[financial candy]

Why $140 a barrel crude is unsustainable

noreply@blogger.com (Rabinder Sekhon) — Tue, 08 Jul 2008 21:24:00 +0000

(graph courtesy of wtrg.com)

Despite the hand wringing about crude prices, there is plenty of evidence to suggest a top forming and prices headed in one direction --- down. The basic economic principle, which has stood the test of time and applies to this day, is that, supply rises in response to prices while demand has an inverse relationship to prices.

Following the 1973 oil embargo prices which earlier had been at a nominal $20 a barrel since the twenties (in 2007 dollars) tripled and seven years later, following the overthrow of the Shah, hit almost $70 a barrel.

By turning down thermostats, using better home insulation, driving slower and buying smaller more fuel efficient cars, Americans conserved energy and consumption crashed. In the meantime, production had just begun to soar as high prices stoked greater exploration. As a result oil began a 7 year decline back down to it's historic average of $20 a barrel.

With a few shocks along the way, oil continue to limp along until the housing mania around 2003. Forgetting the lesson of the early eighties, Americans bought bigger cars, built Mcmansions and raised their energy consumption. Easy credit fueled the buying binge and cheap energy made it feel good. As a corollary exploration slowed down at the very time that newly industrialized economies began to demand more oil to fuel their growth.

Today with oil at $140 a barrel, we hear the message that this time it's different and that cheaper oil is no longer in the cards. Well, we seem to be going by the same play book as consumption has already started to slow. Developed economies are using less oil as drivers consider making unnecessary trips and airlines cut routes. In the developing world, India and China have cut their fuel subsidies resulting in higher prices and it's only a matter of time before demand slows, if it hasn't already. Crude inventories continue to build and supply may become even more plentiful as newly discovered oil fields such as in Brazil come on tap.

The most telling feature of a world awash in oil is the following statement from an Aramco manager from a recent story by the New York Times on the Khurais oil field in Saudi Arabia (http://tinyurl.com/5em4e7):

“We’ve asked all the international oil companies that buy from us if they want more oil,” Mr. Nasser said. “But we can’t find customers.”

Rising oil may fuel reverse globalization

noreply@blogger.com (Rabinder Sekhon) — Wed, 25 Jun 2008 18:23:00 +0000

As oil continues it's upward trajectory so have the costs of transporting goods and materials across oceans. In a globalized world reliant on shipping raw materials to one place to be made into finished goods and sent someplace else, this trend in costs is bound to make the economics of manufacturing in far off places questionable. This is especially true for low value to freight ratio products such as raw materials, furniture, apparel and machinery.

At $200 a barrel shipping a container from Shanghai to New York will cost $15,000 compared to $8,000 today and a mere $3,000 in 2000 when oil was $20 a barrel. This portends a fundamental realignment of trade which, has to some degree, already been set in motion--a number of US manufacturers have regained their footing and have restarted their production lines in the South East.

How much of manufacturing comes back from China remains to be seen. During the 1974 OPEC oil shock consumers bore the brunt of the additional costs but in time markets adjusted to substituting for goods that were sourced closer to home. In some capital intensive sectors such as steel, the US already has a competitive advantage as the cost of labor is a small part of the process.

Rather than finding the cheapest labor, producers are going to have to find places within reasonable distance to their markets. This may be a second opportunity for Mexico having earlier lost some of it's maquiladora production to Asia.

As an unintended consequence, shippers, just as the airlines, have reduced ship speeds to save fuel. Consequently there is less cargo space available at any given point in time--more ships are at sea rather than in port. The changing winds have also impacted the exporting of agricultural products from the US (California grows 80% of all worldwide almonds) leading to lower revenues to growers.

While liberalization and technology have facilitated globalization, transportation costs may once again change the economic landscape.

Wal Street expertise

noreply@blogger.com (Rabinder Sekhon) — Tue, 13 May 2008 03:55:00 +0000

Many large Wall Street firms tout the depth and breadth of their research expertise. But as we face one of the greatest financial crises since the Great Depression, it is interesting AND revealing to see how major financial services firms have fared. According to Bloomberg.com (4/1/08), some experts estimate that there has been $1 trillion in write downs and credit losses through April 1, including:

UBS ..................................................... $38 billion
Merrill Lynch......................................$25 billion
Citigroup..............................................$24 billion
HSBC.................................................. $12 billion
Morgan Stanley..................................$12 billion
Bank of America.................................$8 billion
JP Morgan Chase...............................$5 billion
Wachovia ............................................$5 billion
Goldman Sachs...................................$3 billion

The irony is that these losses have occurred in areas of the market once regarded as relatively safe and secure.

The firms tout their experience, the range of their resources, their research prowess, even the “safety” of investing with a large institution. Given what has happened recently, these claims ring a little hollow.

Commodities - What next?

noreply@blogger.com (Rabinder Sekhon) — Wed, 02 Apr 2008 00:07:00 +0000

Commodities have sky rocketed in the past 6 months as speculators bid prices to stratospheric heights. There isn't a day that goes by without a new ETF, index fund or mutual fund touting commodities. Prices are so far ahead of themselves that there is talk of the next bubble forming. Not that was until the Fed made noises about inflation and uncharacteristically let some of the air out before the bubble popped.

Of course, there is no way to read the "tea leaves" and make an accurate prediction. However, it's interesting to attempt to make sense of the future by observing investor behavior.

A chart from Barrons indicates that sophisticated investors, energy companies, food processors and farmers, shall we say smart money, are betting heavily against commodities. We think of them as smart money as they trade commodities on a daily basis and have an understanding of their markets. On the other hand, speculators who represent dumb money are hoping for a continuing boom. As with any bubble when too many such investors move in, it's time to head for the exits. I'm reminded of a story by a portfolio manager who once told me that when his mother called in to ask him what he thought about a high flying internet stock, it was his signal to sell.

Inheritance is not always a good thing

noreply@blogger.com (Rabinder Sekhon) — Fri, 09 Nov 2007 23:23:00 +0000

"From shirtsleeves to shirtsleeves in 3 generations".

Families are finding it difficult to maintain their wealth for multiple generations.

There are a number of potential problems with the transfer of great wealth. Many children have a difficult time coming to grips with the unearned wealth that they acquire. With wealth comes responsibility and unfortunately young people are not easily taught about responsible action.

Children in wealthy families often feel a sense of unworthiness questioning what they had done to deserve the wealth through no effort of their own. Research also shows that children of wealthy families suffer from low self-esteem for this very reason. Success becomes defined as being primarily through lineage and not by way of personal achievement.

For this reason more and more of the wealthy are choosing not to leave their wealth to their children.

That's not to say that a family might abrogate on it's responsibility to ensure that preceding generations do not spend their lives in squalor. Warren Bufffet said it best when he declared that he's leaving enough for his children so that they will do something and not so that they do nothing.

Momentum Venture Partners and Mentor Capitalism

noreply@blogger.com (Rabinder Sekhon) — Sat, 20 Oct 2007 18:19:00 +0000

As some first time entrepreneurs may already have experienced, attempting to get through to a VC with the hopes of securing a Series A round is really tough to do right now. There is a funding void left by VC firms shifting their investments downstream. This has left many unseasoned entrepreneurs to fend for themselves to bring great ideas to fruition.

Filling this void is Los Angeles based Momentum Venture Partners, founded in 2004 by a pair of veteran start-up executives - Matt Ridenour and Andy Wilson. Momentum works closely with a company's founders to shape their business plan, find experienced management, finalize a product and gain customers - a process that typically takes about nine months to complete. At that point, they pitch the company to VCs with hopes of securing a $4 million to $5 million Series A round.Momentum’s distinctive model dedicates far more time than a typical angel or seed-stage investor while also assuming considerable risk. A typical assignment begins with a six weeks first phase - usually for a fee of less than $20,000 - validating a business plan, building chemistry with the founder and carrying out due diligence before committing to the start-up. Upon approval, one of four Momentum partners then takes on an interim CEO role, moving the founder to the chief technology officer role. During the process, Momentum provides a bridge loan - typically $250,000 to $500,000 from a bridge fund pooled from high net worth individuals - to keep the company operating, all for a ‘nominal' monthly stipend.Unlike a traditional VC who might split his/her time with many companies, Momentum partners typically work with, at the most, two companies at a time spending half of their time on each, with an operating associate subbing in the other half as a project manager and director of operations. Momentum's ultimate goal is to deliver the company to venture capitalists and secure that first round of capital, when the firm's bridge investment converts, often at a discount, into Series A preferred stock. It's at this point the firm gets paid for its work after having deferred the majority of its management fees during the previous nine months.So far all seven of its start-ups have made it to the Series A level, focusing on Los Angeles-area technology companies that require less than $10 million in funding to break even on a cash-flow basis. The seven have raised a total of $30 million in Series A funding. The firm had its first exit in 2006 when Discovery Communications Inc. acquired Academy123 Inc., which had raised a $5 million Series A round the year after Momentum brought the company to venture firms Arcturus Capital and Hanseatic Group.

Momentum is especially beneficial to VCs because it's bringing only companies with proven business models and customers. From the point of view of the entrepreneur, Momentum understands what VCs want and helps clear up legal and other issues that prove invaluable to companies who make the grade to be part of the Momentum portfolio.

Snakes and ladders

noreply@blogger.com (Rabinder Sekhon) — Mon, 08 Oct 2007 19:57:00 +0000

It seems to me that for most people, their financial affairs, more often than not are akin to a game of snakes and ladders.

A lot of intelligent, educated people are finding out the hard way that it is easier to earn your wealth than to preserve and build upon it. Consequently a lot of people are worried about how not to lose their hard earned capital and if they're not worried, they ought to be.

Here then are the "snakes" to watch out for:

1. Putting your finances on the "back burner"

2. Investing in a poorly conceived manner

3. Having little or no risk protection

4. Not contributing to a retirement fund

5. Not planning for your heirs

6. Misusing debt

7. Not managing cash flow

8. Depleting a retirement portfolio

9. Mishandling windfalls

Buy versus Rent

noreply@blogger.com (Rabinder Sekhon) — Mon, 08 Oct 2007 03:10:00 +0000

As the real estate market has unravelled it has started to beg the question whether it's financially prudent to buy or rent.

Prices throughout the country have become so out of touch with rents that even without a calculator buying is not a good option today. Prices in Los Angeles would have to rise an average of 5% per annum for buying to be a viable option.

The National Association of Realtors will tell you that this is a good time to be buying but numbers say otherwise. The New York Times earlier this year carried out a survey of major metropolitan areas and has concluded that the costs of buying - realtor fees, escrow, mortgage payments and taxes - end up being much higher than rents for a comparable property.

Don't take my word for it, try the buy versus rent calculator for size.

What's the difference between Wealth and Affluence?

noreply@blogger.com (Rabinder Sekhon) — Thu, 27 Sep 2007 16:24:00 +0000

The word Wealth comes from the word "weal" meaning a great surplus of money and property. Affluence is a derivative of "allure" a Latin word that means to flow freely.

The affluent drive expensive cars and live in big houses. More often than not, people who may appear to be wealthy are actually affluent. Conversely most people who are wealthy do not flaunt their wealth; they live modestly, they save and invest and have a plan for their future.

Warren Buffet drives around Omaha in a 2001 Lincoln Town Car with the license plate "THRIFTY" and has lived in the same house he bought in 1958 for $31,500. And he is the second wealthiest man in the world. Jim Walton heir to the WalMart fortune continues his father's tradition. His father Sam Walton use to drive around Bentonville, Arkansas in a beat up pickup truck.

What's wrong with target date funds?

noreply@blogger.com (Rabinder Sekhon) — Wed, 26 Sep 2007 21:52:00 +0000

The concept seems simple enough; pick a retirement date, select an off the shelf portfolio from a brokerage and sit tight. Let the brokerage determine the funds in the portfolio and have them adjust it accordingly ratcheting down your risk profile as you reach retirement.

Any confusion regarding asset mixes or a confusing array of mutual fund choices is instantly eliminated. Funds are named by year and are spaced 5 years apart. making it easy to select a target portfolio.

So what can possibly be wrong with this approach?

Too often, investors don't use target date funds properly, and you have to wonder whether one fund can really be appropriate for everyone who retires in a given year. The asset allocation of a particular fund won't suit the risk tolerance of all individuals who plan to retire in that year.

Each fund family is different and each investor is different. I might want to be as conservative as possible as I get closer to retirement and my fund might still have 30 percent in stocks, when I'd rather prefer to be 100 percent in bonds. People have to understand what they're buying, and many people don't look under the hood.

Another potential problem is that investors aren't given enough information regarding the philosophy behind target date funds and how they should invest their money.

The concept is one-stop shopping, but people don't do that. About 90 percent of the people who have money in the fund have it in there incorrectly. It's just another fund that they put their money in. They might have money in six other funds -- growth, value, etc., and then maybe 15 percent in target date.

While that problem might be fixed by better educating employees and other investors who consider these funds, another situation might be more perplexing to consumers. The asset allocation in a specific target date fund can vary from one firm to another.

Look at the 2020 target date funds from Fidelity, T. Rowe Price and Vanguard, and you'll see quite a bit of difference among them in asset allocation.

	Cash	Stocks	Bonds	Other
Fidelity Freedom 2020 Fund	4.76%	69.43%	17.85%	7.97%
T. Rowe Price Retirement 2020 Fund	4.75%	76.48%	18.03%	0.74%
Vanguard Target Retirement 2020 Fund	1.31%	70.22%	27.65%	0.82%
Data from Google 9/27/07

T. Rowe Price looks to be the most aggressive of the three with more than 76 percent of the portfolio in stocks, a mix the company finds appropriate for someone 13 years from retirement.

Above all, for the level of risk, consumers should check the performance of any target date fund to see if it at least matches the performance of a benchmark index or category.

Another potential weakness is that most fund companies will use a roster of their own funds, some good and some not so good. Moreover not every company has great funds across the board. Fidelity may have a fantastic large cap value fund while T. Rowe Price excels at small cap.

When's the best time to plan for retirement?

noreply@blogger.com (Rabinder Sekhon) — Wed, 26 Sep 2007 20:11:00 +0000

Somebody recently asked me whether it's worth their while to even bother to think of retirement in their twenties. After all serious adult preoccupations such as financial planning and retirement are for people in their 40s when there is something to plan for. The truth is that it's never too late to plan for the future as this striking example will illustrate:

Scenario 1:
Joe a 19 year old socks away $2,000 a year into a retirement account for 8 years

Scenario 2:
Jill a 26 year old diligently invests $2,000 a year from age 26 to age 65. That's 39 years of investing!

Assuming that both Joe and Jill earn a 10% return per year who do you think comes out ahead at age 65?

Age	Joe 19		Jill 26
	Savings	Year end balance	Savings	Year end balance
19	$ 2,000	$ 2,200		$ -
20	$ 2,000	$ 4,620		$ -
21	$ 2,000	$ 7,282		$ -
22	$ 2,000	$ 10,210		$ -
23	$ 2,000	$ 13,431		$ -
24	$ 2,000	$ 16,974		$ -
25	$ 2,000	$ 20,872		$ -
26	$ 2,000	$ 25,159		$ -
27		$ 27,675	$ 2,000	$ 2,200
28		$ 30,442	$ 2,000	$ 4,620
29		$ 33,487	$ 2,000	$ 7,282
30		$ 36,835	$ 2,000	$ 10,210
31		$ 40,519	$ 2,000	$ 13,431
32		$ 44,571	$ 2,000	$ 16,974
33		$ 49,028	$ 2,000	$ 20,872
34		$ 53,930	$ 2,000	$ 25,159
35		$ 59,323	$ 2,000	$ 29,875
36		$ 65,256	$ 2,000	$ 35,062
37		$ 71,781	$ 2,000	$ 40,769
38		$ 78,960	$ 2,000	$ 47,045
39		$ 86,856	$ 2,000	$ 53,950
40		$ 95,541	$ 2,000	$ 61,545
41		$ 105,095	$ 2,000	$ 69,899
42		$ 115,605	$ 2,000	$ 79,089
43		$ 127,165	$ 2,000	$ 89,198
44		$ 139,882	$ 2,000	$100,318
45		$ 153,870	$ 2,000	$112,550
46		$ 169,257	$ 2,000	$126,005
47		$ 186,183	$ 2,000	$140,805
48		$ 204,801	$ 2,000	$157,086
49		$ 225,281	$ 2,000	$174,995
50		$ 247,809	$ 2,000	$194,694
51		$ 272,590	$ 2,000	$216,364
52		$ 299,849	$ 2,000	$240,200
53		$ 329,834	$ 2,000	$266,420
54		$ 362,817	$ 2,000	$295,262
55		$ 399,099	$ 2,000	$326,988
56		$ 439,009	$ 2,000	$361,887
57		$ 482,910	$ 2,000	$400,276
58		$ 531,201	$ 2,000	$442,503
59		$ 584,321	$ 2,000	$488,953
60		$ 642,753	$ 2,000	$540,049
61		$ 707,028	$ 2,000	$596,254
62		$ 777,731	$ 2,000	$658,079
63		$ 855,504	$ 2,000	$726,087
64		$ 941,054	$ 2,000	$800,896
65		$ 1,035,160	$ 2,000	$883,185

Surprisingly enough Joe, who started early and even though he only paid in for 8 years is better off to the tune of close to $200,000. He's 20% better off due to the power of compounding!

What's the difference between a broker and an investment advisor ?

noreply@blogger.com (Rabinder Sekhon) — Thu, 23 Aug 2007 22:50:00 +0000

Earlier this year, the U.S. Court of Appeals for the District of Columbia Circuit vacated a controversial SEC rule which exempted fee-based brokerage programs from the Investment Advisers Act of 1940.

The "Merrill Rule" or exemption, allowed broker-dealers especially brokerage firms and wirehouses to offer their clients fee-based brokerage accounts without first registering those accounts with the SEC under the Investment Advisor Act of 1940.

Investment advisors offer similar fee-based accounts—termed ‘advisory accounts—and are held to the fiduciary standards stipulated in the 1940 legislation. Brokerages are governed by an earlier Act that ensures that what they recommend is suitable for the client and does not require them to act in the client's best interest.

The real problem is a need to completely separate "brokerage" from "advice".

Brokerage is a sales function and not an advisory function. And I don't mean simply execution of buy and sell transactions for securities. The primary function of a broker is to sell products and services that are created or managed by the investment banking and execution services side of the brokerage.

Earlier that meant encouraging lots of stock transactions and peddling offerings of stocks and bonds. In the bad old days it meant peddling mutual funds that offered the firm a kickback of some form. These days, it means offering the service of managing your money for an annual percentage fee. But in all cases, the brokerage firm is still in the business of selling products and services that the investment banking and execution services portions of the business profit from. Selling advice may sound like a service, but at a brokerage firm it is really more of a collateral activity to induce demand for the actual products and services that benefit the investment banking and execution services sides of the brokerage firm.

That is the key difference of an independent advisor : they don't have investment banking and execution services interests to peddle.

Another related issue is that brokerages are earning increasing profits from their in-house proprietary trading desks. In other words, the firm is trading for its own account. Your assets are on the books as belonging to you, but once you hand them over to the brokerage firm to manage, they can utilize them to fuel the in-house trading operation. For example, your stock can be borrowed to permit a short sale.

Part III - Is the stock market a better long term investment than real estate?

noreply@blogger.com (Rabinder Sekhon) — Thu, 16 Aug 2007 22:04:00 +0000

What about the tax benefits of owning real estate?

Real estate, especially if you own your own home offers a number of tax benefits; you can deduct mortgage interest (up to $1m) as well as property taxes. Furthermore when you sell, provided that you've lived in your home for 2 years, the first $500,000 in capital gains are tax free.

Rental property also comes with the very same breaks in addition to the deductibility of maintenance costs, advertising and depreciation. The only difference is that there is no $500,000 capital gains exclusion.

Stocks on the other hand are subject to capital gains tax and provided a stock is held for more than a year, a 15% federal tax rate applies. Moreover any investment losses can be offset against gains.

Part II - Is the stock market a better long term investment than real estate?

noreply@blogger.com (Rabinder Sekhon) — Thu, 16 Aug 2007 22:01:00 +0000

"What about the obvious advantage of leverage?" "Doesn't a mortgage magnify the return?".

You know, buy a condo in Miami for $500,000 with a 5% down payment of $25,000 and the condo appreciates 10% in two years. Voila ! Assuming no transaction costs we have a spectacular 200% return!

You can also leverage stocks by buying on margin although only up to 50% of the stock price. You could do even better in options but risk losing everything.

Remember there's a flip side to leverage; take today's condo glut in Miami. In the scenario above the same condo today is worth $450,000, that's if you're lucky enough to find a buyer. Ouch ! now you find yourself owing the bank $25,000; something a lot of people in formerly "hot' markets are experiencing first hand.

Despite this wrinkle, nothing beats the leverage one can get in real estate in taking a small amount of money to make great gains in a rising market.

Part I - Is the stock market a better long term investment than real estate?

noreply@blogger.com (Rabinder Sekhon) — Wed, 01 Aug 2007 01:01:00 +0000

Real estate packed quite a punch from 2001 through 2006 appreciating 12.4% annually. That quite handily beat the S&P 500 which gained 4.3% for the same period. So, even though today, the sector has started to lag can we say that real estate is a better investment than the stock market?

When it comes to performance and the long run, there is no question that stocks beat real estate. A recent study by Yale's Roger Ibbotson compared annual returns from 1978 through 2004 for real estate, stocks, bonds, commodities futures, mortgage securities and REITs.

Housing delivered 8.6% while commercial real estate did better at 9.5%. The S&P however managed 13.4%. Robert Shiller, also at Yale, argues that over time, housing's rate of return trends back to the mean of around 3% annually.

If that is the trend, given the run up, we're faced with many years of losses or at best little appreciation.

Before you jump to the conclusion that real estate is a poor investment, remember that REITs have performed exceptionally well in the last year with returns close to 15%. Then again REITs are traded just as stocks on the various exchanges.

Why picking mutual funds is a waste of time

noreply@blogger.com (Rabinder Sekhon) — Thu, 12 Jul 2007 01:00:00 +0000

Morningstar, in a study of mutual funds identified that only about 30% of managers are able to beat the index they're matched to and that almost no one manager can consistently beat the index.

If one then extrapolates these results into a portfolio of funds with various asset classes, the probability of picking all winners in a four asset class model add up to a little more than 1%. On the flip side there's almost a 33% chance that one would pick all losers in this scenario. Clearly the odds are against an individual investor in selecting a basket of active managers.

The picture gets even grimmer if we look at the impact of taxes on active fund management returns.

Once again Morningstar, in a study of US equity funds from December, 1994 through December, 2004 reports that for the large cap value funds, while 87% of managers underperformed the index, fully 97% did so when taking taxes into consideration. For large cap growth the percentage of under performing managers was 54% and 80% when factoring in taxes. Only small cap growth managers tended to outperform the index with 16% under performing and 29% when adjusted for taxes.

As this study shows, taxes have a considerable impact on investment results and over a 10 year period active managers under perform their indexes especially when factoring in taxes.

Index funds have always provided a tax-efficient way to invest for two primary reasons. Fist, index funds experience lower turnover than most actively managed mutual funds. The second reason relates to the way index funds are bought and sold. When investors sell shares in a traditional mutual fund, the fund company redeems the shares for cash. Any resulting capital gains are distributed on a per-share basis to the funds remaining shareholders.