Tuesday, May 27, 2008

New Home Sales - Revising Their Way Higher

Yet another housing data point to digest. This time it’s the monthly New Home Sales report from the Census Bureau. It looks like all of the headlines concerning the release are touting a 3.3% rise in new home sales from last month (to an annualized rate of 526,000), and a number of articles are once again implying that, again, this may again be yet the latest sign again that the end of the real estate downturn again is here – once again.

Most of the articles I've seen either ignore or glance over the fact that last month's figure was revised down from an annualized rate of 526,000 to 509,000. So, if last month's figure hadn't been revised lower, this month's figure would have been dead flat with last month. Depending on your level of optimism or pessimism, that's either 0% growth or a 0% decline, but it's definitely less than 3.3% growth. It is, however, a nice easy way to manufacture growth. Personally, I'm thinking of revising my April intelligence lower by 10% to boost my self-esteem this month.

To be fair, the report itself isn't completely terrible. The months-of-supply figure (how long it would take to sell the new homes currently for sale given the current rate of sales) fell modestly from an absurdly high 11.1 months to a ridiculously elevated 10.6 months. That's the right direction, but only time will tell if it's the beginning of a trend. It does illustrate what needs to happen to get back to equilibrium -- builders need to build fewer houses relative to the level of sales. You can track all of the home price data, builder optimism surveys, permit numbers, and sales info you like, but residential housing isn’t going to bottom out until the months-of-supply (inventory) figures for both new and existing homes get a lot closer to normal levels.

As an aside, those who are clamoring for a return to normalcy (which I think includes everyone) should be embracing the fall in housing prices. The lower prices will make housing once again affordable to more people and thus lead to the higher demand that the housing market needs. Moves by Congress to offer "aid" and to "support" the housing market at best will forestall the correction in prices that must ultimately occur to get back to equilibrium.

Despite having strong contrarian sympathies, I currently remain modestly short the real estate sector -- primarily through exposure to two ETFs (long SRS and short XHB). I suspect the real estate shakeout will take longer to occur than many think. Furthermore, it's very unlikely that we'll experience another real estate boom for quite some time.

The home builder industry is likely to emerge a bit smaller and more consolidated with rather unspectacular growth and margin opportunities. Even once they bottom, I imagine that there will be more fertile pastures elsewhere - probably in fertile pastures (I like agriculture.). That’s not to say that there may not be some intriguing deep value plays at some point, but at the current time, my strategy with the housing sector is fairly straightforward -- short substantial advances, cover on the declines, and some day finish staining my deck.

Wednesday, May 21, 2008

Oils Well That Ends Well

It looks like our overpaid Congressfolk are at it again - flexing and preening for the American public. This time the House has approved a law that would allow us to sue OPEC for high oil prices. They'll debate and pontificate about limiting frivolous lawsuits and excessive malpractice awards but then turn around and pass a law like this? It makes me pine for the glorious days of the Truman-era "Do-Nothing Congress". Good times.

Before getting to the new OPEC law, let's look in at today's Senate Judiciary hearing which is questioning oil executives about the rise in oil prices. Here's my favorite quote so far, and it comes from Senator Patrick Leahy, D-VT: "Normal supply and demand says prices should be around $55 to $60 a barrel."

Where does he come up with that? This guy must be pretty flexible to reach around and pull those numbers out of his ... assistant. Seriously, Mr. Leahy is incredibly arrogant to think that he knows what the "real" price of oil should be and to think that the market has it so incredibly wrong. I'm sure he also knows the "real" price of health care, ethanol, interest rates, rice, wheat, housing bailouts, etc. Ah, to be blessed with the intelligence of Mr. Leahy!

Back to this whole suing OPEC farce. This is a joke on many different levels. Let's start with the fact that one of the biggest gasoline bottlenecks we face comes from a lack of refinery capacity, and Congress certainly isn't doing anything to address that. Even if OPEC could immediately double its production, it would be irrelevant since there isn't enough global refining capacity to turn it into gasoline. Similarly, if my income suddenly doubled, it wouldn't be relevant since my wife couldn't spend it fast ... bad example.

Second, if anyone thinks that OPEC isn't pumping pretty much full-out at these oil prices, they're probably crazy enough to be running for office. When I say "full-out", I'm talking about maximum rates without damaging the oil fields, but I wouldn't be surprised if some countries were producing above such levels. Furthermore, it wasn't that long ago when OPEC was faced with $10/barrel oil. We certainly weren't rushing to subsidize them at those levels or accusing them of overproducing.

I won't get into the details of Peak Oil in this article, but there has only been one truly major oil discovery (offshore Brazil) since the mid-1970's. This includes OPEC countries where we think the oil just bubbles out of the ground. They've been picked over. The easy oil has been discovered. There is plenty of other oil still out there, but it's expensive to find and develop. It's buried deep below the ocean, in oil shale deposits, in tar sand deposits, and in hostile regions like the Arctic. It will take a high oil price to make this exploration and development economically viable, so trying to constrain oil prices isn't going to be encouraging the development of additional supply.

Then there are those (presumably including the members of the House who voted for this bill) who believe that oil prices at these levels are based largely on speculation by Wall Street types. I imagine this is a minor factor, but you can blame the Fed for this being a factor at all. Given the debasement of the dollar, who can blame anyone for preferring to own real hard assets (like oil) instead of dollars? Also, if these prices are being driven largely by speculators, why has the price of oil continued to make new highs in the days following the announcement that the government would stop adding to our Strategic Petroleum Reserves? The price is hitting new highs because there is no longer a supply cushion, and developing countries like China and India have a voracious appetite for oil.

Next, we have the Europeans who are paying between $6-7 a gallon for their gasoline. We don't hear them whining. I imagine their legislators are spending their time on less economically destructive endeavors like watching Dr. Who, going on fox hunts, and rioting at soccer matches.

I also have a bit of a logic issue with this new law. If you've been bitten by a snake and you're not happy about that, why would you turn around and poke the snake with a stick? If we really do think that OPEC has idle production capacity, why are we antagonizing them? Shouldn't we be making nice? We're not really in a position of power. Are we going to threaten to stop buying their oil? Stop laughing -- that was rhetorical. I think we're all familiar with the quote, "You attract more flies with honey than by poking them with a stick."

Here's the point that I believe is most interesting. If you were to ask every one of our congresspeople if they are pro-environment, every one would say yes. Most are also concerned with global warming and actively want to address it. Many also want to spend our tax dollars on helping to develop alternative energy sources. If they are really so concerned with the environment and the energy crisis, then why in the world would they want to do anything to limit the price of oil and gas? The single biggest driver of the development of alternative energy sources is higher oil and gas prices. For example, high oil and gas prices are making solar and wind power more economically viable. No one knows what the leading energy sources will be in 50 years, but with oil and gas prices as high as they are, the incentive is there for private industry to solve this problem. We don't need folks like Mr. Leahy spending our tax dollars as they see best, and we definitely don't need to be suing OPEC.

As for strategy, I've been bullish on energy for quite a while and remain so. Having said that, I continue to lighten on price spikes and rebalance as necessary. I continue to like a number of names including PBR, ESV, and NOV. Briefly, Petrobras was added following their discovery of the huge offshore Tupi field. The cost of developing their deep offshore finds will be tremendous, but PBR has a very good chance of becoming one of the leading oil producers in time as production ramps significantly over the coming decade, and there is, of course, hope of future large discoveries. As for Ensco, they are one of the largest offshore drilling contractors. They have one of the lowest fleet ages, a growing deep water capability, and one of the most attractive valuations in the space. With talk of Petrobras trying to lock up as many deep-water rigs as possible, the future looks bright for ESV and its peers. National Oilwell Varco has its hands in every aspect of the design, construction, and service of most of the systems and components used in oil and gas drilling and production. This includes the construction of rigs which is likely to benefit from increased drilling, particularly offshore.

As much as I like the fundamentals of these firms, I am not adding to them at these levels, given the recent run in oil and oil-related stocks. Sentiment has turned very bullish for this entire space over the past couple of months, and the space is due for some consolidation. Should the oil complex continue to move up near term, I would anticipate taking some profits or initiating a short-term hedge. I have, however, recently added a new position in Petrochina (PTR) at levels not too far below the current price and would look to add further on pullbacks.

As for our government, it they want to sue someone over price gouging, maybe they should go after Starbucks. The price of my Venti mocha works out to about $1,075 per barrel. Keep that in mind the next time you're filling up your tank.

Thursday, May 15, 2008

Agricultural Smackdown - South Asian Style

“Food is an important part of a balanced diet.” Fran Lebowitz

There was an interesting article in yesterday’s New York Times discussing the developing spat/misunderstanding between the U.S. and India about responsibility for the rise in food prices. The whole to-do started a couple of weeks ago with some comments by Condoleezza Rice and was exacerbated by President Bush a couple of days later (shocking).

I’ve looked over a number of articles discussing this issue and, as usual, most of them just pick and choose which quotes to offer or simply paraphrase what Rice and Bush (hereafter referred to as Brice) said. To paraphrase the paraphrasing, a good portion of the commentary has gone something like, “Brice blames rising food prices exclusively on the irresponsible growth in India and China and their lack of willingness to continue starving for the benefit of the West. To address this travesty, the U.S. is now developing a secret program to sterilize all of the women in both countries to ensure a continued orgy of steak, ale, Oreos, and Hummers for the best, brightest, sexiest, most shaved, and most smiled-upon people ever to grace the face of the planet – Americans.”

Let’s actually take a look at exactly what our beloved leaders said. First off, Rice was offered the following question at a recent Peace Corps Conference:
Many of us are in countries where the predominant source of food is grain, rice, et cetera. And I’m wondering about your thoughts about the US government’s thoughts about the skyrocketing prices of grain worldwide?
Her reply

We obviously have to look at places where production seems to be declining and declining to the point that people are actually putting export caps on the amount of food. Now, some of that is not so much declining production as apparently improvement in the diets of people, for instance, in China and India, and then pressures to keep food inside the country. So, that’s another element that we have to look at.
Now let’s look at exactly what Bush said a few days later.
Worldwide there is increasing demand. There turns out to be prosperity in developing world, which is good. It's going to be good for you because you'll be selling products in the countries, you know, big countries perhaps, and it's hard to sell products into countries that aren't prosperous. In other words, the more prosperous the world is, the more opportunity there is.
It also, however, increases demand. So, for example, just as an interesting thought for you, there are 350 million people in India who are classified as middle class. That's bigger than America. Their middle class is larger than our entire population. And when you start getting wealth, you start demanding better nutrition and better food, and so demand is high, and that causes the price to go up.
So…………they’re basically saying that declining production, trade restrictions, and the increasing demand for more and better food from a wealthier developing world are contributing to the rise in food prices. Sounds like a no-brainer to me. The problem with it, apparently, is simply that Brice didn’t explicitly state that these were SOME of the factors impacting food prices rather than ALL of the factors.
Because of this, we’ve seen an outpouring of hostility and disbelief from a portion of the developing world, most notably India, which is screaming that the U.S. is the real culprit behind rising food prices. Here’s an example from the NYT article,
…Pradeep S. Mehta, secretary general of the center for international trade, economics and the environment of CUTS International, an independent research institute based here, said that if Americans slimmed down to the weight of middle-class Indians, “many hungry people in sub-Saharan Africa would find food on their plates.”
He added, archly, that the money spent in the United States on liposuction to get rid of fat from excess consumption could be funneled to feed famine victims.
Explaining the food price increases, Indian politicians and academics cite consumption in the United States; the West’s diversion of arable land into the production of ethanol and other biofuels; agricultural subsidies and trade barriers from Washington and the European Union; and finally the decline in the exchange rate of the dollar.
Mr. Mehta just gave me my newest million dollar idea. Let’s re-package all of that cellulite into 8 ounce plastic containers and market it in the developing world as a high-calorie snack called YoGurth! Everybody wins!

Ok. Now let’s look at who has the upper hand in this argument. I’ve thought short and soft about this, and the winner is………..well, it’s a tie. We can debate the relative importance of each factor, but most of the points that both sides are making are valid.

• As wealth in India and China increases, demand for more and better food increases. This higher demand is one factor leading to rising food prices.

• The average American has enough fat to live off of for two entire years (note: this statistic has not been scientifically proven and was pulled from the author’s nether-region in the interest of editorial expeditiousness).

• Export barriers and tariffs may temporarily limit price increases internally, but they exacerbate global supply problems, lead to higher prices globally, and will likely result in lower domestic supply.

• Americans are the largest per-capita consumers of many things: oil, food, liposuction, therapy, fatuous TV programming, lust, gluttony, greed, sloth, wrath, etc.

• Some farm land has indeed been converted from food production to feed the ethically-bankrupt subsidized beast of ethanol.

What are the key points from all of this?
• The economies of China and India are growing quickly. It’s reasonable to expect them to want to improve their diets. Given that they’re moving from the starvation level to one of mere malnutrition, we Americans should take care not to speak too indelicately with our mouths so full.

• We’re never going to out-run the Indians and Chinese if they ever invade us. It’s in our own best interest to fatten them up.

• It’s hard to get the full story from the press. They write with the short attention span of the average American in mind and therefore feel the need…………….what were we talking about?

• YoGurth – Saturate Your Diet with the Taste of America!

• The fertilizer stocks are still looking good. Still a buyer of POT, AGU, and MOS.

Monday, May 12, 2008

Death, Taxes, and A Ridiculous Employment Report

I’m finally getting around to reviewing the latest monthly employment report. I would have tackled it sooner, but I don’t type well when I’m rolling on the floor laughing and coffee is coming out of my nose. Now that my sides have stopped hurting and my nose isn’t burning, let’s take a look at the report.

To recap, the market was looking for a loss of 80,000 jobs in April, and the “official” number came in much better at a loss of only 20,000. The media pretty much universally applauded the report with headlines such as:

“US Stocks Rally on Jobs Report” – International Herald Tribune

“Jobs: Glimmer of Good News in April” – BusinessWeek

“Fur Seal Caught Trying to Have Sex With Penguin” – FoxNews

“Stocks Seeing Strong Gains On Employment Report” – RTT News

“Job Loss Far Below Expectations” – TheStreet.com

This employment report reminded me of the recent Google and Intel quarterly earnings reports. If you keep bringing down the estimates prior to the report to a level that’s easy to beat, you look like a hero when your report is just bad instead of apocalyptic. The purported loss of 20,000 jobs should look very suspect to anyone willing to pop an extra Ritalin, take a few minutes, and look beyond the headlines (this rules out most portfolio managers, government employees, and the breathing).

To really understand the employment numbers we have to look at what the Bureau of Labor Statistics (BLS) calls its Birth/Death model. According to the BLS,

There is an unavoidable lag between an establishment opening for business and its appearing on the sample frame and being available for sampling. Because new firm births generate a portion of employment growth each month, non-sampling methods must be used to estimate this growth.

What’s going on here? Basically, the BLS samples businesses and government agencies for its employment report. These sampled entities account for about 1/3 of all nonfarm payroll jobs. The BLS should be able to accurately measure the change in employment for those firms that remain in the sample from one month to the next. After coming in late for work on one of his 27 annual non-holiday work days, catching up on the latest Hollywood gossip online, and taking a lunch break that would make even the Italians blush, your average government employee can still probably muster up the simple arithmetic needed for this calculation. The picture is a little fuzzier for those firms that die (go out of business) since some of them may be too busy hocking their nail guns and backhoes at the local pawn shop to respond to the survey, and others will have already fired everyone, including whoever was responsible for reporting their data to the BLS. The final factor is the birth of new firms. This one isn’t directly measurable in any given month since it takes about 7 months before a newly spawned firm is available for sampling.

So, the BLS created a statistical model to estimate the net employment effect of the recently deceased and the newly hatched. Unfortunately, their model doesn’t appear to be very effective at times when a significant change in trend is occurring. This is hardly surprising. They’re no better than any other government agency, circus monkey, Federal Reserve chairman, or economist at knowing when a recession is underway (no offense to the monkey), so we shouldn’t expect their model to accurately account for this. So there’s a lag between what the birth/death model calculates and what’s happening in the real world at significant turning points in economic activity. When we’re headed into a recession, the model is spitting out fairy tale numbers based on much more robust historical comparisons while real jobs are disappearing. When the economy is turning up and creating more jobs, the model is finally reflecting the preceding deterioration and predicting fewer birthed businesses. Interestingly, they used to admit to this shortcoming on their website but no longer do.

With that background let’s turn to the most recent employment data.
According to the bullish BLS report, the economy only lost 20,000 jobs last month. Virtually everyone in the media focused on this figure (including the experts dropped off at CNBC daycare). What they should have been discussing (had they been aware of it) is that this figure includes 267,000 jobs assumed to have been created by the birth/death model! Unless Obama infiltrated the BLS with his cronies who secretly adjusted the numbers for his 7 new states, this number is ridiculous. Ignoring those assumed jobs, the economy would have registered a loss of 287,000 jobs. Can you imagine how the market would have reacted to that headline?!

So, GDP is flat-lining, the financial and retail industries are suffering, manufacturing remains a basket case, and housing is in freefall, but somehow this model assumes that new businesses created 267,000 jobs last month. It stretches the limits of one’s imagination. Where exactly is this job growth? Not everyone can be a repo man, auctioneer, or Wal-Mart greeter. The model tells us that 72,000 jobs were added in the “Professional & Business Services” category. Maybe all of those ex-Realtors and mortgage brokers have reinvented themselves as credit repair specialists. 83,000 jobs were supposedly created in “Leisure and Hospitality”. I guess it’s possible if they’re counting all the new stay-at-home Dads. 8,000 new “Financial” jobs were supposedly created despite the carnage in banking. Maybe they recategorized all of the lawyers now lining up to sue the banks?

I saved the best category for last. The model assumes that 45,000 jobs were created in April in the construction industry. The construction industry! Seriously, why are we paying these folks? Why do we have or need a BLS if this is the quality of their work? How do they explain this? We all know that the construction firms are going out of business and laying people off. Residential building is screeching to a halt and commercial is now being impacted as well. I suppose all of those people who were fired from their construction jobs turned right around and started their own construction businesses to take advantage of all the business the firm that fired them didn’t have. Before hocking his nail gun I think our pawn shop friend used it to put the last nail in the coffin of common sense.

Here’s another point I love. The actual full release of the employment report runs to 28 pages. Guess how many of those pages make mention of the 267,000 birth boost? Zero. There is a reference to the existence of the birth/death model in the “Frequently Asked Questions” and the “Reliability of the Estimates” sections, but if you want to actually find the number you have to go to a separate web page (http://www.bls.gov/web/cesbd.htm).

Furthermore, we all know that the employment figures are often significantly revised. The birth/death figures are no different. So, why does anyone pay attention to these releases, and why does the market move on this “news”? First of all, most participants don’t take the time to delve into the details of these reports. As I mentioned, the BLS doesn’t even provide the birth/death figures in its 28-page release. Second, even if you know these numbers are inaccurate at best, if you think that the rest of the market is going to pay attention and trade off of them then you need to be interested in them, too. In this case, if Trader Timmy is going to jump off a bridge, you’d better at least go and dangle your toes off the edge.

As for the BLS statistical methodology, I’m not one to rush to judgment. In the interest of fairness, I decided to use their random sampling methodology on the BLS itself. The results were as expected. I just came up with the B and the S.

Thursday, May 8, 2008

.....Stuck In The Media With You

"U.S. Stocks Slip on Crude Oil, Fall Hard" - TheStreet.com
"Stocks Fall on Gushing Price of Oil" - Chicago Tribune
"Stocks Decline as Oil Prices Creep Higher" - Associated Press
"Stocks Skid on Record Oil Prices" - Seattle Times
"Stocks Sink as Oil Soars" - Business Week
"Oil at $123 Hits Wall St." - Reuters
"Stocks Retreat as Oil Prices Creep Higher" - Forbes

This is just a sampling of the headlines I saw concerning Wednesday's stock market decline. I've always been amused at how the press seems to think they can precisely explain just why the market goes up or down on a daily basis. Did oil prices rise Wednesday? Yep, by about 1.45%. Did the stock market fall? Yep, by about -1.80%. Isn't it logical to assume that the higher oil price led to the stock market decline?

To help answer that question, let's look at the stock and oil action from Tuesday (the prior day). Oil prices rallied nearly 1.5%, which just happens to be about the same percentage increase that the price of oil rallied on Wednesday. So let's check to see how much the stock market fell on Tuesday. What's this? It looks like the S&P 500 was actually UP 0.75% on Tuesday. Well, how about that? Oil prices spiked, but the stock market went up.

So, how is it that the press knows that Wednesday's oil price increase led to the stock market decline if a similar increase the day before was met by a rising stock market? The simple answer is that the press doesn't have a clue. Of course, when terrorists destroy the World Trade Center we can be pretty sure why the stock market falls. However, on the vast majority of days there are far too many variables at play to really KNOW why the stock market rose or fell.

Did some people sell stocks yesterday only because of the rising price of oil? There are many thousands of participants in the market each day. Someone out there sold solely because of the rise in oil prices. Someone else out there probably sold because the entrails of the squirrel they ran over that morning looked a bit suspicious, but we'll leave that for another article. Most market participants don't focus solely on one factor. In all my years in the investment business (including as an energy analyst), I've never had a conversation go as follows:

Ken: Hey, Doe. Anything looking interesting to you in the market these days?

Portfolio Manger Doe: Hi, Ken. Look, I've got to make this quick. Did you see that oil prices are rising 1.5% today! I've got to dump my stocks.

Ken: Ummmmmm.....ok. But we've been making new highs in the oil market pretty regularly for a while now. What's got you so lathered up today?

Doe: Don't you see it? This is a bearish increase in oil! It's time to blow stocks out, man. I've already liquidated my 401k and invested it in used drill bits.

Ken: So, you must've been selling yesterday as well given that nice jump we saw in the oil price.

Doe: Yesterday? No way. Are you crazy? I was buying. That was a bullish increase in oil!

If oil rises by the same percentage on two consecutive days, but the stock market rises on one and falls on the next, clearly the market isn't just focused on oil prices. What about Cisco's outlook, renewed financial contagion fear, profit-taking, the Miley Cyrus scandal, rising interest rates, exchange rate expectations, the productivity and pending home sales data, the weakness overnight in Asian markets, valuation concerns, etc.? Furthermore, there are large institutional investors who trade based on technical criteria. Maybe some large quant funds exacerbated yesterday's selling with a large sell order based on some technical threshold being violated. Perhaps Buffett and Munger had a spat and Munger started a rumor that Buffett really preferred Diet Pepsi Vanilla to Cherry Coke. Maybe Grandma had to sell off her IRA to pay her mortgage, health insurance, and grocery bill.

Oil prices are just one piece of the puzzle. All we really know is that when the stock market rises, demand for equities exceeds supply that day, and the reverse is true when it falls. It's fine to say that the stock market fell and oil prices rose, but we really don't know the extent to which the oil price rise (or any other factor) CAUSED the decline in the stock market.

(As an aside, let's not forget that the energy sector is a beneficiary of rising oil prices, and the energy sector is a growing part of the S&P 500 and a key reason that overall corporate earnings haven't completely imploded.)

Also, am I the only one amazed at how the press as a whole comes to the same conclusion as to what drove the market? All of these different people sitting in Seattle, Chicago, New York, and London all come to the same conclusion. I couldn't find one headline attributing yesterday's fall to anything other than the rise in oil. Are they all using the same source? Are they just wiring their stories in from the same hash house in Amsterdam? Are they the product of inbreeding?

I've got to run. I've got a hot tip on a used drill bit.

Disclosure: The author is not long used drill bits and does not condone the reading of entrails.

Monday, May 5, 2008

Hillary and John vs. The Economists

Hillary Clinton was on "This Week With George Stephanopoulos" yesterday and was asked about her gas-tax proposal. She is calling for the 18.4 cent per gallon tax to be paid by the oil companies this summer instead of the consumer, claiming this would save the average American an eye-popping $70 (McCain favors eliminating the tax entirely for the summer).

The biggest problem with this proposal, however, is that it assumes the price of gas will fall by 18.4 cents per gallon. Refineries aren't exactly holding back production. They're operating at effectively full capacity so supply is what it is. Demand isn't likely to fall during the summer driving season.

The price of gas is where it is because that's how much consumers are willing to pay for the given supply. So, there really isn't any reason to believe that gas prices would fall at all with Clinton's proposal. If we're willing to pay $3.69 per gallon right now, we'll be willing to pay $3.69 per gallon if the gas tax is "removed". Basic supply and demand.

Clinton isn't stupid, and she isn't surrounding herself with stupid people. She must know that there is no economic justification to her proposal. Unfortunately, she's simply pandering for votes.

Here's a part of yesterday's exchange with George:

STEPHANOPOULOS: Economists say that's not going to happen. They say this is going to go straight into the profits of the oil companies. They're not going to actually lower their prices. And the two top leaders in the House are against it. Nearly every editorial board and economist in the country has come out against it. Even a supporter of yours, Paul Krugman of The New York Times, calls it pointless and disappointing.

Can you name one economist, a credible economist who supports the suspension?

CLINTON: Well, you know, George, I think we've been for the last seven years seeing a tremendous amount of government power and elite opinion basically behind policies that haven't worked well for the middle class and hard-working Americans. From the moment I started this campaign, I've said that I am absolutely determined that we're going to reverse the trends that have been going on in our government and in our political system, because what I have seen is that the rich have gotten richer. A vast majority -- I think something like 90 percent -- of the wealth gains over the last seven years have gone to the top 10 percent of wage earners in America.

STEPHANOPOULOS: But can you name an economist who thinks this makes sense?

CLINTON: Well, I'll tell you what, I'm not going to put my lot in with economists, because I know if we get it right, if we actually did it right, if we had a president who used all the tools of the presidency, we would design it in such a way that it would be implemented effectively.

Whoa. Ok. So, she isn't going to put her lot in with economists. Now, I'm not one to rush to the defense of economists too often, so I won't do it here either. But let's look at a few of the folks who she does "put her lot in with".

First of all, there's Sandy Berger who was disbarred and pled guilty to stealing documents from the National Archive and then lying to the feds about it. Next, we have Roger Altman who served as the Deputy Secretary of the US Treasury, before resigning in 1994 because of a record-keeping scandal. Her recently-resigned Chief Strategist was Mark Penn who is a pollster.

I'm glad I'm not an economist! Hillary would clearly rather take the advice of the disbarred and the disgraced. As for pollsters, at least the economists offer their own opinion. Ouch.

Saturday, May 3, 2008

An Entry From My Dromediary About POT and MOS

Commodities are clearly in the midst of a bull market. On a daily basis, we're being deluged with stories of rising gasoline prices, rice shortages, soaring demand for steel, etc. These high prices will certainly encourage the development of new supply in time. A nearer-term impact will be product substitution when feasible. If steak costs too much, buy chicken instead. If the price of rice is too high, substitute potato. If the cost of cocoa soars.....bad example. I'm still buying cocoa.

The following example of the substitution effect is from a recent article in the Financial Times. It has me seriously thinking of swapping my Accord for some sled dogs.

Farmers in the Indian state of Rajasthan are rediscovering the humble camel.

As the cost of running gas-guzzling tractors soars, even-toed ungulates are making a comeback, raising hopes that a fall in the population of the desert state’s signature animal can be reversed.

“It’s excellent for the camel population if the price of oil continues to go up because demand for camels will also go up,” says Ilse K√∂hler-Rollefson of the League for Pastoral Peoples and Endogenous Livestock Development. “Two years ago, a camel cost little more than a goat, which is nothing. The price has since trebled.”

The shift comes not a moment too soon for a national camel population that has fallen more than 50 per cent over the past decade, to about 450,000, according to government figures.

Market prices for these “ships of the desert”, which crashed with the growing affordability of motorised transport, are rising again as oil prices soar.

A sturdy male with a life expectancy of 60-80 years now fetches up to Rs40,000 ($973), compared to Rs5,000-Rs10,000 three years ago, according to Hanuwant Singh of the Lokhit Pashu-Palak Sansthan, a non-profit welfare organisation for livestock keepers. Entry-level tractors cost around $4,000.

As far as I know, there are no camel futures or ETFs, and I'm not suggesting you mail order a caravan of camels in the hope of reselling them for a tidy profit . Remember, you have to pay for shipping, feed them, and pick up after them. And then there's the spitting. Oh, the spitting!

The point, as usual with commodities, is that the end of the bull for any particular commodity will eventually come from falling demand, rising supply, or both (2 years spent getting an MBA for that insight). Product substitution is just one factor to keep an eye on. In the short-term, we're more likely to see it in the agriculture space than metals or energy, given their relative fungibility.

If you really know what you're doing and have a great handle on the fundamentals of different agricultural commodities then you can do very well in the futures market. This can also be a bit dangerous since not all crops move together and significant retracements should be expected.

My preferred way to gain exposure to the agriculture space has been through the fertilizer space, which has been enjoying and is likely to sustain favorable supply/demand fundamentals. With these firms, we don't have to worry too much about product substitution. Yes. Different crops have different fertilizer needs, but there's nothing in the immediate future likely to totally replace potash and nitrogen use.

This past week, I added to positions in Potash (POT) and Mosaic (MOS). Both of these stocks have pulled back roughly 15% in the past 10 days as investors began rotating out of the the commodity space in general. I believe these names (and AGU which I also own) are in a secular (rather than cyclical) bull market. Their earnings growth is terrific, their valuation looking into 2009 is attractive (low double-digit P/E for both), and they're generating a ton of free cash.

Key fertilizer supply is constrained and demand continues to grow given the rising populations and dietary demands of the developing world. The rising prices of agricultural commodities is increasing the demand for fertilizers in order to maximize crop yield and also increasing the ability of farmers to pay higher fertilizer costs. These are the types of names that institutions will want to own given their fundamentals, valuation, and stock performance. This share demand support is likely to limit downside barring a significant adverse change in fertilizer supply or demand.

My strategy with these names has been to lighten as they've gone parabolic or become too large a portion of the portfolio and to add when we get these 10-20% pullbacks. A core position has been maintained regardless of price action. Should the stocks continue to fall in the coming weeks, I fully expect to keep adding.

The author currently has no camel position.