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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Stay Away from U.S. Banks

Good advice, right?

Financial stocks are, once again, the scourge of Wall Street. There is talk of new financial regulation, rumors that the big banks will be broken up and sold, criminal investigations, and concerns about bad debts in Europe - all of which are making headlines daily. Will the horrors never end?

Professional money managers have been busy writing articles with frightening headlines, warning you that financial stocks are dangerous and to avoid them "at all costs." Yet, at the same time as they have been telling you to stay clear, they have been buying a lot for themselves.

Institutional ownership of Bank of America is 56%, Wells Fargo 75%, Morgan Stanley 75%, and Goldman Sachs 72%. For comparison, institutional ownership of Wal-Mart is 36%, Exxon 49%, Proctor and Gamble 58%, and General Electric 50%. If you want to have some real fun, go to the disclosure section of any article that tells you to sell stocks, and check the author’s holdings. You may find that while the author is telling you to sell certain stocks, the disclosure reveals that he owns them all. So yes, he does indeed want you to sell your stocks - so that he can buy them from you.

Here are the major reasons why financial institutions are set to outperform long-term:

The U.S. housing market
In 2008 and 2009, the price of real estate was plummeting, taking the net worth of the average American down with it. But prices have now stabilized, and at extremely low levels. The painful de-leveraging of America is over. The U.S. now has some of the most affordable housing in the industrialized world, and it won’t stay that way forever.

Client Purges
In the previous two years, numerous clients of major banks received letters telling them, for example, that their line of credit would be cancelled if they did not use it within the next 90 days. Clients were outraged, and many cancelled their cards just out of spite - which is was exactly what the banks wanted. This was money that the banks could have been lending out for a profit, but that was instead locked into credit with customers who would never use it. The banks, from their perspective, got rid of a lot of dead weight. They also got rid of a lot of credit risk.

Restructuring
During the height of the financial crisis, the industry was shedding 39,000 jobs every month. Although layoffs can hurt good employees as well as bad, it can safely be said that the best, brightest and most necessary were not the first to go. In addition to the widespread layoffs, many financial institutions streamlined their processes, eliminated business segments not related to their core business, and just generally refocused. The financial industry is leaner and hungrier than it has been in a very long time.

Solid balance sheets
The balance sheets of U.S. financials have been heavily scrutinized by investors, the SEC, the government, hedge funds, and the Federal Reserve. Tier 1 Capital ratios (measures of bank safety) are well above normal. Citigroup, generally considered one of the weakest, has a Tier 1 capital ratio of 11.92% - almost double the level necessary to be called "well-capitalized." In addition, many banks are sitting on extraordinary amounts of cash and have large loan loss reserves.

Financial Reform
The proposed financial reform legislation is often portrayed as a capitalism killer in the conservative media, but it is nothing of the sort. The bill proposes larger capital requirements for those who take more risks, greater transparency in general, and a federal body for winding down companies that nonetheless fail. In other words, large financial institutions will be more subject to scrutiny, require more fallback as their risk levels climbs, and if they fail their operations will be wound down in a manner that is least disruptive to markets and paid for by the industry itself (not taxpayers). Accountability makes for good capitalism.

Valuations
Many financial institutions belong in the single digit forward P/E club. JP Morgan has a forward P/E ratio of 8.2; Goldman Sachs 7.0; Morgan Stanley 7.5, and Citibank 8.9. Citi also has $5.61 of book value per share. Imagine if someone came up to you and said, "I'll sell you this genuine $5 bill for $4 dollars." You would probably assume it was fake, since in the real world this never happens. In the world of Wall Street, however, it happens all the time. At the moment, you can buy $5.61 worth of Citibank assets for $3.81, and get all their clients, brand names, and worldwide businesses for free: Morgan Stanley, Bank of America, MetLife, Travelers, Capital One, and many others are the same.

For small investors to get significant coverage in the financial industry, you need only buy two exchange traded funds - the XLF (large institutions) and the KRE (regional banks). Due to the present worldwide housing bubble, I recommend buying mostly regional banks (KRE) first, until the full brunt of International problems hit their markets (in the short term, psychology trumps value every time). But for value investors, buying time is now.

Statistics (at time of writing):
KRE $27.32
XLF $15.35

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“You can’t make a baby in one month by getting nine women pregnant.”
Warren Buffett, 2009, explaining the importance of investment patience.
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Disclosure and Disclaimer
I own all companies listed here as individual stocks, in ETFs, or both.
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.

Greek Debt Bailout – What Happens Now?

The Greek (actually Euro) debt crisis has been, at least temporarily, averted via a $1 trillion rescue package that could really be looked at as a “render predatory traders useless” package. Now what? Is the EU set to recover? Is everything just fine?

Despite these efforts, much of the world including the U.K., Canada, Israel, Dubai, Korea, China etc. (see: World Housing Bubble) are set to stagnate and/or enter recession within the next 18 months. In these countries, economic recovery has been more about new housing bubbles and consumer credit growth than real recovery.

Although the U.S. was the instigator of the worldwide collapse, it is now in the best position to move forward (no one said life is fair). The U.S. has inexpensive housing, low interest rates, a devalued dollar, moderately valued stocks, citizens with reduced debt, and increased productivity - all of which give the U.S. economy plenty of upside potential.

Under normal circumstances, a multinational recession would not bode well for U.S. stocks and I would say, “sell.” However, the current situation is more complicated than that. American stocks today are priced at levels that reflect modest post-recessionary income and a definite lack of euphoria. Even if world markets slow down, it is already priced into U.S. stocks at this level.

Secondly, you may have noticed that although world markets are global and affect each other, it is mostly the U.S. market that affects the rest of the world – and not the other way around. Even when a powerhouse like China experiences market drops, for example, the effect on the U.S. market is negligible. I suspect that when world markets decline it will bring down the American market only temporarily, until everyone realizes that U.S. growth is sustainable domestically at a level that supports and even exceeds today’s stock prices.

In short, most Commonwealth, EU, Arab and Asian countries have, at this point, little or no room on the upside, but plenty of room on the downside. Conversely, U.S. stocks that grandmothers around the world are still afraid to buy are the best investment opportunities around.

Many high-quality U.S. stocks, including members of the Dow 30, remain at single digit or low-double digit P/E levels, even on modest sales. If prices drop from here and you are a long-term investor, I recommend going against the grain and buying more, since any dip below today’s reasonable prices is a blessing. If you are afraid of volatility in your portfolio (there is sure to be plenty), ignore all this advice and stay away from the cheap-stocks party.

PS - The International cheap stocks party should begin sometime next year.

Statistics (at time of writing)
Dow Jones Industrial Average: 10,785
Hang Seng: 20,320
FTSE 100: 5,385

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"These high prices [in the Dow] were the cause of great jubilation on Wall Street, but I found them depressing. I was happier with a good 300-point drop that created some bargains."
Peter Lynch, Beating the Street
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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.

Canadian Debt II

Nothing confirms things like a good old-fashioned survey.

When I wrote about the perils of Canadian debt (Spending 'til it Hurts) I had no idea that CMHC would soon be confirming those ideas; but they did, with the spin cycle set on high.

Today, CMHC released the results of a survey showing that Canadian consumers are not - in the least - concerned about their high debt levels. In fact, 68% of new homeowners feel that they will be able to pay off their mortgages early, which means that they expect free cash flow and good times ahead.

The report also confirms that Canadian consumers feel they are savvy real estate investors, due to the extensive "self-education" they undertake before making purchases. This self-education includes consulting mortgage brokers, lenders, and real estate agents (all of whom have a vested interest in selling homes).

As a side note, the CMHC report frequently reads like an advertisement for mortgage brokers, including this gem: "According to mortgage consumers, the benefits that mortgage brokers offer are that they are able to get the best deal or rate for their clients, they are convenient, and they offer time-savings when obtaining a mortgage." On the same page is a photo of a smiling, embracing couple: presumably homeowners.

Hubris and propaganda continue to feel the love in Canada.
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CMHC survey

CNBC article (regarding CMHC survey)
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"(It's) actual mandate today, which is different from what it was back 20 or 30 years ago, is really just to get people into houses...and that's always been something that bothers me, because it really doesn't have a stability mandate."
David Dodge, former Governor of the Bank of Canada, describing the role of the Canadian Mortgage and Housing Corporation (CMHC), February 2010.

Socially Responsible Investing

Nice concept. Stupid, but nice.

Socially responsible investing is the art of investing in companies that are morally upright: no arms manufacturers, no tobacco companies, no companies that have questionable labor practices or pollute the environment, nor companies whose employees surf pornography at lunchtime.

The problem with investing in socially responsible companies is that they don’t actually exist. Medium to large companies, no matter what their field of interest, eventually end up with some kind of litigation against them. Human nature says that if you have 500 employees, not all of them will be angels.

Years ago, when I was in the military, I remember the surprise we all felt when we saw the manufacturers of our equipment: “Don’t they make Barbie?” asked one soldier when examining a trademark on his machine gun. “Hey!” said another, “this landmine is the same brand as my cell phone!”

Since the terms “ethical,” “moral,” and “socially responsible” mean different things to different people, the investment choices of your moral mutual fund may not provide you with the peace of mind you were looking for. In the top-ten holdings of your socially responsible mutual fund you will likely find oil & gas companies, pulp & paper manufacturers, mining companies, banks, breweries and property developers. Wal-Mart famously sells semi-automatic rifles but not pornography: which, if either of these do you consider ethical?

The other major issue with socially responsible investing is, of course, the returns. Finding nice companies that stay nice takes a lot of time and effort, and therefore a lot of stock switching (causing high taxation) and high management fees. My $200 socially responsible mutual fund, purchased when I was in high school, has yielded an annual return of about -.02%. The only reason I don’t sell it is because I couldn’t be bothered to pay the transaction fee. And besides, it amuses me to see it there, performing pathetically.

My recommendation is to stop trying to find “clean” companies, and instead choose your vices carefully. If you drive a car, consider purchasing oil stocks. If you wear jewelry, consider a gold or diamond mining company. If you use a computer, consider an electronics manufacturer. If you use fertilizer in your garden, consider a chemical manufacturer.

You are directly supporting these companies anyway – you might as well make money with them.
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“If you pretend to be good, the world takes you very seriously. If you pretend to be bad, it doesn't. Such is the astounding stupidity of optimism.” Oscar Wilde

Sell the Chinese Market SHORT!

China has been making headlines recently with its amazing economic numbers.

Production, capacity, exports etc. are all up and the economy looks fantastic. It appears to be an economic marvel. Why then, would anyone of sound mind want to sell it short?

In fact, I believe that although the Chinese economy appears to be a roaring bull, it is in fact a bloated, sickly beast. And, the Chinese stock market may soon become of the single greatest short-selling opportunities in history. Here are five reasons why:

5) Social Security – The Chinese are gambling with their social security funds (worth $102 billion US), in the stock market and risky ventures. In 2009, the rate of return on social security investments was 16.1% (a ridiculously high rate for someone’s life savings), prompting Vice Premier Zhang Dejiang to call for “prudence” and “stronger management” (Xinhua, March 15th 2010).

4) Inflation – According to a recent poll (Xinhua, March 16th 2010), 51% of Chinese consumers feel that prices are “unacceptably high,” the highest percentage to say so since the survey began in 1999. Despite this already unacceptable level, inflation continues to escalate, with the Producer Price Index on track to rise 5.2% year on year.

3) Overcapacity – Like Japan after their economic collapse (where stimulus building included lining rivers with concrete blocks), the Chinese have built massive amounts of currently unusable infrastructure. The problem, according to many, was that once a project was announced it could not be cancelled, since any cancellation would cause local officials to lose face. So, projects went ahead, even if it was clear from the beginning that the capacity would not be used.

The result is unoccupied office blocks, newly built factories producing unwanted goods, and toll highways with no traffic. According to Government officials, the areas where the most overcapacity exists are iron and steel, cement, glass, coal chemical, solar energy materials, and wind power equipment – although 17 industries are listed in all.

2) The Housing Bubble – There is almost an unlimited number of things I could say about this one, but I will keep it simple. Housing prices are out of reach for most every Chinese citizen, and prices keep rising even while large housing projects remain virtually unoccupied (since so many units are owned by speculators). In Beijing, housing prices nearly doubled in 2009 alone. The Government’s attempts to stop the problem (including measures to prevent house flipping, and implementing lending restrictions to developers) have all failed.

The situation has gotten so severe that in March, China’s banking regulator simply said that Chinese banks "should not extend loans to home buyers who intend to use the money for speculative purposes," or unless they make a down payment of 40% or more and are charged higher interest rates to compensate for the risk (Xinhua, Mar 15th 2010). One recent headline (April 3rd 2010, Xinhua), simply read, "Collapse predicted, welcomed as housing prices continue to skyrocket."

1) The Chinese Government– The people of China are not Communist, but their Government is. China’s wonderful economic numbers are at best misleading, and at worse inaccurate or simply wrong. As worrisome as some of these facts are, the real ones are probably worse.
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Crisis: "Danger and opportunity" (literally translated from Chinese).

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Disclosure
Do not buy stocks, sell short, 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.

Canadian Consumers – Spending ‘til it Hurts

Canadian consumers are confident – really confident.

The credit crisis, which caused home prices to plunge and unemployment to soar in the U.S., was merely a blip on the radar screen in Canada. It isn't that Canadian homes weren't overpriced, or that debt levels weren't high: it's just that low interest rates re-inflated the bubble before it ever had a chance to pop.

Since the credit crisis began, the Bank of Canada has been playing good-cop-bad-cop with consumers. While stating clearly that the reduction in interest rates was intended to stimulate the housing market & related purchasing to help pull the country out of recession, the BOC has been simultaneously warning Canadians not to stretch themselves financially by taking on too much debt.

In Dec 2009, Bank of Canada Governor Mark Carney warned Canadians so bluntly about the dangers of debt that it garnered the headline, "Bank of Canada warns of debt peril" on CBC news. In January 2010, with the housing recovery well under way, David Wolf (on behalf of Bank of Canada’s Timothy Lane) noted that “the current rebound in the housing sector is taking place in tandem with a very rapid rise in household indebtedness.” In February, Finance Minister Jim Flaherty issued another strong public statement, warning Canadians about using their homes as ATMs and against the dangers of variable rate mortgages. The advice made headlines for a few days before being confidently ignored.

Instead, like cattle running to the slaughterhouse, Canadian consumers are engaged in a “buy now before its too late” real estate shopping frenzy. Terrified of being priced out of the market - or of missing today's low interest rates - consumers are buying whatever they can (barely) afford, as quickly as possible. They do so knowing full well that the properties they are purchasing are expensive or even overpriced, yet with confidence that prices will further soar.

The short-lived recessionary ride convinced Canadians that their economic system is better, their banks superior, and real estate investing acumen greater than the rest of the world - and that therefore “it can't happen here.” The rise of the CDN$ relative to the USD has only added fuel to the fire.

In short, for Canadians the credit crisis has inspired a sense of economic godliness. Consumers have been aptly warned, but, due to fear and greed, have chosen to put on their rose-colored glasses and continue shopping.
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http://www.cbc.ca/money/story/2009/12/10/carney-financial-system-review.html
http://www.bankofcanada.ca/en/speeches/2010/sp110110.html
http://www.financialpost.com/story.html?id=2547222
http://www.fin.gc.ca/n10/10-011-eng.asp
http://research.cibcwm.com/economic_public/download/feature3.pdf
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"Living a life of simplicity is not simple. Rather, trying to simplify one's life is a constant challenge to embrace discipline - to edit out unnecessary items and to minimize desires that fuel their acquisition." Sri Chinmey

Alternative Energy – Cap and Trade

You’ve heard about Cap and Trade, but what is it?

Before talking about Cap and Trade, one first has to understand pollution control. Note that I am using the term “pollution control” (a tangible, measurable phenomenon) as opposed to “climate change” (a debatable, difficult-to-measure phenomenon).

When talking about pollution control, one has to be sensible. Americans are not going to park their cars and start cycling to work any time soon. On the other hand, it doesn’t make sense to drive your SUV two blocks to buy milk, either. Any good economist will tell you that to control pollution you have to control behavior. This means either putting incentives on green, putting disincentives on brown, or both. And you have to do it without killing the economy.

Say that you own a company that produces 1 tonne of pollutants per day of production. If you were to build infrastructure to reduce that pollution, it would cost you $50/tonne. Since there is a cost with no equivalent savings, there is no inventive to implement pollution control measures. But, if the Government were to start fining you $60 per tonne of pollutants, suddenly there is an incentive not to pollute: your company saves $10/tonne to build the anti-pollution infrastructure. The point is, while free market economics takes care of most issues of industrial production, pollution is rarely one of them. Pollution control has to be mandated.

Measures that have been already been used to control pollution include taxes on gasoline, emissions taxes for corporations, tax credits for buying low-energy home appliances, banning polluting substances (such as DDT and CFCs), and rebates to convert gasoline vehicles to natural gas. So how about Cap and Trade?

Cap and Trade -- also known as cap-and-tax by those who oppose it -- is the name given to a system where a central authority (ex. Government) sets a limit on the amount of pollution that can be emitted. Companies are issued credits, giving them the right to produce a specific amount of pollution (that is reasonably low). If they are efficient (pollute less than their allowance), they can sell their excess credits to other companies for cash. If they are inefficient (pollute more), they need to buy credits from other companies to avoid heavy fines. In other words, there is an economic incentive to meet pollution targets and become more efficient. In theory, it’s a good idea.

The problem with Cap and Trade is that it is complicated and easy to manipulate. If a company manufactures energy-efficient camp stoves, for example, and sells them to African villagers to replace their dung-burning stoves, should they be able to claim credits? If they plant a forest of trees, should they get credits? If a fire destroys the forest, should the credits be taken away? It’s all very opaque. This is not to mention the potential for corruption when big businesses trade credits for cash. And, who decides how many credits to give out, anyway? Will the amount of credits issued rise during an economic crisis, so that businesses can save money?

In my opinion, the best solution is to keep doing what we are already doing. When I visited California as a kid, the smog was so thick it literally made my eyes water. After California passed a law requiring low-emission mufflers, the smog cleared up. When I visited England as a child, households burned coal for heat and buildings looked filthy. Since the government expanded the infrastructure for natural gas and gave incentives to switch, the same buildings now look pristine. When my mother was a child, DDT was a common pesticide. After it was determined to be dangerous, DDT was banned.

The American Clean Energy and Security Act, now in Congress, includes many elements similar to those that have already proven successful; for example, increasing standards of energy efficiency for buildings, modernizing the electrical grid, giving incentives for energy efficient appliances, and requiring large utility companies to obtain some of their energy from renewable sources. But Cap and Trade is also a primary element of the bill.

Cap and Trade isn’t a terrible idea, I just don’t believe it is the best idea. Contrary to some news reports, most major companies support pollution control: it is good for public relations as well as the environment. But they want the playing field to be fair. Existing pollution control measures work and should be expanded. The Cap and Trade portion should be removed and replaced with carbon control measures, tailored to local areas and individual industries.

America Wasn't Ready

This Sunday, the U.S. health care bill was passed after a furious battle.

The center and left were virtually silent this week, giving the limelight to those who believe that Barack Hussein Obama is not working in their best interests, to say the least. In fact, the opposition united in what both looked and sounded like a religious crusade to save America.

“We have to deny the power of the devil and his disciples in our midst,” wrote one blogger. “Pray to the father God to wake up Congress,” pleaded another. References to “rebuke,” “wickedness,” and “righteousness” were everywhere.

Then there was the coming revolution. There were calls for “bloodshed” if the bill was passed, for “revolution in the streets,” and to “impeach the foreign born dictator.” Conservative talk-show host Rush Limbaugh said that Obama’s secret goal is to divide America before destroying it, while house Minority Leader John Boehner likened the bill to "Armageddon." An ad on the Washington Post's website offered free handguns and knives to those who enrol in a self-defense training course, to prepare you "for what's coming."

The conservative right says that their hatred of Obama is politically – not racially – motivated. Casual observation suggests otherwise. One commenter on a national news website called President Obama a “lying sack of Kenyan dog crap.” Another said that he “lies through purple lips.” Yet another said that the “monkey man will get beaten.”

Of course, the health care bill passed and will now become part of American life. Citizens will have health coverage, whether they like it or not.

For investors, the big question is “what to do now?” When propaganda is rampant & emotions high, what can investors expect? At the opening bell this Monday morning, the 22nd of May 2010, two possible scenarios could occur: A) The right will demonstrate its genuine belief that Obama has destroyed their economic future by selling off U.S. stocks like mad, creating one of the largest stock market crashes in history. Or B) nothing dramatic will happen, showing that it was all just crazy talk.

Personally, I’m hoping for “A.” If so, you will find me at my computer, happily buying underpriced stocks of great American companies, while everyone else loses their minds.
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“Reactance – the urge to do the opposite of what someone wants you to do out of a need to resist a perceived attempt to constrain your freedom of choice.” Wikipedia, “List of Cognitive Biases”

Gold, Finger

Nothing excites people like gold. It is malleable, shiny, never loses its luster, and looks great around a girl’s neck. It is the stuff of legend, where a new discovery can make a man rich overnight. Gold is now at record prices, and the airwaves are inundated with ads to buy gold, sell gold, and invest in gold. What do you get when you combine beauty, excitement, and instant riches? Why, a great opportunity to scam investors, of course.

The typical gold mining scam follows a theme with common elements. The first of these is a great story. Maybe the speculative property is an “overlooked” piece of land next to one owned by a large mining firm. Maybe the owner went bankrupt and had to sell it on the cheap, regardless of its true value. Maybe the story combines a bit of everything.

I attended a seminar of a TMX-venture listed company a couple of years ago that nicely illustrates the “story” portion of a gold venture. First, the meeting place itself. The conference room was supplied with boxes covered in gold foil (each of which, I was told, represented one metric tonne). On the tables were gold vases and gold foil chocolate bars on gold tablecloths. But aside from flair, this presentation had a great story.

As I soon learned in a video, an old prospector (we’ll call him “Yukon Bob”) had a gold mine. The mine was so successful that he made a living at it using only a pick, shovel, and some occasional dynamite. It was this dynamite that proved his undoing. Yukon Bob’s beloved mine collapsed upon him, killing him instantly. That was about a hundred years ago. The family kept the property, but did not mine it in memory of poor Yukon Bob. Our heroic CEO convinced the family to sell this accursed mine to him for a small sum, just to be rid of it. Great story.

After hearing the tale, I perhaps didn’t look as excited as I might. The CEO noticed this, and immediately sent over a honey trap. Sitting uncomfortably close for a room full of people, the lovely lady asked me what I do for a living. Upon saying, “banker,” I thought I could see drool form at the edges of her mouth.

The other part of their story, which is typical of gold-mining presentations, is the quality of management. Having nothing but a hunk of land and an office somewhere, the company will tell you how management is “well respected” in the industry, and has “100 years” of experience between them.

A truly really great opportunity (you will hear) is when the company has not yet gone public. They will hint that if you invest now, the eventual IPO will make you rich whether the company finds gold or not. Not mentioned is that in the meantime, the CEO and directors will pay themselves nice six-figure salaries using your money until, hopefully, the company goes public as planned. At the peak of the hype, the owners will sell most of their shares, leaving penny stocks that will eventually get bought out by still more promoters, at which point the company’s name will change. This is why venture companies often have press releases for names that read like a play-by-play of what is hot in the market; for example, “Super Wind Alternative Energy, formerly known as Capsule Biomedical, formerly known as BuyIntoIt.com, has changed its name to Gold Sierra Cortez Inc.”

Then there are companies that tell you the truth, but neglect to mention the downside risks. Take for instance, a company that made a great gold discovery in Peru. The core samples showed excellent potential. The mineralized area was close to the surface, in rock that was easy to mine. All great so far. What the promoters neglected to mention was that the property is commercially inaccessible except by helicopter, that local prospectors frequently get kidnapped and held for ransom, and, oh yes, the small matter of the thousands of land mines.

Of course, some companies actually do search for gold, and some even build mines and strike it rich: probabilities, however, are not on your side.

The “golden rules” (pun intended) of investing in venture mining companies are as follows: first, if you want to invest your money, choose companies that are either in the process of building a mine or where production has already started – this alone with weed out the 95% of discoveries that never pass the feasibility stage; this should be the start of your research, not the end. If you want to speculate, there are almost no rules save one: don’t commit a penny more than you don’t mind losing.

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“Oh, the only gold I know about is the kind you wear... you know, on the third finger of your left hand?” Miss Moneypenny to James Bond, Goldfinger, 1964

Barack’s Reforms make Big Banks Cry

Being that I own hordes of bank stocks in my personal portfolio -- and that I work for one -- you might expect me to decry President Obama’s recent pronouncement that big banks will no longer be allowed to engage in certain high-risk trading. On the contrary, I think it’s a perfectly acceptable idea, one that Wall St. professionals have known the practicality of for years.

In 1987, when markets crashed and big banks were “saved,” many thought that this set a dangerous precedent. It was believed that banks, confident that they would be bailed out no matter what their level of gambling, would start acting like hedge funds and go for broke. And they did.

So, while I am dismayed that my annual investment returns may decline a few points due to the proposed changes, I am also grateful that I won’t come back from the bathroom to find my stocks down 80%. In short, I expect my U.S. bank stocks to become more like the banks themselves: large, boring, and immensely profitable.
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“If we bail out this one (Penn Square Bank)…then the markets will know that, no matter what risks they take, the government will bail them out. Eventually, it’s going to lead down the road to nationalization of the banking system.” William Isaac, FDIC chairman, July 1982.
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“CMO equity is a particularly slippery mortgage investment. The CMO stands for Collateralized Mortgage Obligation, but bond salesmen call it ‘toxic waste.’” Michael Lewis, The Money Culture
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“I would confidently predict that most of the derivative books of major banks cannot be liquidated for anything like what they’re carried on the books at. When the denouement will happen and how severe it will be, I don’t know. But I fear the consequences could be fearsome.” Charlie Munger, Poor Charlie’s Almanac, 2005
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