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Saturday, 31 May 2008

Where the Financial Crisis Is Headed Next

by Lawrence C. Strauss

Three years ago, hedge-fund manager Sy Jacobs told Barron's that serious trouble was brewing in the housing market, predicting that "the bursting of the housing bubble [would] be a dominant theme for investing in financial stocks in the next decade." He was right. Jacobs, 47, is the founder of New York's JAM Asset Management, which runs two funds, both focused on financial stocks and closed to new investors. The larger entity, JAM Partners, follows a market-neutral, long-short strategy and has close to $300 million in assets. As of May 21, the fund's year-to-date total return, net of fees, was 9.6%, versus a 4.5% loss for the S&P 500. Its annualized return since inception in 1995 (through April 30) was 16.6%, compared with 9.9% for the S&P. The $45 million JAM Special Opportunities Fund invests in illiquid private-equity holdings. Jacobs' familiarity with financial stocks dates to the 1980s, when he worked as an analyst at firms like Salomon Brothers and Alex. Brown & Sons. To find out where Jacobs sees new problems emerging in the financials -- surprisingly, they're not in the subprime arena -- read on.

Barron's: You were early in detecting the serious problems in subprime mortgages. That turned out to be a great call.

Jacobs: About three years ago, we were worried about subprime specifically. And that view very much paid off for us as we were short a host of such companies. More than a year ago, in another interview with Barron's, we said subprime was already in a full meltdown mode, but the idea that subprime was somehow isolated was still popular. Our message was that the mortgage-credit tail was going to wag the capital-market and economic dog. That's coming to pass now.

Looking ahead, what do you see for the financials?

We believe the recent rally in financial stocks -- and for the whole market -- is a bit of a head fake that will prove to be a bear-market rally.

What's your premise?

After first ignoring subprime, people now are too focused on it and they're missing the broader storm coming -- that's the head fake. While the bursting of the housing bubble produced all sorts of headline-making losses for some, it is just starting to drag down the rest of the economy. Separate from subprime, you are seeing diminished ability for consumers to spend their home equity. The securitization market, which banks and finance companies use to get funding, has slowed. So we see consumer and business spending slowing; the economy will falter.

In a recent letter to your investment partners, you noted that you were very concerned about the health of construction loans. Could you elaborate on that concern for us?

I spent a week recently in California, visiting some troubled, or soon-to-be-troubled, banks. With home sales down so much, construction lending is becoming a problem. You have a lot of developers and home builders stuck with homes that aren't moving. And they are sitting on lots that have loans against them. Subprime is such a small piece of the banking industry, but construction lending is a core product. If the housing market stays weak for much longer -- and it seems to be getting weaker -- construction-loan losses are going to be a big problem.

After the brutal real-estate recession that occurred in the early 1990s, there was a sense that banks had finally learned their lesson and would be much better fortified for the next downturn. I take it you don't think that's true.

I take a pretty cynical view of whether bankers have gotten smarter. We've had a real-estate bull market ever since the early 1990s. I think you are going to see the same thing again. The number of banks that get taken over by the FDIC and disappear may not be as high as it was in the late-1980s and early 1990s because there is strength in the energy patch now. But real-estate lending institutions are the bulk of the community-bank world, and I think you are going to see a lot of banks disappear.

What's your sense of the prevailing views of the financials right now?

People are trying so hard to believe that the Bear Stearns crisis in March was some sort of financial crescendo and represents the bell that gets rung at the bottom, as if that happens. But just because we got saved from what would have happened that Monday if Bear went down doesn't mean we are saved from all the forces that conspired to get Bear Stearns to the brink in the first place. Bear was not the sacrificial lamb to the market gods. It got knocked down by the same winds that are affecting everybody else. Credit destruction is a process -- not an incident. And avoiding that particular meltdown doesn't mean that things are getting better -- and yet that is how financial stocks in particular and the market in general have acted ever since.

You're a fundamental stockpicker, but are there any interesting trends you see in the financials?

One of our themes on the long side is that local plain-vanilla, over-capitalized community banks, especially thrifts, are in a position to gain back market share in the lending business. And they have real deposit franchises that they can fund themselves with. They have been losing market share to the Countrywide Financials [CFC] of the world for a generation. Now, though, they are going to gain a lot of that market share back, because they suddenly have a funding advantage, relative to the larger financial firms that have been securitizing their loans. That market has been discredited. We're long lots of micro-cap ways to play this, but they're too illiquid to mention here.

Fair enough. Let's discuss some of your holdings, starting on the short side.

The first one is Wells Fargo [WFC], trading at 12 times '08 estimates and 2.7 times tangible book; the group trades at less than two times book. The Wells Fargo name has a storied past and gets the Warren Buffett halo effect because he owns a lot of the shares. But if you look back at the last real-estate recession in the early 1990s, the Wells Fargo side, focused on California, had a lot of credit problems in the real-estate area, and the stock underperformed during that period. The Norwest side, which has more exposure to the Midwest, still has a lot of consumer-credit exposure. Of particular concern is the bank's portfolio of home-equity loans.

What's the big worry there?

Home-equity line of credit (HELOC) is 16% of their portfolio. More than a third of their HELOC exposure is in California, which is now developing very badly on the home-price and employment fronts. And delinquencies and losses are already rising pretty sharply. But they also have a big unfunded exposure to the undrawn lines of credit. Also, despite their reputation for being conservative, their loan-loss reserve at the end of March was lower than their annualized charge-off rate for the first quarter. Given the prospects for rising losses that we see, that's not conservative. We think they will disappoint this year and next and, as a result, their premium multiple will go down.

Wells Fargo, however, is known as a well-run bank. One example of that is the company's reputation for being very effective at cross-selling its products.

We're most concerned with their exposure to home-equity loans at the top of a real-estate bubble. Remember that home-equity lines of credit sit on top of first mortgages. So if home prices depreciate, which is what is happening now, and a home goes into foreclosure, the home-equity line often gets wiped out. The first mortgage holder can get most of their money back, but the home-equity line absorbs all of the loss.

Let's move on to another short position.

BB&T [BBT], which operates in the Southeast. The stock trades at 11 times '08 earnings and 2.5 times tangible book. It's bounced about 30% off its lows in January. They've gotten a pass because, to some extent, their core Carolina and Virginia real-estate markets were among the last to roll into home-price depreciation. So their non-performing assets are still low. But we listened to the Toll Brothers [TOL] conference [call] recently. [Chairman and Chief Executive] Robert Toll graded the markets they operate in and he gave Charlotte an F-minus for current home-building conditions and Raleigh a C-minus. We're also concerned that they have 4% of their portfolio in Alt-A mortgages, which are between prime and subprime, and 20% in construction loans.

As with many of the financials, there was this big relief rally on first-quarter earnings. The thinking was these results weren't so bad, but we think that more credit losses are ahead of us.

How about a different short holding?

Hudson City Bancorp [HCBK], which is based in New Jersey. The shares have gained about 60% from their July '07 lows and now trade at 21 times '08 estimates and two times tangible book. They have a wholesale funding and asset-generation strategy, which allows them to keep expenses low.

Could you elaborate on that?

Basically, they borrow funds from the Federal Home Loan Bank of New York and use repurchase agreements. So they, in effect, purchase money, more so than relying on deposits. In addition, they buy most of their assets, usually through brokers. A big chunk of their assets are first mortgages and mortgage-backed securities. So for the most part, they are not a retail originator of loans, and they are benefiting from the steepness of the yield curve.

And, even with all that, they will earn less than a 10% return on equity this year, so I just don't get the valuation. Furthermore, when you have a wholesale business model, that means you don't really have a valuable franchise that another bank would pay much for. So a recent stock price represented approximately a 100% premium for their core deposits, which is how bank acquisitions typically get priced. And I don't think their deposits are worth nearly that much to a buyer. Everything looks great for them now, if you a call 10% ROE great. But they are not immune to credit risk in a recession and a weak housing market. I also think their loan-loss reserve at 0.15% is very low, relative to others'. When the Fed rate-cutting cycle is over, I don't want to own a spread play with credit risk that's trading at two times book.

Let's move to the long side of the ledger. What financial firms do you like?

One is Hatteras Financial [HTS], based in Winston-Salem, N.C. They are a mortgage REIT. We bought it in a private placement last year and it recently went public at $24 a share. They own all agency adjustable-rate securities, so there is no credit risk here. The market capitalization is about $630 million.

What's the biggest risk for this firm?

I'd say it's yield-curve risk, but, trading at just over one times book value, it's well- factored into the price. We estimate that they will earn $4.50 to $4.75 a share from mid-year '08 to mid-year '09, once the IPO proceeds are invested. As a REIT, they will pay out all -- or nearly all -- of their earnings in dividends. So at 25 recently, the stock was sporting an expected yield of around 19%. We think the stock gets to 30 at least. Between the appreciation and the yield, it's a great total return.

Could you explain their yield-curve risk in a little more detail?

Like all mortgage REITs, they use leverage. They borrow at short-term maturities so they have been benefiting -- and continue to benefit -- from falling federal- funds rates. It's very similar to what Hudson City is doing. They are benefiting from falling short-term interest rates because they use the wholesale market to buy funds. And yet, somehow, the market is paying two times book for that, whereas you can buy Hatteras for 1.1 times book -- and Hatteras earns a 20% ROE, versus Hudson's 10%.

Last pick, please.

This is a more controversial long holding: MGIC Investment [MTG], in which we used to have a short position.

What made you switch to the long side?

The stock's down from north of 70 in early 2007 to around 12, bringing its capitalization down to about $1.5 billion. One reason we like the company is that it was able to raise more capital recently, something its competitors haven't been able to do. In March, they did a common offering that raised about $500 million -- so they've been able to raise liquidity and capital. At the same time, they are raising prices on premiums and tightening underwriting on the business now being written. The new business is being written based on lower home appraisals after the housing bubble burst -- and yet they are still showing good growth despite the fact that the whole industry has slowed down.

Our thesis is that once MGIC gets through writing down its old book of business, the new book will be very profitable and valuable. Even applying our bearish mortgage-credit outlook, we don't see more than another $4 or $5 per share of losses in the next two years. So current book value of $24 should bottom in the high teens in '09 and start rising from there. They'll be quite profitable after that, given their better margins and more conservative underwriting of the current book of business. The stock should trade upward of two times book. So we see the stock, currently at around 12, as a double-to-triple over the next few years.

Thanks very much, Sy.

Thursday, 29 May 2008

Oil surge could trim 1.5 points off US economic growth

WASHINGTON - A TOP White House economic aide to President George Bush said that the surge in oil prices could cut at least 1.5 percentage points off US economic growth if it continues.
'The high price of oil has already cost us a significant amount in terms of economic growth,' Mr Edward Lazear, the chairman of the president's Council of Economic Advisers, said in a speech to the Hudson Institute, a Washington-based think tank.

Mr Lazear estimated that each US$10 (S$13) rise in the price of oil per barrel over the course of the year reduces gross domestic product (GDP) growth by about a quarter of a point.

Oil prices have skyrocketed since crossing US$100 for the first time on Jan 2. Prices hit record highs above US$135 last week before easing back on concerns about demand from the sluggish US economy.

The New York benchmark contract rebounded on Wednesday to above US$130.

'If you think about the amount by which oil has gone up in price over the past year, you're talking about 1.5 point or so of GDP growth,' Mr Lazear said.

The economist declined to discuss recession risks facing the world's largest economy.

'Whether it implies a recession or not, it clearly does hit us hard in terms of GDP growth and it will continue to do so unless we think of ways to deal with this,' he added.

His remarks came a day ahead of the government's revision of first-quarter GDP growth, which for the second quarter in a row was a meager 0.6 per cent annual pace, according to the initial estimate.

Most analysts expect that the economy grew by more than first estimated in the January-March period, at an annual 0.9 per cent pace.

The generally accepted technical definition of recession is two consecutive quarters of negative growth, or contraction. -- AFP

Investing Like an Oracle

By Tom Gentile, Profit Strategies.com

Of all the longer-term investors out there, Warren Buffett is probably the most notable. It’s hard not to like this guy. Other than being an astute investor, he is also a notable contributor to various charities. Let's dive into the Oracle of Omaha's investing style and how to trade options using Warren Buffett stocks.

So, why you are reading this article? What you really want to know about Warren Buffett is his criteria for picking value stocks. Okay, here is a breakdown on what we have discovered in the search for Warren Buffett picks:
Warren Buffett is a value investor. That means he doesn’t participate in wildly running growth stocks—in fact, he was ridiculed for staying out of the tech boom in the late '90s. Of course, we all know how right he was just after the year 2000, when everything DotCom collapsed. Warren Buffett has a unique style when it comes to investing, so without writing a novel on the subject, let me get to the point of what he looks for.

Brand Recognition – One of his key criteria… Is the company well known? Does it have a stronghold in its core products with consumers? The company has to be a recognized brand in its industry for Warren Buffett to consider it as part of his holdings.

Earnings Consistency – Warren looks for a growing company with no negative years of earnings growth in past 5 years. If the company has had at least one year of negative earnings growth in the last 5 years, then it will not be considered. By the way, Long-term Earnings Per Share [EPS] growth indicates that the company is growing over time. The EPS of a company must be continually growing.

Long-term debt – This is the company's current long-term or multi-year debt structure. This could include mortgages, long-term bank notes, etc. In order to pass the Warren Buffett test, long-term debt must not be greater than 2 times net income. This is a liquidity measure which ensures that the company has not taken on too much risk through its borrowings.

Return On Equity – Return on Equity [ROE] measures the return on shareholders funds or shareholders equity. ROE is calculated by dividing the net profit by shareholder equity and multiplying it by 100 to express the result as a percentage. The higher the ROE, the better. Buffett requires a return on equity of 15% or more.

Capital Expenditure – Free cash flow per share is the amount of money that is free to be spent. It is cash flow minus all expenses. Buffett likes free cash flow per share to be positive.

Utilization of Returned Earnings – This is all about seeing if management is using retained earnings to increase shareholder value. In order to be increasing shareholder value, according to Buffett’s methodology, retained earnings should provide a return that is 15% or better, but he will accept if a company has a return that is better than 12%.

Wednesday, 28 May 2008

Meet Your New Recruits: They Want to Eat Your Lunch

by Aili McConnon and Jessica Silver-Greenberg

Thirteen young men and one woman meet in a drafty medieval-style room in a campus residence hall at Yale University. Thick exposed beams cross the ceiling above a large fireplace. A stained-glass panel in the heavy wooden door is decorated with a cobalt "Y." "Anyone interested in finance wants to join the Globalfund," says Philip Uhde, 22, the group's founder and president. "And the smartest of those people are here."

A cross between Yale's secretive Skull & Bones society and a young tycoons club, the Globalfund is one of a growing number of exclusive business groups cropping up at elite colleges across the country. The organizations, fueled by a mix of youthful ambition and careerist anxiety, have become an increasingly important part of the competition for the most lucrative jobs at investment banks, hedge funds, and consulting firms. For many students, it's a race for money and prestige that's starting earlier and earlier. The slumping economy and tens of thousands of layoffs on Wall Street have only aggravated the angst.

Launched in 2006, the invitation-only Globalfund calls its undergraduate members "partners" and evaluates candidates based on their investment ideas. Even among hand-picked aspirants, the partners reject three out of four. Partners pool earnings from summer internships at financial firms to make real, if modest, investments backed by research the students do themselves. One Monday evening in March, Harry Greene, another founding partner, rattles off statistics about China Natural Gas, a small distribution company based in the city of Xi'an that trades over the counter. Glancing periodically at his BlackBerry, Greene, a 23-year-old senior majoring in economics and mathematics, describes to his colleagues how he called a company investor-relations representative from his dorm room and grilled him—in Mandarin, which he mastered after extensive classroom study and a year off from college spent in Beijing.

Most Globalfund partners speak a second language, Greene explains later. "We can often do more-thorough due diligence than Wall Street analysts because we can interview management in their native language." The fund's initial $800 stake in the gas company nearly tripled over four months last year, and the students sold their shares for a profit. A more recent $2,300 position in China Natural Gas has slipped slightly in value, but Greene assures the group it will bounce back soon. After graduation in May, he plans a short stint with a software company before heading to an investment banking job.

Once, merely graduating from an Ivy League college or similarly prestigious rival like Stanford or Swarthmore qualified students for a choice entry-level perch on Wall Street. No longer. "The whole idea of smart people just falling into banking is becoming rarer," says Lance LaVergne, a vice-president and global head of diversity recruiting at Goldman Sachs. "Clubs are essential to preparation, especially for students who are not majoring in traditional disciplines like finance or accounting."

Blue-chip employers are looking for substantive experience and signs of early commitment. Wall Street internship programs that used to seek out students after their junior year now invite motivated freshmen and sophomores. Students feed the frenzy themselves, some showing up at college having already attended summer business-prep camps while still in high school.

Desperately Seeking Distinction

Now the credit crunch is chewing up many of the jobs hyper-directed undergraduates yearn for. As the contest for junior analyst and novice trader slots intensifies, unlikely rumors keep some awake at night. "I have been hearing that a lot of these banks are only taking one student from Harvard," says Anthony Genello, a 21-year-old junior and president of operations of the Harvard Financial Analysts Club. "It definitely hit home and makes everyone more crazed." Desperate to distinguish themselves, students on at least two dozen top campuses have lately formed or expanded high-powered clubs, some of which offer eye-popping opportunities to invest and network. "As markets become more difficult and hiring needs are reduced, it will likely become more difficult for students to just wind up in our business," Goldman's LaVergne says.

Some veterans in business and finance worry that increasing student fascination with pre-professional clubs bespeaks a lack of appreciation for the perspective afforded by a liberal arts education. Etched high on the stone wall of the grand room where Yale's Globalfund holds its weekly meetings, a quote from poet Edgar A. Guest urges the precocious partners to value life's intangible joys:

The thing that we call living isn't gold or fame at all,
It is laughter and contentment and the struggle for a goal,
It is everything that's needful to the shaping of a soul.

But these words seem lost on the Yale students, most of whom look elsewhere for inspiration. "We are followers of Warren Buffett," explains Greene, who says he studies the famed Omaha investor's letters to shareholders as if they were sacred texts.

In dollar terms, the Globalfund is relatively small. At any given time, it has about $25,000 from students' pockets to deploy. The partners liquidate it at the end of the school year and distribute the proceeds on a pro-rata basis. Their counterparts at a cross-campus competitor, the Yale College Student Investment Group, manage no less than $280,000. That money remains within the university's endowment, having grown from seed funds donated by alumni such as investment guru James B. Rogers Jr., who earmarked cash years ago to improve undergraduate investment acumen at the New Haven campus.

As students sense tougher times setting in, many seek to "front-run the process," says Chris Borrero, president of the Yale College Student Investment Group. "People are taking a step back and trying to get a [Wall Street] internship earlier so they have a better résumé for the junior internship." Membership in a finance club is seen as a boost up the career ladder. Borrero, a 21-year-old junior from Westford, Mass., says he began reading The Wall Street Journal aloud to his father in the second grade. He notes that 40% of the investment group's 250 members are freshmen, far more than in the past.

High-revving students scoff at advice they sometimes hear about intellectually browsing before settling on a narrow employment path. "Many of my fellow classmates have been planning out their college choices since middle school, so to tell them not to plan for a future career during freshman year is illogical," says Janet Xu, 22, a senior at Yale and editor of the undergraduate magazine Yale Entrepreneur. She is heading off soon to be an analyst for Sears Holdings in Chicago.

Driving some of the credentials-mania is the impression that campus clubs open doors to summer internships many firms are relying on more heavily for full-time hiring. JPMorgan Chase, for example, says 90% of its entry-level hires last year were former interns, up from 60% five years ago. At the big consulting firm Accenture, "these clubs help us identify the best people for our internship program," says John Campagnino, global recruiting director.

Some of the organizations aim to broaden opportunities for women and minority students. At Columbia University, sophomore Anastasia Alt, 19, helped raise nearly $30,000 from Fidelity, Goldman, Morgan Stanley, and other financial titans for a recent career-networking conference of the 300-member Columbia Women's Business Society, a campus group. Firms use such events as an extra recruiting opportunity beyond visits regulated by career services offices. Alt's pitch to prospective sponsors: "Here are women who are both talented and interested in your company." Currently she's launching a Columbia chapter of Smart Woman Securities, a club started in 2005 at Harvard to give women a crash course in investing.

A trio of minority undergraduates at Harvard created a club last year called Veritas Financial Group as a way to learn the financial basics they couldn't find in the regular curriculum. JPMorgan, Goldman, and Credit Suisse Group have given Veritas a total of $15,000 in startup money. "I feel that I need to be doing everything I can to compete with students who are given the opportunity to have some pre-professional education," says co-founder Ryan Williams, a 20-year-old African American sophomore from Ossining, N.Y. His club already has 90 members, including some white students. It's the 13th undergraduate business organization available on the Cambridge campus alone.

Too Narrow a Focus?

Some prospective employers welcome the abundance of undergrad societies devoted to pecuniary pursuits. "Supporting a club like Veritas is important, as it provides the kind of hands-on, practical experience that can only benefit students who are planning a career in finance," says Brian Marchiony, a JPMorgan spokesman.

But others express reservations. Michael J. Mauboussin, chief investment strategist for Legg Mason Capital Management, worries that a premature narrowing of focus could hurt future employees. "If you are specialized too early, there is a risk you will be less innovative because you have fewer building blocks to combine in new ways," says Mauboussin, 44, who majored in government at Georgetown.

Carly Fiorina, the former CEO of Hewlett-Packard and now an unpaid adviser to Republican Presidential candidate John McCain, agrees. She majored in medieval history and philosophy at Stanford. Such fields help hone judgment and perspective in a way that an investing club cannot, she says: "Judgment is knowing when to act and when to pause. Perspective is the ability to separate the merely interesting from the truly important." Companies can be impaired by too many people with similar backgrounds, she adds. "If everyone is the same, your decisions won't be as sound and you probably won't be as innovative a place."

Frisbee Deficits

More immediately, if everyone in the finance club is fixated on picking stocks, they may not pay very close attention to the lectures and lab sessions for which their parents are paying serious tuition. Students on the executive board of Tufts Financial Group, a newly minted club at Tufts University near Boston, confess that they habitually track their investments from a $30,000 fund created by an alumnus gift to the university's endowment. "I'll take care of e-mails and work on spreadsheets during class if I need to," says Chris Cerrone, 20, a sophomore juggling an internship at Century Capital Management in Boston along with his major in economics.

At Tufts, a school that ranks just below the Ivies, the formation of the finance club's investing arm last year has caused a stir. Membership has swelled to 200. Lindsey Tannenbaum, a 22-year-old senior and president of the group, says some students are listing the club on their résumés even though they barely participate. "It looks good if you're applying for a career in finance," she says. In response, she's now taking attendance at weekly meetings and restricting access to the group's online investment research. After interning for Lehman Brothers last summer, Tannenbaum is returning full-time to the New York investment bank later this year. Meanwhile, at Lehman's request, she's vetting résumés of other students from her club.

In some campus groups, it's a miracle members have time to sleep or eat, let alone study or write papers. Shortly after arriving at Stanford from her home in Houston, Connie Yu applied for admission to Stanford Finance, which helps undergrads find corporate and consulting firm internships. One of the most selective of the 25 undergrad business groups on the sunny Palo Alto (Calif.) campus, Stanford Finance gets about 200 applicants a year for only two dozen spots. Yu, now a 20-year-old junior, was admitted but didn't stop there. She then joined the Blyth Fund, through which 25 undergrads manage a $180,000 stock portfolio begun with a gift from investor Charles R. Blyth, who made similar donations to several California universities in the late 1970s. The Stanford students trade through an account at E*Trade Financial, where the money is registered to the university's endowment-management company but otherwise is controlled by the undergrads.

Completing what Stanford students call a rare "triple crown," Yu also gained admission to Stanford Consulting. That group rejects four out of five applicants with a notorious entrance interview. Yu's included a business-school-style question about how a deodorant company ought to reverse its declining market share. "It's so competitive to get into Stanford, and then it's kind of a shock you still have to apply for the student groups," says Yu, clutching her personalized Stanford Consulting tote bag to her chest.

The reward for getting into 20-member Stanford Consulting is the chance to do volunteer work 15 hours a week for a real consumer-products company, which Yu declines to name because she signed a nondisclosure agreement. She says she's helping management figure out how to gain attention with ads on YouTube. Red-eyed and, by her own admission, sleep-deprived, Yu says she has had to sacrifice her hobbies of playing keyboards and ultimate Frisbee to complete her club obligations, along with classes in international trade and game theory. But she says it's worth it. She worked as an intern at Lehman last summer and is returning to the bank for another stint this year.

Meanwhile, she'll be paid up to $50 an hour to advise other undergraduates on navigating the choppy recruiting waters. She works with a company called Higher Recruiting started last year by students who met at the New York private high school Horace Mann and since have worked at various Wall Street banks. With 32 student consultants serving undergrads on more than 20 campuses, Higher Recruiting pitches itself to those who fear that their career services departments may not be savvy or aggressive enough.

Some career offices seem wary of the profusion of finance clubs, though most hesitate to criticize them explicitly. The Columbia Women's Business Society had planned to give recruiters at their upcoming conference a book of student résumés, but refrained when it learned that the university's career office discourages such contacts out of concern that all students should have equal access to potential employers, regardless of club membership, according to the women's society. Columbia's career staff declined to comment.

Stanford's career center says it established a more formal relationship with student business groups this academic year so it can keep closer tabs on their dealings with recruiters. Beverley Principal, assistant director of employment services at Stanford, frets that some employers might take advantage of applicants they meet outside of the regimented career-office environment: "If a student comes in crying because a potential employer has asked, 'What will you do if you have this job and get pregnant,' we have less of a leg to stand on when we try to help them." A counterpart at Harvard, Bill Wright-Swadel, has similar concerns. "The [career] conversation now begins virtually at Day One" of freshman year, before most students have any clear sense where their skills and proclivities will take them professionally, he says. For the moment, Harvard's career office monitors clubs only informally.

A new addition to Harvard's roster of undergrad business organizations is Williams' Veritas Financial Group. Williams brought some entrepreneurial experience with him to Cambridge in the fall of 2006. As a 13-year-old, he started a personalized sweatband business called Rapappay Active Wear. After classes at his public junior high school, he trekked down to Manhattan's garment district to find inexpensive supplies. "A lot of my Friday and Saturday nights, I spent catching up on sleep or working on my company operations," he recalls. Last year he says he had earnings of $3,500 but has put the operation on hold to focus on his studies.

Williams was alarmed to learn that Harvard doesn't offer any undergraduate classes on accounting. He and classmates Charles Cole and Derrick Barker started Veritas to help undergrads, especially minority students, who might lack personal contacts with the business world, to learn basic skills. Sitting on beanbag chairs, surrounded by half-eaten granola bars, rifled cereal boxes, and other dorm room detritus, the three friends cobbled together their own curriculum from financial texts they lugged from the Harvard Business School's Baker Library, across the Charles River from the college. They blasted Harvard's entire B-school faculty with e-mails explaining their mission and asking for help.

The business school doesn't permit undergrads to cross-register for classes; those who sneak in anyway are known as "sharks." But Veritas' call for assistance was heard. Professor Arthur Segal, an expert on real estate, met with Williams to provide counsel. Craig Canton, a 29-year-old second-year student at the B-school on his way to a Wall Street sales job, leads a seminar on finance for Veritas once a week. At one session, 14 undergrads from a wide variety of ethnic backgrounds listened as Canton dissected the subprime mortgage mess and explained exotic financial instruments known as collateralized debt obligations.

While he's eager to help, Canton observes that some Veritas members seem overwrought. "These students are a lot more focused and seem to be having a lot less fun," he says. "I was scooping ice cream as a sophomore. There is a lot more worry than I felt."

Williams says a ruthless business world demands focus: "It's extremely competitive and cutthroat out there, so you have to take initiative." Last summer he worked for JPMorgan's private equity arm; this summer he heads to Merrill Lynch.

McConnon is a staff editor for BusinessWeek in New York. Silver-Greenberg is a reporter for BusinessWeek.com.
Copyrighted, Business Week. All rights reserved.

Tuesday, 27 May 2008

Soros: 'We face the most serious recession of our lifetime

George Soros, 'the man who broke the Bank of England', tells Edmund Conway of his fears for the economy

'This is a period of wealth destruction. The people who make money will be few and far between. There will be a lot more money lost than made." When George Soros - the phenomenally successful hedge fund manager - says this, you know something is wrong, very wrong. And indeed it is. The 77-year-old billionaire sinks back into the sofa in his Chelsea townhouse and exhales.

He has managed to make money almost consistently for over half a century - from his early days as one of the world's first major hedge fund traders to his involvement in Black Wednesday as the man who "broke the Bank of England", and in the latter years generating multi-billion-dollar annual profits throughout the 1990s. The conditions today are almost uniquely dismal, however.


Telegraph TV: George Soros on the Bank of England


"I think this is probably more serious than anything in our lifetime," he says. In short, his feeling is that the United States and Britain are facing a recession of a scale greater than the early-1990s, greater even than the 1970s.

"I think the dislocations will be greater because you also have the implications of the house price decline, which you didn't have in the 1970s - so you had stagflation and transfer of purchasing power to the oil producing countries, but here you also have the housing crisis in addition to that."

The financial crisis in full
Such apocalypticisms would be less worrying were it not that Soros was among the few prominent experts who warned of the dire consequences facing the American economy years ago, when the housing bubble was still inflating.

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But even cottoning on to the big economic story early on hasn't meant guaranteed success. He returned from retirement last summer, and no sooner had he started trading than he pulled hundreds of millions of dollars of investment out of the US and the UK. It was enough to help him to a 32pc return last year. But amid the turbulence of 2008, he admits he is barely breaking even.

One of the problems is that leverage, the juice that has driven the hedge fund and finance trade in recent years, has all but dried up; the other is that the impending economic slump will be far-reaching and painful.

In the UK, the economic clouds are particularly dark, he says. "House prices have risen over the years and are further away from sustainable than in practically any other country, in terms of household indebtedness and the relationship of house prices to incomes." The slump may be more gentle than in the US, he adds, but it will be more drawn out.

"This is going to be compounded by the fact that the financial industry weighs more heavily on the economy than in other countries, because London is the centre of the global financial system, and you have the unfortunate condition that the Bank of England is bound into inflation targeting, and is not in a position to lower interest rates until you have an economic slowdown."

The nice decade, he says, borrowing a phrase from Bank Governor Mervyn King, is over and now the Bank has struck a "Faustian bargain between economic slowdown and inflation".

Ah, the Bank of England. There can be few more eventful relationships between one man and a bank than this one. There is no doubt he remains proud of his central role in Black Wednesday, when he helped drive Britain out of the Exchange Rate Mechanism, making around a billion dollars in the process. He is reminded of it by the fact that sterling has recently fallen some 20pc against the euro.

"It's much better than the straitjacket sterling was in when I broke the Bank of England."

For which, by the way, he is, rightly, unapologetic: "The ERM would have been abandoned even if I had never been born."

The son of the ERM, meanwhile, the euro, looks unbreakable in comparison - by speculators, at least.

But as hedge funds and other speculators pile in to the current crude oil boom, the Hungarian-born investor instead focuses on the wider picture - maintaining his estimated $8.5bn (£4.3bn) fortune, much of which he spends on his philanthropic and political ventures - most notably his Open Society Institute, which has a particular focus on Eastern Europe. However, don't try to read any of his politics into his trades, he insists.

"As a hedge fund manager, I do not claim to be serving the public interest. I am in the business to make money," he says. "It's a difficult point for people to understand and there's a general attitude when they see people profiting to say that markets are immoral, or making money by speculating is immoral.

"It's really the job of the authorities to set the rules, and there are times when some people break the rules or engage in improper activities, like the sub-prime mortgages. The impact fell particularly heavily on black and Hispanic minorities.

"It is a scandal, and I think you can blame [former Federal Reserve chairman Alan] Greenspan for not regulating the mortgage industry. But that's very different from speculating in government bonds or financial instruments, and that's a difficult point to get across, but I feel very strongly.

"Markets play a very useful role and they are amoral, not immoral."

Evolution of flu strains points to higher risk of pandemic

CHICAGO - SOME strains of bird flu are coming ever closer to developing the traits they need to cause a human pandemic, a study released on Monday said.
Researchers who analysed samples of recent avian flu viruses found that a few H7 strains of the virus that have caused minor, untransmissible infections in people in North America between 2002 and 2004 have increased their affinity for the sugars found on human tracheal cells.

Subsequent tests in ferrets suggested that these viral strains were not readily transmissible.

But one strain of the H7N2 virus, a low pathogenic avian flu strain isolated from a man in New York in 2003, replicated in the ferret's respiratory tract and was passed between infected and uninfected ferrets suggesting it could be transmissible in humans.

The investigators said the evidence suggests that the virus could be evolving towards the same strong sugar-binding properties of the three worldwide viral pandemics in 1918, 1957 and 1968.

'These findings suggest that the H7 class of viruses are partially adapted to recognize the receptors that are preferred by the human influenza virus,' said Mr Terrence Tumpey, a senior microbiologist with the US Centers for Disease Control and Prevention in Atlanta.

The authors said that if the viruses continue to evolve in this direction, the avian flu viruses could travel more easily between other animals and humans. They called for strict surveillance of avian flu viruses and continuing federal preparations for a possible future pandemic.

The study appears in the Proceedings of the National Academy of Sciences. -- AFP

US recession still probable: Greenspan

LONDON - A RECESSION in the United States remains a probability, former Federal Reserve chairman Alan Greenspan said in an interview published on Tuesday.
Speaking to the Financial Times from Washington, Mr Greenspan said he believed 'there is a greater than 50 per cent probability of recession'. He noted, however, that 'that probability has receded a little'.

The likelihood of a severe recession had 'come down markedly', he added: but it was too soon to tell whether the worst was already over.

According to the Financial Times, Mr Greenspan estimated that house prices in the United States would drop by a further 10 per cent from their levels in February, which comes to a 25 per cent drop from their peak.

'Such house price declines imply a major contraction in the level of equity in owner-occupied homes, the ultimate collateral for mortgage-backed securities,' he said.

United States economic growth has slowed dramatically in recent months and a growing number of economists believe the world's largest economy will experience a recession during 2008 amid a housing slump and related credit crunch. -- AFP

Monday, 26 May 2008

It was not Bear Stearns but JPMorgan that was bankrupt

Courtesy of Johnlaw2012 from CNA forum

The Highly Suspicious Out-of-the-Money Puts

That was one of many questions raised by John Olagues, an authority on stock options, in a March 23 article boldly titled “Bear Stearns Buy-out . . . 100% Fraud.” Olagues maintains that the Bear Stearns collapse was artificially created to allow JPMorgan to be paid $55 billion of taxpayer money to cover its own insolvency and acquire its rival Bear Stearns, while at the same time allowing insiders to take large “short” positions in Bear Stearns stock and collect massive profits. For evidence, Olagues points to a very suspicious series of events, which will be detailed here after some definitions for anyone not familiar with stock options:

A put is an option to sell a stock at an agreed-upon price, called the strike price or exercise price, at any time up to an agreed-upon date. The option is priced and bought that day based upon the current stock price, on the presumption that the stock will decline in value. If the stock’s price falls below the strike price, the option is “in the money” and the trader has made a profit. Now here’s the evidence:

On March 10, 2008, Bear Stearns stock dropped to $70 a share -- a recent low, but not the first time the stock had reached that level in 2008, having also traded there eight weeks earlier. On or before March 10, 2008, requests were made to the Options Exchanges to open a new April series of puts with exercise prices of 20 and 22.5 and a new March series with an exercise price of 25. The March series had only eight days left to expiration, meaning the stock would have to drop by an unlikely $45 a share in eight days for the put-buyers to score. It was a very risky bet, unless the traders knew something the market didn’t; and they evidently thought they did, because after the series opened on March 11, 2008, purchases were made of massive volumes of puts controlling millions of shares.

On or before March 13, 2008, another request was made of the Options Exchanges to open additional March and April put series with very low exercise prices, although the March put options would have just five days of trading to expiration. Again the exchanges accommodated the requests and massive amounts of puts were bought. Olagues contends that there is only one plausible explanation for “anyone in his right mind to buy puts with five days of life remaining with strike prices far below the market price”: the deal must have already been arranged by March 10 or before.

These facts were in sharp contrast to the story told by officials who testified at congressional hearings on April 4. All witnesses agreed that false rumors had undermined confidence in Bear Stearns, making the company crash despite adequate liquidity just days before. On March 10, 2008, Reuters was citing Bear Stearns sources saying there was no liquidity crisis and no truth to the speculation of liquidity problems. On March 11, the Chairman of the Securities and Exchange Commission himself expressed confidence in its “capital cushion.” Even “mad” TV investment guru Jim Cramer was proclaiming that all was well and the viewers should hold on. On March 12, official assurances continued. Olagues writes:

“The fact that the requests were made on March 10 or earlier that those new series be opened and those requests were accommodated together with the subsequent massive open positions in those newly opened series is conclusive proof that there were some who knew about the collapse in advance . . . . This was no case of a sudden development on the 13 or 14th, where things changed dramatically making it such that they needed a bail-out immediately. The collapse was anticipated and prepared for. . . .

“Apparently it is claimed that some people have the ability to start false rumors about Bear Stearns’ and other banks’ liquidity, which then starts a ‘run on the bank.’ These rumor mongers allegedly were able to influence companies like Goldman Sachs to terminate doing business with Bear Stearns, notwithstanding that Goldman et al. believed that Bear Stearns balance sheet was in good shape. . . . The idea that rumors caused a ‘run on the bank’ at Bear Stearns is 100% ridiculous. Perhaps that’s the reason why every witness was so guarded and hesitant and looked so mighty strained in answering questions . . . .

“To prove the case of illegal insider trading, all the Feds have to do is ask a few questions of the persons who bought puts on Bear Stearns or shorted stock during the week before March 17, 2008 and before. All the records are easily available. If they bought puts or shorted stock, just ask them why.”5

Suspicions Mount

Other commentators point to other issues that might be probed by investigators. Chris Cook, a British consultant and the former Compliance Director for the International Petroleum Exchange, wrote in an April 24 blog:

“As a former regulator myself, I would be crawling all over these trades. . . . One question that occurs to me is who actually sold these Put Options? And why aren’t they creating merry hell about the losses? Where is Spitzer when we need him?”6

In an April 23 article in LeMetropoleCafe.com, Rob Kirby agreed with Olagues that it was not Bear Stearns but JPMorgan that was bankrupt and needed to be “recapitalized” with massive loans from the Federal Reserve. Kirby pointed to the huge losses from derivatives (bets on the future price of assets) carried on JPMorgan’s books:

“. . . J.P. Morgan’s derivatives book is 2-3 times bigger than Citibank’s – and it was derivatives that caused losses of more than 30 billion at Citibank . . . . So, it only made common sense that J.P. Morgan had to be a little more than ‘knee deep’ in the same stuff that Citibank was – but how do you tell the market that a bank – any bank – needs to be recapitalized to the tune of 50 - 80 billion?”7

Kirby wrote in an April 30 article:

“According to the NYSE there are only 240 million shares of Bear outstanding . . . [Yet] 188 million traded on Mar. 14 alone? Doesn’t this strike you as being odd? . . . What percentage of the firm was owned by insiders that categorically did not sell their shares? . . . Bear Stearns employees held 30 % of the company’s stock . . . 30 % of 240 million is 72 million. If you subtract 72 from 240 you end up with approximately 170 million. Don’t you think it’s a stretch to believe that 186+ million real shares traded on Friday Mar. 14? Or do you believe that rank-and-file Bear employees, worried about their jobs, were pitching their stocks on the Friday before the company collapsed knowing their company was toast? But that would be insider trading – wouldn’t it? No bloody wonder the SEC does not want to probe J.P. Morgan’s ‘rescue’ of Bear Stearns . . .”8

If real shares weren’t trading, someone must have been engaging in “naked” short selling – selling stock short without first borrowing the shares or ensuring that the shares could be borrowed. Short selling, a technique used by investors to try to profit from the falling price of a stock, involves borrowing a stock from a broker and selling it, with the understanding that the stock must later be bought back and returned to the broker. Naked short selling is normally illegal; but in the interest of “liquid markets,” a truck-sized loophole exists for “market makers” (those people who match buyers with sellers, set the price, and follow through with the trade). Even market makers, however, are supposed to cover within three days by actually coming up with the stock; and where would they have gotten enough Bear Stearns stock to cover 75% of the company’s outstanding shares? In any case, naked short selling is illegal if the intent is to drive down a stock’s share price; and that was certainly the result here.9

On May 10, 2008, in weekly market commentary on FinancialSense.com, Jim Puplava observed that naked short selling has become so pervasive that the number of shares sold “short” far exceeds the shares actually issued by the underlying companies. Yet regulators are turning a blind eye, perhaps because the situation has now gotten so far out of hand that it can’t be corrected without major stock upheaval. He noted that naked short selling is basically the counterfeiting of stock, and that it has reached epidemic proportions since the “uptick” rule was revoked last summer to help the floundering hedge funds. The uptick rule allowed short selling only if the stock price were going up, preventing a cascade of short sales that would take the stock price much lower. But that brake on manipulation has been eliminated by the Securities Exchange Commission (SEC), leaving the market in unregulated chaos.

Eliot Spitzer has also been eliminated from the scene, and it may be for similar reasons. Greg Palast suggested in a March 14 article that the “sin” of the former New York governor may have been something more serious than prostitution. Spitzer made the mistake of getting in the way of a $200 billion windfall from the Federal Reserve to the banks, guaranteeing the mortgage-backed junk bonds of the same banking predators responsible for the subprime debacle. While the Federal Reserve was trying to bail the banks out, Spitzer was trying to regulate them, bringing suit on behalf of consumers.10 But he was swiftly exposed and deposed; and the Treasury has now broached a new plan that would prevent such disruptions in the future. Like the Panic of 1907 that justified a “bankers’ bank” to prevent future runs, the collapse of Bear Stearns has been used to justify a proposal giving vast new powers to the Federal Reserve to promote “financial market stability.” The plan was unveiled by Treasury Secretary Henry Paulson, former head of Goldman Sachs, two weeks after Bear Stearns fell. It would “consolidate” the state regulators (who work for the fifty states) and the SEC (which works for the U.S. government) under the Federal Reserve (which works for the banks). Paulson conceded that the result would not be to increase regulation but to actually take away authority from state regulators and the SEC. All regulation would be subsumed under the Federal Reserve, the bank-owned entity set up by J. Pierpont Morgan in 1913 specifically to preserve the banks’ own interests.

On April 29, a former top Federal Reserve official told The Wall Street Journal that by offering $30 billion in financing to JPMorgan for Bear’s assets, the Fed had “eliminated forever the possibility [that it] could serve as an honest broker.” Vincent Reinhart, formerly the Fed’s director of monetary affairs and the secretary of its policy-making panel, said the Fed’s bailout of Bear Stearns would come to be viewed as the “worst policy mistake in a generation.” He noted that there were other viable options, such as looking for other suitors or removing some assets from Bear’s portfolio, which had not been pursued by the Federal Reserve.11

Jim Puplava maintains that naked short selling has now become so pervasive that if the hedge funds were pressed to come in and cover their naked short positions, “they would actually trigger another financial crisis.” The Fed and the SEC may be looking the other way on this widespread stock counterfeiting scheme because “if they did unravel it, everything really would unravel.” Evidently “promoting market stability” means that whistle-blowers and the SEC must be silenced so that a grossly illegal situation can continue, since the crime is so pervasive that to expose it and prosecute the criminals would unravel the whole financial system. As Nathan Rothschild observed in 1838, when the issuance and control of a nation’s money are in private hands, the laws and the people who make them become irrelevant.

It was not Bear Stearns but JPMorgan that was bankrupt

Courtesy of Johnlaw2012 from CNA forum

The Highly Suspicious Out-of-the-Money Puts

That was one of many questions raised by John Olagues, an authority on stock options, in a March 23 article boldly titled “Bear Stearns Buy-out . . . 100% Fraud.” Olagues maintains that the Bear Stearns collapse was artificially created to allow JPMorgan to be paid $55 billion of taxpayer money to cover its own insolvency and acquire its rival Bear Stearns, while at the same time allowing insiders to take large “short” positions in Bear Stearns stock and collect massive profits. For evidence, Olagues points to a very suspicious series of events, which will be detailed here after some definitions for anyone not familiar with stock options:

A put is an option to sell a stock at an agreed-upon price, called the strike price or exercise price, at any time up to an agreed-upon date. The option is priced and bought that day based upon the current stock price, on the presumption that the stock will decline in value. If the stock’s price falls below the strike price, the option is “in the money” and the trader has made a profit. Now here’s the evidence:

On March 10, 2008, Bear Stearns stock dropped to $70 a share -- a recent low, but not the first time the stock had reached that level in 2008, having also traded there eight weeks earlier. On or before March 10, 2008, requests were made to the Options Exchanges to open a new April series of puts with exercise prices of 20 and 22.5 and a new March series with an exercise price of 25. The March series had only eight days left to expiration, meaning the stock would have to drop by an unlikely $45 a share in eight days for the put-buyers to score. It was a very risky bet, unless the traders knew something the market didn’t; and they evidently thought they did, because after the series opened on March 11, 2008, purchases were made of massive volumes of puts controlling millions of shares.

On or before March 13, 2008, another request was made of the Options Exchanges to open additional March and April put series with very low exercise prices, although the March put options would have just five days of trading to expiration. Again the exchanges accommodated the requests and massive amounts of puts were bought. Olagues contends that there is only one plausible explanation for “anyone in his right mind to buy puts with five days of life remaining with strike prices far below the market price”: the deal must have already been arranged by March 10 or before.

These facts were in sharp contrast to the story told by officials who testified at congressional hearings on April 4. All witnesses agreed that false rumors had undermined confidence in Bear Stearns, making the company crash despite adequate liquidity just days before. On March 10, 2008, Reuters was citing Bear Stearns sources saying there was no liquidity crisis and no truth to the speculation of liquidity problems. On March 11, the Chairman of the Securities and Exchange Commission himself expressed confidence in its “capital cushion.” Even “mad” TV investment guru Jim Cramer was proclaiming that all was well and the viewers should hold on. On March 12, official assurances continued. Olagues writes:

“The fact that the requests were made on March 10 or earlier that those new series be opened and those requests were accommodated together with the subsequent massive open positions in those newly opened series is conclusive proof that there were some who knew about the collapse in advance . . . . This was no case of a sudden development on the 13 or 14th, where things changed dramatically making it such that they needed a bail-out immediately. The collapse was anticipated and prepared for. . . .

“Apparently it is claimed that some people have the ability to start false rumors about Bear Stearns’ and other banks’ liquidity, which then starts a ‘run on the bank.’ These rumor mongers allegedly were able to influence companies like Goldman Sachs to terminate doing business with Bear Stearns, notwithstanding that Goldman et al. believed that Bear Stearns balance sheet was in good shape. . . . The idea that rumors caused a ‘run on the bank’ at Bear Stearns is 100% ridiculous. Perhaps that’s the reason why every witness was so guarded and hesitant and looked so mighty strained in answering questions . . . .

“To prove the case of illegal insider trading, all the Feds have to do is ask a few questions of the persons who bought puts on Bear Stearns or shorted stock during the week before March 17, 2008 and before. All the records are easily available. If they bought puts or shorted stock, just ask them why.”5

Suspicions Mount

Other commentators point to other issues that might be probed by investigators. Chris Cook, a British consultant and the former Compliance Director for the International Petroleum Exchange, wrote in an April 24 blog:

“As a former regulator myself, I would be crawling all over these trades. . . . One question that occurs to me is who actually sold these Put Options? And why aren’t they creating merry hell about the losses? Where is Spitzer when we need him?”6

In an April 23 article in LeMetropoleCafe.com, Rob Kirby agreed with Olagues that it was not Bear Stearns but JPMorgan that was bankrupt and needed to be “recapitalized” with massive loans from the Federal Reserve. Kirby pointed to the huge losses from derivatives (bets on the future price of assets) carried on JPMorgan’s books:

“. . . J.P. Morgan’s derivatives book is 2-3 times bigger than Citibank’s – and it was derivatives that caused losses of more than 30 billion at Citibank . . . . So, it only made common sense that J.P. Morgan had to be a little more than ‘knee deep’ in the same stuff that Citibank was – but how do you tell the market that a bank – any bank – needs to be recapitalized to the tune of 50 - 80 billion?”7

Kirby wrote in an April 30 article:

“According to the NYSE there are only 240 million shares of Bear outstanding . . . [Yet] 188 million traded on Mar. 14 alone? Doesn’t this strike you as being odd? . . . What percentage of the firm was owned by insiders that categorically did not sell their shares? . . . Bear Stearns employees held 30 % of the company’s stock . . . 30 % of 240 million is 72 million. If you subtract 72 from 240 you end up with approximately 170 million. Don’t you think it’s a stretch to believe that 186+ million real shares traded on Friday Mar. 14? Or do you believe that rank-and-file Bear employees, worried about their jobs, were pitching their stocks on the Friday before the company collapsed knowing their company was toast? But that would be insider trading – wouldn’t it? No bloody wonder the SEC does not want to probe J.P. Morgan’s ‘rescue’ of Bear Stearns . . .”8

If real shares weren’t trading, someone must have been engaging in “naked” short selling – selling stock short without first borrowing the shares or ensuring that the shares could be borrowed. Short selling, a technique used by investors to try to profit from the falling price of a stock, involves borrowing a stock from a broker and selling it, with the understanding that the stock must later be bought back and returned to the broker. Naked short selling is normally illegal; but in the interest of “liquid markets,” a truck-sized loophole exists for “market makers” (those people who match buyers with sellers, set the price, and follow through with the trade). Even market makers, however, are supposed to cover within three days by actually coming up with the stock; and where would they have gotten enough Bear Stearns stock to cover 75% of the company’s outstanding shares? In any case, naked short selling is illegal if the intent is to drive down a stock’s share price; and that was certainly the result here.9

On May 10, 2008, in weekly market commentary on FinancialSense.com, Jim Puplava observed that naked short selling has become so pervasive that the number of shares sold “short” far exceeds the shares actually issued by the underlying companies. Yet regulators are turning a blind eye, perhaps because the situation has now gotten so far out of hand that it can’t be corrected without major stock upheaval. He noted that naked short selling is basically the counterfeiting of stock, and that it has reached epidemic proportions since the “uptick” rule was revoked last summer to help the floundering hedge funds. The uptick rule allowed short selling only if the stock price were going up, preventing a cascade of short sales that would take the stock price much lower. But that brake on manipulation has been eliminated by the Securities Exchange Commission (SEC), leaving the market in unregulated chaos.

Eliot Spitzer has also been eliminated from the scene, and it may be for similar reasons. Greg Palast suggested in a March 14 article that the “sin” of the former New York governor may have been something more serious than prostitution. Spitzer made the mistake of getting in the way of a $200 billion windfall from the Federal Reserve to the banks, guaranteeing the mortgage-backed junk bonds of the same banking predators responsible for the subprime debacle. While the Federal Reserve was trying to bail the banks out, Spitzer was trying to regulate them, bringing suit on behalf of consumers.10 But he was swiftly exposed and deposed; and the Treasury has now broached a new plan that would prevent such disruptions in the future. Like the Panic of 1907 that justified a “bankers’ bank” to prevent future runs, the collapse of Bear Stearns has been used to justify a proposal giving vast new powers to the Federal Reserve to promote “financial market stability.” The plan was unveiled by Treasury Secretary Henry Paulson, former head of Goldman Sachs, two weeks after Bear Stearns fell. It would “consolidate” the state regulators (who work for the fifty states) and the SEC (which works for the U.S. government) under the Federal Reserve (which works for the banks). Paulson conceded that the result would not be to increase regulation but to actually take away authority from state regulators and the SEC. All regulation would be subsumed under the Federal Reserve, the bank-owned entity set up by J. Pierpont Morgan in 1913 specifically to preserve the banks’ own interests.

On April 29, a former top Federal Reserve official told The Wall Street Journal that by offering $30 billion in financing to JPMorgan for Bear’s assets, the Fed had “eliminated forever the possibility [that it] could serve as an honest broker.” Vincent Reinhart, formerly the Fed’s director of monetary affairs and the secretary of its policy-making panel, said the Fed’s bailout of Bear Stearns would come to be viewed as the “worst policy mistake in a generation.” He noted that there were other viable options, such as looking for other suitors or removing some assets from Bear’s portfolio, which had not been pursued by the Federal Reserve.11

Jim Puplava maintains that naked short selling has now become so pervasive that if the hedge funds were pressed to come in and cover their naked short positions, “they would actually trigger another financial crisis.” The Fed and the SEC may be looking the other way on this widespread stock counterfeiting scheme because “if they did unravel it, everything really would unravel.” Evidently “promoting market stability” means that whistle-blowers and the SEC must be silenced so that a grossly illegal situation can continue, since the crime is so pervasive that to expose it and prosecute the criminals would unravel the whole financial system. As Nathan Rothschild observed in 1838, when the issuance and control of a nation’s money are in private hands, the laws and the people who make them become irrelevant.

Sunday, 25 May 2008

US already in recession, says world's richest man Buffet

BERLIN (AFP) - - While economists quibble, the world's richest man has decided: the United States is already in recession. So Warren Buffett tells German magazine Der Spiegel in an interview to be published on Monday.

"It is perhaps not a recession in the way that economists would understand it... but people are already feeling the effects and it will be deeper and longer than people think," Buffett said on a visit to Frankfurt.

Buffett, the 77-year-old chief of the Berkshire Hathaway holding company, blamed financial institutions for introducing instruments "they can no longer control" and said the "genie can no longer be put back in the bottle."

Buffett, who overtook Bill Gates this year as the world's richest man, said he believed the financial markets should be more tightly regulated.

According to the Forbes annual billionaire's list published in March, Buffett saw his wealth jump from 52 billion dollars last year to 62 billion, pushing Microsoft co-founder Gates into third position after 13 years at the top.

US economic growth has slowed dramatically in recent months and a growing number of economists believe the world's largest economy will experience a recession during 2008 amid a housing slump and related credit crunch.

Saturday, 24 May 2008

The Fund Mgt Activities in Singapore", by Valerie Wu

EXECUTIVE SUMMARY

Singapore's booming asset management industry saw its sixth consecutive year of double-digit growth in 2006, boosted by continuing worldwide interest in Asia's rapid economic.

According to the Monetary Authority of Singapore’s (MAS) latest survey of the asset management industry, the amount of assets managed by Singapore-based fund managers swelled by 24 per cent last year, reaching $891 billion at end-2006, compared to $720 billion a year earlier. Since the mid-nineties, the Singapore Government has identified the investment management industry as one of the key financial sectors to develop. With this in mind, the MAS has introduced a variety of incentives and reforms to encourage the growth of the investment management industry.

 The MAS and the Government of Singapore Investment Corporation (GIC) have committed to place out a total of S$35 billion of funds to external fund managers over the next few years. This will serve as seed money to grow the Singapore fund management industry.

 The Central Provident Fund (CPF) Investment Scheme for unit trusts was also revamped to increase the number of quality asset managers and products available to CPF members.

 MAS also liberalized the investment guidelines for both CPF and non-CPF unit trusts to give asset managers the flexibility they need to diversify their portfolios. Restrictions on regular savings plans were also lifted so that asset managers can decide whether they want to offer regular savings plans, and their structure.

 To improve and streamline the regulatory structure for asset management companies, MAS reduced the minimum group shareholders' funds requirement for an investment adviser's license from S$500 million to S$100 million. The minimum amount of global funds that the company must manage was also lowered from S$5 billion to S$1 billion.

 Steps have been taken to make rules more transparent. For example, new disclosure requirements and investment guidelines for unit trusts are now set out in the Handbook of Unit Trusts, issued by MAS and the Registry of Companies and Businesses (RCB).

 MAS raised the disclosure standards for unit trusts so that investors would be adequately informed of the returns and risks associated with their investments, and can compare the performance and charges of different unit trusts and asset managers.

 In March 1999, MAS introduced measures aimed at nurturing the local boutique fund management (BFM) industry, including a new Approved Boutique Fund Managers (ABFMs) Scheme, which allowed investment income earned by foreign investors from funds managed by ABFMs in Singapore to be tax-exempt.

 To attract new asset managers to Singapore and encourage existing firms to expand their operations, the Government has introduced various tax incentive schemes for the asset management industry. For example, the Enhanced Fund Manager scheme allows fund management companies who manage at least S$5 billion of foreign investors' funds to enjoy tax exemption for the fee income earned from providing investment management or advisory services.

 SGX has also allowed the listing of hedge funds from June 2006.

These efforts appear to have met with some success, as many international fund management firms have set up offices in Singapore and do business there. Singapore is certainly fast emerging as a major centre for fund management activities in the region.

INTRODUCTION

Fund management is defined as collecting funds from individual investors and invest those funds in a potentially wide range of securities and other assets. Pooling of assets is the key idea behind investment companies.

There are two types of fund structure: open-ended funds and close-ended funds. Open-end funds stand ready to redeem or issue shares at their net asset value while close-end funds do not issue or redeem shares, so investors who wish to cash out must sell their shares to other investors.

Singapore’s fund management industry here has benefited from rising private wealth worldwide, boosted by the strong global economy and robust stock markets, and keen interest among investors in Asia's economic growth led by China and India.

NATIONAL DEVELOPMENT STRATEGY

The national development strategy for the fund management sector is to build on existing strengths, address weaknesses, prioritize likely market niches, and take into account related activities and their support factors, and leading edge global developments.

 Expanding the government’s role in developing the asset management industry by:
(1) developing start ups and small and medium sized fund management firms;
(2) extending fund management mandates granted by the GIC and the MAS;
(3) providing funds to attract private equity players.

 Boosting competitiveness as pre-eminent asset management centre by
(1) improving tax treatment;
(2) reviewing CPF structure;
(3) improving investor education;
(4) improving professional training.

 Increasing focus on developing alternative assets (ie hedge funds) cluster by
(1) raising developmental focus and regulatory responsiveness;
(2) establishing the limited partnership structure (ie for an investment vehicle, as in the US) in Singapore;
(3) reforming the Trustees Act;
(4) streamlining tax incentives for private equity into a single package;
(5) increasing tax certainty for private equity;
(6) establishing a favorable tax environment for alternative investments;
(7) upgrading professional skills in private equity;
(8) using private equity as an option to help Government-Linked Companies (GLCs) to spin-off non-core assets.

 Developing ancillary services by:
(1) developing trustee and custody services;
(2) developing specialized legal, custody and other ancillary services.

FUND MANAGEMENT ACTIVITIES: GOVERNMENTAL MEASURES

Singapore aims to be the premier asset management hub in Asia. To achieve this aim, various measures have been put in place.

1) Central Provident Fund
The Central Provident Fund (CPF), a compulsory government-managed retirement savings scheme, was set up in 1955. Current contribution rates are very high – up to 20% of salary from the employee and 16% from the employer, subject to a cap. The CPF absorbs much of the population’s savings and majority of which is invested in Government bonds. However, in recent years, CPF account holders have been permitted more flexibility in usage of their accounts. Drawdowns for major items such as house purchases are permitted, and CPF account holders may even invest a portion of their fund in stocks.

2) Handbook on Unit Trusts
MAS, together with the Registry of Companies and Businesses (RCB), has also published a Handbook on Unit Trusts. The Handbook provides easy reference to industry practitioners on the legal requirements as well as administrative guidelines for the offer, management and operation of unit trusts.

MAS has raised the disclosure standards for unit trusts so that investors are adequately informed of the fees and charges, risks and performance associated with each unit trust. Such disclosure helps investors to compare different unit trusts, enabling them to make informed investment decisions.

The Central Provident Fund Investment Scheme for unit trusts was revamped to increase the number of quality asset managers and products available to CPF members. This would further increase the pool of domestic funds available for professional management.
However, “The Code on Collective Investment Schemes” replaces the “Handbook on Unit Trusts” with effect from 1 Jul 2002. The Code is issued pursuant to Part XIII of the Securities and Futures Act (Offers of Investments).

3) Outplacing Government Funds for Private Management
In 1998, MAS has adopted a strategic approach towards developing the fund management industry. Following the Asian Financial Crisis, which hit Singapore’s neighbours such as Indonesia particularly hard, the Singaporean authorities redoubled their efforts.MAS and the Government of Singapore Investment Corporation (GIC) have decided to place out a total of S$35 billion to external fund managers over three years till 2000. This will act as seed money to grow the Singapore fund management industry.

4) Revised Requirements and Tax Incentives for Fund Management Companies
To attract more fund managers to operate out of Singapore, the minimum shareholders' funds requirement for an Investment Adviser's licence was reduced in February 1998 from S$500 million to S$100 million. The minimum amount of global funds that the company must manage was also lowered from S$5 billion to S$1 billion. The government also introduced tax incentives which allow qualifying fund management companies to enjoy tax exemption for the fee income earned from providing investment management or advisory services.

Fund management companies are entitled to the following fiscal concessions:

i) Fee income received by fund management companies in respect of services rendered are exempt from corporate income tax for a period of 5 years provided the fund management company manages an asset portfolio with a value in excess of S$5m (at the time of writing). The exemption period can be 10 years if the fund managers can make suitably strong commitments to significantly increase their level of fund management activities in Singapore. The exemption is granted by the monetary authority of Singapore on a case by case basis.

ii) Dividends: In Singapore there are no withholding taxes levied on dividends. Instead dividends are taxed at 20% with a tax credit being given for any corporate tax levied on the profits out of which dividends are paid. Where there is a shortfall between the tax credit and the 20% charge levied on dividends the shortfall must be made up by the company paying the dividend and not by the shareholder receiving it. Companies engaged in fund management are exempt from any further taxation on the shortfall in so far as that shortfall is caused by the concessionary fiscal status granted to the company.

Regulatory changes introduced in 2004 mean that international fund managers are no longer required to maintain a physical presence in the territory, and are permitted to make their funds available via private banks.

5) Licensing Regime for Boutique Fund Managers
In March 1999, MAS introduced a streamlined licensing scheme aimed at admitting more boutique fund management firms (BFMs) to add greater depth to the fund management industry. BFMs are owned and operated by experienced fund management professionals, provide specialised investment advisory services to selected institutional and high net-worth clients.

Singapore's Prime Minister Lee Hsien Loong announced in his 2005 budget that start-up fund managers would be given a 12-month grace period to meet the requirement that 80% of share capital must come from foreign investors to qualify for a 10% tax rate on fee income.

Foreign fund managers, ie those based overseas, are actively solicited to set up offices in Singapore. The authorities also recognize the value of innovation and are keen to get the leading edge firms to set up in Singapore. In accordance with this policy, Singapore has been welcoming to hedge funds, and has granted them mandates of government money to encourage them to set up in Singapore.

The other aspect of hedge fund taxation that industry participants called for to be changed was the level of the 10% tax, considered somewhat high by many. By cutting this levy to 5%, observers believed that Singapore would be able to continue to carve out a niche as a centre for the management of Indian, Japanese and Korean-based funds, in addition to capturing some of the growing interest in specialist Islamic hedge funds.

6) SGX Listing of Hedge Funds
In June 2006, Singapore Exchange Ltd (SGX) announced that it would accept listings of hedge funds. Although eligible hedge funds are listed, however there is no trading in their units on SGX. Typically, issue and redemption takes place in the over-the-counter market.

The new listing rules for hedge funds have the following key features:
i) Hedge funds must be authorised or recognised under section 286 or 287 of the Securities and Futures Act; or be offered only to institutions and/or accredited investors;
ii) They must have a minimum asset size of at least S$20 million or US$20 million for Singapore and foreign currency denominated funds respectively.

Under additional rules, fund managers are required to have in place an independent risk management function. The investment management team of a hedge fund is expected to have at least one principal with a minimum of five years relevant investment management experience. A hedge fund will have to announce its net asset value per unit, as soon as practicable after each month end, but in any event no later than seven business days. In addition, a fund must immediately announce any material change relating to its operations, including but not limited to, any change in its investment manager, custodian, administrator or independent auditor.

FUND MANAGEMENT ACTIVITES: STATISTICS

“Fund managers continue to use Singapore as their regional HQ because they see Singapore as a prime location to service clients, raise capital from the region, as well as invest into the region and beyond,” said MAS chairman and Senior Minister Goh Chok Tong, speaking to equity investors and business leaders from around the world at the fourth annual Asia Equity Forum organized by Japan's largest brokerage, Nomura.

Most of the growth was contributed by foreign traditional asset managers, which accounted for 85 per cent of the rise in total assets under management. The rest of the growth came from local asset management firms and alternative asset managers like hedge fund managers.

Hedge fund services are seriously lacking in the region, especially the early stage arena in Singapore, even though there has been an increase in the number of hedge fund managers in Singapore.

The number of hedge funds based in Singapore grew from just eight in 2001 to more than 50 in 2004 and rose sharply to about 190 at end-2006, a 76 per cent jump from a year earlier. Together, they managed more than $40 billion worth of assets, a 150 per cent increase from 2005.

Over the year, the total number of portfolio managers, investment analysts and other investment professionals rose 23 per cent to reach 1,786 at end-2006. Of these, a third are employed by local asset management firms.

As at 2005, more than 80 per cent of the funds managed out of Singapore last year was sourced from abroad. About half the total funds came from institutional investors; the rest were assets managed on behalf of other investors, including individuals and collective investment schemes.

Forty-three per cent of the funds was sourced from Asia Pacific, while the US contributed 11 per cent and Europe 24 per cent. The proportions were broadly unchanged from 2005. Asset managers here also reported a surge in funds from South Asia and the Middle East; funds sourced from these regions grew by 36 per cent and 21 per cent respectively.

According to the latest World Wealth Report published by Merrill Lynch and Capgemini in June 2007, Singapore saw a 21 per cent jump in its population of people with more than US$1 million in assets in 2006 - the fastest increase among the 71 countries covered in the report.

The total number of such high-net-worth individuals worldwide rose by 8.3 per cent to 9.5 million, while their combined wealth grew 11.4 per cent to US$37.2 trillion. In the Asia Pacific region, high-net-worth wealth rose 10.5 per cent to US$8.4 trillion, and is projected to grow at an average rate of 8.5 per cent a year to reach US$12.7 trillion by 2011.

A measure of the continuing keen interest in Asia was demonstrated in the data published by MAS on 4 July 2007 - 57 per cent of the total assets under management in Singapore last year were invested in the Asia Pacific region, up from 53 per cent in 2005.

The share of assets invested in Europe rose slightly to 12 per cent from 10 per cent in 2005, while the proportion of funds allocated to the US - the other main investment destination - was unchanged at 7 per cent. As stock markets worldwide soared, the proportion of assets invested in equities grew to 55 per cent in 2006, up from 47 per cent in 2005. This ate into the share of funds invested in bonds and other assets.

FUND MANAGEMENT ACTIVITIES: INSURANCE

In recent years, we have seen a very significant increase in the number of unit trusts and investment-linked life insurance products in the Singapore market place. Singapore is one of the most open insurance markets in the world. As at 17th March 2000, the market became fully open to foreign insurers and the 49% limit on foreign shareholdings was also removed.

Singapore's development as a leading insurance centre has seen a rich pool of 56 direct insurers (including Life, General and Composite), 28 professional reinsurers, and 60 captives today. We are currently the largest domicile for captive insurers in Asia and 20 of the top 25 reinsurers globally are based in Singapore.

Some of the incentives in the recent years for the insurance industry include:
i) Tax Incentive Scheme for Offshore Insurance Business.
A concessionary tax rate of 10 percent can be granted to insurance companies on income derived from writing offshore insurance business.

ii) Tax Exemption Scheme for Offshore Marine Hull & Liability Insurance Business. This scheme aims to encourage all general direct insurance and reinsurance companies in Singapore to tap the insurance potential of the shipping communities in the Asia Pacific region. It provides tax exemptions for income derived from underwriting profits of offshore marine hull and liability business as well as non-Singapore dividends, realized capital gains, and interest including Asian Currency Unit (ACU) deposits derived from investing premium income from offshore marine hull and liability insurance business and shareholders’ funds used to support the offshore marine hull and liability insurance business.

iii) Abolition of Withholding Taxes on Financial Guarantee Insurance Contracts. To promote financial guarantee business, claim payments made under financial guarantee insurance policies by approved financial guarantee insurers to nonresidents are exempt from withholding tax.

FUND MANAGEMENT ACTIVITIES: REITS

A report released by Standard & Poor's (S&P) Ratings Services in September 2004, entitled 'Securitizing Real Estate in Asia: Is Singapore a Prelude of Things to Come?' noted that Singapore, with over US$1 billion in capital raised since 2002, is increasingly seen as a factor in the region's REIT and securitized real estate market arena. The report also pointed out that Singapore's many other advantages including location, a highly skilled and educated workforce, its 'AAA' sovereign rating, and clear legal system are also standing the city-state in good stead within the international real estate market.

According to S&P, the marriage of these factors with relevant tax benefits is making Singapore the preferred location to list shares for many regional real estate owners. Singapore has emerged as an inviting market for local and regional REITS issuers with pressures from investors and regulators driving the market toward international valuation, governance, and transparency standards.

In his 2005 budget speech, Prime Minister and Minister of Finance, Lee Hsien Loong announced that foreign non-individual investors would be encouraged to invest in the Singapore property market with a proposed reduction in the withholding tax on REIT distributions to 10% from 20%, for a period of five years. Additionally, to attract more REIT listings, the government will waive stamp duty on the instruments of transfer of Singapore properties into REITS to be listed, or already listed on the SGX, for a five-year period.



FUND MANAGEMENT ACTIVITIES: HEDGE FUNDS

Singapore is also emerging as the most popular Asian location amongst hedge fund managers for fund start ups, and the city state saw more new fund registrations than either Hong Kong or Australia in 2004. Singapore saw 19 fund launches last year, compared to 13 each in Hong Kong and Australia. Institutional asset managers accounted for 85% of the increase, with hedge funds adding impetus – there were 190 hedge funds in Singapore at the end of 2006, compared to 107 at the end of 2005.

Singapore has recognized the opportunity presented by the ambiguous tax stance of the Hong Kong Inland Revenue Department towards unauthorized funds (i.e. most hedge funds); and it has been soliciting Hong Kong-based fund managers to relocate to the island state.

The factor that appears to be spurring hedge fund growth in Singapore is the relatively short time taken to register a fund in the city-state, an issue identified by hedge fund managers as the most crucial.

In his 2006 budget, Lee Hsien Loong announced a range of tax and other initiatives aimed at spurring growth in the financial services and asset management industry. Among the measures designed to promote the development of Singapore as a financial centre were enhanced tax incentives for asset and wealth management, capital and treasury markets, and captive insurance.

The current stable cost structure and clear and conducive regulatory and tax environment has primed Singapore into one of the most desirable places in Asia for fund managers to open their own boutique hedge funds. Singapore overtook Hong Kong in terms of hedge fund launches in 2004 – 13 new set-ups in Singapore compared to 12 in Hong Kong. In the first half of 2003, 12 new hedge funds opened their doors in Singapore, while only 6 were launched in Hong Kong.

According to Eurekahedge, as at 6 September 2006, across all strategies, there are pproximately 84 hedge fund firms located in Singapore, 134 in Hong Kong, 58 in Japan and 115 in Australia.

The growth in assets employed in the region, across all strategies, has been impressive in recent years, rising from USD 16 billion in 2000 to USD 90 billion in 2005. During that period, the number of single manager funds dedicated to Asian markets has also grown from approximately 180 to 650.

The high remuneration and independence of hedge funds, compared with traditional fund houses, means they tend to attract the best and brightest of the profession. The transfer of knowledge from these practitioners promotes the general development of the financial market in which they are based. Through the high fees they earn and active trading, hedge funds generate fee income for their suppliers. Hedge fund activities also boost GDP, tax revenues and stimulate quality employment in firms from which they purchase services, such as prime brokers, custodians and accountants and lawyers.

CONCLUSION

In accordance with its government-led economic philosophy, the Singapore authorities have expressly targeted the development of the fund management as a key element of the financial sector. A range of incentives are provided by the government to encourage international fund managers to set up in island state. Factors that support fund managers aggregating in a centre like Singapore include good infrastructure, availability of quality legal and accounting services, sound regulatory environment, low tax rates and a clear tax regime, and the potential demand for their products from the individuals and businesses in the economy. With these, Singapore’s fund management industry is set for exponential growth.

Valerie Wu
10 August 2007

What's Next for Commodities

By Katy Marquardt

How much juice is left in this commodity boom? The managers of the RS Global Natural Resources fund--which has shot up an annualized 34 percent over the past five years--contend that we're still in the early stages of a bull run, yet the easy money has been made. According to MacKenzie Davis and Ken Settles, who manage the $2.2 billion fund along with Andy Pilara, the best deals now aren't in the commodities themselves but in the stocks of commodity producers. U.S. News spoke recently with Davis and Settles about bubbles, "advantaged" companies, and why they don't invest in $125-a-barrel oil. Excerpts:

What's your outlook for commodities? Settles: We believe that we are in the early stages of a 10-to-20-year uptrend for commodities, driven largely by the rising costs to add new supply. As such, we don't see commodities as a speculative bubble. However, we do believe that the natural resource stocks are much more attractively priced than the commodities themselves. In fact, using long-term commodity price assumptions that are well below current spot prices, valuations for many natural resources stocks remain quite attractive. The opportunity is as good today as it was two to three years ago.

Davis: But the easy money, driven by the homogenous rise of commodities over the past five to six years, has been made. Going forward, investors will need to take a more nuanced approach when investing in the sector to reflect the expected differentiation in performance between commodities and commodity producers. We look for advantaged companies that can generate attractive returns in a much lower commodity price environment. That helps to protect our investors on the downside.

Settles: One thing that is important to realize is that there is a big difference between low-cost producers and high-cost producers. For example, there are some oil projects today that require $100 oil in order to generate a decent rate of return on the investment, and there are other projects that can generate attractive returns it at $30 to $40 oil. Rather than invest in companies that need extremely high oil prices to generate a decent rate of return, what we do is invest in companies that have the ability to reinvest in low-cost projects.

I would ask where you see the price of oil going, but I hear that you don't forecast commodity price levels. Settles: We don't spend a lot of time forecasting short-term moves in spot price, but we have pretty strong opinions about the long-term outlook. Although commodities will continue to be cyclical, we see the cost of most commodities continuing to rise, thus driving prices higher over time. If you're a longer-term investor, it's more important to pick the right company than to speculate on the near-term direction for the commodity.

What's a stock that fits your investing strategy? Settles: Denbury Resources owns a large, naturally occurring source of carbon dioxide in Mississippi, which puts it at an advantage in the Gulf Coast area. Injecting carbon dioxide into a reservoir allows previously inaccessible oil to be recovered, at very low capital costs. Finding and development costs in North America are running $20 to $30 a barrel, and we think Denbury's enhanced oil recovery projects will come in around $5 to $10 a barrel.

Davis: The CO2 deposit is a structural advantage that can't be competed away. The geology gives them a competitive advantage which can't be replicated.

Settles: We think there's very limited downside for Denbury in a multiyear period. We don't need to invest in $125 oil; we can find companies that can profitably produce at $40 a barrel.
What's a nonoil stock you like? Davis: Century Aluminum, a relatively small aluminum company based in Monterey, Calif. They have a collection of U.S.-based smelters [smelters process alumina into aluminum] which sit in the middle of the industry cost curve. Several years ago, they took on a significant project in Iceland, where they're developing a series of new smelters. Power is a key determinant of the aluminum cost curve, and in Iceland, Century has access to inexpensive hydro and geothermal power. The value of owning those assets in Iceland grows over time because of the structural challenges facing power on a global basis. They've locked up long-term power contracts at very low rates, which should allow Century to remain at the low end of a cost curve which continues to steepen.

Do you invest in renewable energy? Davis: We're focused on the economics and understanding the math behind projects. Broadly speaking, what we've seen so far in the alternative energy space is that the projects don't necessarily work without government subsidies, and the stocks don't work unless you're willing to assume very significant rates of growth over long periods of time.

However, we're looking for free options inside larger companies. For example, we have a number of coal investments that are putting significant funding toward clean coal technologies. That's a way to get access to their development without having to pay for it. We also try to follow the food chain with things like the nuclear renaissance and the water shortage, which we think we're getting closer to on a global basis. We won't necessarily invest in a General Electric, which is building a lot of the infrastructure, but we'll look at who the parts suppliers are and who's supplying alloys and metals.

How much of a portfolio should be dedicated to commodities? Davis: What's happening in commodities is probably the same thing that happened to real estate 10 to 15 years ago. Real estate went from being an optional allocation to pretty much a permanent allocation in portfolios. Whether it's a 5 percent or 15 percent allocation to commodities and natural resources varies by individual. It's also an interesting way, we think, to get exposure to the emerging economies, where much of the demand is coming from.

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