate that makes the stream of payments worth par using rates determined by the yield curve today... and that's actualy determined by ZERO rates, NOT implied forwards.

Movements in the rates are free to go where they please, and the swap contract is not worth zero anymore after time progresses and rates shift. What was I thinking? Swap contracts worth an initial NPV zero and not no-arbitrage zero... HA!

That's alot of "X"es on my Problem Set #3 :(

Debt instruments kicks my ass.

Sunday, October 08, 2006

Why should swap contracts ever be set to zero?

It's strange... when two parties enter into a swap contract, the initial agreement is worth zero, and the fixed rate payment recieved by the party long the swap is determined based on implied forward rates that would make the value of the floating contract equal to that of the fixed to create an NPV zero exchange.

However, implied forward rate movements almost always exceed that of the actual future spot rate as a function of the averaging effect of the increase or decrease. Does it make sense that swap contracts should be zero at the initial signing? If so, doesn't that mean that the party that long the swap contract almost always receive a fixed rate that is slightly higher than what should be received (provided that the six-month coupon implied by the forward rate overshoots that of the actual coupon paid in an increasing rate environment, and the long swap receives fixed payments higher than what is deserved) or receive a fixed rate that is slightly lower than what should be received (provided that the six-month coupon implied by the forward rate undershoots the actual coupon paid in an decreasing rate environment).

The floater that is implied in both scenarios derive its value from implied forward derived from zero rates. Unless the yield curve is a straight line, the value of the floater in the swap contract value equation seems almost always over/understated.


Friday, September 29, 2006

The Principle of No Arbitrage and The Beauty of Relative Comparison

Fixed income pricing is super cool. I've not seen this side of financial valuation since I've gotten to college and now that I've been exposed to it, I feel drawn into it. I've always thought of finance as more of an art than it is science... and even if it is usually on instruments that don't have a definite stream of cash-flow, and most results are based on expectations rather a focus on the present relative to other things in the present. Bond pricing is the latter, of course, and one thing: everything... EVERYTHING... is based on the principle of no arbitrage.

I think that's pretty cool, as I've never really dived into the quantitative side of things... but the way mathematics really help in making money here lies in the fact that certain functions MUST equal to other functions (after taking into account certain transaction costs, which diminishes with scale), or else one can always buy the cheap instrument and sell the expensive until the spread narrows with exploitation. And the beauty of that is, even if one were to be wrong in predicting the future, one only has to be less wrong than the other side of the hedge and there is money to be made. Returns are made by locking in inefficiencies rather than soothsaying the future.

But, most attractive opportunities out there are exploited, and spreads which exist out in the real world are often miniscule in that one has to commit billions of dollars in capital and leverage for the trade to make sense. Or else, there are also more and more exotic options available to the clever and the brave, playing with eurodollar futures and interest rate swaps to pocket the difference between locked in linear term structures and positive convexity LIBOR rates (I don't have any idea what I'm talking about anymore). And this takes huge amounts of capital, and is very much an economies of scale thing.

Today it hit me... that's exactly why fixed income returns are on average lower than that of equity returns over the historical average. You have all these math geniuses seeking the midas touch, and there are really only so many trades that can be done, and the fact that so many bright and talented people are out there everyday taking advantage of snippets make it very difficult to make abnormal gains. The factors that go into fixed income pricing, although complicated as hell, is still a system one can exploit effectively, by valuing one instrument relative to another, and making small and yet almost risk free returns. Equities, on the other hand, are different in that there's always more "expectation" or "unquantifiable" factors involved, and the risks an equity investor takes on are almost always more of a "business" calculation rather than mathematics. Of course, it's where most excess return come from over risk free, but it's also where the most volatility lies. And there really is no system in equity, only philosophy, contrast to fixed income, where everything falls into place beautifully in advanced quantitative valuation--and though expectations regarding the short-term volatility of interest rates, general movements of the term structure, and such and such--the expectations are still not USED to make money, but used to take an advantage of an inefficiency in pricing between two functions.

I'm confusing myself, better stop writing and start learning more...

Monday, September 18, 2006

Good stocks is like good underground music

Finding undervalued stocks is a lot like finding new underground punk rock bands. You try out everything that nobody has ever heard of before, and then you start liking a few of them. You get more and more excited about them, and then you get to "own" them, and it feels good when nobody else knows about it.

When the stock/band sellout, you sell them out of your portfolio. And viola, and the process starts again.

Friday, September 08, 2006

Shortfalls in the Use of Modern Finance Theory in Equity Investments

I've always wondered why exactly so many practitioners of investment valuation have fallen for the concepts delineated in modern financial theory in applying them to the determinant of the "correct" price of a business. It's not as if the concepts of risk and error are infallible, but research analysts and investors alike set target prices and returns based on a certain way numbers are crunched. Assumptions are made about a certain company in its ability to produce cash-flows, or in comparing it to other businesses that are similar (preferably exactly alike) in the industry, and then a recommendation or investment decision appears magically based on the results. I'm not arguing the merits of modern financial theory in giving the investment community a valuable tool to ground a thesis, or to descibe a certain investment in the language of statistics and arithmetic. I'm arguing that the way people choose to perceive our theories in modern finance as anything but incorrect and infallible is wrong. The assumptions that most individuals choose to attribute to a model, or an investment thesis is quite often based on their opinion of what is correct. However, many fail to capture "correctness", and instead capture an ersatz of such which is a motley composition of past results, blanket assumptions of expected risk and return, greed, or fear.

Case in point, some might view DCF models and relative multiple models to be the holy grail of investment valuation, and that armed with these tools, one can have the midas touch in stock picking. Of course, many realize--too many bad investments later--that things are not always what they seem, and just because they have bought or sold a stock based on their perceptions and assumptions, does not mean the market will be kind enough to support that assumption and narrow the gap between perceived value and actual market price. Now, modern finance theory, although genius, must be analyzed from the perspective of one that is detached from its use. Those that stick fast to the explanations offered by serendipitous combinations of certain costs of capital, market risk, volatility, growth rates, expected returns, etc. will often find it difficult to question these.

Cost of capital, for one, especially that one used in the CAPM model, is really a function that determines a correct "discount" rate based on experiences of the past. How that measures up to performance of a certain company in the future is anybody's guess, as there has never been (at least not to my knowledge) any studies that have shown that CAPM is flawless in its ability to predict future risk with data from the past. I know of no greater hoax than the assumption of a WACC or Cost of Equity. Beta, for example is one of the most absurd variables. The concept that risk of equity can successfully be measured with a regression of how the stock price of the business in question correlates with the performance of the market over a range of the past seems almost silly or even stupid. Although price performance may indeed have certain correlations, the value of a business certainly should not, and to look towards beta as if its a knob to where risk and return, and thus the value of a business, can be adjusted accordingly is fundamentally wrong. The risk that beta measures does not differentiate between upside and downside risk, and it has no way of predicting whether or not the future upside or downside of a business will still be the same. Cost of debt may have its merits if a business is predictable or stable enough to constantly borrow at the same rates as it has been in the past, but even cost of debt fails to consider future issuance, retirement, or refinancing of debt and at what rates companies might be able to borrow at that point in time. And when one consideres the inaccuracies in predicting a "market risk" in the equation, the picture gets more blurry.

Thus, a classic case of "garbage in, garbage out" exists, where if certain variables in a model simply don't make sense, the results of that model will not make sense either. Of course, the Godly redeeming feature is the epsilon attached at the end of the equation which accounts for "errors and unsystematic risk", which vindicates all the absurdities. However, one must realize that most of the time, it is certainly due to "errors and unsystematic risk" in market perception that investors can successfully take advantage of them and intelligibly make an investment decision and make returns. I would argue that most excess return can only be garnered with security analysis in finding and analyzing specific and unsystematic characteristics of a business that can be predicted with reasonable certainty. Risk is a perception and a personal preference, and should be discounted according to an investor's own definition of how much risk to take.

Valuation is never meant to be a "precise" science, and since more often than not, human nature tends to err towards optimism and hope, variables are often assumed to be more on the bright side of things. Of course, it is only with that that investment bubbles and euphoria is born, where a "new economy" is coming that warrants infinite growth and opportunities. And even if assumptions do not go out of hand to such an extent, most of the times, those that analyze an investment develop a certain love for the investment and an urge to attribute positive characteristics where none exists factually. Of course, when expectations are not met, or when markets disappoint, assumptiosn prove to be wrong, and the price regresses to the "true" value of a business absent of any emotion or optimism attached.

Investing is more of an art than science, and though mathematics is a must in calculating NPV, liquidation value, or market comparables, it should be done in such a way that error is made in the name of conservatism, and the preservation of capital and risk-aversion should be the first and foremost philosophy in making good returns. Mathematics and philosophy may have found thier common grounds in logic, but perhaps not so much yet in the world of investment valuation.

Monday, August 14, 2006

InfoUSA to buy Opinion Research Corporation

At a 85% premium!!!

It's a small world after all!

On Political Risk

Though the pen is mightier than the sword, and philosophy the mother of all lasting authority, civilization--when it begings--is built upon a foundation of force and violence. Our world today is not too different from the world eons ago, where man fought one another for reasons that might include one of these: (1) scarce resources or (2) ideological dominance. The former is purely economic, where those with lesser and poorer populations loot a more powerful neighbor for survival, in which the intellectually and materialistically impoverished peoples gather against a larger people who do not share in the misery. The latter is more or less philosophical, often fought between parties of equal strength, sometimes also serving as a guise to justify more economic reasons for warfare, that bring not only necessity and survival into the game, but also propaganda in the name of the good, the just, and the righteous, and whoever wins obviously had all three on their side. Power comes before civilization, and brute force opens the gate to knowledge and economic trade. Those who dabble in the benefits of civilization must never forget the legacy of blood and realpolitik behind every lasting peace.

Likewise, those who dabble in blood and realpolitik should never forget how to harness peace to bring the benefits of civilization.

Anyone who prospers under peace usually do so through the creation of value, and that usually means production, commerce, and finance in one form or the other. Of course, most countries in our world today can at least call themselves a "nation" if nothing else, even though some probably do no better than nomadic tribes under that title, and the benefits of national soverignty that come with it including a government, a standing army, and at least some infrastructure to support the rule and law of both. Such benefits, however, are too often perceived as "enough" or "as good as it gets", though it may be no where near the standards that must be in place in order for prosperity to take root, though the facade of peace and control may exist.

While the capital markets do not discriminate between "right" and "wrong", or between what's "warm-hearted" and what's "cold-blooded", it at least knows perfectly well the conditions under which wealth and prosperity of a people must operate commercial enterprises and participate in trade. After all, one of the greatest perks to civilization is specialization of skill which brings those who know best to provide to society with the fruits of their best-practices in exchange for others' best-practices, and a society which facilitates this sort of exchange is a society that ultimately prospers, and a society that seeks to dampen free-exchange and commerce for whatever reasons may be will find itself destroying value and alienating itself from the forces of economic progress.

Venezuela is a case in point. President Hugo Chavez, through an interesting twist of socialist ideology, have decided to nationalize many of the country's energy and mineral assets in order to finance the demogaugic promises widespread education, healthcare, and crime reduction. To the investment community, this is horrible news, and Venezuela will have successfully cut itself out of any promises of future benefits and welfare that result from foreign capital and investment. While education, healthcare, and the safe enforcement of law is important to any society--the tax at which Venezuela extracts against the world's capital is too great a burden, and like any investment that simply do not make sense from a cost-benefit perspective, the wonderful promises are sure to be empty as financing escapes the tentacles of these so-called social initiatives which have unlimited costs. Decades from now Venezuela will no doubt find itself to be a poor country with nationalized and yet undeveloped reserves of natural resources as the world shuns its lack of protection for the individual.

When the capital markets speak of political risk, they are speaking of simple initiatives in favor of individual rights--starting with the right to property--that a country lacks, which dampens any "rule of law" that might protect an investor's interests from being nationalized or expropriated, which often have unreasonable compensation schemes that completely disrespects and mocks the hard-earned value in which a corporation or an individual works to create and maintain. Though "a fight to take from greedy capitalists what naturally belongs to the people" might make a great demogaugic slogan, it completely throws one of the most important rights of man: the right to own. While equality and social justice is important to a certain extent, such should not come at the expense of the individual, and any society that deviates philosophically from the free-giving of freedom in building wealth and enterprise, then, should be best avoided by the investment community at large.

On Market Timing and Value Investing

It's no news that the market has been completely tanking over the past couple of months. Institutional investors, fund managers, and retail investors alike are pulling their hair out while watching their the best of ideas and the worst of ideas going down down down. So a few questions regarding this sudden downturn should be posed: what is happening? what is to be done?

We are in a period of a much needed correction on the stock market. In a way, we were still feeling the effects of the economic recovery as a result of Greenspan's relentless easy money policies from 01/02 on--until now. Back when interest rates were eased down to nearly 1%, the hope was the excess amounts of easy capital to business people would be enough to finance capital investments to save the economy from an oncoming doom. The stock market was thus saved, as people got out of fixed income investments because of the low yield and put money into equity investments again. As the stock markets began to rise, investors once again had the confidence that they had lost after the tech bubble, and the stock market became, for a short period of time, the investment vehicle of choice once more. The market gained momentum... and everyone made money, though not anywhere near the amount that people lost in the burst.

So what's happening now? To answer this question, one must first aggregate everything that has happened in the stockmarket the market for the past five years. Before the bubble burst, stocks were allowed to rise to cosmic levels in praise of a "new economy" where financial valuation no longer mattered, and earnings were expected to be able to rise on forever and ever. The over-valuation of equity investments were obvious, but no one really cared. And as the fate of any investment bubble in the financial history of man, it was destined to burst. However, one should be aware of something that often escapes observation. The bubble burst never actually corrected stock market valuations to its historical levels. Meaning, the stock market after the bubble should have crashed lower than it should have before it started to recover during the latter 2002/early 2003. One only needs to look at what happend to interest rates during the crash:

In a way, the Fed saved the markets from an even heavier downfall by decreasing interest rates almost immediately after to historical lows (interest rates that haven't been seen since the late 1950s). By doing so, the Fed has successfully taken the interest out of bond-investments, and thus, naturally--hungry for returns, most investors went back into the equity markets again without the stock market having hit its bottom. It's very important to emphasize the role of the Fed in brining the stock market back up during the past couple of years away from the perceived doom of 2000 - 2001. One can look at the current price investors are willing to pay for the future stream of corporate earnings vs. the historical average level that investors were willing to pay that's been around for many many years:

Taking a look at the end of 2005, it doesn't seem to be too far off from historical highs. Meaning that, in a way, we are still in a period of overvaluation in the market, and that valuation after the bubbles crash can only be considered "relatively low" compared to the heat of the 90's as the tech era boomed. Of course, many could argue that we have reached the highest levels of productivity that mankind has ever seen, with countless number of new innovations that have facilitated efficiency gains beyond anyone's dreams before the advent of the technology boom. However, I fail to grasp how this should affect financial valuation. As much innovation and productivity gains that the American business landscape has seen over the past two decades, the fact that businesses still compete for market share and businesses still compete for capital do not change. And thus, why would financial valuation change? It's not as if a business will be able to make higher returns with less risk than before. If anything, the risk has increased and returns have decreased as a result of a "flatter" business environment.

So, what the Fed right in coming to the rescue back in 2001 when they decreased interest rates to where they were? Yes and no. Yes in that America badly needed an injection of confidence to prevent recession/depression/whatever. No in that the Stock market still needed to go down more.

Anyway, back to present times. Alan Greenspan probably realized that too much money was created in the economy, and started raising interest rates again not too long ago. Bernanke has continued this legacy. But why is too much in the economy bad? I've heard many "average joes" asking very difficult questions such as why "the Federal government is trying to bring down the value of their homes?", or why the government is "trying to create a recession at the expense of the people?". How do you answer these questions? Can you simply tell people that, well, they made too much money with historically low interest rates, and these extra monies went towards intangible investments and bubbles such as (in order of appearance) the tech bubble, the nascent mini-recovery in stocks, and real-estate? No... you probably can't, because chances are, the average joes didn't really make that much money in the tech bubble, and the value of their homes is the only real tangible capital gain that they have seen over the last few years. It's the "smarter" people that got away with real value... like, perhaps the now-famous Andy Kessler who got away just in the nick of time when the bubble burst. So, the average joe got screwed then during the bubble, and they will probably get screwed in the next couple of years that the Fed is tightening to take the extra money (including the gains in home prices) away from the economy (god knows how many people actually went through with taking mortgage-equity out of their homes).

Bernanke is continuing the tightening policy in order to take all the excess liquidity and M2 out of the system. And by tightening, the stock market goes down as returns are discounted at ever increasing risk-free rates and bond markets look more and more attractive to investors that don't want to deal with the risk of capital depreciation. The market has been going down finally for the past few months as rates broke the 5% mark since the lows that it has hit during 2001 - 2002. We can already hear the griping of equity investors begin--and what do you know, they are hammering for a "pause" and an "ease".

Bernanke threw them a bone in the last speech he gave congress--which, by the way, was hilarious because of the congresspeople's insistence that a pause should happen right now (especially the ones with lobbyists from the housing sector and the mortgage financing sector). Bernanke said that the Central Bank would now be more careful in considering many factors that are facing the U.S. economy, including:

1.) The effects of past interest rate hikes in the pipeline that have yet to hit the economy
2.) The possibility of a recession on the horizon and the fallibility of an overhike
3.) The possibility of even more inflation if the previous two scenarios don't play out.

So, anyone dabbling in the equity markets must beg the question... what is to be done?

Will the Fed pause? Or will they keep tightening? Or, everyone's favorite, tighten one more time in August and then ease up?

There is one answer for the value investors--and that is: keep on truckin' :D
As the vagaries of the market and the fed seem to be endlessly unpredictable and volatile, there is almost no certainty and no risk-control in a situation where the average investor is powerless against bigger things than themselves. To rely on the performance of one's portfolio on the effects of the market is akin to taking seriously a young woman's perspective on the "right" kind of man... both are easily swayed by the seasons. So, it is best if serious investors stayed out of the market as a whole, and instead, looked for investments that have "value", not "price".

Of course, even value investors must weather the ups and downs of the market. Any investment in a portfolio lacking immediate catalysts could be subject to heavy correlation with how the market performs. The fact that everyone dabbles in every stock won't change. And since it is indeed everyone that invests, good stocks can face bad returns in down-markets. In a way, I guess I am a hypocrite, in that, I do my best to criticize the market's overvaluation, and yet, I should curse and suffer too if the market corrects itself by falling since I am a part of that everyone.

However, market-risk is one thing, fundamental-risk is another. Market risk is the kind of risk that gives you gains and losses in volatility swings, but fundamental-risk is the kind that gives you a permenant gain/loss of capital. The difference between value investing and investing with an eye on the market is that the former should only care about the permenant loss/gain of capital, and have a strong conviction that so long as the crux of the fundamental investment thesis do not change, value will out despite short-term short comings.

Of course, that kind of thinking is also dangerous in many respects. Unless one completely understands the investment that one makes, it is very difficult to have that level of conviction that is required to stick it through a great many deal of short term losses... and oftentimes, volatility can often be distorted by emotion to become perceived by investors as a permenant gain/loss of capital every time the ticker moves. Loss aversion is there for a good reason, however, when the fundamental value of anything is worth more than the price that the market currently assigns, then value should out, eventually, even if the market thinks otherwise.

That's not to say that the people who correctly make money on market swings are any less intelligent than value investors. On the contrary, many market-timers I know are brilliant in every respect... and most can make money on advanced mathematics and financial derivative trades that most value investors will probably never understand. However, the philosophy is different. Successful market-timers make money on derivatives and hedging, while value investors make money mostly on long-term equity investments. It helps to have a little bit of both, but no strategy is perfect.

And well, I guess my conclusion: as value investors, there is a conviction that so long as discounted equity are correctly assessed, one does not need to worry too much about the vagaries of the market... only fundamental changes that would change one's thesis. As the market goes through a period of much needed correction, the market will be flat at best, and down at worst. Well, value will out no matter what the market does, but personal discipline and constant thesis checking will be the responsibility of every value investor as pride, love, fear, greed (well, maybe a little bit of greed), and soothsaying cannot ever be allowed to affect one's judgement in what is "value" and what is not.

Of course, the trick is to make money on a down market. Oh value, where art thou?

Chinese market sucks

Call me a China bear… it’s unbelievable how messed up China’s financial situation is. I came here thinking that an inefficient market would breed profitable investment opportunities. Inefficient it is indeed, but not in a good sense. Here, the inefficiency is not so much investor inefficiency or hidden value. Here, the inefficiency is on an infrastructural and fundamental level the market system. I guess I had to have seen it with my own eyes… but the bottom line is that the Chinese stock market really sucks, but nobody seems to care. The valuations are through the roof!

Though I cannot say I have looked at all Chinese companies to know if all Chinese stocks are as bad as what I am about to mention… I’ve seen enough of how the system works to know that without the proper frameworks, China is only a fa├žade of capitalism. Of course, things should get better slowly from here as the Party is trying very hard to set policies favorable towards the development of the capital markets. But the way it seems right now, real lessons will probably only be learned if a severe fundamental correction that really hurts happens within the next five to ten years. Only then can the widespread pseudo-wealth of fiat currency created through bad bank loans, the bogus financial disclosures that detail very much but say very little, and the horrible conflicts of interest that exist on almost every level of finance be wiped clean.

But anyway, enough with the small-talk… I have five reasons why China probably won’t be able to sustain its meteoric rise in the next five to ten years. Although I cannot say that China would not be a good investment in the long-run, I’m fairly certain that at the rate China is growing presently, a severe fundamental correction will take place in good time. A simple explanation of why:

(1) A bad case of bad loans outstanding caused by numerous conflicts of interest between politics, economics and guanxi.

(2) Which brings crazy growth in money supply that cannot find value-generating investments. Which brings inflation on intangible/big-ticket items such as real-estate, commodities, and equity (in a way this goes for the entire world too)

(3) That causes social inequality, and the “income gap” continues to widen, with the government continually having to find itself subsidizing the poor mainly in rural areas and urban slums who have virtually no investment opportunities available to them to keep up with the times and yet have enough will to live and breed at an increasing rate. They in turn…

(4) Continually bring inexpensive labor on the market and continue to consume inferior goods and services on a second-tier economy (sometimes black) that is tied to a currency—the Renminbi—that continuously loses value domestically due to inflation, and increases in value paradoxically relative to the rest of the world because Mr. America thinks inexpensive Chinese products are a result of an undervalued currency and not a result of an excess labor market and an overflow of people desperate for work. So that when the Renminbi actually appreciates in value, strangely enough domestic inflation will also go up (as China is not an import economy) with exports failing and unemployment rate rising.

(5) In turn, so long as there are enough currency in circulation for the wealthy to continuously invest in projects with negative value or intangibles, manufacturing, commodities, and excess export capacity will continue to grow at an alarming rate without regard to margin… and even the most saturated of markets will be subject to ever-increasing investment because, where else would the glut of currency go? Until all falls down as loans must be written down, and money supply must naturally contract.

Oh! What’s the catalyst? One might ask…

A slowdown in international demand for Chinese goods I say! Value will quickly contract then. People speak of domestic demand picking up that could perhaps offset the slowdown in international demand… that might be the case, except for one small problem: the majority of Chinese are poor. The high and middle class cannot possibly create enough demand (and do not have enough logical reason to buy) for goods that are propping up the Chinese economy: cheap apparel, cheap electronics, cheap toys, etc.

Wealth disparity is one of the most economically disastrous problems… for the rich get richer to buy goods produced by the poor… and the poor produces hordes of supply that cannot possibly be consumed, which must be sold for ever lesser values, while the wealthy have nowhere to invest except intangibles such as tulips, imaginary stocks, and commodities like gold (gold is another story altogether)… until one day *poof* money goes away magically, just like it appeared as mere flickers on a bank-machine.

At least America invests in intellectual property and innovation… where do the Chinese invest? You guessed it… bad businesses, intangibles, and U.S. treasuries (at least they are long-term treasuries that destroy value and burn excess money as U.S. interest rate hikes continue).

I’m very bearish on the Chinese market. Cash will get burned… bad habits won’t change until their short-term advantages turn into short-term woe…

And you know what? Shorting is illegal in China, and there is no active bond market… in short, the transfer of risk to stupid people who deserve to get their money burned does not exist…

Let the anti-climax unfold! (I must remind readers that this anti-climax might happen next year, or five years from now, even ten years from now… however long the Communist government can inject money into the system to pretend everything is alright… but alas! The longer the denial the greater the demise. Such… is life :D)

Saturday, February 11, 2006

Initiative Revamp

In the form of trade notifications:

Hey Guys,
Sold out of our 345 shares of YRC Worldwide at today's close of $47.61

It is our opinion that the bull market, in light of all the negative economic indicators being published, is at a very risky turning point in the next couple of months. With the inversion of the yield curve, continual falling of labor participation rates, massive current account deficits, and a less than impressive GDP growth rate, we think that there is a very high probability that the economic well-being of the United States--despite appearances--is headed for a decline (or at best, lack of growth) over the course of this year and the next.

While we could be wrong, this is a chance we are not so willing to take with highly market correlated equities like YRC Worldwide, and instead, we plan on reverting our focus back to securities that is catalyst driven/non-market correlated, and hedge our portfolio against any further market decreases that might come in the next couple of months.



Hey Guys,
Bought 965 shares of GBN at today's close of $1.65, ramping it up into a 15% for the initiative.

I like Goooooollllddd (for market hedging purposes).



Hey Guys,

Sold out of 9,306 shares of ETLT at today's closing of 0.60 will keep selling until this company is 5% in the portfolio.

After re-evaluating the company, we've come to the conclusion that the company is already at least fairly valued in terms of the cash on their financial statements. They are trading AT cash. Despite potentials for the company to acquire more cash in its operating future, we are not without the same kind of concerns that we've had before when we first invested in this company:

1.) Uncertain revenue streams from embryo transfers/meat sales. What happens if the Chinese government suddenly stops subsidizing this?

2.) Uncertainty regarding the operations of E-Sea. Women don't need to go to clinics and examine their breasts on a quarterly, or even annual basis. This is not sustainable revenue, despite government subsidies.

3.) Everything is fake

If 4th quarter does give us the 100% upside we were looking for, then kudos and we will gain more than enough from a 5% position.

If however, 4th quarter comes out with something else unexpected... e.g. if management states that revenue streams will be lower this year, financial statements can't be filed on time... etc. Then we will lose tons of money with a 15% position.



Hey guys,

Bought 36 shares of PONR at today's close of 29.77.
Our thesis has not changed for this company. We are merely ramping it up to 15%.


Thursday, January 26, 2006

Eternal Technologies... Again

I've been in a love/hate relationship with this tiny little agricultural biotech company from western China for a while now. The stock has lost me a good 300 bps over the past couple of months. I haven't really thought about the stock as much as I should... but maybe that's a good thing. Investors who think too much get scared; sell off shares due to a lack of news, or let the best of the personal demons of loss-aversion get to them. One can almost always find a thousand reasons why a stock will go up, and a thousand reasons why a stock will go down. In the case of Eternal Technologies, the two arguments seem to weigh equally. The mega-attractive quantitative aspects are off-set by a less than comforting realization that the numbers could be wrong. And the repurcussions from the downside of 3Q can still be felt in the silent wake of losses taken from the mini "bubble" bursting.

Are things starting to look different? After all, as investors, we want to know what will happen in the future, and detach ourselves from what has happend before. I can't claim I know with absolute certainty that the stock will experience the upside that we had expected when we first presented the company. I do know, however, that the story/hype are starting to look better.

The acquisition that we had doubts about--E-Sea Biomedical--is apparently in the process of handling government orders for breast examinations in the city of Shenzhen, and netting a good 400-600k from its operations. Despite the shaky merger and pro-forma numbers due to incompetent accounting/auditing, the business seems real enough. Does this mean that the company, on top of what we originally had valued as only the core agricultural biotech business of Eternal Technology, will be even better than we had originally hoped?

Again, I can't predict the future. But I am fairly confident that 4Q earnings, on top of what we had originally expected from embryo transfers and meat sales, will also include positive net effects from E-Sea. Only time can tell whether or not holding on to the stock is the right thing to do; but boy, am I glad I held on despite the poor performance of the past 2 months.

Thursday, January 19, 2006

Pioneer Companies, Inc.

In the form of a trade letter to the board

Hey guys,

Bought 550 Shares of Pioneer Companies, Inc. -- Ticker PONR -- at today's closing price of 29.55.

Pioneer Companies seem like a regular commodities business at first glance. They specialize in the production of Chlorine and Caustic Soda (baking soda and the like). One might expect the super cyclicality and the macroeconomics of the business to make this investment suck. But...

Ever since the emergence of bankruptcy, Pioneer Companies has focused on the reduction of costs and closing unproductive and uncompetitive production plants within its portfolio. It is now a formidable player in the industry due to:

1.) Monopoly-like presence in the western part of the U.S. -- They have the only producing plant of Chlorine and Caustic soda there, and are able to out-price most of the competitors located in southern U.S. because of their geographic proximity to their markets. Plus, there's a huge issue with railroads that prevent their competitors from entering their markets effectively. Pioneer also own three pipelines in the area that allow them to transfer products more efficiently than competitors who have to use trucks and rails.

2.) Industry capacity being reached. As of Dec 2004, 97% of the industry capacity is filled. Prices have been on the rise like mad. Pioneer still has a 20-something percent discount relative to market average prices because of their geographic location. They expect their price to become the market average in time, AND THEY DON'T HAVE TO WORRY ABOUT COMPETITORS while raising prices... at least, not for another year or two. The industry isn't expected to increase their capacity though.

3.) Strong cash position/balance sheet by the end of 2005. Most of these will be used to exclusively pay down their 10% senior debt (issued during bankruptcy), thus reducing interest expense and improving free cash flow to equity. Also... since the notes are due in 2006, the company should have no problem refinancing them on better interest rate terms due to its good financial performance.

On top of it all, the company is also selling 60-acres worth of empty land sometime in 1Q 2006. They recently sold a 11-acre land for 2x the book-value... so we can expect a pretty nice cash inflow from those things. Management stated that the proceeds will be used to pay down existing debt.


With all these things in mind, the company trades at a market cap to free-cash-flow multiple of just 5-6x, and an EV/EBITDA multiple of 3-4X

I think its cheap because chemical companies and the industry as a whole is seen as a super-cyclical business... and earnings are generally unreliable. Pioneer Companies, specifically, might have been mistaken for a "general" chemicals producer, and the special situation of Chlorine and Caustic Soda may not have been taken into consideration. Also, there is virtually no analyst coverage for Pioneer.


Our target price for this investment holding will be $44.90

If any of you want more details, please let me know.

Best regards,

Monday, January 02, 2006

Initiative Update - Winter 2005

There's really no REAL trades going on during the break for the initiative. Most of it was trying to exit an illiquid position (MRCBF). The portfolio value as a whole is $100,723.55, a roughly 2% underperformance relative to the S&P 500. We have only $6,504 in cash, meaning we are roughly 94% invested. We are still actively looking for ideas to replace ones that will soon be taken out of the portfolio when 4th quarter earnings hit.

With that said, here is an overview of all the investments we are currently holding:

Yellow Roadway (YELL) - 16%
Avg Cost: 41.13 - Current Price: 44.61

Yellow Roadway is a very solid play on the transportation industry and the wellbeing of the economy as a whole. Although it is somewhat market correlated, we believe that it is still a good investment in light of the low valuation multiples it's currently trading at relative to most other businesses in the industry. 3rd quarter marked the highest earnings quarter the company has ever seen in its entire operating history. I expect to see the same trend in the 4th quarter.

SFBC International (SFCC) - 17%
Avg Cost: 17.92 - Current Price: 16.01

SFBC is an event driven investment that was attractive to us because of the ability for the company to generate earnings despite tremendous negative publicity that has hit it over the past couple of months. They lost 2 clients (which were no more than 2% of their revenue). This company was accused of violating human rights by treating human testers in drug trials with negligence, sometimes causing painful disabilities and death. Two independent law firms were set to review the company's activities, and both of them have exonerated the company and called the recent bad press "wholly unfounded". The employee that was said to have threatened illegal immigrants with deportation resigned, and we should see a good solid 4Q with SFBC coming up.

Terra Nitrogen (TNH) - 14%
Avg Cost: 24.52 - Current Price: 19.04

To be honest, this is a stock that is killing the portfolio. It is a Nitrogen/Ammonia producer that makes fertilizer products for the agriculture industry (Nitrogen/Ammonia is made out of natural gas as its base cost by the way). It has close ties with its parent company, Terra Industries, in the UK. There has been recent announcements that Terra Industries has closed many of Terra Nitrogen's peer companies in the Oklahoma area, and have started massive imports of Nitrogen products outside of UK due to the unproportionally high LNG prices there. We have reasons to believe that most of the imports will come from Terra Nitrogen. This company is a highly volatile investment with tremendous short-term downside risk, depending on where the natural gas prices go. In the long-term it is more solid due to fertilizer prices adjusting for any increases natural gas prices might have. Im not too comfortable holding this company into the 4Q... but I don't plan in exiting the position unless a better investment comes along to replace it. Even with all the downside risk, it is still a very attractive investment should our thesis play out that the results of 4Q will be favorable due to a significant decrease in Natural Gas prices over the last quarter from the Sept 30, 2005 levels.

Keystone North America (KYSNF) - 17%
Avg Cost: 6.67 - Current Price: 7.50

Keystone North America deals with death care services in North America. As far as I know, this is a stable company with predictable earnings because death is about the most solid kind of certainty one can get in life. It is still trading at a discount relative to many of its peers in its industry due to the fact that it is a rather illiquid stock, under the radar, and traded on the Toronto Stock Exchange. This is also a stock that pays out an estimated 3% ROI every quarter due to its income trust status. It is a solid play offering us a stable return. The only concerns we might have with this stock is its status as an income trust in Canada, and also the trend towards "cremation" instead of burial--where the company gets most of their revenues from.

Morguard Corporation (MRCBF) - 1.2%
Avg Cost: 26.01 - Current Price: 26.34

We are currently trying to exit this position for reasons mentioned in the sell e-mails.

Great Basin Gold (GBN) - 15%
Avg Cost: 1.48 - Current Price: 1.55

Great Basin Gold is a gold explorations/mining company with properties in Nevada and South Africa. This is a very attractive company due to the prospects it has in its Burnstone property located in South Africa, which is estimated to be able to produce a sizable amount of gold in the next couple of years once the explorations stage is complete. In fact, the company's prospects is so attractive, that it has attracted one of the most successful gold moguls in South Africa--Mr. Dippenar--to become president and CEO. We expect this to be the next Big Sky Energy as we wait and see what news the company will unfold.

Eternal Technologies (ETLT) - 14%
Avg Cost: 0.47 - Current Price: 0.40

This is another stock that is currently killing the portfolio second to TNH. The only thing we are waiting for on this company is 4Q release, and then we are going to exit the position no matter what the results are. We don't believe 4Q will have a negative impact on the stock price of the company, as it is expected to report record earnings for the company, surpassing 4Q of last year, and also last year as a whole when the entire fiscal year is taken into account. However, there is a very good possibility that the market has already taken that into account. We have enough downside protection, however, to warrant us taking this risk.


Some current ideas that we have been looking at over the past few weeks are Innotrac (INOC) and Rent-A-Center (RCII). If anyone would like to help me with these stocks, please feel free to let me know. But again, I'm still looking for better ideas out there, and I can't quite get comfortable enough with those two. Overall, other than TNH which doesn't let me sleep at night, I have a very optimistic outlook for the initiative in the second semester, and hopefully, the markets will be more agreeable for us.

If you have any questions, please feel free to let me know.

Best regards,