Saturday, December 31, 2011

Canadian Business & IBM

Well it appears I was quoted over at another major news publication, Canadian Business.  To read the article click below.

I must apologize... I have been very busy with work lately and haven't been able to post.  In short I am transitioning into a new role back at the parent company from a subsidiary.  I have really enjoyed my time at the subsidiary as it was much smaller (than the parent) and working through the unique business challenges we faced has definitely helped me become a better investor. 

One key point I have learned is how sticky business and business relations are.  Things don't change drastically over time.  In fact many companies resist change because of fear of the unknown.  For example, if you changed suppliers how can you trust the new products, quality, or service?  From this perspective you can see how Warren Buffett likes the stickiness of IBM.  IBM's competitive advantage is the relationships they have built with hundreds of businesses around the world. 

Speaking of IBM, shortly after Buffett announced his purchase of IBM stock he also mentioned one other detail.  It was that he read the book, Who Says Elephants Can't Dance? Inside IBMs Historic Turnaround by Louis V. Gerstner Jr., not once but twice before buying the stock.  That was I needed to hear so I quickly got my hands on the book. 

The book is an account of some of the steps Mr. Gerstner took to save IBM.  Back in 1992 IBM was on the brink of failure, bleeding cash, and left for dead by wall street.  Kind of sounds like Blackberry, except Blackberry isn't even close to losing money yet.  Basically, IBM became a victim of their own success and seemed unwilling to adapt to the changing computing world. 

The most interesting fact in the book is Mr. Gerstner's background. It is definitely not what you'd expect for a CEO of a computing giant.  He had worked for McKinsey & Company (consulting), American Express, and finally was the CEO of RJR Nabisco before coming to IBM.  Although he was educated in engineering he went straight into Harvard for an MBA and had zero experience in computers, software or IT. 

Despite his unusual background Mr. Gerstner did turned transform IBM into one of the most successful IT companies in the world prior to his retirement in 2002.  He transformed not only their competitive position but radically transformed the culture to become customer centric and customer focused.  These and many other good leadership principles are discussed in the book. 
Anyway, I have been working on a few new posts and how to be back soon with some good new content and discuss some stocks for the year ahead. 

Happy New Year!

Disclosure - I own shares in BRK.b, thus I indirectly own shares in IBM.

Monday, December 12, 2011

Home Prices Are Crashing in China

I hate doing this type of post...but the title really says it all. 

Anyone who is still long commodities needs to give their head a shake.



Tuesday, December 6, 2011

Economics - Why Oil Prices Will Fall

I posted a while back Five Reasons Why Oil Prices Will Fall.  I want to follow up with the Number One Reason why Oil prices will fall over time. 

It appears the shale gas revolution that has been on going in North America has dramatically changed the energy landscape for Natural Gas (NG).  I would point to this blog post (Click Here) on NG over at Carpe Diem blog.  The shale gas revolution has dramatically transformed the energy picture from where North America was running out of NG five years ago to being awashed in NG today. 

NG production in the US just reached a new all time last week according to the EIA (Click Here).  You can also see the dramatic increase in production in the last five years due to the shale gas paradigm shift. 

With NG prices currently around $3.25/mcf in Canada, and $3.40/mmbtu in the USA, NG is very, very cheap relative to Oil.  (You can consider a mcf approximately equal to mmbtu)

On an energy equivalent basis natural gas has 1/6th the amount of energy as a barrel of oil.  So to compare apples to apples we need to multiply our NG prices by six to compare correctly. 

So at current prices, NG is available as an energy source for roughly $19.50/bbl or you can get the equivalent amount of energy from a barrel of oil for $101/bbl (WTI).   That is over 5 times the cost for the same amount of energy. 

Can you imagine how much cheaper our vehicles would be to run if we used NG instead of oil?  As  Scott Grannis has said, "It is hard to underestimate the degree to which cheap and abundant natural gas is going to transform U.S. manufacturing and energy generation in the years to come".

Now NG is cleaner a much more plentiful energy source than many oil.  Since the cost is over 80% cheaper than Oil, NG will eventually become a very common energy source.  It's hard to justify paying 5 times more for the same amount of energy in the long term. 

Of course utilizing NG as a common energy source will take years happen.  We would need new technology and infrastructure.  The infrastructure will take time to build, but given the economics the ball has already started rolling.  If you think this is all fanciful thinking, Click Here to see what Encana thinks about the future. 

Paradigm shift are hard to spot and some people deliberately stick their head in the sand and refuse to accept the change.  I must admit that I wasn't a believer in the shale gas revolution until very recently.  The stubbornly high production data is simply too overwhelming to neglect. 

What about the Big Energy Picture?

I read an interesting short booklet almost 10 years ago, called the age of energy gases or something like that.  While I found the little booklet kind of stupid, it did take a philosophical look at the form of energy man has used throughout history.  If you go back a couple hundred years or so we used 100% solid energy sources.  These would be wood, coal, and other solid forms of energy (typically burned).  Once we got onto liquid energy forms like oil, the percentage of our energy consumed from solid forms has constantly fallen.  We currently use a very little amount of solid energy as a percentage of our total energy sources. 

Today Oil is by far the largest energy source, but as the book pointed out it will never reach 100%.  The book drew something like a bell curve with energy liquids reaching somewhere around 60-70% of our energy needs and then eventually entering a terminal decline just like energy solids.   

Finally, the book described the age of energy gases.  In this phase both solid and liquid forms of energy are in decline and energy gases become the most common energy source, eventually reach 100% of our energy usage. 

While I found this historical study of our sources of energy quite stupid at the time, I am wondering if the guy who wrote it isn't such a quack after all.  We seem to be able to access more and more gas reserves every day.  If we could unlock unconventional gas sources we would be accessing huge energy sources. 

My only question that remains is how atomic energy (uranium) fits into the big picture. 

Kevin Graham

P.S - Here is an interesting article that sums up my thoughts above:

Monday, December 5, 2011

China's Hard Landing

China is in big trouble, something I have been saying for a while.  Individuals and governments cannot defy economic gravity.  When you monkey around with the FREE MARKET this is what you get:

I particularly like this quote.

China is a poster child for the Austrian school of economics' theory of the business cycle. After undertaking the biggest stimulus program the world has ever seen in response to the global financial crisis, the country is drowning in unproductive investments financed with credit.

You cannot legislate your way to wealth or prosperity.  Every attempt in the past or in the future will be met with the same result.  Otherwise we would all be filthy rich by now.  Real wealth comes from savings, good investment, and increased productivity on the supply side.  The more we produce (directed by consumer preference, not government regulation) the more wealthy we become. 

Enough with the Crony Capitalism. 

I wonder how much further ahead (and less wasteful) we would be if the business environment was unencumbered by artificial demand created by some politician who thinks they know better?  (Think interest rates, cash for clunkers, energy rebate programs, tax breaks for certain companies, pet projects, etc, etc)

Best Regards,

Saturday, December 3, 2011

Bank of America & Europe

We'll I know it's been a while since my last post, I do intend on making up for lost time shortly.  When a guy goes away for a week (with no phone or email), it leave quite a bit of work when you return.  We'll I was poking around over at Corner of Berkshire and Fairfax today and posted this reply to a comment on Bank of America (BAC).  To save money and use the shotgun approach, I am re-posting here to save time. 

Just so everyone knows, and to repeat from my first post ever, I don't enjoy rehashing the latest news and current events.  I strive to provide original content, full of facts and written in an enjoyable way.  This post does discuss Europe which I have been trying to avoid since it's not original, but I believe contains some interesting facts and puts things into perspective.  Enjoy!

My reply...

Can you please provide sources for your numbers?  For instance that the big 5 banks have CDS exposure of $244 trillion?  I think you might be confusing CDS exposure to total notional derivatives at the big 5 banks.  For instance BAC has $68.2 trillion in total notional derivatives outstanding.  What is interesting is 86% of these are interest rate contracts.  Specifically, looking at the CDS exposure, they have written about $2 trillion in CDS and have also purchased $2 trillion in CDS contracts.  Actual net exposure is about $100 billion CDS written and $100 billion CDS purchased.  At the end of the day netting CDS assets from liabilities gives an asset of $5.6 billion down from $6.6 billion and the beginning of the year. 

Now the real question is who/what are the CDS contracts written on AND who/what are the CDS contracts purchased on?  If you know I would like to know.  When people talk about banks being black boxes this is exactly what they mean (or should mean). 

Many say banks are black boxes because of the removal of mark to market (FASB 157), which is not true.  Mark to market still applies unless the market is illiquid or non existent.  For BAC Level 3 assets (the ones marked to fantasy) are 2.9% of total assets and 4.8% of risk weighted assets (RWA). 

Ironically, these are the best among the large US banks, including WFC, JPM, C.  So when pundits toot their horn saying you can't believe the balance sheet, this is the part they are talking about.  This brings me to my next point. 

Many people claim that JPM has a rock solid balance sheet.  This includes newspapers and the nut jobs running around over at seeking alpha that either post OR comment out of ignorance.  Level 3 assets are 5.0% of total assets and 9.3% of risk weighted assets at JPM.  That is enough to drive a truck through.  They also have the largest notional amount of derivatives outstanding and the largest amount of trading assets.  If anyone says JPM has a rock solid balance sheet (including Jamie Dimon), are talking their own book or don't know the facts.  The only company with a rock solid balance sheet is Wells Fargo, the only one that didn't need TARP.   

Now I am long BAC.  The reason why I am long is because the numbers just say they are too cheap.  If they earned 1% on assets or 10% on equity that would be $22 billion profits vs a $55 billion market cap.  Even if the market cap doubled to $110 billion that still would only be 5 times average earnings.  The math isn't hard.  But i'll be honest; the reason why BAC is a crappy company is management.  How many screwups in the past year?  You can't even count them on all your fingers and all of your toes. 

Anyway getting back to the CDS stuff, it's not nearly as big as you think and if you have any details on who/what then that would be of value.  From what BAC has broke out on Europe in Q3 they have $1.5 billion in derivatives outstanding on Italian sovereign debt (likely CDS written) and have purchased $1.2 billion in CDS protection.  The net is about $300 million or not enough to worry about.  They also have some exposure Portugal and Spain in the tens of millions, but they are totally covered by CDS protection purchased. 

Just to put the European debt crisis in perspective, the US debt crisis was $15 trillion of bad mortgage loans against a $15 trillion dollar economy.  Huge.  If you add up all the sovereign debt of the PIIGS, it's $4 trillion at risk against a $15 trillion dollar economy (European union).  In my opinion, Italy and Spain won't default and they contribute $2.2 trillion and $0.9 trillion respectively to that $4 trillion total.  So the rough $1 trillion that's left isn't as much as the pundits make it out to be.  Now if the creditors accept a 50% haircut that further brings it down to $500 billion, something still very large but not unmanageable.  The real reason why Europe is a mess is because of the political structure and the inability to run a printing press to bail them out. 

Best Regards,


Disclosure - Long WFC and BAC