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Monday, October 17, 2011

Rules of Engagement - Military to Uganda

Typically in my blog posts I have criticized our leaders for their economic policies but today I am diverging from that tack to raise awareness of an issue that arose on Friday. On Friday October 14, 2011 President Obama announced that 2 days prior he authorized 100 Combat equipped troops deployed to Uganda as “advisers”  to help regional forces  “remove the battlefield” against the LRA or Lord’s Resistance Army. Now granted the LRA is a despicable bunch and the atrocities that are occurring in Uganda and elsewhere in Africa are barbaric, but the question I have is, why is the US going there and why are people not upset about this?  


At first I did not think much about this announcement but last night I was watching a movie on TV with my son and it got me thinking. The movie was “Saving Private Ryan” a very well done film with an all star cast. The premise of the movie for those of you who do not know it is that Pvt. Ryan and his four brothers were all involved in various divisions of the military in different battles during WWII. As it turns out Pvt. Ryan was the last of the Ryan boys to survive and instead of allowing the family linage to be potentially snuffed out a group of American soldiers were charged with the mission of rescuing the young private from the battle in the European theater.  The thought was the Mrs. Ryan’s boy should be saved as she had sacrificed enough already.
This movie got me thinking about the sacrifices that our military and their families make each and every day and that because of their commitment and willingness to do violence on our behalf that we enjoy the freedoms we generally accept as “god” given. Whether it is me writing this blog , a tea party member giving a speech, Al Sharpton bloviating on TV, Occupy Wall Street protesting, or congress going about its business it has all been made possible by the commitment of generations of our military that have pledged to up hold the constitution and serve the President.
Back to Pvt. Ryan and its influence over today’s piece. The “Left” in this country was and is still angry at Former President George W. Bush for his involvement in wars, yet they and the media continue to give President Obama a pass on these things whether it is sending troops to Libya, not closing Guantanamo  and now Uganda. Dear reader don't get me wrong I am not on the "right" per se and I too was upset with Bush and his wars I felt were wrong then as I feel the actions today are wrong as well.  My issue is three fold 1) even in his statement the President made it clear that this was the first of several deployments, 2) what is the justification for insinuating our military men and women in harm’s way and 3) is it even constitutional?
“The forces will deploy beginning with a small group and grow over the next month to 100. They will ultimately go to Uganda, South Sudan, the Central African Republic, and the Democratic Republic of the Congo, with the permission of those countries.  The President made it clear that the mission to Uganda was but the first stop in some sort of African Military campaign. Note that he stated with the permission of the countries, yet not with the permission of Congress.
Unlike in Pvt. Ryan’s case where congress had declared war on Germany making it a legal action, therefore asking Mrs. Ryan to have her sons pay the ultimate price was justified.  The situation in Uganda is a Civil War and Congress has not declared war on Uganda.  Yes, there is reprehensible bloodshed and violence taking place in Uganda, but there is similar strife occurring in some 100 other locations around the globe, are we going there as well? Can we afford to in these times of Government Deficits? It looks as if Obama has his way we will be.
The bottom line is that it is a Civil war and we have no business being there. The US has provided training and support for militaries battling the LRA over the years, but it was just training and no troops were put in harm’s way. Now troops will be thrust in to a situation that has the potential to draw us further in to a conflict that is not of our own making or interest.  Even though the President has said that the Troops will not be engaging in combat unless it is self defense,however,  it is the nature of conflict that they will have to defend themselves and potentially get drawn into offensive measures as well.
The President cited as his justification S. 1067 [111th]: Lord's Resistance Army Disarmament and Northern Uganda Recovery Act of 2009. This aforementioned bill was passed by congress states “ providing political, economic, military, and intelligence support for viable multilateral efforts to protect civilians from the Lord’s Resistance Army, to apprehend or remove Joseph Kony and his top commanders from the battlefield in the continued absence of a negotiated solution, and to disarm and demobilize the remaining Lord’s Resistance Army fighters”. The resolution specifically says support and does not open the door to conduct missions, yet here we are.
The problem I have is that this is just another symptom of our rights, freedoms, and constitution breaking down. Moreover, just like the abrogation of bondholder’s rights in the “Government Motors” bailout this Uganda deployment it is symptomatic of the “get er done mentality” based upon someone's agenda, but it does not seem to be the American people's.
Part of what makes America great is that we are a nation of laws. These laws are what protect our freedom and allow our economy to function. Who would want to live or invest in a place where the law is constantly twisted to the special interest of the day or where your property is yours one day then the next you have no right to it. The continual chipping away at the very core of our system is leading us down the road to perdition like others before us, whether it be the Romans or the French of the Assignat period. Furthermore, one could easily argue that or economy will not recover or ever go back to the status quo if we can’t decide on a good course of action but rather keep shifting the rules.
It is most bothersome to me that we have a President that believes he is above the law and can make the decision himself to commit troops in to a hot zone without real authority. It is even more disturbing that we have not heard from any one of any authority questioning the legality of this maneuver by the President. Of course if it had been a Republican there would be riots in the media. The only one who has said anything publically has been John McCain and he is not even questioning the legality, instead he is just upset that Obama did not consult with Congress before hand.
Article One, Section Eight of the US Constitution states that Congress shall have the power to declare war, which in this case it has not. There are those that argue that the “War Powers Resolution of 1973” provides the justification for sending these “advisers” to Uganda, but it does not pass the sniff test.
 
Under the War Powers the President can commit the US to an armed conflict without the congress in cases of national emergency by attack on the US, its territories or military. The War Powers act goes further talking about “necessary and proper” which could be best understood as an explanation of what is the “clear and present danger “ to the United States.  Moreover, the War Powers also states that any action is to be limited to 60 days, plus an additional 30 days for withdrawal. Does it sound like this situation that our good men and women of the military are being asked to go in to will be a 60 day affair?
If you believe in the rule of law you need to call your Congress person and or Senator and do what Occupy Wall Street is attempting to do PROTEST!

Monday, August 29, 2011

Gold's Prophets Of Doom

Investing today is hard enough and just when you find a sector that you think will help your portfolio recover from the battering it has received over the past few years it falls apart. Investing in any sector of the market makes one feel a bit like the guy who drives the caged Jeep at the driving range collecting golf balls, while they know full well that people are teeing up with the full intent of being able to hit the moving vehicle with their drive, whether they admit it or not.  One of the arguments that is commonly used to justify why all of us sheeple should not be investing in the “metal of Kings” is that it is an emotional investment and requires a “greater fool” to drive it higher, as opposed to mainstream stocks that have earnings and cash flow to justify their valuations and when that is not enough we are to rely on tried and true valuation methods like eyeballs, hit counts or some other bogus metric.  The greater fool theory lives in stocks as much as in metals, where people delude themselves that the price they pay for a stock today will be worth more based upon assumptions of future cash flow that may or may not materialize.

If you are following my blogs or Twitter posts you have pretty good idea of where my thinking lies regarding the general economy and the stock market. I am by no means a gold or silver bug, although I do hold a percentage of assets in the metals via allocated closed end funds, along with other precious metal and regular equities.  I do understand and respect the value the metals bring to a portfolio, maybe because of my parents European background.

The lack of understanding and use of the metals in finances is really more of an American cultural bias partially driven by the FED, Wall Street, Government and misguided Keynesians. In many other areas of the world the metals are not only part of the culture but also have a place in finance.  People around the world view the metals as a store of value, something that can’t be printed up or debased at will by a government. To people around the world the metals provide the foundation of their savings and has for generations.  People in the US always use that tired statement that you can’t eat it and it doesn’t pay interest along with other Wall Street logic. You can’t eat stocks either and many of them don’t pay interest ie.. dividends.

Enough digression into my philosophy regarding the metals instead I want to focus on what is going on with them. As gold was making its run to $1,917.10 I could see the mood was becoming euphoric and began tweeting that one could contemplate putting on a hedge for safety’s sake. I am not pointing that out to gloat but instead to show that you need to keep a cool head while everyone else has stars or Dollar signs in their eyes. Of course we all know what happened gold hit is high and was trumpeted from the roof tops by CNBC and alike and then promptly began to decline. Yes things were getting a bit frothy but once the decline began I fail to see why the CRIMEX had to raise margins to exacerbate the decline. I find their excuse about curbing volatility (I know they have a formula) pathetic as they only seek to curb it on the upside but their requirements never seem to be concerned with the shorts and downside volatility doesn’t bother them, but that is a different story for a different day.

Let’s take a look at the situation since the drop. Gold has declined and out of the woodwork as usual came the bears or bearish minded people not that I mind them as it confirms for me that there still is another side to the trade and not everyone is onboard. After all you will need suckers to sell to at the actual top. Everywhere you turn now all you hear is that the “Gold Bubble” has burst and everyday there are calls by so called experts for lower and lower correction prices.  One must remember that these are the same guys that missed the run up and continually called the top for years.  As a gold investor one should welcome these corrections to be able to acquire more metal at a better price even though it is human nature not to want to see lower prices and profits temporarily eroded. The reality is that the Gold market was beginning to go parabolic and had this correction not occurred gold truly could have become a bubble and fallen below its intrinsic value. If gold did put in a exhaustion top then ask yourself where would you be safe to park your wealth and ride out the reorganization of the world monetary system?

Gold started this leg of it historic run on July 5th when it hit bottom at $1486.20 and peaked out almost 1.5 months later at $1,917.90 a move of $431.70. When trying to project where prices of various securities or assets are likely to go I have found that using Fibonacci retracements are a pretty accurate method.  

Fibonacci retracement is a method of technical analysis for determining support and resistance levels. They are named after their use of the Fibonacci sequence as discovered by Leonardo Fibonacci one of the greatest mathematicians of the dark ages. He noticed that certain sequences of numbers occur in nature and subsequently people who study markets have found use of his discovery.. The idea behind Fibonacci retracement is that markets or a security will retrace a predictable portion of a move, after which they will continue to move in the original direction

In the markets the Fibonacci retracement levels are 23.6%, 38.2%, 50%, 61.8% and 100%. Using Fibonacci levels helps one stay more focused on reality and tune out the doomsayers who are making outrageous calls. I am convinced that all these people that come out with these highly negative predictions are not only bearish on whatever they are making the call (for any number of reasons) but I believe that they are hoping to place a bet on an outlier. What I mean is they are trying to make a name for themselves and because they either don’t have enough knowledge to make accurate calls or they are gambling that they might achieve notoriety by having the outrageous miraculously materialize. No matter whether you have invested in Gold, Stocks, Bonds or whatever these guys and gals are always out there doing this sort of “bashing”.

Back to Fibonacci in terms of this gold run. The move was $431.70 from bottom to top. Below I have placed a chart showing the Fibonacci levels and the corresponding dollar value of the drop and the price at the specific level.

On this current correction the gold price retraced almost exactly 50% of its move which is a very common retrace for a large move. I had been expecting a retracement of 50% with an outside possibility of the 61.8% retracement since there was a breakaway gap at about $1,673 where the price had jumped higher. If you follow charts there is a saying that gaps get filled, and while they usually do there is not iron clad law that they must be filled. Regardless I thought there would be a possibility that a test of the 61.8% retracement in order for that gap to get closed. Instead what we saw was a pull back to the 50% level not once but three separate times in the same day before Gold bounced and put in what technicians would call a “hammer” indicating a trend reversal or bottom on Thursday accompanied by strong volume. The bounce on Friday was very healthy and also on excellent volume but in my opinion in typical gold fashion it overshot too much to the upside. I personally would have been happier if it would have had the same volume and closed around $1,785 and that would have set us up better for today, but as the Rolling Stones say “you can’t always get what you want”.

Today Gold dropped down in to the $1,780s which is over a 3% move to the downside, however, volume declined appreciably on the day indicating less selling. I know those who own the yellow metal would like to see it jump to the upside everyday but that is just as unrealistic as the calls for a drop to $1,250. Nothing goes up in a straight line not stocks, not planes not even gold can defy the laws of physics, for if they do go straight up they tend to fall back to earth with terminal velocity.   

Since Gold hit its current high on 8/23 I have seen a ratio of 13:2 bearish vs bullish articles regarding gold. The current situation reminds me more of the battle of gold $1,500 where back in January of this year the Barbarous Relic bottomed out at $1,309.10 on the 28th and then proceeded in a spectacular run to a high of $1,571.40 (5/2) a move of $262.30. Then like today Gold peaked out and there were any number of bearish articles and the metal retraced just under 50% of its move testing down to $1,462.50 on May 5th or a move of $108.90. At the May price level that $108 was about a 7% price swing. In the current correction the numbers are larger so the swing while roughly 3% greater in size the amount of dollars in the swing has doubled. I point that out because as gold continues to march to its ultimate peak the dollar value of the corrections will be larger and more dramatically reported  which will also serve to keep people out of the market as they will be feed a constant diet of why the metal is risky and they should fear it. Of course the swings in the purchasing power of their currency will be as extreme if not more to the downside and they like many throughout history will not understand why it is happening.

At the moment I do not see any meaningful changes in the world that would change the long term trajectory of gold or silver for that matter. All the fundamentals are still in place and those of you who follow this market or have read my many missives know the reasons that gold and silver are rising. The plain truth is that the metal just plain got ahead of itself and needs a rest before going into its seasonally strong period. After the drop in May it took gold a second retest at the beginning of July for Gold to kiss the $1.500 level good bye and get us to where we are today, and this took placeat the beginning of the summer traditionally the weakest period for the metals. It is my contention that the gold doomsayers are wrong and that the metal is going to consolidate around this area and possibly (although I think it is a low probability event) retest the $1,702 level before ramping up again. It would be healthy for gold to back and fill here for a couple weeks and build a base from which to recapture $1,900 and take out $2,000 in the fall seasonally a gold friendly time of year.

We have heard all the gold naysayers and their tired arguments and they sound like a broken gold record. At the moment the problem child EU is finishing off their vacation month and soon enough it will be back to business and I believe that is when the fireworks will restart, since the cracks are already showing and there like here things are only band aided or smoke and mirrors. The governments of the West are running out of road to kick the can down, but they will try. All of this is gold positive which is why I believe that much more support exists for the yellow metal than the naysayers believe.

Let’s look at the charts below :

This first chart is of the US Dollar. The Dollar is contained within this descending triangle and looks like it is biding time before it continues on its downward path. The Dollar is not in an oversold situation and while it has not broken down it really has not had the ability to rally with any significance. There are many that argue the Dollar is about to enter a multi month rally, but the chart does not say that to me.


The next chart is one of gold that has been circulating showing a head and shoulders top forming. I don’t buy this for a couple reasons. First, this formation only really shows on a line chart with end of day prices and it is short in duration. Second, head and shoulder tops especially when they are this small have a tendency to not get validated as they may not complete or may complete but still not be of significance. Moreover, look at the chart immediately following from 2009 when the gold market was arguably under a lot more downward pressure and you can see the same formation that the naysayers were touting then and they were wrong. Instead I would submit this is too easy and instead it is a bear trap.




Lastly let’s look at today’s gold chart in candlestick form where things look clearer to me. Gold opened today with the excess left from Friday’s continuation of the snap back rally and proceeded to drop. Notice the volume on the chart declined and the overbought condition is relieved on the RSI at the top of the chart.  Additionally the entire correction has still essentially occurred within the confines of the uptrend line and the supposed neckline from the head and shoulders intersects with the uptrend support at about $1.750.  My hope is that gold grinds sideways here and works off some of the remaining exuberance before continuing higher, but gold has a mind of its own and will do what it wants. If we do get a retest in price I believe it will be an opportunity to add or load more. To paraphrase Ronald Reagan, Ask yourself is the economy and the underlying situation that has brought gold to these levels any better now than when the bull market started? The answer to that question will determine if you will buy more on a dip or sell in to any panic.





Wednesday, August 3, 2011

Operation Twisted: Gold, the Swissie, Financial Repression and Annaly

The markets rebounded today and prevented the earning of the dubious distinction of longest down day streak set back in 1978 at 9. All three major indices finished up less than 1% but up none the less. Today Gold hit new highs today closing at $1666.30 after reaching as high as $1,675.90. Gold’s rise today was spurred by the economic situation and Switzerland’s decision to lower interest rates to try and weaken their currency.

There are few safe haven assets today besides the metals but the “Swissie” is one of them. The problem is that the amount of money flowing out of the Euro zone as well as other money from around the world seeking safe haven related to a growing distrust of FIAT currencies has been driving the “Swissie” to records. Yes, the Swiss Franc is a FIAT currency but the Swiss are known for their stewardship of the currency as well as being a monetary haven. Dear reader, if you think of Switzerland who still has a AAA credit rating along with a positive outlook but a GDP of about 550 Billion Swiss Francs and then think of the oceans of cash looking for a port in a storm and one can see why the “Swissie”  has appreciated.

The problem for the Swiss is that their currency has gotten so strong that it has caused a feedback loop of money seeking safe haven which continues to reinforce that strength. Ironically, just about a week ago I saw an article that described a proposal to have two Swiss Francs one of them backed by gold. Could you imagine how strong that currency would be versus how weak the regular “Swissie” would become.

Switzerland has a population of about 8 Million which is not large enough to have internal markets to support their industries, to do that a country needs around 30+ Million inhabitants. The Swiss economy is heavily export dependent and the strong currency is impacting their ability to compete for business. Remember that the manufacture of fine watches and great chocolates is only part of their economy and they have a very large and strong industrial sector as well.

As an aside before I went in to finance I ran a small manufacturing company that used to import machinery from a Swiss company. The machines that we imported were of very high precision and quality but the pricing was shall we say less than competitive with machines of the same size but lesser quality coming from Asia. The high price structure was due to the strength of the “Swissie” even at that time and the high cost of skilled labor there versus the same labor elsewhere in the world. The Swiss company ultimately went out of business and we acquired the rights and assets so we could continue to manufacture the machinery but here in the US. Even with the weaker dollar the labor costs of American machinists ate heavily in to our margins and while we were more competitive than our Swiss counterparts we were less competitive than manufacturers from the far East.

As a result of all the capital rushing in to the Swiss banking system and driving the value up action had to be taken. The Swiss have long been known as a business savvy and practical people so it did not surprise me to learn that that counter measure they took did not have to do with intervening in the markets like Japan regularly does.  The Swiss central bank instead decided to lower interest rates which made the “Swissie” slightly less appealing as a safe haven as some of the hot money may pull out seeking better yields elsewhere. This seems like a good strategy to me as not to undercut your currency but stem the flow with longer lasting results than direct intervention. The  problem for the Swiss is that their interest rate  is now basically at zero so they can’t pull that rabbit out of their hat again. This action by the Swiss National Bank is part of the reason for the strength in Gold and Silver today as another perceived safe haven takes it on the chin.

In addition to the Swiss actions today the rumor mill was fired up as there were rumblings of QE3 being discussed by various FED officials. The QE3 boogey did not cause but certainly aided the bounce off the lows today. As the markets were tanking out I decide to tune in CNBC again today to get a pulse of the mood. The prevailing mood was again a mixture of fear and despair as the stocks descended in to their lows and everyone from the hosts to the guests were bearish and expect further large declines.  I am not sure about you dear reader but after 8 days of declines it felt to me more like an exhaustion day and interestingly the volume increased as we came off the lows today. The consensus was that no one believes that this was a bottom of any kind, where as I get the feeling that the decline was manufactured since the markets got everything the wanted: no debt default, no tax raises, and no credit downgrade. The other fear over the past couple days was Italy’s debt status as they are considered “to big to bail” so fears of a contagion gripped the markets even though nothing really transpired there.

It would be my contention that what we have witnessed is the markets throwing a temper tantrum to cajole “B52 Ben” to fire up the QE3 bombers and give the order from HQ in Jackson Hole later this month. Now dear reader I have made my position pretty clear in the past that QE is a giant waste and serves no purpose other than to foster bubbles and bail out fat cats, but who is it that comprises the market? The QE programs have been a failure on so many levels but they did goose the markets didn’t they? I have also said that the next QE may not take the same form and most certainly will not be called QE. A new old euphemism has been circulating in place of QE called “Operation Twist” which is a rehash of the same ploy used 40 years ago in 1961. Essentially it is QE targeting certain duration of the yield curve to flatten it out. The net effect of Operation Twist, QE or Financial Repression is the same, to suppress interest rates and allow inflation to increase thereby reducing the size of deficits over time.

In this kind of environment safe havens like Gold and Silver (anti-debt assets) work well since you are dealing with negative real interest rates, cheap FIAT money and lots of debt. As I have stated in other missives companies that can grow their earnings and have a record of increasing dividends are also good candidates for this environment as I believe that for many investments dividends will be a major component of total return.

One stock that I have featured in the past is Anally Capital (NYSE : NLY) a stock that is commonly referred to  as an MReit or Mortgage Reit. Given that the FED has stated they intend to keep rates suppressed for an extended period a stock that pays a 14% yield is attractive and trades close to book value. Annaly is not the only MReit but in my opinion their management is top notch and has proven itself capable of navigating today’s tricky waters. I wrote an article recommending Annaly a while ago but I feel that the same rationale applies today, and you can read the article by clicking here. Others of interest in the Mreit space are Hatteras Financial (NYSE : HTS), Chimera (NYSE :CIM) (which Anally owns a big chunk of) and American Capital Agency Corp (NASDAQ : AGNC) . Each of the Mreits pays a high dividend but you should do your own due diligence as there are differences in how they get to those dividend numbers by the kinds of securities they deal in.

If you do buy in to the MReits you need to be aware that they can be somewhat volatile at times for a variety of reasons.  I have owned Annlay for well over a year and in that time the stock has trended higher over time and paid dividends but also there have been several price drops.  The most common reason for the drops in price that happened while I have owned the stock have come as a result of secondary offerings. The perception is that the secondary offerings are diluting the current share holders but that has not been the case. Instead of dilution  the capital raised by the offering is used to acquire more securities after all this is the method by which Annaly maintains market share and grows their own fees since they want to continue to make increasing sums of money just like you enjoy a salary increase.  A real risk to the Mreit is one of rising rates, since they do use leverage to achieve the high dividends they pay out, but in the current environment where the FED has telegraphed that its intention is to keep rates low the MReit should perform very well. The key will be not to overstay your welcome with an MReit. If one feels that rates are to rise then a new home should be found for your capital, until then you can enjoy the income.

The MReits have pulled back and are working their way back to equilibrium from a precipitous but extremely short lived crash. You see dear reader the Debt Ceiling debate, possible default,  potential US credit downgrade  and algorithmic machine trading all conspired one day last week to takedown the MReits. At the height of the Debt Ceiling Kabuki theater ,with the media publicizing every move of the legislative sausage making process the notion that Congress would not come to an agreement and actually default ran wild through the credit markets. MReits are interest rate and credit market sensitive instruments so the idea of a default caused a “no bid” scenario in the repo market and the next reaction was for the algorithms to kick in and sell off the MReits plunging some of them in excess of 15% in seconds. Fortunately, sanity returned to the market as the media flipped back to a story that no default would take place and the Mreits recovered much of their losses and today are almost back to the level they were at prior to the selloff. The other threat to Annaly or the other MReits would have been a credit down grade as that would have affected interest rates, but Fitch and Moodys both affirmed the US’s AAA status so that is not a problem at the moment.

I tell you this story because I want to highlight the potential scenarios you could face if you decide to invest in an MReit like Annaly. Armed with knowledge you will not panic when these situations play out and you can make clear decisions ahead of time and evaluate what is going on in the heat of battle.

Wednesday, July 27, 2011

“Plus ca change Plus c'est la même chose"—"the more things change, the more they stay the same.”

 The More Things Change the more they stay the same 
The more things change the more they stay the same 

Ah, is it just me or does anybody see 
The new improved tomorrow isn't what it used to be 
Yesterday keeps comin' 'round, it's just reality 
It's the same damn song with a different melody 
The market keeps on crashin' 
The more things Change – Bon Jovi (partial lyrics)


"Plus ca change Plus c'est la même chose"—"the more things change, the more they stay the same."
This familiar proverb of French Origin is credited to the novelist Jean-Baptiste Alphonse Karr (1808-90). I am sure the phrase is familiar to you as it has appeared in many instances from George Bernard Shaw’s “Revolutionist’s Handbook” to an utterance by Kurt Russell as he depicted “Snake Pliskin in “Escape From LA” the movie sequel to “Escape From New York”. Perhaps watching those films might be in order as if things continue on the current trajectory society could end up imitating art. Now please understand dear reader I am not an alarmist by nature but I do believe in looking at things from many perspectives.

The current Kabuki Theater as I have called it for the past few weeks in my Tweets continues to drag on and on far longer than I had expected. It is obvious to me that there is a dearth of leadership, economic knowledge, reality and cooperation by all parties involved. There is much talk about “sharing the pain” but whether it is coming from congress or comments on articles posted on the net the message is clear we should share the pain as long as someone else is getting the pain. In other words cut that program or increase that tax but don’t cut my program or increase my tax. Instead of sharing the pain or fixing the problems we are all engaged in this twisted form of “class warfare”.  I am not interested in the politics of the situation just the reality. The reality is that we are now subject to the laws of large numbers.

It does not matter how we got here or who is to blame because we are all to blame. We are all to blame because we have all benefited from the excesses of Government in one way or another. Really, how many of you reading this bought a car under “cash for clunkers” or a new appliance using “dollars for Dishwashers” or even a home with the $8,000 first time buyer credit? Even if you did not participate in those deals there are so many other areas where the government has been subsidizing throughout the economy that virtually everyone has contributed some to this mess whether they realize it or not.

 
Alexis de Tocqueville’s quote describes the point at which we have arrived in our society. "A government that provides total security for its people, foresees and supplies their necessities, manages their principal concerns, directs their industry, regulates the descent of property and subdivides their inheritance-what remains but to spare them all the care of thinking, and all the trouble of living.”  Along the same lines in 1917 Vladimir Lenin looked around at what he saw at the time and made some predictions that: “Germany will militarize herself out of existence, England will expand herself out of existence, and America will spend herself out of existence." These two individuals had the foresight to connect the dots as to the probable future outcomes; while it is ironic that the father of communism would be one of the predictors, he obviously had a grasp of human nature and government.

As I watch what passes for Government leadership and compromise I am brought back to an article I read back in 2009 when things seemed pretty dire, but at least at that time the government appeared to be functional. Today the Debt Ceiling deadlock has exposed a raw nerve that is a crack in the republic. The Wall Street Journal featured an article regarding the predictions of one Prof. Igor Panarin. Panarin a 52 year old professor is a former KGB analyst, as well as the dean of the Russian Foreign Ministry's academy for future diplomats. Needless to say Panarin is an expert on US - Russian relations. His prediction at the time of the article was that the US will split in to 6 separate regions by 2010. The regions are depicted in a graphic contained in the article. Back in 2009 when I read this I dismissed the theory out of hand and felt that Professor Panarin may be an expert but he is not an American so he cannot fully understand our republic. With each day passing I can see the divisions and fractures that are growing in the republic. While I still believe that the good Professor is wrong I will say it does feel as if we are accelerating down the path toward his vision as the rhetoric, vitriol and lack of cooperation grows in Washington.

Our leaders and government are making it impossible to work toward repairing our republic. Now please understand dear reader I have made it clear that I feel that both parties are to blame for this mess so I am not looking to pin blame on either side. I believe that neither party is competent or has our best interests at heart.  We all know that George W. Bush was a big spender and swung the country from the miniscule surplus, but surplus none the less, to some pretty large deficits.Of course people also fail to comprehend that just because there was a surplus does not mean that we did not havea large national deficit, but it was much more managable at that time. Not that I am defending Bush but after he took over he did have to deal with the tech wreck, 9/11, Afghanistan, Iraq, prescription drug program then the Lehman\subprime debacle. Obama has the continuation of Bush’s problems, auto bailouts, omnibus stimulus bill, Obamacare and Libya to name a few items. Due to the combination of circumstances and his own ideology Obama has been a big spender as well, but unfortunately for him we are much closer to the endgame and the spending measures don’t have the same effect as in the past.  To papprhase John Maynard Keyenes, "in the long run we are all dead" and we have arrived at the long run. Many people misinterpret the meaning of what Keyenes said as a live for today mantra, but that is not what he meant. Keyenes knew that the policies that he put forth and have been adopted as a psuedo religion would eventually undo the economy, but he also knew that the leaders of his day including himself would not live to see theaftermath.

The current Debt Ceiling debate and “deficit reduction” are a giant sham. To truly take care of this situation would require enormous pain on all ends from rich to poor. No politician alive with the goal of getting reelected will do the right thing, so we are condemned to a crisis before this is repaired. Congress has not put forth a budget in 2 years since Obama took office because instead of addressing real problems they had to both deal with issues in the economy as well as create massive new legislation which we have yet to see the unintended consequences of.   On the other hand Obama to his credit presented a budget back in 2010 that would have had us on a course for $1T deficits basically as far as the eye could see. Obama’s rosy ,if you can call it that, budget made some assumptions to get to the $1T mark. The budget was predicated on the assumptions that we cannot have a recession, the unemployment rate needed to fall from 9.6% to 8% and lastly GDP would have to grow 3.2% in 2010, 4% in 2011 and 4.6% in 2012. The people who made these budget assumptions have all subsequently bailed on Obama, probably because they all knew that this scenario could never happen.

This brings us to the Current situation which has rocked the confidence of the nation as we are on track this year to run a deficit of $1.7Trillion.  Tax Receipts account for about 2.2 Trillion of our roughly $3.9 trillion in spending for the year. Obviously because the assumptions were incorrect the deficit is larger than the $1Trillion projected and will be larger again next year if the economy does not improve. It is possible that the current projections will be off yet again and the Debt Ceiling will need to be addressed earlier than Obama or congress believes. Without front loading of real cuts any deal is suspect at best and I don’t believe will fix anything. First off looking at both the Boehner and Reid plans the “cuts” all come in the latter portion of the 10 year plan, which the next congress will at best modify or at worst ignore rendering them ineffective. Furthermore, the Government is the only entity in the world that can increase baseline spending but still call them cuts. You see dear reader if the Government is slated to increase spending by 7% but they agree to spend only 6.5% more then it is considered a cut, don’t you wish you could do that! Additionally, many of the savings in both plans are fictitious as they count things that may not happen but it is still a cut and savings you see, like money for ending the War in Afghanistan but not counting the action in Libya.

Even if it is not publically admitted the Republicans and Tea Party members have scored a huge victory for their side. They stuck to their guns and changed the direction of the dialog. If you notice dear reader that the original discussions had the Democrats and Obama looking for a revenue rise (..IE Tax increases) and no cuts for social programs. The Republicans were seeking the opposite side of the coin. Both sides were at least paying lip service to deficit reduction but without any real way to get to that end. The problem is so large that you can’t cut your way out without causing real problems for individuals and the economy. 

You can’t tax your way out, in fact there is a great YouTube video that explains this better than I can. You can watch “Eat The Rich” by clicking here. Politicians always use linear thinking when it comes to Taxes as they think if 10% tax brings in $100 then raising it to 20% will automatically bring in $200. The problem is something known as Hauser’s law which was coined by Kurt Hauser, Former Chairman of the Hoover Institution, at Stanford University. Hauser studied Federal Revenue as a percentage of GDP since WWII. What Hauser found was that regardless of the tax rates federal revenues hovers around 19.5 percent of GDP. This is because the higher rates influence behavior and result in lower growth levels for GDP and consequently tax receipts suffer. Hauser’s law is kind of like the law in physics that states nothing can travel faster than the speed of light.

So it appears to me that we are not addressing our problems and whether we passed either plan currently in congress we are just papering over the problems. We as a nation have been papering over things for decades so the powers that be believe that they can do it again just like before. It is kind of like buying a fixer upper house that has lots of holes in the walls but instead of repairing them you just put wall paper over it to make it appear fixed.  The rating companies like S & P or Moody’s know what the deal is and this is going to result in a downgrade in addition to more debt both of which will devalue the Dollar further acting as a tax on the economy and citizens. In many respects we have now entered a visious feedback loop that is extremely tricky to extricate the country from. Even without a downgrade it should be apparent to the whole world that we are not addressing our issues and this will cause the Dollar to decline, because the day of reckoning has not been averted but only postponed.

The US won’t default as tax receipts come in on a monthly basis that are adequate to service the debt and pay prioritized bills. The Default notion was tossed out by Obama and backed by Turbo Timmy as a political tactic to light a fire under congress to act and I consider it fear mongering which is what Bush constantly accuesd of(and I think he was guilty of it too). The law of unintended consequences reared its ugly head at a most inopportune time resulting in congress linking the debt ceiling extension to deficit reduction, based upon Obama's insistence as part of his move from the political left to the center. So instead of dealing with the two problems separately and calmly a crisis has been manufactured that is having unpredictable results. Markets are all over the map because uncertainty is the theme of the day and each time one of our leaders gets on TV to report the chasm between the sides it is like pouring gasoline on the fires of political machinations.

So with uncertainty on the rise here the markets are becoming unglued as there is not much good news to focus on since earnings are essentially done and the economic reports are not coming in so strong.  So what is an investor to do? For starters you need to keep a close eye on your portfolio and protect gains. One can buy some inverse ETFs to profit from a down turn and if you are comfortable you can hedge your positions with puts on the S&P or NASDAQ. It makes no differnece if either of the plans passes or the US defaults(very unlikely) I believe that we will see a further decline in the dollar which will drive precious metals even higher. Ironically if we the US does default it is possible that the Dollar could have a bust of strength up for a short period as a result of asset realignments around the world creating demand for dollars before the dollar resumes its decline. The stocks of companies that have pricing power and exposure outside the US will recover and rise as well.  My current plan is the same I am continuing to average in to Precious metals funds outside the US like Central Fund Of Canada (NYSE : CEF), Sprott Physical Gold Trust (NYSE : PHYS), Central Gold Trust (NYSE :GTU) and certain intermediate and exploration precious metals stocks. If you are looking to buy CEF, GTU or PHYS I have updated a spread sheet that was originally created by Jesse From Jesse’s Café American(a Gold site). The spreadsheet calculates on a delay basis the gold silver ratio as well as the premium or discount on the various closed end precious metals funds. If you are looking to acquire precious metals then you want to buy when the premium is the same or better than what you would pay for physical, so this tool will help you identify that situation.

 I am also in the process of making a shopping list of stocks and price points especially in the more blue chip and international names as this impasse will probably drive prices further down creating some tremendous bargains. Of course if you believe Professor Panarin I would not be worrying about investing as much as acquiring stuff you will need to survive, I am not there yet so let’s hope that our leaders can get their act together before it comes to that.

All the same we take our chances
Laughed at by time
Tricked by circumstances
Plus ca change
Plus c'est la meme chose
The more that things change
The more they stay the same

                Circumstances (Chorus), Rush

Thursday, July 21, 2011

Debt Ceiling, Delusion and Gold...

First off dear reader I must apologize for the tardiness of this missive as I was delayed due to prior family engagements that ran much longer than expected.

The topic that is grabbing most of the headlines is the “Debt Ceiling” solution. If you haven’t heard about this bit of Kabuki theater then you must be the neighbor of the guy in the “GEICO” commercial, who lives under a rock by the road, unaware that he can save money on his car insurance. All kidding aside the debt ceiling debate is more political show than true substance although they make it seem like more. The level of fear mongering seems to be rising by the day and it reminds me of those dark days in 2008 when then Treasury Secretary Paulson was depicted to have gotten down on his hands and knees begging Nancy Pelosi for “TARP” money. We all know how well the TARP package worked out and it stands as an example of how making decisions in a panic mode is never a good idea.

Everyday there are more and more articles released about the minutia of the wrangling around the Debt Ceiling debate. As someone once said there are two things so disgusting that one is told never observe them being produced, the first is sausage and the second is legislation.  Of course since this is a topic that I need to keep on top of I read every article that I can reporting on the Debt negotiations. The thing that strikes me is not the reporting or the two sides being so far apart on the method by which to resolve the problem, but instead the comments on each article. The comments section gives one an idea of where the public thinking is on the subject. As far as I can see the public is heavily divided and the comments reflect it. These comment sections degenerate in to the blame game where people from one political bent try to cast the opposite in a negative light blaming all of our woes on one party’s leaders or another, all of which is pointless to me.  

It is obvious to me that the general public, at least those that read articles on line are no longer adults but instead petulant children hell bent upon proving each other wrong. I say to all these people grow up as this infighting does nothing to move the dialogue forward nor does it get us any closer to solving our problems, whether on a message board or in the halls of Congress. If these people were in a fox hole during war time they would end up dead as they would not be able to work together and the enemy would come up and just shoot them as they argued. It doesn’t matter who did or spent what to get the US to this point but it does matter that we are not galvanizing to come up with a solution. I know we as a nation can come up with a solution for our problems if we would all put aside the past and look to the future.  To paraphrase Winston Churchill’s famous quip, “Americans will try everything but the right solution first but will ultimately do the right thing.” The problem is that we are actually running out of time to do the right thing and I am not just talking about Turbo Timmy’s August 2nd ultimatum but instead the law of large numbers where the debts and other figures become mathematically insurmountable.

Needless to say the debt ceiling and all the debates has an impact on the financial markets at least to some degree. With all the wrangling taking place and the appearance that there is a possibility of not coming to an agreement the markets have remained extremely calm. The common perception is that the two sides will hammer out a hodge podge proposal and the Government will be given an upward bump on their credit card to keep things going. I guess the question I have is what if those in Washington don’t do what the markets are anticipating? I believe that as the saying goes the stock market would become a market of stocks and many issues would decline where others would be much less affected and possibly even go up.

If the US were to default you could see the stocks of those companies like Flir Systems  (NASDAQ :FLIR) that derive a substantial portion of their earnings from the government decline. Additionally, a default would probably raise interest rates because investors would demand more compensation for the new risk associated with the formerly “riskless trade”. As a result of the rate rise stock sensitive to such things could get hurt as either their borrowing costs escalate or they are unable to get funding. The rise in rates would also kick the housing market in the teeth. While it would benefit savers in the form of increased yields it would decimate the baby boomers who have exited the stock market in droves and piled in to bond funds.

Around the world US Treasuries are considered a safe haven and in past crises investors have run to the Dollar and treasuries. This time around when treasuries are the epicenter of the storm I don’t foresee the masses diving headlong into the very assets that are defaulting.

 Ironically the US Dollar would probably be a beneficiary of a debt default as there could be a demand for Dollars as other assets are sold. The synthetic spike in the Dollar would be short lived in my opinion as people would be looking for other areas to park their assets. When a country defaults on its debt its currency becomes suspect and people look to exit to greener pastures.

The US Dollar is currently the reserve currency which has afforded the Government and the FED exceptional privilege in the past and I believe that may not be the case if there is a default. Reserve currency or not the Dollar is backed by the full faith and credit of the US Government in other words it is an IOU. How much is an IOU worth when the “ower” is in financial straits? Think of the down on his luck gambler who has exhausted their money and used up his “credit” lines. Is the House going to lend the gambler more or cut him off and force a payment? The same is true of the Dollar once “faith” is lost in the Government’s ability to back the Dollar.

There are many that argue the Dollar cannot be supplanted because it is such a deep and liquid market and there is no single currency to replace it. I agree with that statement except in the circumstance where the Government has destroyed the confidence in its ability to deliver on monetary promises.  In a world of US default , trading internationally would become more difficult as exchanges would have to be worked out between trading partners. A loss of confidence in the Dollar would hurt world GDP as it would force a decrease in trade velocity until a system of exchange could be implemented.

I am pretty sure that the powers that be understand that a debt default would be inherently bad for both the US and the world and I have to believe that the Congress will pass something and at the very least raise the debt ceiling, albeit in the 11th hour.

In the meantime there are at least 4 plans floating around  1) the Republican (cut, cap and balance), 2) The Coburn (Back in Black), 3) The Gang of Six plan and 4) Just get us to 2012(the kick the can plan or the McConnell/Reid plan). All the plans have inherent problems but I do believe that either a combination of elements or the “Gang of six” plan will make it through. While the “Gang of Six” plan is what appears to be in the lead it has issues and I don’t believe after reading the points that it will achieve anywhere near what is being touted. I believe that there are holes in the ideas big enough to drive a truck through, for example there is no real plan to come up with the initial $500 billion but it is up to each entity to review and propose cuts, I am sure dear reader that you can remember how well that worked when President Obama tired to get his own cabinet to find $100 million to cut. Additionally without any kind of amendment to force compliance in the future do you really believe that a future congress is going to be held hostage to today’s budget negotiations, I don’t.

As many of you have read my articles here and on my own site I advocate ownership of precious metals along with stocks as assets you need to protect yourself in the financial landscape of today. The $64,000 question is what impact does debt and the debt ceiling debate has on stocks and precious metals.  When congress passes the raise to the debt ceiling I believe you will see a rise in the general equities market as Wall Street will interpret the action as business as usual. Meanwhile I believe that the passage of the Debt Ceiling will cause a sell off initially in the precious metals markets and conversely a great buying opportunity.

Regardless of what is passed I think ultimately it will be perceived as kicking the can down the road. The deficits will continue to grow even as the economy grows just not at a fast enough clip to meet the assumptions laid out in any of the deals.  I also can foresee that as the deficit does not really get fixed but instead expands that gold and silver will continue to perform very well. Gold and silver are really the anti-debt and during periods of uncertainty and debt inflation especially coupled with negative real interest rates the metals perform very well. I am attaching a chart below that shows the rise in the deficit has fostered the rise in gold. As the events unfold and shake confidence in the FIAT regime the precious metals will grow stronger and tugged higher by the even larger debt.


It really is the “the best laid plans of mice and men”. What I mean is that until something forces the US to deal with its issues and prioritize what is really needed we will not get our house in order. Just look at all the plans proposed they all make rosy assumptions that will reduce the debt by large amounts but are they based in reality. Think back dear reader to when Mr. Obama proposed a budget that would have had the deficits falling during his term. His budget predictions were predicated on high GDP growth, lower unemployment and reduced borrowing none of which came to pass so consequently neither did the reduction in the annual deficit.  As Yogi Berra once said “predictions especially about the future are really difficult” and that is why I believe that regardless of what plan is adopted their assumptions are too rosy and they need to take a scalpel (or a chainsaw) to the budget or we will be having this conversation again in a few short months. The difference is in the future the conversation might be with a gun to congress’ temple.  Until I see the move toward positive real interest rates and a credible plan to reduce the deficit not a delusion I will continue to hold my precious metals.

Wednesday, July 13, 2011

Of Broken TVs And Netflix..

Just yesterday I drove 55 minutes through heavy rush hour traffic to retrieve my HD TV . You see dear reader, one night I was watching a show and the TV with no warning at all went black. As far as I can tell the set did not fall victim to a power surge, but instead had a “freak” situation occur internally. This started an odyssey in to the world of TV repair that I hope none of you ever have to face. I searched around to find someone to come to my home to repair the set and there were a couple of repair men that I spoke with. Well after a few calls I got one who was willing to come out and fix the set.

To describe the repair guy , Vlad, would be to say he was a nice Russian immigrant,  what I would call “hustler”. I don't mean hustler in a bad way but instead in the sense that he talked fast and moved fast but you felt a little uneasy with what he was saying. Dear reader, I am not picking on Russians as my wife has some in her background and I only mention it for color commentary purposes.  
You see I am pretty mechanically adept and have built computers and know how to repair many things mechanical and electrical, but I had never opened and HDTV. Once Vlad opened up the set  I recognized immediately that at least my Toshiba was essentially a large screen computer. I know how to check circuits but I deferred to Vlad as I was going to be paying him to fix the set. He quickly identified that the issue was the power supply board which I had suspected. So he told me  that he was going to order a replacement and we would pop it in solving the issue with the set.

Well Vlad disappeared and would not return phone calls so my set sat idle on our large living room coffee table. After a few days giving Vlad the benefit of the doubt I decided I could remove the board and get a new one myself. So I hopped on to Google and began querying for the part using the Toshiba part numbers. I discovered some interesting things in my search. First, there was a lack of any new boards from Toshiba and one supplier told me it was as a result of the earthquake, while another supplier informed me that Toshiba was no longer supplying those boards. Second, the supply cycle for replacement parts used to be quite long, I hate to date myself but I have a CRT based TV that I acquired new in college and was able to get replacement parts for 20 years after manufacture. My current HDTV I had to have in 2006 and 5 years after manufacture parts are barely available, is the part of planned obsolescence?
 I was not ready to give up on the set after all it cost a pretty penny and I do not want to go out and buy yet another set even though that is what Benny and Turbo Timmy would like me to do. Initially I tried EBAY to see if anyone was selling one of the boards from a parted out set they were unable to repair after putting a Wii remote or some such object through the LCD screen which carries an exorbitantly expensive replacement cost. No luck on EBAY and it seemed all the TV parts suppliers were out of stock. Not ready to give up just yet I stumbled upon a site that showed me the capitalist spirit is alive and well. The site tvparts4less.com offered a service that seems to be the only one out there (at least that I could find). In the true American entrepreneurial spirit seeing that there was a need the company rebuilds the power supply boards.  You send them your board and they send you out a replacement when they have the tracking number of your board.  In the ture spirit of American business the service and product were outstanding.

The board arrived via another outstanding American business United Parcel Service (NYSE :UPS) in a couple days. I popped the board in and thought I was home free. Of course on my Toshiba the way it relays a problem to you is what I refer to as the triple Blink red light of Death or TBRLOD. As soon as the set went to power up the TBRLOD appeared, so I was back to square one.

Trying to find someone who was willing to take the time to figure what else could be the issue was a task on to itself. After many calls and convoluted searches though Craig’s List I located a retired TV repairman, Rico, who works out of his basement for what he calls smoking money (what is it with TV repair guys and chain smoking?). So I hauled the set over to Rico's house several towns away. Within a couple minutes Rico had the set apart and had diagnosed another board buried inside had craped out as well. Once again the challenge was going to be getting the part. Fortunately, one of the suppliers that Rico uses had one board of the kind I needed so the story has a happy ending.

Living without a TV for several weeks allows one to do other things with their time, but I have this habit of watching documentaries on a variety of topics before I go to bed. Needless to say without a TV one has to use other methods to get their fix. My choice was to utilize my laptop and stream Netflix (NASDAQ : NFLX).  Honestly I am fortunate that I enjoy the documentary genre as Netflix streaming options are shall we say not up to snuff in other areas.  
Today Netflix announced its plans to separate its streaming and DVD monthly plans which for some customers will result in a 60% price increase to maintain their current level of service. This announcement comes on top of a price increase just 8 months ago.  So now you have the “choice” to get unlimited streaming for $7.99 or unlimited 1 DVD out at a time for an additional $7.95. Netflix then sent out an email announcing the changes and the manner in which it has transpired has left a bitter taste in many consumers’ mouths including mine. Apparently I am not alone as the Netflix blog has some 8600 + comments at the time I am writing this and the count on their Facebook page stands north of 42,000 comments. On both sites the comments are overwhelmingly negative with members indicating that they were unhappy and either had cancelled or intend to cancel their service.

It seems that people myself included don’t see the value for the consumer in separating the services. In essence Netflix is requesting that you pay an additional $7.99 without any additional improvement in service. Netflix blog site explains the pricing structure and states  We hope one, or both, of these plans makes sense for our members and their entertainment needs.” Clearly judging by the reaction Netflix missed the mark in customer satisfaction. In the next paragraph they glibly write, “As always, our members can easily choose to change or cancel their unlimited streaming plan, unlimited DVD plan, or both by visiting Your Account.” It appears like many members are following their advice by canceling.  To put things in perspective Netflix has 23 million subscribers and so far only about 50,000 have voiced their opinions on the available outlets, but one should also not forget that this is still day since the announcement.

Many analysts are dismissing this outcry by saying things like once people sit down and think about the dollar value they will not leave Netflix. I beg to differ with the analysts in this case. In an economy where it has been reported that at dollar store revenues are down because the people who used to come in with $12 dollars to do their purchases have cut back to $8; people could jettison a service that they perceive is no longer a value for the buck. The same analysts argue that customers won’t leave the Netflix ranch because there is no competition, once again I disagree. There are alternatives to Netflix like Vudu and Hulu which both stream recent movies and TV.  Hulu Plus is around the same price of Netflix streaming and has a somewhat different content mix, but people might just opt to switch in protest. Vudu provides a wide selection of first run movies in 1080P HD which Netflix doesn’t offer, however, the cost is $2 rental for 2 days. Unless one is a DVD power watcher more than 4 dvds a month then the cost is the same for the privilege. In my own situation there are times where we watch more movies than others but it would be cheaper to go with VUDU on average. Additionally you have no monthly fee for the privilege of using VUDU. There are other services like Cinema Now and one for Amazon (NASDAQ :AMZN) so one can investigate those as well. For the DVD diehards there is Redbox which is a DVD vending machine that is a division of Coinstar (NASDAQ :CSTR).

Essentially the analysts and Netflix itself live in a static world where they don’t see that the barriers to entry are not that high. This move by Netflix is being lauded by the sell side analysts but it from my perspective it appears that the brand loyalty is what they are banking on keeping customers, which I don’t think will be enough. Given the alternatives and with Netflix raising the price it provides ample incentive for an Amazon or other competitor that has the capability of Netflix to come in and undercut them.  Once a company reaches a certain level of hubris they end up losing customers just like broadcast TV lost out to cable and in turn cable has lost to satellite. It doesn’t always have to be this way, for example look at Apple (NASDAQ :APPL), who competes by gong to extreme measures for customer service , quality and design. Apple essentially creates both brand loyalty and a barrier to entry against multitudes of competitors.

 Does this mean that Netflix will crash immediately, well the answer to that is no. But Neflix sports a pretty lofty valuation of 85 times earnings and the future stock price gains are based upon some fairly strong estimates of growth and earnings. The backlash developing over this perceived highway robbery could cause a stumble in Netflix and given the high valuation the fall could be spectacular.

At the moment most are very optimistic about Netfix as investors continue to see more and more dollar signs, and price the stock to perfection. As of this point in time I think Netflix will run higher because it can. If I were a shareholder in Netfix I would keep one eye on the stock and my finger on the sell trigger to protect profits.  As for me I am leaning toward canceling my own account and moving to other services. You see it is not that I can’t afford the extra $7.99 but it is the principal of it. I don’t like it when I am asked to pay an excessive amount for no new or improved service or product. It would seem that there are somewhere in the neighborhood of 50,000 members that agree with me.

Wednesday, July 6, 2011

The Beef Stops Here...

Taking time off for the July 4th weekend was probably one of the best decisions I made all year. It is incredible how one can get caught up in the day to day minutia of the markets and you don’t even realize how cluttered your mind becomes with information. The longer you go without taking a break to recharge the old batteries the more you become like those Bing! search engine ads with the people spouting off useless information when asked a question. So for me and the family it was off to one of the best summer places I can think of in New England, which would be Narragansett, RI.

 I won’t go in to much detail about Narragansett except to tell you that it is a wonderful town to vacation in during the summer and the town beach is perhaps one of the best family friendly beaches I have ever been to. The beach itself is a wonder of nature with a long stretch of white sand bordered on one end by the old Seawall and the Narrow River on the other end.  There really is something for everyone there from surfing, building sand castles, floating in the river to just sitting with your beach chair in the water as the tide goes out.

Well to make a long story short while down in the Isle of Rhode we were searching for a place to get a roast beef sandwich quickly as in fast food.  Initially we were told that we should try Walt’s roast beef a local “mini” chain but the nearest one was too far. At this point we decided to check and see if there were any Arby’s located nearby as they have been affiliated with Wendy’s for a while and I would have thought there would have been more locations nearby. So after doing a little searching I found out two things first that the nearest Arby’s is located in Massachusetts and that Wendy’s was also miles away.

Now I have followed Wendy’s stock for a while as I have long felt that in this down economy fast food places would benefit as a result of their ability to provide larger portions of food at less cost than healthy alternatives. It is sad but true that there are many among us who are either filling in meals or forced to essentially live off “the dollar menu.”.  The trend is what it is and it has and continues to enrich the shareholders and owners of companies like McDonalds (NYSE :MCD) and Yum Brands (NYSE :YUM).  I am not looking to get in to the negative health aspects for those that do utilize fast food as a staple as there are many issues , like obesity or excess sodium. Fast food is just that a meal on the go and I don’t believe that it was ever intended to be a lifestyle choice but unfortunately economics sometimes trumps good decision making.

Back to Wendy’s which has been in existance since I was a kid. In keeping with the spirit of July 4th the story of Wendy’s depicts a true American success story. The founder Dave Thomas started Wendy’s in 1969 in Ohio and became a household name just a few years later.  Thomas focused on quality and presented himself in many of the ads. Wendy’s first giant leap in popularity came in 1984 with the unbelievably popular and very humorous “Where’s the beef?” campaign. For those of you too young to remember the commercial featured a then elderly lady, think it could be your grandmother, looking at a very skimpy burger asking the now famous question. As a result of the commercials the Wendy’s franchise grew nationwide. 

Later on by the 1990’s Thomas was out in front of the cameras doing his own commercials and his folksy style connected with people and Wendy’s continued to grow.  By the time Thomas died in 2002 he had appeared in some 800 commercials and 9 out of 10 Americans knew who he was and his restaurant chain.

Triarc a holding company, run by Nelson Peltz, was attempting to change itself from a holding company in to a true food company.  Over the years building the food empire Triarc acquired Snapple, Royal Crown Cola, Mistic Brands and Cable Car Beverage Company.  In 2008 Wendy’s International was acquired by Triarc in an attempt to become a full service food and beverage company. The acquisition of Wendy’s added about 5,200 restaurants to the Arby’s Group’s holdings of 3,700 locations.

 Triarc brought together the Wendy’s and Arby’s brands, but the latter has been a drag on earnings for a long time. Then on June 13, 2011 it was announced that Wendy’s\Arby’s group was selling the majority of its Arby’s chain to Roark Capital Group, although they will retain an 18.5% stake in Arby’s. Retaining the stake allows them to participate in some of the upside should Roark engineer a turnaround.  Roark is spending $130 million in cash and assuming $190 million in debt to acquire the Arby’s business. In the meantime Wendy’s appears to be the value trading essentially at book.

The problem for Wendy’s is both that Arby’s was underperforming and they had lost their focus. The latest ad campaign “You know it’s real” is an improvement over some of the prior ones. If Wendy’s can get back to focusing on the core business and the “mop bucket” mentality that Dave Thomas brought to the fore then a turnaround is in the making. Wendy’s will have to look at its menu and offer the old classics and introduce some new items to draw in new customers. Over the years Wendy’s has stressed the idea of fresh and better quality and in this author’s opinion the management needs to raise the stakes to compete.  Wendy’s has fallen from the third largest fast food chain just a few years ago  to number 7 at present so there is room to grow.

So what this all boils down to is two things. First, the question is whether management will stay focused and make the right decisions to bring Wendy’s out of its funk. They have to execute as management no longer will have the crutch of Arby’s lackluster earnings and sales to hide behind.  Second, Wendy’s will have to evaluate their business model to see what is working and revamp that which is not in order to improve margins .

With the off loading of Arby’s I believe Wendy’s is in a competitive position and will have reduced its debt load as well as gained an infusion of cash. The market apparently agreed as the shares surged today almost 5% on more than double normal volume. Looking at the weekly chart for Wendy’s the stock has been in a chop with a slight upward bias above its 40 week moving average. The daily chart is no work of art and one can clearly see the choppiness and the near term bottom established with the June 13th announcement of the Arby’s divestiture.

 Today’s breakout on heavy volume looks good and if one is so inclined to speculate on a turnaround story then you could take a flier on Wendy’s.  I would keep the position on a tight leash and pay no more than $5.75 using a 15% trailing stop. If management has learned from the 3 year union that has ended in divorce then the growth potential is there. Wendy’s has many obstacles to overcome but the potential is huge. Maybe we will not be asking “Where’s the beef?” but instead “The Beef Stops Here!”
Wendys - Daily Chart Click on Image to enlarge


Wendy's Weekly chart - Click to enlarge

Pictures of Narragansett Beach if anyone is interested

The Famous Narragansett Towers and the old Sea wall in front..
Beach with the Narrow River in the backround



Some surf too
Looking from the Narrow River back to the beach