Bill Miller vs. Instant Gratification

From 1991 to 2005, value investor Bill Miller headed one of the most successful investment funds in the world, beating the S&P 500 (“the market”) for 15 consecutive years.  On November 17 2011, however, Bill Miller stepped down as superstar manager for the fund he made famous.

It is said that Bill Miller has lost his touch.

During 2008 and 2009, Bill bought “horrible” companies like U.S. financials.  Many of these picks lost large amounts after his purchases (some up to ¾ of their value), and are still now languishing as losers.

Phil Pearlman said this of Bill Miller and of mutual funds in general: “Mutual funds remind me of AOL dial-up (Internet service): a dwindling collection of old people who don’t know better, contributing monthly to a comically inferior product.”

What many consider to be the new and superior product is the Hedge Fund.

Hedge Funds assets have grown dramatically, from just $38 billion in 1990 to more than $1600 billion in assets today.  Hedge funds are hip, cool, young, exciting, and promise to make you more money with less risk - even if they have higher fees (see the next Frost Report article for more about this).

In many ways, Bill Miller is the latest victim of a worldwide phenomenon – lack of patience and the desire to get rich quick.

The very word “investing” implies buying an undervalued company, then waiting for the company to improve and grow and the stock price to improve along with it.  Virtually no one does this anymore.  People want instant gratification.  They think that if a stock doesn’t rise in 6 months or a year (or, god forbid - that it drops even more), the stock pick must have been “wrong.”  Others believe that the market is so rigged against them there is no point investing at all.

For value investors of the world, the societal shift from value investing to stock trading and hedge fund purchasing is a blessing.  The fewer the number of people who believe in value investing (picking great, out of favor companies and holding them for years), the more successful the strategy is.

Bill Miller was ruined not because his value picks were bad, but because they didn’t bounce back fast enough to prove the quality of his convictions; and, his investors didn't have the patience to find out.

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"The market does reflect the available information, as the professors tell us. But just as the funhouse mirrors don't always accurately reflect your weight, the markets don't always accurately reflect that information. Usually they are too pessimistic when it's bad, and too optimistic when it's good."

Bill Miller

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Forget Greece and Italy

Greece and Italy have been stealing economic headlines these days.

The media has been so focused on Greece and its pint-sized economy, that they have completely missed what should really be headlining world economic news…the slowdown of the world’s second-largest economy.

China’s government-induced GDP growth and red-hot housing market have both stalled.  Ironically, the government itself caused the slowdown, as it introduced prudent anti-bubble measures throughout the year.  Such measures were an unfortunate necessity: without them, inflation was turning rampant.  But now the slowdown may turn out to be just as devastating.  And, it seems that the largest companies in the world are well aware of what is coming.

Last week, Goldman Sachs sold $1.1 billion worth of its shares in Industrial and Commercial Bank of China (1398.HK).  This week, Bank of America announced it was selling the remainder of its shares in China Construction Bank (0939.HK) – $6.6 billion worth.

Today, the International Monetary Fund announced that Chinese banks could suffer “huge losses” on the very extreme case that credit shock, currency shock, and yield curve shocks were to occur together.  Interestingly, this “slim and rare occurrence” appears to already be starting.

The IMF's Jonathan Fiechter stated rather bluntly stated (as far as economist-speak goes) that "while the existing structure fosters high savings and high levels of liquidity, it also creates the risk of capital misallocation and formation of bubbles, especially in real estate." In other words, the current government’s financial policies force people to invest in real estate (since buying other asset classes in China is considered too risky), and, banks are lending too much to capital projects with no economic future (again based on government direction).

One could say that the Chinese economy is a centrally-controlled “our government knows better” economic marvel mess.

It is my advice - stated on several occasions previously - that you follow the lead of Morgan Stanley, Goldman Sachs, and Bank of America; that is, sell all but your very best Chinese holdings.

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See also:

China faces grim foreign trade outlook

China's property cost curbs to remain despite home price drop

China’s CCB Plays Down BofA Share Sale Impact

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Time Machine - 1111 and the US National Debt

INVESTOR PSYCHOLOGY

Recency Bias is the tendency for people to remember recent events more than past events, and to believe that the most recent situation has always been so.  Put another way, people tend to frame their memories based on recent events, and to remember what they want - and likewise, to forget what they want.

I mention all this because it seems like lifetimes ago that the US national debt was not only in control, but people were actually talking about paying it off.  That moment was 11 years, 1 month, and 1 day ago today.

Bill Clinton had just finished his term in the White House, stained by political scandal (ie. the Monika Lewinsky affair).  Many viewed Clinton as a very unpresidential, even embarassing president.  Yet, no one could deny the positive economics of his term.  At the end of the Clinton presidency, the National Debt stood at 5.73 trillion dollars - a relatively small sum for the massive US economy.  After three straight years of budget surpluses, economists were estimating how long it would take to pay off the National Debt completely.

Presidential hopeful Al Gore, for example, outlined an economic plan that would eliminate the National Debt by the year 2012.  When candidate George W. Bush was asked if he had a similar plan, he said that although he agreed with paying off the debt in principal, he would not commit to a specific date.

Soon thereafter, Bush was elected as President.  He immediately began a series of tax cuts for high-income families, which he (and his economic advisors) believed would stimulate the economy so much that the end result would be an overall increase in tax revenues (known as "trickle-down economics."); unfortunately, it didn't work .  Tax revenues declined drastically with each cut.

Bush ran a budget deficit (increasing the national debt) in 7 of his 8 years in office.  In 2003,  he set a record for the largest annual debt increase in US history.  Due to a combination of tax cuts and expensive foreign interventions, by the end of the Bush term the US National Debt had nearly doubled - from $5.73 to $10.69 trillion.

People now talk about the National Debt as if it was meant to be, always was, and always will be.  Many cannot remember the time - not so long ago - when there was talk of the United States of America having no debt at all.

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"I've abandoned free market principles to save the free market system."

George W. Bush, 2008

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An Ode to Steve Jobs

MASTER OF CREATIVITY

As you have no doubt heard by now, Steve Jobs of Apple Computer passed away this Wednesday.

Many obituaries have already been written about Jobs by writers far better than I.  So, this short ode is about one remarkable aspect of the man: his creativity.

Famously, Steve Jobs is a university dropout.  This fact has been used to insinuate that higher education is worthless, yet it really tells only half of the story .  Jobs didn't actually drop out of university: he created his own.

Tired of attending classes for which he had no interest, the young Steve Jobs dropped out of formal college and began attending classes he wasn't actually enrolled in.  Many of the courses - such as typefaces and calligraphy - were "useless" to him at the time, but would become fundamentally important later when designing the Apple Macintosh computer.

In North America, we have a tendency to disdain anything that is less than 100% and immediately useful.  Statistics is a useful course; philosophy is not.  Carpentry is a useful course; art history is not.  Steve Jobs understood the importance of "pure learning" and the way it expands the mind, enhances creativity, and almost invariably becomes useful at some point in the future.

Steve Jobs, we will miss your genius.

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How to Live before you Die: Steve Jobs




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Ghost Cities of China

A short post...because this Australian documentary describes the situation in pictures better than mere words ever could.




See also:

Fear and Soap in China

China's Housing Bomb

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Stocks I Like - New Millennium Iron

New Millennium Iron (stock symbol: NML) is the revised name for New Millennium Capital. This change is appropriate, since the fortunes of the company are now firmly in iron.

New Millennium’s DSO (Direct Shipping Ore) project in Canada is scheduled to start producing ore in 2012, and ramp up production through 2013.

Of course, mining companies commonly give estimated completion dates for their projects even if they haven’t secured funding, and even if the mine has virtually no chance of ever being constructed. Giving a completion schedule is an old trick to increase the stock price. So what makes New Millennium different?

When a mining company signs up a multinational end-user of their product as a partner, this shows that the property has serious potential. It also means that the project will likely be developed with minimum dilution of shares. When Copper Mountain Mining, for example, announced that it was partnering with Mitsubishi, I bought shares immediately and have been very pleased with the result.

New Millennium’s partner is the massive Tata Group (you may be most familiar with Tata Motors, makers of low-cost cars in India). Tata Steel Minerals Canada has acquired 80% of the DSO project, and has an agreement to purchase 100% of its production. In other words, Tata Group’s industrial companies will be using the iron produced by New Millennium, and have a vested interest in seeing the project’s timely completion.

In addition to the DSO project, New Millennium has other nice properties making up the “Taconite Project,” which contains an estimated 9+ billion tonnes of iron ore. In fact, NML’s total projects are so interesting that Tata Steel has acquired 27.1% of the entire company, and has 3 members on the board of directors.

If you buy NML now, I recommend holding it through every conceivable credit crunch or world disaster until about 2017, since this is when all of NML’s current projects are likely to have been completed and producing cash. Any time after 2017, you have my blessing to sell.

NML promises to be a long-term cash flow giant.

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"Blood, iron and gold promise victory. But even the greatest material resources do not avail, if the human qualities necessary to animate them are lacking."

John Keegan

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For further information, see: New Millennium Iron's official website.
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Disclosure

Do not buy stocks, or take this or any other financial advice without doing your own analysis; including, but not limited to: reviewing business models, financial statements, management style and philosophy, recent developments, market macroeconomic analysis, and chart analysis. If you do not know how to do these things, you shouldn't be buying stocks in the first place. Seek the advice of professionals, as appropriate.
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PS - In case any directors from NML are reading this website...

Please don't do the same stupid s**t that so many other mining companies do after they become successful. That is, once you start raking in the cash, do not immediately look for new acquisitions to spend your money on. With estimated mine lives in the decades, you can afford to wait. Pay out dividends instead. Thank you.

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Be Kind to your Banker: new release

After a few weeks of admitted laziness, last weekend I finally finished my second book. I hope you like it!

The official press release follows below...

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Be Kind to your Banker: new book explains lending from a banker’s perspective.

Be Kind to your Banker is the latest release from finance writer Eldon Frost, author of The Intelligent Investor’s Mind.

Be Kind to your Banker is written for three types of readers: those who have recently been declined for a loan or mortgage; those who wish to receive a better rate on a new or existing one; and, those who simply wish to improve their personal financial knowledge.

"When I worked as a lender," Frost explains, "it was striking to me how many people were unaware of how the loan process works. For example, people with good credit would apply for loans that they could not possibly afford, and would be surprised to be turned down. Even worse, they might be approved! This book explains step-by-step how the loan process works, and how a banker views an application."

"Everyone should know how to save money on a loan or mortgage," Frost adds, "and everyone has the right to know if they are making the best financial decision. These are the kinds of things that should be taught in school - but aren’t."

As the cover explains, the advice in this little book (just 80 pages) could save you hundreds or thousands of dollars.

Be Kind to your Banker is available at www.amazon.com in paperback format only.

- ends –

Lessons from Aristocrats - Income

In Boswell’s London Journal of 1762-1763, he writes extensively about his annual income and necessary changes in budgeting.

At the time (as a youth), Boswell’s personal income was 200 pounds per year - about $400 - which was just enough to live as a gentleman. He tried to obtain a military commission which, depending on his rank, might have added another 20 or 30 pounds per year. Book sales (most aristocrats write books) may have added a bit more.

A client visited my office last year whose profession is to take care of the North American finances of an aristocratic European family. After asking many questions I realized that, aside from the figures, the aristocratic idea of “annual income” or “annual allowance” for has changed little since 1763.

When one asks about the wealth of an average person or even a wealthy businessman, the response invariably turns to net worth. For example, “He is worth 5 million dollars.” However, if you ask an aristocrat what he is worth, his response is never about net worth (which he probably doesn’t even know), but rather about the income that his assets produce. For example, “My income is 80,000 pound per year” This focus on income – as opposed to net worth – reveals fundamental differences between how aristocrats and commoners think.

For most Americans, investment preoccupation takes the form of a home – an American’s primary source of wealth. Homes are (except for recent overpriced years) good long-term investments.

First, there is the forced savings that comes with paying down a mortgage, which requires no mental effort. Then, there is the fact that when one sells a home, there are no capital gains taxes. And, despite brief periods to the contrary, homes have increased steadily in value over time. If the same funds were invested in bonds or dividend-paying stocks, the result would be taxable income, which to Americans is therefore the inferior form of investment.

Consider the following example:

Prosperous American Family
U.S. property worth $2,000,000, which increases in value by 3% ($60,000) per year
$500,000 in U.S. Venture stocks, which increase in value by 10% ($50,000) per year

Young Aristocrat
UK property worth $2,000,000, which increases in value by 3% ($60,000) per year
$500,000 in German corporate bonds earning 5%, or $25,000 per year.
$500,000 in Canadian preferred shares earning 5%, or $25,000 per year.

On paper, their annual change in net worth is exactly the same - $110,000. But, the American family employs $500,000 less to achieve the same gain, will pay no taxes on the capital gains of the property, and will pay no taxes on their shares until they sell. The aristocrat, on the other hand, will pay taxes on $50,000 of income every year. Why then, do aristocrats prefer large amounts of income-producing investments? Isn't the American way better?

It must be understood that aristocrats earn their money not only for themselves, but also for posterity. That is, they expect their wealth to improve the fortunes of their family for hundreds if not thousands of years to come. It also must be understood that they hope for the best but prepare for the worst.

In the example given above, the American family’s gain in net worth is completely a “paper profit,” which does not make daily life any easier. And, paper profits have the rude habit of evaporating just when you need the money most.

Aristocrats know that governments and laws change, that wars disrupt wealth, that revolutions change established order and that bubbles burst; therefore, they diversify their investments. At any given moment, they might be invested in rental properties, bonds, antiques, metals, and factories. And, these investments are never concentrated in a single country, but instead spread throughout the world, thereby minimizing political risk. Finally, most investments are expected to produce real income.

Years ago I visited one of the Rothschild manors in England, and was surprised to find that the huge estate has its own cricket pitch and pub. Just as interestingly, local residents are welcome to use both. The resulting cricket games and post-game celebrations not only create goodwill toward the wealthy family, but also presumably pay for a substantial portion of the estate’s annual taxes.

Since aristocrats don’t intend to suffer the ignominy of physical labor, passive income is a necessity. Passive income, though it is taxed, is tangible and real. Passive income can be used to conduct new business, to provide funds for additional investment, or simply for adventure. Passive income makes life easier today.

If you want to get ahead faster, think beyond your annual change in net worth. Think also about how much income your investments are earning. Ideally, over time your money (not you) should be providing the majority of the cash flow used for additional investing.

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“Gentlemen Prefer Bonds.”

Andrew Mellon

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The Death of Silver

Silver died an untimely death this week.

Retribution was swift and merciless. As soon as the Chicago Mercantile Exchange raised margin requirements (meaning you have to provide more of your own money to speculate), skittish traders headed for the hills. Silver lost a quarter of its value in just 3 trading days.

On of the big winners of the silver bonanza was billionaire George Soros. In weeks past, Soros noted that although gold prices kept rising higher and higher, the price of silver hardly moved. Realizing that at some point people would opt to buy the grey metal instead of gold, Soros loaded up. He was quickly proven correct as silver rose in a parabolic chart.

Soros reportedly sold heavily early this week: a beautiful trade - and the reason why he is a billionaire.

As for me...I'm not a big fan of jumping on any fast-moving investment train. I can't babysit my investments on a minute-to-minute basis, so I don't like investing in anything that I know will end in a major crash.

As Soros was busy making his latest millions, I received my first silver-related injury. While generously helping a client unload a large quantity of silver ingots, I somehow managed to hit myself in the face. Handling a 120-pound safety deposit box is not as easy as you might think.

Even as the blood streamed off my nose, I recognized that owning a horde of physical silver must be gratifying.

Will silver rise from the dead, and achieve its previous highs? Who knows. But, I sincerely hope that the volatility lasts for a few days more. I have been busy entering lowball orders for great mining companies, just in case the chaos continues. It would be nice if they all fill.

Silver is dead! Long live silver!

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"I feel like a virgin on prom night."

"Uncle Red," in the Stephen King movie, Silver Bullet.

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Let’s just say what we really think about Barack Obama

An Open Letter from Donnie Drumpf to the American People


Dear Citizens of America,

In recent days, the media have played into my doubts about Barack Obama’s citizenship, his academic abilities, and more. But now I am thinking, “Why all this pussy-footing around? Why not just come out and say what we are all thinking?”

Barack Obama is a negro! Am I the only one who has noticed this? I referenced an anthropology textbook (just to be sure) and it is undeniable: he has big lips, a wide nose, and dark skin. He looks like a heterosexual version of Michael Jackson before he became white. Weren’t these people slaves just a while ago? How did we allow this to happen?

Obama has relatives in Africa, spent part of his life in Malaysia, and yet still speaks English more eloquently than I do. Do you know how annoying that is? Black people aren’t supposed to be good at English. They are supposed to say, “yassah, nossah,” and “You’s disrespectin’ me, Holmes.” Of course, there are other members of the blacks who sound like white people. I forgave Denzel Washington and Laurence Fishburne because they make good movies. But now a President? This is too much.

And that name: Barack Obama. What kind of name is that? “George Washington” is a good American name. “Abraham Lincoln” sounds a bit Jewish, but is still pretty good. “Barack Obama” sounds like the kind of person we look for in caves in Afghanistan.

We’ve tried labeling Obama as the anti-Christ, linking him to communists and racists, challenging his citizenship, and of course the general and sweeping comment that he doesn’t seem American. The whole time, he keeps smiling and saying, “We need to focus on the issues.” He talks about the economy, energy planning and health care - completely ignoring our requests for college transcripts. What is it going to take to get rid of this guy!?

Barack Obama is better educated than I am, obviously smarter, holds the highest position in the world, and even has a better beach body. What’s not to hate?

By the way, did I mention that I have the highest rated show on the Gonzo network? It’s a great show, with a great fan base. We have a great name. People would be impressed if they knew how much money I have. I’m important. Right?

Sincerely,

Donnie J. Drumpf®

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"Don't hate me because I'm beautiful."

Kelly LeBrock, 1980s shampoo commercial

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The US Federal Budget (and my 10th Grade teacher)

No, John Maynard Keynes was not my 10th Grade teacher. But it was in Grade 10, from my history teacher, that I learned about famous economist John Maynard Keynes.

It was Keynes who first proposed that markets move in cycles - in repeating booms and busts - and that the best way to lessen the impact of these booms and busts is to implement countermeasures.

Prior to Keynes, governments taxed less and spent more during good times (when they could afford to do so), and taxed more and spent less during bad times (when they couldn't). It all seemed very straightforward. After the Great Crash of 1929, for example, the US government cut back on myriads of projects and social services in order to save money.

Keynes argued that such seemingly sensible measures only worsen recessions. Instead, he argued that in bad economic times we need to cut taxes, cut interest rates, and increase government spending in order to “stimulate” the economy back to life. Then, in boom times, we need to increase taxes and curtail spending (since the economy is sustaining itself), and pay back that debt.

My 10th grade teacher pointed out that Keynes was foolish and that his ideas would never, ever work. The problem was not with Keynes' theory, but rather that his plan ignored human psychology and the reality of politics.

In bad economic times, people enjoy having their taxes reduced and interest rates cut, even though this leads to the large government deficits that these same people become angry about (rather like being pleased to receive expensive presents from your wife, then complaining that she spends too much).

As the economy improves, it gets even harder for the government to implement Keynes’ ideas. Despite being angry about large government deficits (“debt for our children!”) people are nonetheless unwilling to pay more in taxes to reduce it.

In the United States, any proposed tax changes are complicated by the remarkable fact that low-income earners have been led to believe that rich people need lower taxes, but that they personally don’t need them! Yes, only in America, prefabricated home owners and squirrel hunters can actually be seen protesting against higher taxes for the rich, even if that results in higher taxes for themselves.

The US budget promises to be a Frankenstein-like creation. The US Democratic Party hits walls of opposition because they propose ideas that only economists can appreciate. The US Republican Party is politically successful because they propose simple and intuitive economic ideas, no matter how unworkable those ideas may be.

Like John Maynard Keynes, Barack Obama expects people to be as logical and practical as he is – except that they aren’t. Even my tenth grade teacher knew that.

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"The avoidance of taxes is the only intellectual pursuit that still carries any reward."

John Maynard Keynes

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For an example of the class divide in America see:


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Stocks I Like - Nevsun Resources

Hitting new highs, gold is once again making headlines.

Hedge fund managers love gold, since it the easiest thing in the world to sell – gold is shiny, pretty, used to make expensive jewelry, and is great during currency devaluations and other disasters. Gold is easy to sell because it appeals to both greed and fear at the same time.

The problem with gold is that it’s impossible to determine its intrinsic value. Like tulip bulbs, gold has practical purposes but is primarily worth whatever someone is willing to pay for it. Gold doesn’t pay dividends. Gold doesn’t increase revenues. I would never recommend buying physical gold when it is trendy to do so.

Having said all that, I’m not at all against buying companies whose product is gold. One such company is Canadian-based Nevsun Resources.

Among other things, Nevsun Resources (stock symbol: NSU) owns a copper-gold-silver-zinc mine in Eritrea, East Africa. The Eritrean government owns 40% of the mine’s shares, 10% of which was mandated and 30% of which was purchased by the government in the market. In other words, the government has full reason to protect and encourage its investment.

Nevsun’s flagship Bisha mine just began production in January of this year, and is expected to have a thirteen-year mine life. Over those thirteen years it is expected to produce more than 800 million pounds of copper, 1 billion pounds of zinc, 1 million ounces of gold, and 11 million ounces of silver. Promising additional sources of these metals are also being explored in the region.

Despite a newly-completed, fully-functioning mine with enormous reserves, Nevsun shares are trading at only $6.05 CDN per share, giving it a low forward P/E of 7.4 and a great Current Ratio (debt safety measure) of 3.8. Surely there must be a downside, right? Of course there is!

Like many countries in Africa, Eritreans and their neighbors despise each other. The Canadian government’s official warning: "The political situation is highly instable, due to ongoing tension between Eritrea and neighbouring countries, and could become violent at any time.” This is in addition to the street crime, lack of reliable communications, and border area landmines common to this part of Africa. As a poignant example of the dangers, it is fitting to remember that during a geological mapping expedition in 2003, one of Nevsun’s geologists had his throat cut and his four-wheel drive vehicle set on fire.

Those who have studied economics will recall reading about “political risk” - the possibility of losing your investment due to negative political events. Eritrea is an example of political risk at its harshest.

For any investment in Nevsun Resources, the political and also ethical risks must be weighed against the ridiculously wonderful economic potential. Having considered all, I believe an investment in Nevsun Resources is indeed worth it. Supporting this idea is the fact that construction of the Bisha mine (which began in 2008) was completed on time, under budget, and without incident. The locals are apparently completely onside with the positive attributes (ex. non-military jobs, electricity and health care) that have resulted from Nevsun's presence.

As with all stocks I recommend on this site, I own Nevsun shares.

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"If you want to make peace with your enemy, you have to work with your enemy. Then he becomes your partner."

Nelson Mandela

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For more information, see:

Nevsun Resources Main Page

Nevsun Resources - Social Responsibility Page

US Gov't Eritrea Travel Warning

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Disclosure

Do not buy stocks, or take this or any other financial advice without doing your own analysis; including, but not limited to: reviewing business models, financial statements, management style and philosophy, recent developments, market macroeconomic analysis, and chart analysis. If you do not know how to do these things, you shouldn't be buying stocks in the first place. Seek the advice of professionals, as appropriate.

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The Worldwide Business Search Engine

At the top of this blog, you may have noticed what appears to be a regular Google search bar with the title, “WORLDWIDE BUSINESS SEARCH ENGINE.” Since many readers have not taken advantage of this little beauty, let me take a moment to explain what it is.

The first problem with regular Google is what I call “regionalization.” Many of The Frost Report’s readers are from the United States, where Google has particular drawbacks. Specifically, if you do any kind of search from the US, the results are likely to all come from US news organizations. Sadly, most American news sources are rubbish for investors.

The US media market demands constant action, sound bites and screen movement – and the results are predictable. The typical daytime “expert interview” on CNBC lasts less than 4 minutes. And, US citizens clearly love to be told what to think. After the last presidential debates on CNN, a panel of experts was ready to explain for us what was just said, what it means, and who won (there is no point wasting brainpower when someone can think for you). Famously, US media outlets such as FOX News and MSNBC casually mix facts with commentary, not even worrying about possible misrepresentation. All of this results in exciting and highly entertaining news that is of no use to rational investors, whose strength comes from being calmer and more logical than everyone else.

A second problem with regular Google or Bing is that far more than just investing news comes out of a search. For example, if I type “African Real Estate” into Google, the result is marketing websites, real estate agency websites, property developers and more. And again, most of the sites do not even originate from Africa.

The Frost Report’s “Worldwide Business Search Engine” eliminates many of the aforementioned problems. First, it filters out the more sensational news organizations from the listings. Second, it gives precedence to local news: a search about real estate in Africa will result in African sources. Whenever possible, news comes directly from the source rather than being an interpretation by a 3rd party; thus, a search about the latest Federal Reserve speech will likely pull up the Fed’s website directly. Finally, most of the sources are proven and reliable business news agencies. I say “most” are reliable because I intentionally included some unreliable sources - such as the Russian Pravda and DPRK news sites – because they are culturally important.

Give the search engine a try…you will find the results to be far different from what you are used to, and hopefully more insightful.

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“Is there any other industry in this country which seeks to presume so completely to give the customer what he does not want?”

Rupert Murdoch, owner of The News Corporation Ltd.

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The Berkshire Soap Opera

Earlier this week, Warren Buffett’s Berkshire Hathaway issued a surprising press release: one of their longstanding top executives, David Sokol, had resigned.

Here’s the gist of the story… Warren Buffett and his partner Charlie Munger make all the major acquisition decisions for Berkshire Hathaway. Executive David Sokol recommended to Buffett a company called “Lubrizol,” mentioning at the time that he owned some shares of it himself. Buffett was not particularly impressed with the idea of acquiring Lubrizol. About a week later, David Sokol spoke with the CEO of Lubrizol, and based on that conversation spoke with Buffett again, further recommending it as a good purchase. As a result, Buffett changed his mind and purchased Lubrizol, sending its stock price soaring.


What David Sokol had neglected to point out was that when he said he owned, “some shares” of Lubrizol, he actually meant 10 million dollars’ worth (more than 96 thousand shares). In just one day after the Berkshire purchase announcement, Lubrizol stock jumped from $104.50 to $133.80, earning David Sokol a cool 2.8 million dollars.


Was what David Sokol did illegal? Probably not. Was it unethical? Somewhat. Was it honest and open? Not at all.


On July 26th, 2010, Buffett wrote a letter to all Berkshire Hathaway managers (including Sokol), saying that reputation and honesty are of paramount importance to Berkshire’s business. For example, Buffett wrote: “We must continue to measure every act against not only what is legal but also what we would be happy to have written about on the front page of a national newspaper in an article written by an unfriendly but intelligent reporter.” At the end of the letter, Buffett reminds everyone that “there’s plenty of money to be made in the center of the court. If it’s questionable whether some action is close to the line, just assume it is outside and forget it.” Clearly, Sokol didn’t think that any of this applied to him.


Does this mean that Berkshire’s internal controls are weak? Does it mean that you should sell Berkshire stock? Of course not. Berkshire’s internal controls remain amongst the best in the world.


David Sokol didn’t do anything explicitly illegal. But, he did play too close to the line – and he knows it.

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“Somebody is doing something today at Berkshire that you and I would be unhappy about if we knew of it. That’s inevitable: We now employ more than 250,000 people and the chances of that number getting through the day without any bad behavior occurring is nil.”

Warren Buffett, July 2010

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Berkshire’s press release regarding David Sokol’s resignation is available at:
David Sokol Press Release

Japan Finds the Downside to Nuclear Energy

About 5 years ago, I toured the Hamaoka nuclear power plant in Japan. Like all things Japanese, the mood and theme surprised me. Nuclear energy, I learned, is really fun!

First was the powerful “green energy” spin. Part of the tour included watching a show of robotic animation characters (similar to “Bear Country Jamboree” at Disneyland), singing and dancing about the joys of safe and green nuclear energy. There were nuclear games and activities for kids. There were clam-digging tours out back of the reactor. Clams and other shellfish thrive in the heated waters expelled by the nuclear reactor, so local residents dig for clams there. Paradise!

The Hamaoka Nuclear Power Plant's IMAX theatre is, at the time of writing this article, playing "IMAX Under the Sea," and advertising the upcoming Walt Disney flick, "Mars Needs Moms."

Yet, there were always reminders about the negative side of nuclear energy. Worker exposure to radiation makes the news regularly. My friend Mamoru, a nuclear safety inspector, was on NHK news one night explaining how a small crack in the retainer at one of the plants was nothing serious. Then there was the time I had to write diplomatic letters to the Kazakhstani government, asking them to allow human blood samples from radioactive fallout victims to be shipped to Japan via courier for study.

Yes, nuclear energy is a big source of power in Japan, and has thus far been relatively safe. We shall see if it stays that way. If you live on the West Coast of the United States, buy iodine just in case.

As for stock picks as a result of the disaster…Sekisui house (a Japanese homebuilder and Division of Sekisui Chemical) seems like a smart buy. Sekisui builds semi-prefabricated homes, and forms a large part of the new home market. Importantly, Sekisui has seismic test platforms in their factory, and they shake the living hell out of each new home design to make sure they stay together. No doubt, many people will be replacing their traditional homes (or destroyed homes) with Sekisui branded homes.

For obvious reasons, Tokyo Electric Power Company (TEPCO - the nuclear plant owner) is a “sell” until further notice.

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For further information, see:

Sekisui Earthquake Resistant Housing

Nuclear Power Plant safety measures

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Year of the Hot Rabbit

Chinese real estate - hot as ever. But when will it fall?

Last week, the Chinese government implemented yet another measure to reign in the uncontrollable speculation that is gripping the Chinese real estate market.

Already implemented this year were new property sales taxes in Shanghai, and nationwide minimum down payments (for second properties) of 50-60%. This is on top of the Central Bank's three interest rates hikes since October. Now, as of this week, there are new rules for ownership in cities all over the country. In Beijing, for example, only residents are allowed to buy real estate (as proven by 5 years of tax returns and a residence card), and are limited to only one investment property.

It seems that due to strong new beliefs in capitalism, mixed with ancient beliefs about luck and prosperity, no one is getting the hint. Home prices are expected to increase another 6.4% for this year, despite public complaints about soaring costs.

It is impossible to say for how much longer this nonsense will continue. But one thing is certain - the longer it lasts, the more devastating the fall will be. My crystal ball, though hazy, sees the potential for riots.

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"Speculation is only a word covering the making of money out of the manipulation of prices, instead of supplying goods and services."

Henry Ford

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Lessons from Aristocrats - Housing

An elderly client visited my office recently to inquire about the interest rate for a personal loan. The purpose of the loan, he said, was to purchase a new water heater to replace the one that had just broken in his home. The man’s home…a 2.5 million dollar Tudor-style mansion.

This incident reminded me of something that happened to me when I was a college student. I had answered an ad for a basement suite, and was surprised to find myself standing in front of a hundred-year-old residence complete with carved oak staircase, vaulted ceilings, a library, a study, and an observatory. The owner, who had fallen on hard times, had recently converted the damp basement into six rental suites with a shared kitchen, suitable only to college students who will accept this type of accommodation. I kept looking anyway.

Most aristocratic families have, in their history, a successful ancestor who builds a massive family residence to showcase the family’s success. Winston Churchill’s ancestor, the 1st Duke of Marlborough, for instance, built a massive residence named Blenheim Palace.

Subsequent generations develop businesses, pawn heirlooms, gamble, steal, and whatever else is necessary in order to maintain the family estate, some generations more successfully than others. At some point, the family gives up trying to maintain the entire building and moves into a single section, leaving the rest to decay.

Eventually, the family mansion is donated to charity or opened to the public as a tourist attraction, since poor people will pay money to see how rich people live. Sometimes this eventuality takes hundreds of years, and sometimes it occurs within the builder’s lifetime.

The Marlborough family has thus far kept their estate. Due to Winston Churchill’s book royalties, his family has preserved Blenheim palace intact. Before Winston became a famous author (and later politician), the survival of the family residence was in doubt.

In Canada, people have the peculiar habit of moving into larger and larger homes as they become more established, until finally, after the children leave the nest, they find themselves in a home with far more space than they need. In due course they retire, and spend six months of every year in the warm southern United States, living in a camping trailer and enjoying it because it’s “easy to maintain.”

For aristocratic wannabes (easily distinguished by the phrase, “I do a lot of entertaining at home”), remember the lesson you can learn from the mistakes of real aristocrats: buy a home that you can comfortably afford, with rooms that you will actually use. The idea of having 10 extra rooms will bring you much more pleasure that actually owning them.

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"Few rich men own their property; the property owns them."
Robert Ingersoll, speech, New York, 29 October 1896

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Stocks I Like - Taseko Mines

Taseko Mines (TKO) is a gloriously priced stock, due to investor overreaction to a recent "disaster."

Taseko's Prosperity Mine is a property in British Columbia, Canada, with indicated resources of 7.7 million ounces of gold and 3.6 billion pounds of copper: in other words, it is massive. Importantly, the financial estimates of the mine are based on realistic long-term prices of $1.65/pound for copper and $650/ounce for gold.

In November of 2010, the Federal Ministry of the Environment announced that the Prosperity mine project, as proposed, cannot proceed due to environmental concerns. This is despite already having received approval by the Provincial Government, and Taseko having already built a portion of the proposed expansion.

Today's stock price does not accurately reflect the true value of Taseko mines. First of all, Taseko is not a startup. It already has producing properties, giving it earnings of $0.65 CDN per share, and a current P/E ratio of only 8 (at today closing price of $5.22). In short, even without the Prosperity Mine, Taseko has real value.

Of course, Taseko is not giving up on the expansion of its Prosperity Mine. No one seriously believes that Taseko will abandon 7.7 million ounces of gold and almost 4 billion ounces of copper.

According to the company's website, "Taseko is currently in discussions with both the Federal and Provincial Governments to define the issues and determine solutions so that this mining project can move forward and meet the criteria that the Federal Government deem appropriate. The company expects to have more information early in 2011."

Taseko mines is priced like a lightweight, is already a middleweight, and has heavyweight potential.

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“The desire of gold is not for gold. It is for the means of freedom and benefit.”

Ralph Waldo Emerson, poet.

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Disclosure

Do not buy stocks, or take this or any other financial advice without doing your own analysis; including, but not limited to: reviewing business models, financial statements, management style and philosophy, recent developments, market macroeconomic analysis, and chart analysis. If you do not know how to do these things, you shouldn't be buying stocks in the first place. Seek the advice of professionals, as appropriate.

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Back to Business

This blog is a quick apology....Oct 31st is Financial Institution fiscal year-end, which made me extremely busy for weeks before and after. Then a couple more weeks for recuperation and now...The Frost Report is back.

Sorry for the delay!

World Housing Bubble - All Aboard!

For months, I was clearly the minority in saying that real estate prices in places like China, Australia, Canada, Hong Kong etc are experiencing a bubble. I was also the minority in saying that US home prices are, in fact, undervalued. In recent weeks though, such ideas have become accepted, even mainstream.

By now, I have to admit that I am actually sick of writing about housing bubbles. However, I know from emails I have received that as a result of these articles, at least some people have been dissuaded from purchasing high-priced condos at the edge of personal affordability, and for this I feel that repeating the same message ad nauseum is worth it.

Paradoxically, money tends to flow to assets and areas that are considered "safest," without regard to whether or not they are "reasonably priced." For investors, immediate safety of capital (or immediate gain) is paramount, and everything else is secondary. It is precisely this desire for immediate reward that results in horrible long-term investment choices.

In some countries, such as China, investment dollars are still incoming. In the US, real estate is stagnant water, despite low prices and excellent investment opportunities. In Canada, the flow is now a trickle, and ready to backflow.

The educated media is coming on board. For the masses, the onset of reality will still take several months.

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Video: Bubble Trouble - MSN Money
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See also the previous Frost Report articles:

The World Housing Bubble – Part II

The World Housing Bubble

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