Sunday, July 31, 2011

Gold Stocks Versus Gold Bullion

In a period of rising gold prices, such as the last decade, gold stocks would be expected to perform well.  But the mining business is very difficult, and it is particularly difficult for large companies to increase their production, or even to maintain current production levels.  

There are various reasons for the difficult economics of the business.  As with the oil business, the easily accessible reserves have long since been exploited.  In addition, with a large base of current production, it is difficult to find new resources that are large enough to result in a material percentage gain in overall output.  In addition, production costs that include energy, raw materials, and labor, have increased steadily.

Newmont Mining’s latest earnings report illustrates the challenges.  Its net income per share rose only 1.3% over the prior year, even though the average gold price realized by the company rose 26% during the period.  Its production costs rose from $507 per ounce to $588.

I have long favored gold bullion, or financial instruments linked to bullion, to mining stocks.  Over the past five years, the price of gold has risen 150%, while Newmont’s share price rose 14% and the GDX Index of mining stocks rose 47%.   With a correction in the gold price in its eleventh consecutive year of gains quite possible and a potential decline in the stock market also likely in my opinion, I would trim or sell gold stocks and defer additional gold bullion purchases.

Steve Lehman

Friday, July 29, 2011

Multinational Earnings Growth Is Highly Dependent on a Falling Dollar

Aggregate profit growth in the U.S. has been impressive in recent years, in spite of weak economic growth over the past decade.  Of course this is due in part to more robust international operations of leading U.S. multinational corporations.  Coca-Cola, for example, derives approximately 80% of its profits from outside the U.S.

While Asia and South America have had faster economic growth than the U.S., Europe and Japan have been sluggish.  It is exposure to rapid growth in emerging markets that has provided a particular boost to the U.S. multinationals. 

I think, however, that investors don’t appreciate the substantial impact that the declining foreign exchange value of the U.S. dollar has had on the earnings of U.S. multinational corporations.

IBM is an example of a leading U.S. multinational that continues to increase its profits at an impressive rate.  Investors appreciate companies with strong profit growth, but they especially appreciate companies with consistent revenue growth.  IBM has become primarily a computer services business.  In the most-recent quarter, IBM’s servies revenue grew 10%, which is impressive in a developed-world economy that is still struggling.  But after excluding currency gains, the revenue growth was only 2%.

The conventional wisdom for some time has been that the U.S. dollar will continue to fall, with the only question being how rapidly and against which foreign currencies?  (I agree that would seem most likely.)  But the contrarian in me is uneasy with what seems to be so obvious.  What if the U.S. dollar would actually RISE in value, or at least hold its value?  Those optimistic earnings estimates for the S & P 500 would switch from a support for current stock-price levels to a substantial drag.

Steve Lehman

Monday, July 25, 2011

The Failure of Cash As a Store of Value: There Are Alternatives

For years, the policies Alan Greenspan and Ben Bernanke of setting short-term interest rates near zero percent have been perverse.  They have penalized the prudent (savers) by producing a negative real, after-tax return.  They have rewarded the speculators, who borrowed at near zero percent and levered up in various markets that offered a positive interest-rate spread (the “carry trade”).  This effectively removed a primary role of a nation’s currency—a “store of value.”

For those who were willing to reduce their liquidity and venture out with a longer-term commitment to earn an after-inflation yield of zero or more, yields of 3.5%-4.5% on intermediate- to long-term U.S. Government bonds haven’t seemed high enough to justify the risk posed by deteriorating Government finances.  It has been necessary to be creative in addressing this conundrum.

There have been two creative alternatives for protecting the purchasing power of cash reserves.  The first has been to purchase hard (or “soft” agricultural) assets, whose values have been rising because of imprudent central-bank policies and the decline in the foreign-exchange value of the U.S. Dollar.  Hard assets can be purchased directly, but there are storage and illiquidity issues from that approach.  Alternatively, there are exchange-traded funds whose prices are linked to assets such as gold, agricultural commodities, oil, and natural gas (among others).  The price of gold is up 35% over the past year, and the price of my favorite agricultural ETF (the Rogers Index—symbol RJA) is up 35%.  Now that’s a store of value! 

Despite the likelihood of a near-term correction after such a sharp rise, both gold and agricultural commodities remain attractive, as do other hard assets.  Gold will likely continue to rise unless the world becomes more peaceful and governments become fiscally responsible.  Agricultural commodities remain historically cheap on an inflation-adjusted basis compared to other goods and asset markets.  Oil faces increased scarcity, in my view, and natural gas prices are quite inexpensive on a BTU basis.  In addition, expansion of liquefied natural gas capacity will facilitate gas becoming more of a global fuel.  The price of natural gas is less than half what it was in the summer of 2008.  There is an ETF (symbol:  UNG) linked to the price of gas.

The second creative alternative to sitting on U.S. cash that yields close to zero is foreign currencies.  While institutional investors have ready access to forward contracts on currencies and to short-term government bonds in other countries that individuals cannot easily purchase, there are ETF’s linked to foreign currencies.  Various ETF’s linked to foreign currencies have been excellent stores of value over the past year.  Examples include the Australian dollar (+21%), the Swedish Krona (+13%), and the Canadian dollar (+9%).  Australia, of course, benefits from strong commodity demand, as does Canada, particularly from the rising price of oil.  Sweden, my preference relative to the Euro for several years, has a budget surplus and healthy GDP growth.

So there are alternative stores of value for investors.  After all, given the doubling of stock prices over the past two years and a sharp rise in corporate bond prices as well, it is prudent to keep reserves (a store of value) in anticipation of better investment opportunities in the future.   

Steve Lehman

S & P 500:  1340
Russell 2000:  837

Wednesday, July 20, 2011

Supervalu: Enlightened Innovation in a Prosaic Business

Corporate managements are placing a growing emphasis on sustainability.   There is a growing realization that a company’s business practices are critical in determining its profitability, ability to retain and attract desirable employees, and even its long-term viability.  A company’s environmental, social, and governance (ESG) considerations are a reflection of a company’s management integrity and ability to anticipate and respond to changes in the world.  Companies that are well governed have fewer problems with employees and regulators, and good environmental practices save companies money on energy and water consumption, and on waste disposal costs.

Supervalu, the grocery wholesaler and retailer, has several positive developments relating to ESG efforts.  On the environment, Supervalu has set aggressive goals to reduce its carbon footprint.  It is applying LEED standards to new construction and store remodels, which include fuel cell power, LED lighting, composting, and increasingly ozone-friendly refrigeration).  Last year it became the first U.S. grocery retailer to achieve “zero waste” stores with two new stores in southern California.  “Zero waste” is a threshold of 90% of all waste recycled, reused, or composted.  The new Supervalu stores achieved a 95% level.

Sustainability also enhances a company’s bottom line.  Last year, for the first time revenues from recycling exceeded the company’s landfill waste expense.  Their landfill waste expense was more than 12% less than in the prior year, largely due to an aggressive cardboard recycling program.

A particularly innovative initiative is a new store in California that generates 90% of its electricity from a fuel cell, which results in a 40% reduction in energy costs.  Fuel cells are one of the cleanest and quietest energy sources in the world, and are virtually pollution free.  The electromechanical process produces electricity, heat, and water without burning fossil fuels.

Supervalu is also the first retailer to join the World Wildlife Fund’s “Climate Savers” program through improvements in electricity, refrigeration, natural gas heating, and transportation fuels.  It also is a member of the EPA’s “GreenChill Advanced Refrigeration Partnership” and received the Partner of the Year award for altering its refrigerant to reduce emissions and lower carbon dioxide.  In addition, driver education has improved the miles per gallon of its distribution system.

Through it new store design, the use of LED lighting and the use of skylights with sensors that adjust electric light levels accordingly results in a 50-65% savings in electricity.   Their new stores also result in a water savings of 45%.

On social factors, Supervalu achieved the top rating of 100% on Human Rights Campaign Foundation’s annual Corporate Equality Index, for the fourth straight year.  The company was the first grocery retailer to achieve 100%--in 2008.

Supervalu also partners with World Wildlife Fund on sustainable seafood.

Also on social considerations, the company’s Nutrition IQ program helps to inform shoppers of healthful food options.   Last year Supervalu donated 60 million pounds of food (worth $94 million) through its partnership with Feeding America, the nation’s leading domestic hunger relief organization.

Aside from these laudable initiatives by Supervalu, the company’s stock is inexpensive and unpopular among analysts.  The price/earnings ratio on this year’s earnings is 7.3, only slightly more than half the multiple of Kroger and Safeway.  This clearly is a low expectations stock, though there are signs of a turnaround under its CEO, who joined the company from Wal-Mart in 2009. 

The dividend is well covered and yields 3.9%.  Though the debt load from its acquisitions in recent years is heavy, the cash generation has improved considerably.  The free cash flow yield after dividends on last year’s cash flow is 25%, which is probably why the company has been rumored to be a target of a private-equity takeover.

Steve Lehman

Monday, July 18, 2011

"Too Big to Fail" Should Mean Reduced Freedom to Maximize Profits

I have said for some time that little of substance has changed in the global financial system that would prevent another financial crisis comparable to that of 2008--or worse.  The largest financial enterprises, with approximately six lobbyists for each member of Congress in the U.S., have diluted regulatory reforms that were intended to strengthen the financial system.  

That is wrong on multiple levels.  Firms that are so large that their financial distress would imperial the entire financial system must have to pay a price for the systemic risk they pose.  They must be constrained from seeking to maximize profits, either by splitting them into two entities--(regulated) banking and (unregulated) investment banking, as recommended by Paul Volcker, or being required to set aside greater loss reserves than smaller firms.

Despite the lobbying prowess of the biggest financial firms, global officials might be on the verge of major positive reforms that would strengthen the global financial system and make another crisis less likely or at least less calamitous.  International regulators have approved the Basel plans for firms that are considered "too big to fail" without causing a collapse of the entire system.  The reforms would require the largest firms to hold additional capital in reserve against unforeseen losses.  In addition, unlike the 2008 crisis, bondholders would be required to sustain losses and writedowns so as to protect taxpayers from having to bail out the largest firms. 

The rules also would attempt to bring under regulatory oversight the "shadow banking system," which was critical to inflating the housing bubble with reckless lending, inadequate loss reserves, and massive losses to taxpayers.

Not surprisingly, Jamie Dimon and other CEOs of the largest banks are objecting to the proposed rules.  They contend that the reforms would constrain bank lending and hurt the economy.  Government officials must hold firm against this pressure.  For far too long, the biggest financial firms have operated in an ostensibly market system which, in fact, allowed private interests to reap profits but which dumped massive losses on public taxpayers.

If The Financial Stability Board of finance ministers, central-bank governors, and regulators can persevere against the entrenched power of the largest financial firms, taxpayers will be much better protected, and the integrity of the global financial system will be enhanced.

Steve Lehman

Friday, July 15, 2011

Stock Market Churning Near a Major Top or Poised to Break Out?

Stock prices in the U.S. have been bouncing up against major resistance for months.  The Dow Jones Industrials, S & P 500, and Russell 3000 seem to have made double, triple, or even quadruple tops.  This broad price action has occurred despite how on any given day, good news drives stocks up or bad news drives stocks down.  

The big picture is that despite record profits and a systemic bias to drive up stock prices, the market seems to have stalled out.  Raising cash for an ultimate reallocation away from small caps, consumer discretionary stocks, and even technology and toward multinational large caps, agricultural commodities, and emerging market equities and fixed income, seems advisable.

Steve Lehman

S & P 500:  1312
Russell 2000:  827

Thursday, July 14, 2011

Finally, Candor From the Fed Chairman

In congressional testimony yesterday, Ben Bernanke admitted that "We don't know where the economy is going to go."  I nearly dropped the newspaper as I read that.  What a contrast to the days of Alan Greenspan, who was considered an oracle despite his mediocre record as a private economic forecaster and consultant.  

Perhaps the financial crisis of 2008 humbled Mr. Bernanke a bit, along with the knowledge that not much has changed as a result of the crisis.  Wall Street and banks still call the shots, no major financial figures have been prosecuted for fraud, regulators still overlook huge systemic risk factors, financial firms are still insufficiently capitalized, etc.  And the Fed stands ready to prop up markets and the economy with artificially low interest rates, and who knows, buying of stock futures when stock prices decline more than a squiggle.

Steve Lehman

Monday, July 11, 2011

A Long-Term Opportunity in Agricultural Commodities

Market participants seem to be taking shorter and shorter perspectives, especially concerning agricultural commodities.   For example, periodic crop forecasts by the U.S. Department of Agriculture often cause sharp swings in commodity prices, regardless of broader supply and demand factors.  I think this is the case now.

A recent USDA report showed that corn and wheat plantings were larger than expected, as were inventory stockpiles.  In response, Goldman Sachs cut its corn and wheat price forecasts by 26%.  In the two days after the USDA report was released, corn and wheat futures prices fell by 8-9%.

According to a Bloomberg News story, U.S. farmers planted 1.8% more corn than projected by analysts, which is the second-highest amount of acreage since 1944.  Inventory stockpiles as of June 1 were 12% higher than forecast.

I think this recent price drop was an overreaction.  I have seen repeated instances of such short-term forecasts of agricultural prices that are soon made irrelevant—and wildly erroneous—by news of drought, or greater than expected demand, for example.  As with investing in general, the odds for success increase with the length of one’s time horizon (and decrease with one’s portfolio turnover).  This is particularly true for agricultural commodities.

The long-term factors driving agricultural commodity prices remain exceptionally positive for prices—though negative for the world’s poor.  The World Bank estimates that higher food prices have pushed 44 million more people into poverty.  It would be hugely positive if major crop producers would emulate what leading pharmaceutical companies do in providing their product either free or at sharply reduced rates to the poorest countries.

Global stockpiles of corn, the most-consumed grain, are forecast to drop to 47 days of use, the fewest since 1974.  Inventories are declining as demand continues to exceed supply (for a fifth straight year of record production).  Wheat inventories will drop to a three-year low, according to USDA estimates.

As for market participants, the 20-25% price drop in recent weeks for corn and wheat present an opportunity for long-term investors who are interested in protecting the purchasing power of their savings.  I expect agricultural commodity prices to rise over time at least as fast as inflation.  There are exchange-traded funds and exchange-traded notes that provide participation in agricultural markets, and particularly for investors who have no exposure to this area, I suggest building a position at current levels.

Steve Lehman

Wednesday, July 6, 2011

Solar Energy Gets a Boost—In the U.S.

Despite lagging other European and Scandinavian countries—and China—in promoting renewable energy, the U.S. government, a major independent power producer, and the largest industrial real estate company are giving a major boost to solar energy in the U.S.  It would be the largest rooftop distributed solar generation project in the world.

The Department of Energy is backing a loan to NRG Energy, an independent power producer, to support a  $2.6 billion distributed solar program in 28 states and Washington, D.C.  The four-year program will install rooftop photovoltaic projects with a total capacity of 733 megawatts on 750 industrial buildings owned by Prologis, the world’s largest warehouse manager.   The completed project would produce enough electricity for 100,000 homes and is estimated to create 10,000 full-time jobs in 28 states. 

The project would almost double the amount of grid-connected solar generation in the U.S.   NRG also owns the largest solar photovoltaic plant operating in California and has more than 2,000 megawatts of solar projects under development or construction across the U.S.

Though NRG still owns substantial legacy coal-burning generating capacity, the company is moving in the right direction.  As a signatory of the Global Reporting Initiative, it has made meaningful reductions in air pollution and water consumption, and it is shifting at the margin toward renewable energy. 

There are vast rooftop areas available for solar generation in parts of the country with ample sunshine, and this collaborative project demonstrates the potential for a more sustainable future.

Steve Lehman

Tuesday, July 5, 2011

Exxon Is Back in the News—Exactly Where It Does Not Want to Be

ExxonMobil is again in the news, as its pipeline that runs UNDER the Yellowstone River ruptured and more than 1,000 barrels of oil go who knows where.  Of course a company spokesman stated that the company will do whatever it takes to clean up the spill.  Now the company revealed that the scope of the leak is greater than first disclosed.   

The company would much rather quietly reap enormous profits and returns on capital away from the public and policy makers’ attention.  This is the company that for years fought in court to delay the imposition of penalties from its Exxon Valdez spill in Alaska, which until the BP disaster a year ago, was probably the worst corporate-caused ecological disaster.    This is also the company that runs those friendly TV ads featuring genial scientists who talk about their families and how they want to protect the environment for their kids.  That reminds me of the Chevron magazine ads that purport to show how much they care about indigenous people who are affected by their search for oil.  This is after their Texaco subsidiary poisoned thousands of acres of Amazon rain forest and led to premature deaths of those who were forced to drink and bath in water that had become contaminated by toxic effluents from the drilling process, yet the company vehemently denies responsibility.

The recent decline in national gasoline prices provides relief to strapped households, but from a national policy standpoint, it’s unfortunate.  Subsidized oil and natural gas that do not reflect their true cost to people and the environment will keep people hooked and delay the necessary conversion to renewable, sustainable energy sources.

Steve Lehman