Some of his early stories written in the 1930s reflect on the mood of the era. And even if you don’t care for reading about the 1930s, you’ve got to love Runyon’s way of capturing the voices of the times. For instance, “I put the old convincer on him by letting him peek down the snozzle of my John Roscoe.” That’s a pretty colorful way of saying you stuck a gun in somebody’s face.

In these stories, there is also that undercurrent of bad times. You never forget it. People view anybody who looks well with suspicion. Prosperity of any kind is seen as unreal in some way. As Runyon writes:

“You cannot tell by the way a party looks or how he lives in this town if he has any scratch, because many a party who is around in automobiles, and wearing good clothes, and chucking quite a swell is nothing but the phonus bolonus and does not have any real scratch whatever.”

There is also a macabre sense of humor. In one story, Runyon writes of being at a track in Miami. He’s having a run of bad luck. It goes on awhile and gets worse. “I wonder if I will not be better off if I buy myself a rope and end it all on a palm tree in the park on Biscayne Boulevard,” he writes. “But the only trouble with the idea is I do not have the price of a rope, and anyway I hear most of the palm trees in the park are already spoken for by guys who have the same notion.”

It was an era with an undercurrent of playful meanness, too. For example, look at the nicknames of some of the baseball players in the 1930s. Author Bill James wrote about this years ago. “In the ’30s, nicknames turned nasty,” he wrote. If you had a big nose, you were “Schnozz” — a nickname earned by Hall of Fame catcher Ernie Lombardi. If you were overweight, your nickname was “Blimp,” as in Frankie “Blimp” Hayes. Or just “Fats,” the nickname pinned on poor Bob Fothergill.

Some other nicknames used by journalists and forever affixed to players’ names in the registers: “Stinky” “Boob” “Boom Boom” (for a pitcher with a 38-69 career record) and “Suitcase” for anybody who had trouble sticking with a team. Joe Medwick walked with his toes pointed out and got stuck with “Ducky.” An outfield named Cuyler stuttered and they called him “Kiki” Cuyler. It was a brutal era.

I guess with bread lines, shantytowns and so many people out of work, no one cared about playing nice. In 1930s, you had to have thick skin.

Floyd Odlum: Making the Best of Bad Times

And more than just reading about the 1930s out of my own personal fascination with the period, there are also some practical benefits. There were people who made a lot of money in the Great Depression doing legal things. There is Floyd Odlum, for instance. He is sometimes described as the only guy to make a fortune in the Great Depression. (He wasn’t.)

I’ve written to you about him before. The reason to revisit him briefly is that James Grant also wrote a little about him in a recent Grant’s Interest Rate Observer. Grant calls him a “salvage artist par excellence.” “None of us can know the future,” Grant writes. “But like Odlum, we can make the best of a sometimes unappetizing present.”

Grant also managed to scrounge up a pretty good anecdote on Odlum. In the summer of 1933, when all the world seemed to be in pieces, Odlum strolled into his office, looked at his glum partners and said: “I believe there’s a better chance to make money now than ever before.”

Odlum liked poking around in the smoking wreckage of the 1930s. Bad times create wonderful pricing. I suspect if Odlum were still alive, he’d find himself very busy. There is a lot to look at now.

Scared? Read This

A friend of mine recently wrote to me about how he was looking at Potash (POT: NYSE) with “fear and lust.” It was a Hunter Thompson moment, and I knew exactly what he meant. Everything feels a little scary right now. At the same time, your rational brain gets excited about the great prices you see dancing on your screen.

“Fear and lust” sums up what it feels like investing in stocks these days…

Every investor will have to overcome fear to buy anything today. I hate to try to call a bottom. But remember that even in bad times, the stock market can put up stunning rallies. Jeremy Grantham at GMO makes the point about sitting on cash too long:

“In June 1933, long before all the banks had failed or unemployment had peaked, the S&P rallied 105% in six months. Similarly, in 1974, it rallied 148% in five months in the U.K.! How would you have felt then with your large and beloved cash reserves? Finally, be aware that the market does not turn when it sees light at the end of the tunnel. It turns when all looks black, but just a subtle shade less black than the day before.”

Backlash From the CVR Energy Sell

I’ll end this week’s note with a quick word on CVR Energy, which we parted with after a little more than a year with a terrible loss. I always get lots of e-mail after every sell, no matter whether it was up or down.
I’ll reprint one of those e-mails… from my father:

“Your great analysis costs us $7,200 if we sell now. What happened to all that good stuff you wrote about it as far as the fertilizer plant and using its coke to run it? I thought (you thought) it was going to save it money, etc., on running the plant and make money on the fertilizer.

“Love, Dad”

Guess that will come out of my inheritance, assuming there is any. Well, a lot changed. Fertilizer prices tanked. Natural gas prices tanked, thereby making the company’s use of pet coke less appealing with all this cheap gas around. And gasoline demand fell, as did prices, thereby hurting the refinery. On top of that, there is the seeming inability of the company to get it together and deliver a clean set of results.

I suppose CVR Energy will bounce back from these lows at some point. If you want to hold out for a better price, that seems reasonable. But I’d rather own other things in this environment. Sorry, Pop. We’ll hit the next one!

Regards,
Chris Mayer

March 16, 2009

This article was originally featured on Whiskey and Gunpowder

Fear, Lust and That 1930s Feeling

The noodle company got itself into some trouble. To simplify the story greatly, it basically lost a lot of money using derivatives to bet on dollar-rupiah movements. The loss suffered was, in fact, more than the capital of the company itself. At one point, Das writes: “What this had to do with producing noodles was a mystery.”

Exactly!

Unfortunately, this kind of story riddles the markets today like worms in an otherwise worthy cut of swordfish. There are so many of these incidences and they are ruining companies and investors across the world. It takes a nasty crisis like the one we are in to expose all these things. And the rot is extensive.

I want to share with you three little-reported events and one historical example that all show how pervasive this mindless risk-taking became during the last few years. They would be almost comical if they weren’t true.

First, consider the sad example of several Mexican and South American companies that made, large, company-jeopardizing currency bets. For example, Mexico’s third largest retailer, Controladora Commercial Mexicana (COMERCIUBC: MXK), recently filed for bankruptcy after losing so much money speculating in the forex markets. What does currency speculating have to do with selling tortillas, milk and eggs? Nothing. That’s the point.

Similarly, Sadia (SDA: NYSE), a poultry producer; Cemex (CEMEXCPO: MXK), a cement outfit; and Gruma in tortillas – all lost huge amounts of money on currency bets. Aracruz Cellulose (ARA: NYSE), the much admired pulp giant of Brazil, owes more than $2 billion to its banks for making bets on currencies that went sour. What was once a great franchise has been brought to its knees. It will take years to pay that back and debt payments now make up 40% of its pre-tax earnings.

The second example of mindless risk-taking is the story of so-called “portable alpha.” Apparently, the brain trusts that run pension funds thought this strategy sounded like a good idea. What is it? I still don’t understand it fully. But it basically amounts to a leveraged bet on the stock market. If you lose, you lose big as many pension funds are finding out. So now the Pennsylvania state employees’ pension fund, for instance, will have to take a multi-billion bath on this exotic investment strategy.

As the Wall Street Journal reports: “The stock-market downturn could force the Pennsylvania state employees’ pension fund to make cash payments of $2.5 billion or more to trading partners on Wall Street.” The fund has only $27 billion in total. At least, it had $27 billion.

Several other funds have reported billion dollar losses on portable alpha strategies. I can only imagine how many more institutional investors are in the same boat. The people running these things and advising these people should all find other work.

The third example is so-called “accumulators,” which is another kind of tactic for placing highly leveraged bet on stocks, currencies or commodities. I don’t want to get into the details. It’s so complicated; it would take me a page to explain it. Just know that, like “portable alpha” if you are wrong, you lose big.

And yet all kinds of wealthy individuals and businesses have gotten wrapped up in these things. Accumulator losses are showing up in some unlikely places. For instance, VeraSun Energy Corp. (VSUNQ: OTC), which makes ethanol, filed for bankruptcy in part because of big losses on accumulators tied to the price of corn. Citi Pacific (CIY: ASX), a Chinese conglomerate, lost $2 billion on accumulator contracts linked to currencies.

Billions and billions of dollars lost on nonsense. There was no reason for anybody to buy these things – especially when they clearly did not understand the risks involved. The losses are so bad in Hong Kong that Any Xie, an independent economist, said recently that “Accumulators are ruining Hong Kong.”

I’ll offer one other example of this kind of recklessness that is both a historical and contemporary study: Goldman Sachs.

I just recently finished perusing Charles Ellis’ new history The Partnership: The Making of Goldman Sachs. I was particularly interested in the early history of Goldman Sachs. I thought I would come away thinking how Goldman Sachs used to be a simpler business. I thought Goldman’s history would show how it took prudent risks with adequate equity backing those risks. My conclusion would then be that the current crop of leaders at Goldman were just reckless and ruined a franchise that had been around since the 1880s.

In fact, that’s not what I learned at all. From Goldman’s earliest days as a commercial paper specialist it operated with minimal capital. All through its history, it has been a business that took big risks and often took huge losses. That Goldman even exists at all today is something of a financial miracle.

In reading this history, I was struck by how the company found itself in the soup again and again and again. In the 1920s, one of the biggest speculative busts was in investment trusts in which a small amount of capital supported a spider’s web of investments in other companies. Guess who had the biggest blow-up of them all?

Goldman was big in this through a subsidiary called Goldman Sachs Trading Corporation, which basically lost everything for its investors. Ellis writes:

“While all the investment trusts suffered, Goldman Sachs Trading Corporation – because it was so large and so highly leveraged…became one of the largest, swiftest, and most complete investment disasters of the twentieth century.”

The loss to Goldman Sachs itself was enormous. It basically wiped out thirty years of profits and eliminated the “fruits of all the labors of a generation.”

Fast forward to 1970 and the biggest bankruptcy in the country at that time. You find Goldman was waist-deep in it. Penn Central at the time of its bankruptcy in 1970 was the eighth largest corporation in the country. Again, Ellis writes: “the loss it [Penn Central] threatened to impose on Goldman Sachs was not only larger than any prior loss, it was larger than Goldman Sachs.”

And so it is today, that the company once again finds itself in the middle of yet another big crisis that threatens its very existence. I don’t know about you, but I have to wonder about all the brains at Goldman Sachs and all the people who say what a great firm it is. Seems to me, for such a bunch of supposed geniuses, they routinely shoot themselves in the foot, time and time again. You don’t find Berkshire Hathaway fighting for its life every decade.

All of these anecdotes scream at me to avoid the complex and the leveraged, which often means a potential for a mega-loss if you’re wrong. The problem is these kinds of bets infect many companies, as I’ve shown, even when they have nothing to do with the core business. Even otherwise seemingly simple enterprises, like making tortillas or producing chicken, have been hurt.

The advice I have is not novel, but bears repeating since so many seem to forget it. Stay away from anything you don’t understand. (All those folks who lost money with Madoff in his $50 billion Ponzi scheme would’ve saved themselves a lot of money just with this single insight.) And avoid excessive leverage. It’s one thing to lose money. It’s another thing to lose it taking on stupid and pointless risks.

Regards,
Chris Mayer

January 8, 2009

This article was originally featured on Whiskey and Gunpowder

Mindless Risk Taking

Eddie Cantor (1892-1964) was a comedian, singer, songwriter and actor. “Banjo Eyes,” as he was sometimes called, was also the author of two little books on the Great Depression. “People used to rob banks,” he writes in Yoo-Hoo Prosperity. “Now we’re lucky when it isn’t vice versa.” Cantor jokes about many troubles in the Great Depression, but one recurring theme is the relative lack of food.

A millionaire is “one who eats three square meals a day.” Things were so bad that “the pigeons are now feeding the people.” They were funny lines…sort of. For many of the people living during those times, Cantor’s jokes were not so far from the truth.

We have it comparatively easy in this, the crisis of 2008. We may have to make do with fewer Swatch watches and Coach handbags. We may have to pass on the latest iPod and make do with last year’s winter coat. These hardships are not important, except for people selling those goods. But the credit crisis is also affecting the world’s ability to produce one thing important to everyone: food.

It’s harder for farmers to get credit for next season’s crop, especially farmers overseas. They need fertilizer, seed, fuel and more. And most farmers need to borrow money to obtain these essential items. No credit; no crops.

Therefore, the global credit squeeze might reduce plantings of key grains, even as world inventories of these grains hover near historic lows. In Russia, for example, cash-starved banks have cut off funding for the industry. The head of the Russian Grain Union says, “Many farmers probably won’t be able to borrow money for the spring sowing.” This is important because Russia is no lightweight in the grain division. It produces 9% of the world’s wheat, for instance. No surprise that the United Nations considers Russia a critical component of the global food supply.

Ironically, Russia just had its best harvest ever. And still, global grain inventories remain low. Bloomberg reports that global inventories of corn, wheat and soybeans are the second lowest they’ve ever been since 1974.

A number of countries already fear what might happen next year. The Washington Post Foreign Service in Shanghai reports that China adopted a number of measures to protect itself from the worsening food crisis: “Among the most extreme measures [China] took was to impose new export taxes to keep critical supplies such as grains and fertilizers from leaving the country.”

These taxes are extremely high, on the order of 150%-185%. China worries that richer countries may outbid its own farmers for supplies and weaken China’s own food supply. One Chinese fertilizer company, which produces 150,000 tons per year, already said that the new taxes mean exporting is no longer profitable. China was the biggest exporter of certain types of fertilizer. No longer. That’s a lot of supply off the market.

Fertilizers are absolutely critical in maintaining (and improving) crop yields. Without them, we’d produce far less per acre. As a result, in parts of Africa where people depend on Chinese fertilizers, the food supply problem is now more acute. China’s export taxes and bans follow those of other grain producers, including the Ukraine, India, Pakistan and Argentina.

Amazingly, despite these various maneuvers around the world to prevent grain exports, the prices for wheat, corn and soybeans are all half of their mid-summer highs. It seems the market believes a global recession will dampen demand. Maybe so, or maybe the market doesn’t know anything. The severe commodity selloff during the last few weeks might be saying a lot more about the desperation of hedge fund managers to raise cash than about the prospect that grain demand will fall - in which case, we could see another surge in prices next year.

Demand for grains is still very strong. In China, each wage-earner devotes about 40 cents of every dollar earned to buying food. In India, that number is a staggering 70 cents out of every dollar earned. In other words, the food budget in these countries is hardly a discretionary item. It will remain constant, or even rise, no matter what the global economy does.

Meanwhile, the people in these countries who have a couple of extra rupees to toss around are upping their consumption of meats, which increases the per capita demand for grains. As PotashCorp chief William Doyle recently pointed out: “The average daily protein intake in China has increased by 40% over a 20-year period, with the greatest percentage of that increase coming from meat consumption.” You can see it in the size of the people themselves: The average 6-year-old Chinese boy is 12 pounds heavier and 2 inches taller than 30 years ago. These people aren’t going back to the ways thing were. This is a long-term story, and these trends should continue.

Yet even if demand growth for grains slows, it’s not likely that those low global grain inventories will improve. Even if grain demand fell to 2% per year, we’d still need record production to keep grain inventories from falling further.

For all these reasons, I think the future is still bright for agriculture and all that it entails. I think the fertilizer companies look cheap again. In my monthly newsletter, Capital & Crisis, my subscribers owned Agrium (NYSE: AGU) for nearly three years, and it more than tripled our money. The stock is now a good one-third below what we bought it for initially.

PotashCorp (NYSE: POT) and Mosaic (NYSE: MOS) are other names I’m looking at hard right now - both have been crushed in this troubled market.

Beyond that, irrigation companies have come way down, even after posting outstanding results. Lindsay (NYSE: LNN) and Valmont (NYSE: VMI) are two irrigation equipment makers, for example, both coming off great quarterly results.

In 1931, Eddie Cantor wrote that the biggest thing in years was bread. “Why, they’re giving it away free! Whenever four men get together at a street corner, it used to be a merger,” he writes. “Now it’s a bread line!” It’s funny now. Next year, it might not be, at least to some.

Regards,
Chris Mayer

December 03, 2008

This article was originally featured on Whiskey and Gunpowder

Crash in Food Supply

Every crisis, though, brings opportunity. In this one, investors will go back to investing in simpler, more durable things (at least until forgetfulness kicks in). For instance, investing in a company that supplies grains to hungry people looks like a better bet than investing in one that sells mortgages to people who can’t afford them. The focus will shift to things we need, rather than things we want.

I have two ideas for investing in the post-financial world in this letter, including a new idea — a family-owned conglomerate that combines operations in pork, grains, shipping and more. It’s a stock you can sock away for a long time. And if the post-financial world develops as I think it will, you’ll be glad you parked some money in this sector…

I was spending a few days in Paris when the U.S. markets put on a show that had the feel of a movie climax. Uncle Sam bailed out AIG. Merrill Lynch sold out to Bank of America. The U.S. government hastily arranged a $700 billion bailout. Markets rose and fell hundreds of points per day. Gold and oil enjoyed their biggest one-day rises ever. It was a wild stretch.

The French have a chance to gloat a bit. Even though the crisis in America, the world’s biggest economy, helps no one, the French may have a better shot than most at coming through it with only flesh wounds. The housing market stinks in France, too. Housing sales in France are off 20% in the last 12 months. But the French market is not nearly as leveraged as the U.S. market was.

Financial innovation seems to occur slowly here. Mortgages in France are typically for terms of only 15 years. The French have also not embraced creativity in this field, as most mortgages bear fixed rates of interest. There is no subprime market. And French consumers did not borrow much against the rising prices of their homes. (The savings rate here is 13% of income, versus zero in America.)

The U.S. economy followed a very different path. Sometime over the past few decades, we abandoned the old-world notion of making things. We turned to making shuffling paper our stock in trade. Precisely when and why this happened will be something for historians to debate. But sometime in the 1990s, the percentage of corporate profits from finance passed that from manufacturing.

It was the first time that had happened, and the gap has only grown wider since. Before the great credit crisis hit, profits from financial firms made up nearly half of corporate profits. Only 10% came from the manufacturing sector. As recently as the mid-1960s, it was the other way around.

The French go on and on about their cheeses, wines and breads. For us, mortgages became our national product. Mortgages, before the crisis hit, made up 60% of total bank loans and the financial sector grew to become our biggest sector — bigger than health care, retail or manufacturing.

Replay the 1970s — Only Bigger…

To a smaller degree, we had a similar crisis in the 1970s, Kevin Phillips tells us in his new book, Bad Money. Mortgage debt doubled from 1960-70. The Dow crashed, losing 36% of its value from 1969-70. Hedge funds blew up. The top 28 funds lost 70% of their assets, and about 100 brokerage and financial firms disappeared — by either acquisition or outright failure. Seems a lot like the outlines of the present day, does it not? The 1970s also had two major oil price spikes. The first in 1973-74 and the second in 1979-80. We’ve already had one oil spike now, and a second one is in the cards.

The neglect of making things is perhaps most evident in the oil business. Phillips says the U.S. has a “dated, ghost-of-glories past petroleum infrastructure.” He writes that the major oil companies “are wealthy, but aging behemoths, hard-pressed to maintain production levels, despite large exploration outlays, and no longer enjoying access to overseas oil fields they once commanded.”

Exxon Mobil, once the largest oil company in the world, now ranks 25th by booked oil reserves. The top 10 are all state-owned national oil companies (NOCs). The top 13 NOCs own four-fifths of the world’s known oil reserves. They don’t share them cheaply.

A look at where we get our oil is not encouraging, as the chart below shows. Most of these sources of supply are not particularly reliable. As Phillips opines (the table below comes from his book): “Of the eight principal 2007 suppliers of petroleum to the United States as of August, only one, Canada, could be called secure and reliable.” Mexico seems secure, but exports have been falling since 2004, as Mexican production has fallen. It could become an insignificant source of oil by 2012.

And we are not alone in competing for these oil reserves. China became a net oil exporter in 1993, and its appetite grows every year. It is now the world’s second largest consumer of oil, behind only the U.S. China actually imports more oil from Saudi Arabia than the U.S. This partnership is not surprising, given the dynamics of the New Silk Road.

The “New Silk Road” is a term I use for the boom in trade between countries from the Middle East to China. In matters of energy, you see a lot deals inked on the New Silk Road. Saudi Arabia and China get together regularly like newfound pals. Sinopec, a Chinese oil company, recently got the OK to explore the Saudis’ Empty Quarter for oil and gas. Saudi Aramco, the big oil company, put $750 million toward a huge plant in China.

Just as interesting to me is what I like to call the “New Burma Road” — after the road of World War II fame that linked China and India via Burma. The New Burma Road identifies the booming trade between India and China. As Phillips writes, “China has already made a six-lane highway out of its portion of the road from Chinese Kunming to India’s state of Assam… The demographics of a Sino-Indian entente would make it especially momentous.” Yeah, I’d say so, given the strengthened ties between more than two billion people.

As you know, there is an awful lot going on in the world today, and it’s all far more complex than I can get into here. But this is where we are, in brief: The U.S. economy faces a crisis in its biggest sector — finance. The neglect of making things is finally taking its toll, a fact most apparent in the oil and gas world, but also apparent in infrastructure across the spectrum. And the world is less U.S.-centric than it has been in a long time. We see this, too, in the oil and gas sector and in the flurry of deal making along the New Silk Road (and its “momentous” segment, the New Burma Road.)

The implication of this post-finance U.S. economy is a theme we’ll explore more in this letter. As an early conclusion, though, I believe the spread between finance and manufacturing has reached millennial extremes, like a rubber band at its limits. Now begins the snap back.

Regards,
Chris Mayer
October 21, 2008

This article was originally featured on Whiskey and Gunpowder

Useful Activity Will Survive the Meltdown

“If you crossed the street blindfolded, you’d probably be OK. But the consequences of being wrong are so great, it’s a bad idea.”

— Bill Bonner, Founder of Agora

The “financialization” of the American economy is an era coming to a close. It’s back to the basics of wealth creation, to the basics of owning and making useful things. Because of their intrinsic usefulness, these investments hold their value over time. In the current turmoil, the market is tossing out just about everything. So you’re getting good prices for picking up these basics. One of these basics is the ability to produce food.

I was recently in the Chateau de Courtomer, one of the last chateaux built in Normandy, France, shortly before the French Revolution. A large, old painting of the Marquis de Courtomer still hangs in the stairwell. Bill Bonner, my publisher and the owner of the chateau, told me the man lost his head — literally — during the revolution. The chateau was also a regional headquarters for German operations in Normandy during World War II.

It’s a great old building, made of sturdy brick and stone. Imagine all that it’s seen over the centuries: wars, market crashes, all kinds of disaster. Yet it still stands. It’s retained its usefulness, even after all these years. That durability is a good thing — an enviable thing — and not so common among most of our material possessions.

Durable old investment ideas are on my mind today. With the credit crisis gathering power like a hurricane over the warm waters of the Gulf of Mexico and laying waste to the stock market in the process, it seems natural to focus even more on ideas with impregnable staying power.

One night at dinner, we had an interesting discussion about what sort of assets we’d want to own during times of crisis. We talked about gold — which had very recently enjoyed its best day ever, when the price rose by $50 per ounce. We talked about silver. Dan Prescher, the editor of International Living, though, had a different idea.

“I’d own a cow,” he said. “Think about it. What would you rather own if things got really bad? Gold coins or a cow?”

I think he was onto something. A cow is, of course, a useful animal to have around. Maybe some chickens, too, and some farmland with ample water and a good stand of fruit trees. These things have always had value to mankind. We need to eat and drink. During times of crisis, people may make do with an old sweater and forgo buying a new one. They may patch up that old couch, skip the movies and pass on the latest iPod. But they always eat and drink.

I’ve been thinking more about the global food chain lately. In the last issue, I wrote to you about what I called the “topsoil crisis.” Fertile land is becoming an extremely valuable asset. And what I think will happen is that the whole food chain will become more valuable with it. It’s sort of like the oil story.

As the price of oil rose, oil reserves became much more valuable. But so, too, did the whole energy infrastructure — pipelines, refineries, companies and people who can build and repair oil rigs and such. I think the same thing is happening — or will happen — with farmland and the entire food network that feeds this hungry planet. The ability to supply hogs and chickens and grains will become much more valuable.

I’m working more on these ideas, and I’ll have some new research to share with you in your next issue. This market turmoil could create some truly awesome opportunities to get in pretty early on these emerging trends.

Also, the market turmoil has created some great opportunities within our existing portfolio. There are several names I have at “hold” that I am looking to upgrade to “buy.” Otherwise smart investors who may balk at the idea may want to consider some more advice from Templeton.

More Good Advice from Templeton

On Thursday, I shared with you some quotes from John Templeton taken from the latest issue of Outstanding Investor Digest (which I recommend).

Here are a couple more ideas worth rolling around in your head as you think about investing:

The stock selection process is complex. Remember that unlike other professionals, a prudent and wise investor cannot afford to do what other investors do. For example, if 10 doctors tell you an appropriate prescription, then it’s wise to accept that consensus. Likewise, if 10 engineers agree on the design of a bridge, then that’s surely the right way to build it. But if 10 investment analysts tell you to buy a particular stock — or gold, deutsche marks, denominated bonds or whatever — it is probably the wrong thing to do.

Investing inhabits a peculiar world. You have to walk with the minority as an investor. You have to have the fortitude to stand against the crowd. As Templeton says below, the only way to pick up bargains is to buy what people are selling:

Buy those things that are depressed. A security is depressed in price only when people are selling. There is no other reason why the price should drop to an undervalued level except the pressure of selling. So in securities markets, you have to be prepared to do the opposite of what most investors are doing if you are going to get bargains and make superior profits in the long run.

These are certainly trying times. The recent market crash will test the nerve and resolve of every investor. But there is not much to do other than wait it out. And for those who have the stomach for it — and the means — it’s also a time to pick up some great bargains.

Sincerely,
Chris Mayer
October 13, 2008

This article was originally featured on Whiskey and Gunpowder

Useful Stuff, Not Inflated Debt

I have been thinking a lot about the market and the beating we’re taking. It is the worst year I have ever had. Personally and professionally, this year will be — barring some fantastic rally — the worst year I’ve ever experienced. Far worse than the 2000-2002 meltdown, which I largely avoided. I actually made money during that stretch.

But this is wholly different. This is a crisis cutting deep into the very foundations of our financial markets. There has really been no place to hide in the stock market — just about everything has come down, and come down a lot, in hardly any time at all.

A few thoughts on what we’re seeing happening in this credit crisis. As I said, this is severe. This is the real deal. And I think it is possible good companies could go down as the credit markets lock up.

Just today, the Financial Times reports: “A virtual funding freeze…has affected even top-rated companies such as General Electric…and AT&T.” It’s a dangerous time. The fear out there is extreme. That explains why the yield on one-month Treasury bills fell to zero at one point during the recent panic. Investors just wanted safety. They didn’t care about yield. They wanted a place to put their money where they can be sure they will get it back.

Hence, the rush to Treasury securities. On the last day of the quarter, the 10-year note hit 3.83%. If you bought the 30-year T-bond a year ago — which most people thought was a dumb bet — you would have netted a 16% return one year later, as rates fell and your bond price rose. Not bad, huh?

This rush for safety is also rallying the U.S. dollar. Despite all its flaws and all that it’s been through, when people are scared, they want the old greenback. Cash. Commodities, meanwhile, have sold off something fierce.

It’s important to remember, though, that these things happen in markets from time to time. It can be difficult to know what to do when we’re in these times. On the train out here from Paris, I read a little commentary from John Templeton, the great investor who died earlier this year. Templeton lived to the ripe old age of 95. He was a man who’d seen a lot of water go under the bridge, so to speak.

So it’s appropriate, I think, to pull some wisdom from his comments. Some of them are particularly good for times like these. Here is one snippet:

“We have never been able to predict business cycles and we have never been able to predict stock market cycles…and we have never found any person whose predictions on this are right more than 60% of the time. But we say to our clients, ‘Don’t worry about it. Prepare yourself. You know there’s going to be a bear market. And you know there’s going to be a business recession. You just don’t know when.’”

Wise words, these. And keep in mind this is one of the greatest investors of all time. He goes on to say that you prepare for these periods by staying out of debt and keeping your own personal financial house in order. He also says: “You prepare yourself psychologically so you don’t get so frightened at the wrong time that you sell out foolishly. So if you are fully prepared and know you are going to live through bear markets and recessions, you can regard them not only without worry, but also as opportunities…”

Great stuff. By the way, the above comments are from the latest issue of Outstanding Investor Digest, a newsletter I’ve subscribed to for years. It comes out infrequently and has no stock picks. It just collects and publishes insights from some of most successful money managers around. I’d recommend it, if you enjoy that sort of thing.

For now, I’m trying to think like Templeton and see the market as one of opportunities.

Sincerely,
Chris Mayer
October 7, 2008

This article was originally featured on Whiskey and Gunpowder

Wisdom During the Sell-Off

“Taking the long view, we are running out of dirt.” —David R. Montgomery, geologist

Over the summer, Iran bought a large amount — more than ONE million tons — of wheat from the U.S.

That’s something we’ve not seen in 27 summers. In Iran’s case, a tough drought cut the wheat harvest by a third, forcing the country to look abroad. But still, the fact that Iran had to come to the U.S. is telling. It’s like Lee asking Grant for rations in the summer of 1863. As one analyst put it: “Do you think Iran would come to the U.S. if they had any place else they could buy it… They’re searching the world for wheat. They’re buying the U.S. because it’s the only thing they can buy.”

Markets, like great unscripted dramas, develop their own plotlines as time rolls on. Now unfolding is a new plotline in the agriculture boom. It begins with the fact that there are fewer and fewer options these days for importers looking for large quantities of high-quality grains. But it speaks more to a deeper issue: an emerging shortage in fertile soil. Yes, we’re running out of good dirt.

In fact, fertile soil — good dirt — may become more important to land values than oil or minerals in the ground. Some say it is already a strategic asset on par with oil. As Lennart Bage, president of a U.N. fund for agricultural development says, “Now fertile land with access to water has become a strategic asset.”

Doubtful? Consider rising export restrictions around the globe, which act as a sort of fence keeping the goods within borders. India curbs exports on rice. The Ukraine halts wheat shipments altogether. The number of grain-exporting regions has dwindled, like the vanishing buffalo herds. Before World War II, only Europe imported grain. South America, as recently as the 1930s, produced twice as much grain as North America. The old Soviet Union, for all its faults, exported grain. Africa was self-sufficient. Today, only three major grain exporters remain: North America, Australia and New Zealand.

No surprise, then, to find faith in the global food supply at generational lows. So begins the scramble to secure farmland. Saudi Arabia, for example, is particularly at the mercy of the winds of global agriculture. It has little ability to produce its own food. The kingdom, reports the Financial Times, “is scouring the globe for fertile lands in a search that has taken Saudi officials to Sudan, Ukraine, Pakistan and Thailand.” Saudi Arabia’s quest is not one it pursues alone. There are many hunters.

The UAE has also been looking to lock down acreage in Sudan and Kazakhstan. Libya is looking to lease farms in the Ukraine. South Korea has been poking around in Mongolia. Even China is exploring investing in farmland in Southeast Asia. While China has plenty of cultivable land, it does not have a lot of water.

“This is a new trend within the global food crisis,” says Joachim von Braun, the director of the International Food Policy Research Institute. “The dominant force today is security of food supplies.” Food prices reflect this crimp in supply.

The mainstream press focuses on issues such as population, dietary shifts and the impact of biofuels. One thing that doesn’t get talked about much may be the most important thing of all: A growing shortage of quality topsoil. Call it the topsoil crisis.

Quality soil is loose, clumpy, filled with air pockets and teeming with life. It’s a complex microecosystem all its own. On average, the planet has little more than THREE feet of topsoil spread over its surface. The Seattle Post-Intelligencer calls it “the shallow skin of nutrient-rich matter that sustains most of our food.”

The problem is that we’re losing it faster than we can replace it. And replacing it isn’t easy. It grows back an inch or two over hundreds of years.

This is not lost on certain far-seeing investors. Jeremy Grantham, the curmudgeonly head of the money manager GMO, wrote about soil depletion in his last quarterly letter. “Our farmers are in the mining business! Yes, the soil is incredibly deep, but it is still finite.” For every bushel of wheat produced, we lose two bushels of topsoil.

Until the final decades of the 20th century, the amount of new farm acreage added to the mix by clearing land offset the losses on a global basis. In the 1980s, the amount of land under cultivation began to fall for the first time since humble early humanity began to farm the rich land around the Tigris and Euphrates. It continues to fall today.

We lose topsoil to development, erosion and desertification. “Globally, it’s clear we are eroding soils at a rate much faster than they can form,” notes John Reganold, a soils scientist at Washington State University.

Estimates vary. In the U.S., the National Academy of Sciences says we’re losing it 10 times faster than it’s being replaced. The U.N. says that on a global basis, the rate of loss is 10-100 times faster than that of replacement.

In any case, it seems safe to say that good dirt is in short supply. The obvious investment conclusion: Buy farmland. That’s hard to do as an individual investor, although there are at least a few options.

More investment ideas will surely surface as time goes by. The topsoil crisis has a long way to go. It’s not going to resolve itself anytime soon. In the meantime, though, investors may want to rethink the phrase “cheap as dirt.”

Regards,
Chris Mayer
October 1, 2008

This article was originally featured on Whiskey and Gunpowder

Agriculture Soil Shortages

Investors are always on the lookout for the next big thing. You know the sort, a big-picture idea so powerful and long-lasting that you can confidently ride your investments through the ups and downs that market life presents. Holmes calls these “global megatrends” — “sustainable and substantial growth in capital expenditures in any country or sector.”

Holmes offered a couple of past examples. There was the massive growth of infrastructure in the ‘50s and ‘60s, which included the postwar rebuilding of Europe and the massive highway system build-out in the U.S. There was the 1990s megatrend, which led to massive growth in information technology and data communications. And there is the present megatrend: “Unprecedented change in global growth driven by globalization, urbanization and wealth creation, [which] leads to a global infrastructure boom on a massive, intractable scale.”

That’s quite a mouthful, but I believe Holmes is right. Holmes also cites numerous studies — one by Booz Allen Hamilton, as well as ones by World Energy Outlook, the U.S. Department of Transportation, the OECD and a host of other official-sounding places. But the total bill, give or take a few trillion, is about $41 trillion out to 2030 - for water, power, roads and bridges, as well as marine and seaports.

This is your next megatrend. Don’t miss it. We have some ideas at work here, but before we get too ahead of ourselves, let’s look again at some of the key points of the thesis.

First, some mega population shifts. By the end of 2008, half of the world’s people will live in urban areas. Leading the way are some 500 million Chinese and another 540 million Indians. The world’s cities are getting a lot bigger. Beijing alone grew from 12 million to 16 million in the past decade. Plus, there are a lot more souls on the orb than ever — 6 billion of us. Next year, the world’s total urban population alone will exceed the total world population in 1965.

This helps drive economic growth. Asia as a whole, for example, is building five times more homes than the U.S. Incredibly, China alone is constructing 80 percent of them. This, in turn, drives consumption of many commodities, including things you may not think of immediately — like cement. Asia — excluding Japan — uses about 14 times as much cement as the U.S. Asia ex-Japan has also overtaken the U.S. in steel production by a country mile. Asian steel production is more than six times the U.S.’ Electricity consumption is 32 percent more than the U.S.’

I could go on like this for pages…the stats are simply amazing. But I think you get the idea. The industrialization of Asia’s enormous populations has unleashed a torrent of demand for the basics.

There was a lot of discussion at the conference in Vancouver about just how much of Asia’s economic growth begins with U.S. consumers. The answer isn’t clear, as you might expect. But it is clear that trade routes in Asia are flourishing. I’ve talked about the New Silk Road before. It’s one of my favorite themes — the opening of old trade routes that stretch across the Middle East through India and into China. Holmes had a chart that showed that the Asian stretch of that old road is still healthy — despite an economic slowdown in the U.S.

Asian trade is ticking up, even as U.S. exports take a dip. It’s not the only data point, either. Asian retail sales are also trending higher as U.S. retail sales head lower. I think it’s a bit arrogant on the part of some analysts to say that China exists to satisfy our needs for rubber toys and cheap underwear. In their view, a U.S. slowdown dooms most of Asia’s export-driven economies. Plenty of evidence shows that’s not the case, at least not yet.

In fact, Asian demand is on the rise for a whole host of goods. In 2008, vehicle sales in Asia ex-Japan are set to exceed those in the U.S. First time that’s ever happened. Sometime in 2008, also for the first time ever, there will be more Internet subscribers in China than in the U.S. I suspect that’s one top spot that the U.S. will never claim again. There are also four times the number of mobile subscribers in Asia than in the U.S.

All of these points come from Holmes presentation, which I think painted an amazing panorama of the truly historic shifts in the global economy.

As fast as the Asian economies are growing, their demand for power is growing faster. You can also expect to see increasing use of aluminum, copper, iron ore, coal and nickel — all basic infrastructure materials.

Holmes offered that to satisfy the global demand for copper, the world would need to mine as much in the next 25 years as it has up to this point in history. These predictions may prove wildly inaccurate. But even if they are only directionally correct, it points to a long bull market in the basics.

I have recommended stocks that are deeply involved in the megatrend of infrastructure. Companies like ABB Ltd. (ABB: NYSE), the world’s largest builder of power grids, and Astec Industries (ASTE: NASDAQ), a leading manufacture of road-building equipment. Plus, I have also recommended companies that own the basic commodities the world will need — copper, oil, natural gas and more.

As we come to learn early in our investing careers, the market seldom moves in a straight line. Years can separate cause and effect. One of the great megatrends in the market today is this idea of infrastructure and all that it entails. So don’t let the recent volatility in the stock market blind you to long-term investment opportunities.

These are the moments to enter the fray, not to run from it.

Regards,
Chris Mayer
September 15, 2008

This article was originally featured on Whiskey and Gunpowder

Asian Infrastructure

Over the years, I’ve developed quite a network of contacts. If I have a question about natural gas in Kentucky, I know someone who can tell me what I need to know. He’ll know exactly what property I’m talking about and who the operators are. If I want to know about Barnett Shale, I know a guy who’s spent many years in the area. Heck, I talked to a fellow the other day who’s been drilling for oil and gas for 50 years. He talked about 1970 as if it were yesterday. If I want to talk to someone about mining whatever in Western Canada, I have a contact for that, too.

These are all successful and smart people. They are my behind-the-scenes eyes and ears. And while no one wants to call a bottom — they are too smart for that — they all say they are buyers, or at least hanging onto their commodity investments. The view from the field is bullish. Many marvel at how cheap some names have become.

Investing in the Age of Scarcity — the View from Vancouver

“Gastown, Vancouver’s oldest neighborhood…founded on the shoulders of desperate alcoholics by an entrepreneurial bar owner.”

— Anthony Bourdain, No Reservations

It might be too much to say Vancouver got its start with a bunch of alcoholics, but there’s no denying that Jack Deighton, or “Gassy Jack,” as he was known, had a hand in making the city.

As legend has it, Gassy Jack, a garrulous Yorkshire-born steamship operator, arrived in 1867 with a yellow dog, a First Nations wife and a barrel of whiskey. He solicited help from workers by telling them if they helped him build a tavern, he’d give them free drinks. So they did, and within 24 hours, the Globe Saloon was open for business, slaking the thirst of a rough frontier crowd of miners, trappers and loggers.

When a little village grew up around the saloon, Gastown was born.

This is where modern Vancouver began. Today, Gastown is the old section of the city. You can stroll down its cobblestone streets adorned with antique street lamps and stop off at one of the many bars and restaurants. You can see the old steam clock on Water Street, a local landmark. (But it’s kind of a sham, because the steam clock is actually powered by electricity. It was also built in 1977, despite its antique look.) There are also some shops hocking the usual kitschy fare like faux totem poles and snow globes.

Salute the bronze statue of Gassy Jack, standing atop a whiskey barrel, in Maple Square. Then head over to my favorite microbrewery in the city, Steamworks, and order a Lions Gate Lager and a brick-oven pizza.

As you wipe the beer foam from your lips, you can think about the story of early wealth creation in Vancouver. Spanish explorers in search of the Northwest Passage arrived in the 18th century. You can still see their influence in street names such as Cordova, Cardero and Valdez. The British explorer Capt. James Cook also hit the west coast of Vancouver Island, looking for the Northwest Passage. Vancouver, though, gets its name from George Vancouver, who sailed the inlet in 1792.

Eventually, a number of early explorers, including Simon Fraser and Alexander MacKenzie, helped map the region’s interior. In 1824, the Hudson Bay Co. began running fur trading posts out here. In 1858, prospectors found gold on the banks of the Fraser and Thompson rivers. The first sawmills along the Fraser River opened up in 1860. And there you have the triumvirate that drew adventurers and entrepreneurs from all over — furs, gold and timber. Into that swirl stepped Gassy Jack.

I like the city of Vancouver and enjoy going there every year for my publisher’s big annual conference. This year’s theme tackled investing in the age of scarcity. Perfectly appropriate for the market we find ourselves in.

Your Path to Riches Is Well Trodden

Gassy Jack and all those early explorers, adventurers, prospectors, loggers and miners did their part to spice up the 19th century. As with most of the history of the Americas, fortunes bloomed as men beat paths to nature’s riches. It was the basic stuff — metals, timber and other commodities — that made men rich. The voracious appetites fueled by the Industrial Revolution and rising urbanization created enormous demand for the natural storehouse of riches in the largely untapped Americas. If you were bold and talented (and lucky), you could strike out on some open valley or inviting hillside or promising riverbank — and dig or plant or pan your way to fame and fortune.

Despite all the advances and promises of the 21st century, we still need those basics. We’ve always needed them, but there is new urgency to the quest. The motor for that demand is a sort of second Industrial Revolution, in China and India, in particular. But it’s a revolution that broadens out to many emerging markets. The analogy is not lost on certain investors.

Jeremy Grantham heads up GMO, a respected money manager. Grantham has been largely spot on in the big-picture sense of staying bearish on stocks for the last eight years or so. He is bullish long term on commodities. In his latest quarterly letter, Grantham makes some good points about the future of commodities and emerging markets.

His conclusion first: “In the short term, slowing world economic growth combines with credit, currency and inflation problems to dominate the outlook and offer poor prospects for emerging markets and commodities. Longer term, the reverse is true, and they look like the assets to own.”

Regards,
Chris Mayer
September 10, 2008

This article was originally featured on Whiskey and Gunpowder

Finding the Bottom in Commodities

I hadn’t seen Forstmann’s name in years. He once lorded over one of the world’s most famous private equity firms, Forstmann Little. For a time, it was, as the Journal notes, “the most successful private equity firm in the world, renowned for both its outsized returns and its caution.” When things got a little too crazy, Forstmann chose not to play. For two years, he sat on $2 billion of uninvested funds. That’s discipline you don’t find often, in any era.

Ted Forstmann’s caution saved his firm a lot of pain when the private equity market collapsed later. As the interview made plain, old Forstmann has that bad feeling again. “Buffett once told me,” he said, “there are three ‘I’s’ in every cycle. The ‘innovator,’ that’s the first ‘I.’ After the innovator comes the ‘imitator.’ And after the imitator in the cycle comes the ‘idiot.’” We’re in the idiot phase now, he says.

The idiot phase is when financial disasters strike. It’s when the market reveals all the mistakes of the prior boom. It’s when all these supposedly smart people running billion-dollar financial firms get their heads handed to them. “The creation of much too much money caused all of this excess,” he says.

He would’ve found agreeable company in Vienna. The inaugural meeting of the Society for Austrian Economic Thought took place in the elegant salons of the Hotel Imperial. Here, a motley crew of entrepreneurs, philosophers and economists from all over the world met to discuss the world’s troubles.

Austrian Economics, in case you don’t know, refers to a school of thought originating largely in Vienna in the late 19th and early 20th centuries. Its great thinkers include Ludwig von Mises, for instance, who was actually born in what today is Ukraine. (As an aside, this sort of thing happened a lot, as the old Austro-Hungarian Empire’s borders shifted in later years. Carl Menger, another founding Austrian thinker, was actually born in what is today Poland.)

One definite theme of the meeting was the sick monetary systems of the world’s economies. Dr. Andre Homberg, a friend, reader and the organizer of the event, laid it out as the five “D”s:

• Delusions — the notion that “the welfare state can provide everyone with a free lunch and a reliable pension and health care”
• Deficits and Debts — the accumulation of enormous fiscal imbalances, particularly in the public sector
• Dollars — the debasement of the dollar and reckless credit expansion
• Derivatives — Dr. Homberg pointed out that the notional value of derivatives topped $1,000 trillion, as per a recent IBS report. “This excessive leverage could implode anytime and make the U.S. subprime debacle look like a day at the beach,” he said.

The end result of all this? Dr. Homberg happily explained: “The prices of everything that you must have will escalate at a speed that you will not believe. The prices of energy and fuel will continue to spiral higher. Food and water prices will accelerate upward and will result in a lower standard of living for yourself, your family and your loved ones.”

It was a cheery afternoon, let me tell you. There’s nothing quite like sitting under crystal chandeliers in a decadent 100-plus-year-old salon, spooning your weichsel-chily kaltschale mit gebratener Steingarnele — a sort of cold soup with sour cherries, chili and roasted prawn — while also matter-of-factly chatting about the end of the world as we know it.

There are plenty of reasons to feel gloomy. But even Dr. Homberg allowed that there would be great opportunities to make a lot of money. “At least for the ones that understand the forces involved,” he added, “and have the courage to grab the opportunities that this process will create.” Homberg is financially independent, in large part owing to his deft investing since 2000. I’m proud to count him as a loyal reader.

Going forward, I think it will be important to stick with real assets during these inflationary times. I’ve got two very interesting ideas I’m researching now. Both of them are quirky oddball opportunities rich in tangible inflation-beating assets.

Also, in thinking back to the “I” cycle, the idiots eventually make way for the innovators, the winners in the next up cycle. Among the innovators in this cycle will be those who solve or ease the high cost of oil.

I’m currently reading an interesting book, Engines That Move Markets by Alasdair Nairn. It’s all about the history-making shifts of various innovations — canals, railroads, telephones, etc. In particular, the book focuses on their impacts on markets and investing. One early lesson is how people misread key events and missed great investments in the process.

One early quote stands out. The Quarterly Review in March 1825, noted: “What could be more palpably absurd than the prospect held of locomotives traveling twice as fast as stagecoaches?” Stagecoach and canal investors who doubted the power of the trains lost a lot of money. While the losers are easy to spot in retrospect, they’re not usually so obvious to investors at the time, as The Quarterly Review comment shows.

As far as identifying the winners of this process, that was also not obvious. The railroads proved poor investments for most. By the mid-1870s, 40% of American railroad bonds were in default. The real winners were the people who enjoyed the lower cost of freight — traders and merchants expanding into new markets. So, too, the winners in this crisis might not be so obvious.

Regards,
Chris Mayer
August 28, 2008

This article was originally featured on Whiskey and Gunpowder

Investing in Innovators