Latest Jim Rogers Commentary 7/27/08

Jim Rogers' latest words of wisdom

Circumventing Bank Failure Risk

As IndyMac Bank falls, many have witnessed the very real threat of fundamental bank risk, and should take action to hedge against it. As countries like Australia, New Zealand do not offer insurance against bank failure; and the American FDIC remains (very) limited with funding, this calls for an initiative.

Solution Abstract

Since no bank openly admits to having serious fiscal concerns just before crumpling, it makes the risk impossible to assess with certainty for most. Despite that, with a bit of ingenuity and legwork, practically anyone can preserve wealth in the bank, and potentially making a profit.

The solution then centers at gaining value off worst case scenarios to offset the loss in deposit. It is about losing nothing even if the involved bank collapses spectacularly.

Shorting the Bank

Short positions of stocks allow traders to profit off value decline, close to 100% return in the event of corporate bankruptcy. The depositor in this case, let’s say “Bob”, could (through a direct access broker) open a short position against the specific bank stock.

As long as the short position equals in value compared to the bank deposit, fundamental bank risk becomes non-existent. Risk instead, has been reduced to the form of upside market volatility.

Potential Outcomes

Let’s say Bob decides to leave half his wealth at bank X, and use the other half to short bank X stocks. Several outcomes could entail.

1) The bank survives the real estate storm all the way through the credit crisis, and the short position roughly breaks even. Bob makes a return off the interest from the bank account and ends the period with a small net profit.

2) The bank takes a beating, but manages to survive due to some sucker investment institution injecting capital. The stock price suffers, where Bob covers short position and takes trading profit along with interest earned at bank X.

3) The bank reaches its last breath, yet the government steps in and bails it out. In this scenario, the stock price plunges. Bob makes a killing off the short position while preserving the bank deposit along with interest earned.

4) The bank collapses, say in a country with no FDIC. Bob loses the entire bank deposit, but makes 100% off the short stock position. He ends up roughly break even, less transaction costs.

5) Last scenario. However unlikely this may unfold, if Wall Street decides to suddenly apply ethical conduct, Mid East tensions ease, oil prices plummet, and the US Federal Reserve halts inflation, the stock market could rally.

In this outcome, Bob loses some capital off the short position based on average volatility, yet it would still remain a relatively miniscule sum to the potential loss of a naked bank account collapse. (See this for why upside stock moves are relatively mild.)

The economy is in turmoil. Banks are not “safe” anymore.

Statistical Moments of REAL Stock Return Distributions

Jeffery Owen Katz, Ph.D. and Donna L. McCormick (Advanced Option Pricing Models) conducted a statistical moment analysis of stock returns for 2,241 stocks, segmented over something close a decade (since Jan 2, 96). They then compared the results to simulated, Monte Carlo stochastic distributions popularly assumed in many financial models, some interesting results came forth.

Sample Mean Comparisons (5-bars, 20 bars)
Values measured in terms of Standard Deviations, or Z-score.

Growth
Real: (0, 0.001)
Simulated: (0, 0)

Volatility
Real: (2.189, 4.217)
Simulated: (2.225, 4.378)

So far so good.

Skew
Real: (-0.035, -0.051)
Simulated- (-.001, 0)

Kurtosis
Real: (1.093, -0.273)
Simulated- (0.009, -0.395)
-------------------------------------------------------------------------------------------------

Conclusions
Real expected returns over in the long run seems to concur with existing beliefs of randomness, where real (before inflation) returns remain at zero, and volatility roughly multiples of square-root of time elapsed.

The skew and kurtosis values do not agree with conventional assumptions of stock price movements following a Monte Carlo stochastic style. More importantly, the negative skew value reveals a key many public investors will never understand, that the stock markets, like a casino, gives a slight edge to those who bet on the downside (short sellers).

Kurtosis on the other hand tells a much more realistic picture of the markets. Price rarely move in a nice and smooth fashion. Instead, they either crawl at a blistering pace, or jump/dive spectacularly, and the high short-term kurtosis tells it like it is.

The skew of a statistical distribution measures relative asymmetry, and in this case a negative value reveals a fatter tail to the left hand side. It suggests that yes, stocks tend to go up a bit more often than down, but when prices drop they move more violently. This explains why in bearish periods, average investors tend to lose their shirts, short-exclusive funds make fortunes, and in bullish moments crowds make relatively "small" returns, but are happy, while the downside betters sit quietly.

SPY Distribution Skew VS. Monte Carlo Simulation (1bar, 10bar,20bar)
Real: (-0.287, -0.513, -0.377)
Simulated: (-0.005, 0.0370, 0.253)

The stock indice return distribution further supports the notion. Stocks come down hard, serious traders should embrace this truth.

Once understood, it becomes clear why professional traders favor shorts instead of long positions. Of course it is not very politically correct, then again what has political correctness done for you lately?

A Gas Station For Traders

Floor Traders In Action (HK Futures Exchange)

All I can say is "HOLY S#$T!"

Economic Policy Parody (From The Onion)

This is pretty funny yet holds a lot of truth.

From The Onion

Recession-Plagued Nation Demands New Bubble To Invest In

WASHINGTON—A panel of top business leaders testified before Congress about the worsening recession Monday, demanding the government provide Americans with a new irresponsible and largely illusory economic bubble in which to invest.

"What America needs right now is not more talk and long-term strategy, but a concrete way to create more imaginary wealth in the very immediate future," said Thomas Jenkins, CFO of the Boston-area Jenkins Financial Group, a bubble-based investment firm. "We are in a crisis, and that crisis demands an unviable short-term solution."

The current economic woes, brought on by the collapse of the so-called "housing bubble," are considered the worst to hit investors since the equally untenable dot-com bubble burst in 2001. According to investment experts, now that the option of making millions of dollars in a short time with imaginary profits from bad real-estate deals has disappeared, the need for another spontaneous make-believe source of wealth has never been more urgent.

"Perhaps the new bubble could have something to do with watching movies on cell phones," said investment banker Greg Carlisle of the New York firm Carlisle, Shaloe & Graves. "Or, say, medicine, or shipping. Or clouds. The manner of bubble isn't important—just as long as it creates a hugely overvalued market based on nothing more than whimsical fantasy and saddled with the potential for a long-term accrual of debts that will never be paid back, thereby unleashing a ripple effect that will take nearly a decade to correct."

"The U.S. economy cannot survive on sound investments alone," Carlisle added.

Congress is currently considering an emergency economic-stimulus measure, tentatively called the Bubble Act, which would order the Federal Reserve to† begin encouraging massive private investment in some fantastical financial scheme in order to get the nation's false economy back on track.

Current bubbles being considered include the handheld electronics bubble, the undersea-mining-rights bubble, and the decorative office-plant bubble. Additional options include speculative trading in fairy dust—which lobbyists point out has the advantage of being an entirely imaginary commodity to begin with—and a bubble based around a hypothetical, to-be-determined product called "widgets."

The most support thus far has gone toward the so-called paper bubble. In this appealing scenario, various privately issued pieces of paper, backed by government tax incentives but entirely worthless, would temporarily be given grossly inflated artificial values and sold to unsuspecting stockholders by greedy and unscrupulous entrepreneurs.

"Little pieces of paper are the next big thing," speculator Joanna Nadir, of Falls Church, VA said. "Just keep telling yourself that. If enough people can be talked into thinking it's legitimate, it will become temporarily true."

Demand for a new investment bubble began months ago, when the subprime mortgage bubble burst and left the business world without a suitable source of pretend income. But as more and more time has passed with no substitute bubble forthcoming, investors have begun to fear that the worst-case scenario—an outcome known among economists as "real-world repercussions"—may be inevitable.

"Every American family deserves a false sense of security," said Chris Reppto, a risk analyst for Citigroup in New York. "Once we have a bubble to provide a fragile foundation, we can begin building pyramid scheme on top of pyramid scheme, and before we know it, the financial situation will return to normal."

Despite the overwhelming support for a new bubble among investors, some in Washington are critical of the idea, calling continued reliance on bubble-based economics a mistake. Regardless of the outcome of this week's congressional hearings, however, one thing will remain certain: The calls for a new bubble are only going to get louder.

"America needs another bubble," said Chicago investor Bob Taiken. "At this point, bubbles are the only thing keeping us afloat."

"Buy, Hold & Hope" Fails For Gurus

In a volatile period such as now, those who exploit real market inefficiencies (e.g. me) tend to outperform everyone else. Hell, even if I only break even, I'd still beat all these "investors" (someone who buys, holds, and lives off hope, often without a clue).

Here's a list of performance via large investors from Seeking Alpha. Sad to see George Soros on that list, I had read and found his book, Alchemy of Finance quite interesting.

all data is as of June 27, 2008:

Manager…………………. 6-months ……………..... 12-months

Marty Whitman ……….. ( - 43.38% ) ………………( - 34.61% )

Mohnish Pabrai ………... (- 41.20% ) ………………( - 36.88% )

Bill Miller ……………… ( - 37.05% ) ……………... ( - 40.90% )

Joel Greenblatt ………… ( - 37.00% ) ……………… ( - 37.00% )

Eddie Lampert ………… ( - 28.95% ) ……………… ( -33.94% )

Robert Bruce ………….. ( - 25.00% ) ………………. ( - 19.16% )

Bruce Sherman ………… ( - 24.68% ) ……………… ( - 30.55% )

Charles Brandes ……….. ( - 24.58% ) ……………… ( - 29.51% )

Robert Rodriguez ……… ( - 22.20% ) ……………… ( - 17.75% )

Mark Hillman ………….. ( - 21.53% ) ……………… ( - 25.40% )

Carl Icahn ……………… ( -21.00% ) ………………. ( - 3.98%)

Edward Owens ………… ( -20.94% ) ………………. ( - 16.74%)

Irving Kahn ……………. ( - 20.75% ) ………………. ( - 24.68% )

Brian Rodgers …………. ( -20.48% ) ……………….. ( - 24.68% )

Arnold Schneider ……… ( -20.39% ) ……………….. ( - 27.25% )

Bill Ackman …………… ( - 19.38% ) ………………. ( - 23.06% )

Chris Davis ……………. ( - 19.17% ) ………………. ( - 19.75%)

Bill Nygren ……………. ( - 17.80% ) ………………. ( - 27.96% )

Richard Snow …………. ( - 17.68% ) ………………. ( - 19.77% )

Hotchkis & Wiley …….. ( - 17.28% ) ………………. ( - 25.02% )

Richard Pzena ………… ( - 16.27% ) ………………. ( - 25.22% )

David Dreman ………… ( - 15.82% ) ……………… ( - 11.87% )

Tweedy Browne ………. ( -14.73% ) ………………. ( - 17.23% )

Arnold Van Den Berg … ( - 14.67% ) ……………… ( - 22.32% )

Robert Olstein ………… ( - 14.46% ) ……………… ( - 21.05% )

Wally Weitz …………… ( - 14.31% ) ……………… ( - 23.00% )

Third Ave. Mgt. ………. ( - 13.84% ) ………………. ( - 11.83% )

John Rodgers …………. ( - 13.57% ) ………………. ( - 21.47% )

Mason Hawkins ………. ( - 13.51% ) ……………… ( - 20.88% )

Dodge and Cox ……….. ( - 13.17% ) ……………… ( - 15.01% )

Bruce Berkowitz ……… ( - 12.26% ) ……………… ( - 3.68% )

David Swensen ……….. ( - 12.19% ) ……………… ( - 12.23% )

Ron Baron …………….. ( - 11.70% ) ……………… ( - 12.80% )

Ian Cumming ………….. ( - 11.05% ) ……………… ( - 11.68% )

David Tepper ………….. ( - 10.68% ) ……………… ( - 14.87% )

Jean-Marie Eveillard ….. ( - 10.62% ) …………….… ( - 7.23% )

NWQ Managers ………. ( - 10.46% ) ………………. ( - 13.39% )

Ron Muhlenkamp …….. ( - 9.58% ) ………………… ( - 13.39%)

Glenn Greenberg ……… ( - 9.45% ) ………………… ( - 15.22% )

Michael Price …………. ( - 9.26% ) ………………… ( - 13.87% )

Tom Gayner ………….. ( - 9.19% ) …………………. ( - 17.50% )

Richard Aster ………… ( - 6.73% ) …………………. ( - 5.00% )

George Soros …………. ( - 6.56% ) ………………… ( - 9.43% )

Ruanne Cunniff ………. ( - 6.40% ) ………………… ( - 10.61% )

David Einhorn ………... ( - 5.91% ) ………………… + 3.18%

Chuck Akre …………… ( - 4.00% ) ………………… ( - 11.08% )

Warren Buffett ……….. ( - 4.00% ) …………………. ( - 3.60% )

Bad Time For Martial Arts Industry

3,200 martial art studios closed shop in May alone. Found the following article at Tracy's Business Guide to Survival. Enjoy.

--------------------------------------------------------------------------------------------------

For too many studios my advice will be too late

3,200++ Martial Arts Studios went out of business in the month of May alone.

In the history of Martial Arts in the United States - nothing like this has ever happened. In one month about 20% of all studios closed their door. Most will never reopen! Most should never been in business to start with.

Fact: Starbucks is closing 600 locations this year because people cannot afford to pay $3 for a cup of coffee.

How do studio owners - especially those with 90% kids expect parents to pay $100 per month plus testing fee's? Now they have the added expense of $4 a gallon gas.
This is a no brainier for parents: Cut out the kids Karate and Dance lessons.

Three Critical Areas are at the top of the list:

1. Keep your overhead low
2. Do everything yourself!
3. Teaching mixed martial arts is not the solution its part of the PROBLEM!

Your goal for Studio Survival:
Keep you total Studio overhead below $2,200 per month. If you can't do that there is a good chance you will go Bankrupt.
Warning: You still may not be able to survive if your personal living expenses are more then to studio can bring in.

Keeping your overhead low starts with your biggest fixed expenses:
1. Rent and utilities
You control your rent by Leasing a smaller building:
How? If your main teaching tool is Private Lessons you do not need a big building:
1000-1200 feet is ideal!

Lease (Rent) the cost of a building is based upon its size (sq. ft.) Typical Lease fees of $12 a sq, ft, plus about $3 sq. ft for triple net brings the cost of a 1,200 sq. ft . building to about $1500 a month. Many areas may be a little less but most will be a lot more.

The math is simple:
2000 sq. ft will cost you $3000 - per month - $36,000 per year
3000 sq. ft. will cost you $4500 - per month - $58,000 per year
4000 sq. ft. will cost you $6000 - per month - $72,000 per year
All of this goes into your landlords pocket.

To this you must add the new - double edged sword: Utilities - Gas - Heating Oil and Electricity. In the past year energy cost have gone up over 50% and the will get worse!
I know of one large studio that just had a three months utility bill of $10,000!

Warning: The size of your building will directly reflect the cost of Utilities:
Typical Example:

1000 sq ft - average monthly utility costs $150 - annual $1,800.00

2000 sq ft - $300 per month - $3,600 per year
3000 sq ft - $450 per month - $5,800 per year
4000 sq ft - $600 per month - $7,200 per year

Watch out for the knock-out punch: In the hot summers of the south Air Conditioning can easily cost over $1,000 per month. The Same is true of the Cold Winter Months of the North where heating bills have double over the past 1-2 years

2. Wages (get rid of any payroll - that is part of #2: Doing everything yourself!
Assume your are teaching 60 students that is only 30 hours of private instruction - you can easily do yourself!

Is Deflation Really That Bad?

As value of money increases while supply lowers, deflation kicks in; it gives consumers higher purchasing power, had helped America overcome the Great Depression, why the bad sentiment? This scenario sounds great for the average investor, especially those who have little hedge over exchange rate risks.

Who really hurts from deflation?

The banks and leverage needed businesses. As loan defaults increase, banks become forced to tighten credit, therefore resulting in lower revenue. So what? Let a few commercial and investment banks fail, throughout the last century, it has served as the only medicine to wake people up from reckless spending.

Who benefits?

The general investors. For many investors of US equity or treasury debt, high inflation rates usually lead to miniscule (at best) or often negative REAL returns. As deflation sets in, the increase in currency value could serve as a “bonus”.

The general consumers benefit greatly. Having a strong, valued currency is a GOOD thing. The $4.00/gallon gasoline resulted partially due to a falling dollar, thanks to the Federal Reserve’s efforts in expanding money supply, which directly spikes inflation.

The economy as a whole gets the much needed boost. Credit expansion, inflation hurts nations as it devalues the currency, as Ron Paul had once said, the fall of Rome commenced as its currency inflated out of control.

Economists like to associate The Great Depression with deflation, yet they forget to mention that credit expansion was rampant the few years before 1930. Deflation, credit contraction, bank failures occurred AFTER the great crash of 29, and American got back on its feet as the result. It takes rational thinking to see potential fallacies of modern economics.

IMF Intervenes US Financial System

Another informative and very interesting article buried by popular media. It looks like globalization has become more than just fiction as the US faces investigations by an external force. Nevertheless, this might prove to be exactly what the country needs to make difficult, but necessary choices to turn the ship around.

IMF finally knocks on Uncle Sam's door

* David HIrst
* June 30, 2008
*

IMAGINE the Reserve Bank of Australia, concerned that its friends in the city of Sydney (but perhaps Melbourne) who, having wallowed in wealth all their adult lives, were no longer gainfully employable and their wildly extravagant lifestyles were in danger, and, having the powers to intervene in the market, decided to do just that on their behalf.

Imagine them offering to enter the market and buy shares that would prop up the foolish gambles of the bankers, gambles they had encouraged them, until recently, to take by providing them with cheap money.

On top of that, they told this group they would provide hundreds of billions of dollars in credits to these same profiteers on the grounds they were so big and important to the economy they were indeed too big to fail.

Then, imagine, despite pouring untold taxpayers money into stocks and allowing their cronies access to vast sums, the system continued to fail. So they announced they would need greater power and with it more secrecy.

For its growing band of critics has, perhaps unwittingly and in the interest of public good, this has become the principal function of the US Federal Reserve.

If this was to happen in Australia the International Monetary Fund would be hammering at the door of the Reserve Bank. But Australia does not have a President's Working Group on Financial Markets, commonly known as the Plunge Protection Team, that allows the US Government to prop up the markets by buying shares. But to imagine the IMF investigating the US financial system is unthinkable, or was. But, at the weekend, Der Spiegel reported that the IMF would conduct a full investigation into virtually every aspect of it.

Der Spiegel wrote that the IMF had "informed" Federal Reserve chairman Ben Bernanke of plans that would have been unheard of in the past: a general examination of the US financial system. The IMF's board of directors has ruled that a so-called Financial Sector Assessment Program is to be carried out in the US.

This, Der Spiegel wrote, "is nothing less than an X-ray of the entire US financial system", adding that "no Fed chief in US history has been forced to submit to the kind of humiliation that Ben Bernanke is facing".

The fact that the IMF is knocking on the very doors of its parents and waving legal papers about who lost the house, the car and the kids will, if the past is anything to go by, be buried in the US by pom-pom waving on CNBC telling all what a great time it is to buy.

But the news that the US Fed has now lost its last vestige of credibility did not end with the German report.

The Telegraph from London weighed in, following the Royal Bank of Scotland's statement last week (also lost on the US public) that it was time to head for the crags, and reported Barclays Capital's closely watched Global Outlook analysis that said US headline inflation would hit 5.5% by August and the Fed would have to raise interest rates six times by the end of next year to prevent a wage spiral.

If the Fed hesitates, the bond markets will take matters into their own hands. "This is the first test for central banks in 30 years and they have fluffed it," the report found. "They have zero credibility, and the Fed is negative if that's possible. It has lost all credibility."

Der Spiegel reports that the IMF is threatening to seriously study the accounts of America, something President George Bush is determined to prevent at least while he is in the White House, informing the IMF that it can begin its investigation but cannot complete it until he leaves office.

But the reckoning will come and it will shine a light in places where light has been desperately wanted for all too long.

"As part of the assessment," Der Spiegel said, "the Fed, the Securities and Exchange Commission, the major investment banks, mortgage banks and hedge funds will be asked to hand over confidential documents to the IMF team. They will be required to answer the questions they are asked during interviews. Their databases will be subjected to so-called stress tests — worst-case scenarios designed to simulate the broader effects of failures of other major financial institutions or a continuing decline of the dollar."

Under its by-laws, the IMF is charged with the supervision of the international monetary system. About two-thirds of IMF members — but never the US — have already endured this painful procedure.

Australian banks have been buffeted by the storms generated in the US, but strict standards enforced by a Reserve Bank that is independent of private banking interests has prevented such excesses, as vouched by their performance as compared with the broker-trader banks and the retail banks of the US. Shares in once-massive banks and brokerage firms have been stripped by as much as 70%, 80% and even almost 100%. We are taking a trim while US banks are getting a full haircut and shave.

Part of the problem is the US media, which has for so long pretended that all is or soon will be well, a bottom is near, a recovery awaits in the second half of the financial year that will sweep away all problems, sown over decades, in a new expansion, a cycle that is ordained to come. The latest fantasy is that with the quarter's end, new profit figures will invigorate the bull, which will seed fertility.

The next President will be handed at least two wars gone horrible wrong and, by then, an economy in similar shape. The bull will have to be a particularly fertile beast.

Der Spiegel reports: "When the final report on the risks of the US financial system is released in 2010 — and it is likely to cause a stir internationally — only one of the people in positions of responsibility today will still be in office: Ben Bernanke."

While Der Spiegel claims that IMF intervention (my expression) is a humiliation for the US, the real significance may be that this is another blow to American exceptionism.

While the examination is far reaching, and deeply intrusive, Canada, Britain, Italy, indeed two-thirds of IMF members, have participated in the program. The new President will soon discover the age of US exceptionism is over.

Meanwhile the US markets have entered bear territory, the economy has done likewise and we are at the beginning of a long and tortuous process before rebuilding can even commence.

David Hirst is a journalist, documentary maker, financial consultant and investor. His column, Planet Wall Street, is syndicated by News Bites, a Melbourne-based sharemarket and business news publisher.