Sunday, December 23, 2007

The Glory of Ignorance

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

I would look at a development and never see the design issues that scream you have to be moron to put this design feature in homes being built in a rain shadow. You would think that the people trained and educated in home design would hear the screams, but they did not and we had serious water seepage design built into many of our new homes in the 90s. We had thousand of home owners that had rot in their building envelope due to water seepage. My new home had rot in 3 years. I was not bless with being able to remain ignorant about key features of home design to prevent water seepage. We had thousands of home owners hit with assessments of $30-60k to fix rot in their relatively new homes. I was fortunate as my assessment was only about $5k and the rot was limited to balconies, not in the building envelope. I was very lucky, the rot had spread to one inch from the building envelope and that $5k bill almost became $20-25k. And with blissful ignorance, we had homeowners in our complex rallying other owners to vote to delay to fix the problem.

You ought to be able to trust the so called experts and remain ignorant. But in Vancouver, being normal cost homeowners millions of dollars in the 1990s and Vancouver was sprinkle with new homes covered in tarps for years.

The same thing ought to be said of understanding investments. You ought to be able to trust a financial adviser, or trust the so called experts. If an investment has a AAA rating you ought to be able to trust that the investment has a high level of safety, as defined by the rating criteria.

A year and a half ago I had never heard of a credit bubble, economic bubble, stagflation, asset inflation, Austrian economics, monetarist, Keynesian, Ponzi, credit swaps, discount window and well today, "Term Auction Facilities." I read this article, but I didn't quite understand it. I would like to remain ignorant about what it is saying, but powerful people have been grossly incompetent at all of our peril and the way you best protect yourself from what they have done is to study it and keep on top of what they are doing.

Powerful people have been doing things to change the "rules" for the past twenty years, things that have gradually built up enormous fundamental problems in the economy. I guess it was about 13 months ago that I was first steered towards looking a fundamental problems in the economy and started assessing how they gave the appearance of getting around the disaster they were creating in the past but were instead increasing the fundamental problems. I started to assess what these problems would mean to me once the problems started to surface.

These are things we ought to remain ignorant about, but unfortunately, we are seeing the consequence of being normal being played out throughout the world. Yukon has $1200/person of tax payers money "frozen." They might get back their 30-day investment over the next 10 years, at par, if they are lucky. Small towns in northern Norway have lost half their municipal savings. A few Australian municipalities are now suing from losing 70% of their municipal funds to AAA rated mortgage bonds. Countless municipalities and counties across the US are finding their liquid, safe, short-term investments are not.

We ought to be able to trust financial advisers and analysts, but their behaviour is more in line with the snake oil swindlers of the past. This article, "Analysts in fantasyland" points out the degree to which they get it wrong.

My conclusions that I came up with around last February was that banking stocks would be a disaster, and I have been encouraging my friends to sell them.

I also concluded that pension funds would be hard hit and most likely our pensions as we believe them to exist do not. By my assessment, a realistic assessment not built on 30 years forwarding of fantasy beliefs, I only pay for about 40% of what my pension promises me. I suspect I shall see even less than what I currently pay for as people who are collecting are collecting 2.5 times what they paid for and I am 19 years down the pyramid. Most people live in this glory of ignorance and so we continue with this ponzi pyramid scheme of pensions.

I know nothing of US law, but interesting, in my assessment, our pension systems are in gross violation of Canadian pyramid laws.

What is further interesting is that I come up with that we are currently only paying for 40% of the promise, yet the "experts" say that those currently collecting will get about 1.25 times what they paid and they say my age group will break even and that those in their 20s will get about 0.8 of what they've paid in. That 1.25 figure leaves me absolutely dumbstruck as to how they came up with it. It is based on what is being paid out now and this figure can be calculated and it is beyond me how they came up with such nonsense.

I did not foresee the degree to which local governments are being hit. Every hit they take means we pay the taxes twice.

We ought to be able to remain ignorant about things that ought to not concern us.

Read More......

Sunday, December 16, 2007

Petri Dish Planet

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

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

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

Photo Sharing and Video Hosting at Photobucket

This is a graph of bacteria in a petri dish:

Photo Sharing and Video Hosting at Photobucket

The lesson ended by showing how the graph ended. I could not find such a graph, but I found one of E. coli grown in a glucose solution:

Photo Sharing and Video Hosting at Photobucket

The graph I remember of the petri dish did not have much of a stationary phase, but peaked and went straight to the death phase.

The lesson has always impressed upon me that the Earth is finite in its resources. Human population is still growing, however, we have evidence that our current consumption levels are exceeding our renewable resources. The petri dish was a closed system whereas the Earth is replenished with energy from the sun.

But that doesn't mean that resources are being replenished as fast as we are using them. Take water for instance. My recent readings on water include that ships traveling the Great Lakes have had to reduce loads by 10% to prevent scraping on the bottom of the lake. Some northern lake lost 60% of its water in one year.

My travels to the US and my personal visits to the Mt Shasta region and Hoover Dam dating back to the 70s and recently also to the Grand Canyon gave me a personal view of water issues. I have memories of a commercial for Mt Shasta pop and I remember the strong association of the white caps of Mt Shasta with clean, cold, refreshment.

These are two images I found on the web, both summer pictures of Mt Shasta. There used to be a glacier on Mt Shasta and that contribution to the water supply is pretty much gone now.

Photo Sharing and Video Hosting at Photobucket

Photo Sharing and Video Hosting at Photobucket

I took pictures of the enormously declining levels of the water reserves, but they seem to have lost. The water supply from Mt. Shasta is important to California.

Lake Mead is also important to California and much of the agriculture. I visited Hoover Dam in 79 and again this year. I don't know how well the picture shows it, but the water level is disturbingly down.

Photo Sharing and Video Hosting at Photobucket

Photo Sharing and Video Hosting at Photobucket

In that second picture my memory is that the water level was close to the top of the dam in 79.

Information I've seen on Florida indicates that the height of continental Florida is going down because the underground water reserve is declining so drastically. The water reserve was restored due to the swamp land and everglades. Swamp lands have been drained and the everglades have been shrinking. The ability to restore that underground water supply has been cut by more than half.

Everything that we have and know about our economic data is based on a planet that had not yet shown us its limits, however, that is changing. Our food supply has declined since the year 2000. Water and food are pretty damn important. Yes we have ways to make it go further, less resource intensive food choices as in grains compared to meats.

And what of our air quality? Carbon dioxide levels in the world are increasing through a warming period. Historically a warming period, as in after an ice age, has more plant growth that binds the carbon dioxide and it declines. We are living a warming stage that has carbon dioxide levels increasing. We've cut our trees and dramatically increased the release of carbon dioxide by the burning of fossil fuels.

Look at the data and you have to ask, just how good is our economic growth in comparison with the growth in human population? I think the data is telling us that things will be changing and in the process so might our beliefs in economic growth.

Population information.
Bacterial growth.
Bacterial growth data.

Read More......

Friday, December 14, 2007

BHP - RIO -- Merging Bubbles

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

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

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

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

Citicorp Nominees Pty Ltd
HSBC Australia Nominees Pty Ltd 377,638,519 11.25
J P Morgan Nominees Australia Limited 372,983,700 11.11
UBS Nominees Pty Ltd 20,861,621 0.62
HSBC Custody Nominees (Australia) Limited 18,369,730 0.55
ARGO Investments Limited 6,422,411 0.19

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

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

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

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

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

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

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

[Most Recent Quotes from]

[Most Recent Quotes from]

[Most Recent Quotes from]

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

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

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

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

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

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

But, overall, I would anticipate more like a 50% decline in earnings by the time the next year or two play out without increased debt costs.

Read More......

Sunday, December 02, 2007

Political Idiotism on Taxation, Again

This topic is a little stale in terms of current news, Government proposes $60B in tax cuts, with further GST drop, but I never got around to writing about it when it was current and it is so negligent and stupid.

There is a booming economy. The economy will not always be booming. These proposed cuts will NOT be sustainable with a down turn in the economy. It is one thing for an individual to be so ignorant to stretch their resources to the limit in good times and then rightfully deal with the consequences of such imprudent behaviour. It is unacceptable from government and we have a high level of debt because of this kind of negligent behaviour in the past. It is time be responsible and say no to a short term gain for long term pain.

Our collective greater good would be best served by debt reduction and working to ensure we have maneuverability for an economic slow down. The only reasonable thing to do in the whole proposal is to increase the personal tax exemption. That is a tax neutral action that is offset with increased tax revenue due to wage increases. More importantly it is the only thing that reverses some of the gross inequities to the working poor.

I can assure you that the working poor are unlikely to see their income increase by $700 this year and if we have any sense of humanity we should be questioning why anyone who IS working and CAN'T afford to PAY RENT, BUY FOOD and BASIC NECESSITIES is taxed at all at the slave labour minimum wage rates? Indeed, every cent these people get goes directly into the economy because they are trying to live on a deficit level of income despite genius greater than Einstein in budgeting. You simply can not get water out of a stone and they ran out of places to cut spending YEARS ago.

Give me a tax cut and guess where I'm going to spend -- NOT in Canada. I am taking my discretionary income, and going on vacation in another country. Why should tax cuts continue to subsidize this kind of behaviour of the "haves" when we having increasing numbers of working poor lining up at food banks? Giving me a tax break will do zero to stimulate the economy and will increase my ability to take Canadian dollars outside of the country and this is true for where the majority of the proposed tax cuts would go. As a nation we have enormous debt, we should ensure debt is paid back at a faster rate in boom times. Together we will be stronger in an economic down turn.

Better yet, it is high time we took a serious look at where the tax breaks need to be. We have seniors who make up 20% of the population controlling something like 60% of the wealth and we given them an age exemption on top of pensions that they never paid for except for but for a pittance towards it . A pension is something that is supposed to be paid for by those receiving it. At the very least it is high time we got rid of the age exemption and replaced it with a means exemption for the working poor and put some fairness and humanity into the tax system.

How can any nation think they are great when there is such theft of dignity for the working poor?

Read More......