As much as it pains me to document this for my future use. It is necessary to learn from the mistakes of my stock holdings so far.
Divested China Milk 3th November 2009
Reasons:
-Revenue derived from the sale of our pedigree bull semen dropped by approximately 91.6%. -China Milk lost almost all its margins -Operating Profits drop by 80.8% -Cannot see what the management is doing to overcome the obstacles they are facing.
Did not study company’s external factors-Government impact, their suppliers.
-The drop of the raw milk price was mainly attributable to the raw milk buyers/milk processers exercising more testing/quality procedures which have led to their costs going up and that they are reluctant to absorb such costs; and on the other hand, the influx of cheaper imported milk powder.
- More stringent government controls on the quality of raw milk resulting from melamine incident in China lead to higher costs of keeping dairy cattle by local farmers.
-Increase in cheaper imported milk powder was mainly caused by excess supply of milk powder from overseas which resulted from excess raw milk being produced in overseas countries. This has also caused the decrease in the raw milk prices abroad too.
Did not study their competitors, not only locally but aboard.
-Intense price competition by local and overseas producers of bull semen and cow embryos will continue to keep prices of China Milk’s bull semen down and the demand for the Group’s cow embryos low
- Imported milk powder is now selling in China at more competitive prices => milk processors may choose to process milk products with the imported milk powder rather than purchase raw milk from farmers.
-There are also some advantages that milk powder possesses over raw milk, for example,
i.) as long as you have bought the milk powder from a reputable source, then there would not be any quality issues;
ii.) Easier shipping and transportation; and
iii.) Longer shelf-life as compared to raw milk which is significantly more perishable.
Did not apply buffet’s rule no.1: Invest in companies with long good record history.
Did not apply buffet’s rule no.3 properly: Know the industry, is it price competitive.
No doubt, the milk industry is very lucrative in China, but competitors overseas outshine China Milk taking away its future growth prospects, moreover management don’t seem to be doing anything to tackle this problem.
China Milk going forward process
-Focus on herd size expansion
-Actively participated in marketing events such as food fairs, sampling booths at supermarkets and promotional activities at shopping malls => showcase Yinluo brand of dairy products and gather consumer feedback
-Adopting an effective cost management strategy as the Group envisions lower revenue and smaller margins ahead, in view of the challenging business environment
Willing to buy back again, if the company can get back its margins &Operating profits in the coming quarters. The company needs to show me it is able to overcome competitors & their advantages, to take back their market share.
Divested SinoTechFiber 3th November 2009
Did not act fast enough when fundamentals were dropping.
Focused too much on their high profit margins, contracts with the government, high ROE all these are too good to be through. Especially its industry (Textile) where competitors very easily come in taking away its profits and future growth. In addition, consumers in this industry is also very flicked minded, certain times they demand cotton then fibre then linen.
Mistake learnt: Study the industry properly! Have a long term vision (2-3years from now) of where the company will be given that it is operating in this industry, what are they doing to keep it their edge?
Divested China Essence 3th November 2009
The business involves selling potato starch/protein and products related to that commodity.
The company is expanding very rapidly since the beginning of this year, the expansion is so rapid that a huge chunk of their cash reserves are gone and there have to take up extra loans and debt related instruments. A quick look at the latest balance sheet/cash flow highlights indicates the following
-Cash balances from FY 08: 484.3million drops to FY 09:168.3million
-Gearing shot up to 61.8% in FY 09 from 36.5% in FY 08
-Debtor Turnover up 77 days from 34 days
-Inventory turnover up 85 days from 53 days
-Operational cash flow drops from a positive 217.3million to a negative 62.5million
-Net decrease in cash flow 314.3million due to heavy investment inputs
Despite all these, this is the result they give me,
-Revenue drop 36%
-profit drop 58%
-Company losing its margins.
-Gearing is not improving, increased to 61.9%.
-Their growth prospects do not excite me any longer.
Lessons learnt here: Be vigilant and take time to update all released reports by the company, especially those small to medium size firms/ high growth firms/start ups.
-Best is still stick to Buffet’s 1st rule: Invest in good long track record companies.
Company’s argument
-Current slowdown in demand is temporary
-Long term demand for potato starch remains firm due to its wide application in food and non-food industries
-Earnings supported by China Essence’s wide range of other potato starch-based and by-products
-China Essence continues to expand its distribution network in China, especially in Guangdong and Fujian in the Southern region; as well as Shanghai
Perhaps then the company will prosper through its good local distributors and product quantity coverage, in the mean time; all those expansions do not seem to yield any good result by far, debtor turnover is what worries me.
Total Invested: $4347
Total Loss Accepted: $1437
Final word: Perhaps I’ve made another mistake? Are my reasons for divesting these stocks too short sighted? Are my initial reasons for holding on to these stocks like
Huge cash reserves
Good economics of scale (Didn’t study enough)
Strong economic moat (Did not understand enough, how strong it is)
Low PE ratio of 7 times, acceptable PBV of 1.9, Strong ROE
Also too short sighted?
Any advice?
Tuesday, November 3, 2009
Oh well..goodbye.
Thursday, October 22, 2009
Save early. It's as simply as that.
Further, we assume that whatever the investors save during their pre-retirement days will earn 8% annually. After they hit the age of 62, we assume that the return on their savings drops to 4% per annum as they take less risk in their investments. This simple illustration does not take into account your other financial needs, such as whether you have planned for your insurance needs (life or term insurance, mortgage insurance, health and hospitalization plans).
If You're 25
Savings: S$0
Monthly Salary: S$2,500
Rate of Increase in Wages: 3% p.a.
Number of Months in Bonus: 2 months
Housing Loan: Not Required
What You Need to Save per Month for the next 37 years: S$158.30
Planning for your retirement when you are 25 years old may seem a bit far-fetched. But the benefits of starting early cannot be underestimated. Assuming that a person starts working at 25 with a salary of S$2,500, you would need to save S$158.30 per month to ensure that your retirement income can stand at S$2,500 per month during your retirement days, which we assume will run from the age of 62 all the way to 82. Even with no savings to start with, having a regular savings plan (RSP) may be a good way to start planning. An RSP would ensure that you have the discipline to force yourself to invest – there is little room for excuses! Very often, we may be tempted to use up our savings for a travel trip or to purchase that dream car. And even for those who believe in the merits of investing, they may not have the discipline of investing regularly because they feel it is not the "right" time to invest. This could be especially true when markets are going through a bull run and some may feel that it is too expensive to go into markets. An RSP is a disciplined way to ensure that you will invest no matter markets are up, down or sideways.
If You're 35
Scenario 1
Savings: S$0
Monthly Salary: S$6,000
Rate of Increase in Wages: 3% p.a.
Number of Months in Bonus: 2 months
Housing Loan: S$800 per month over 30 years
What You Need to Save per Month for the next 27 years: S$666.57
Scenario 2
Savings: S$40,000 (earning 1% p.a.)
Monthly Salary: S$6,000
Rate of Increase in Wages: 3% p.a.
Number of Months in Bonus: 2 months
Housing Loan: S$800 per month over 30 years
What You Need to Save per Month for the next 27 years: S$620.73
At the age of 35, the monthly salary is assumed to have risen to S$6,000. But being able to afford an expensive lifestyle has meant that there are no savings in the bank account, and now you have a housing loan to deal with. While things do not look very bright, it is not too late. Save S$666.57 per month and you could ensure that you have S$2,500 every month during your retirement days.
If You're 45
Scenario 1
Savings: S$0
Monthly Salary: S$8,000
Rate of Increase in Wages: 3% p.a.
Number of Months in Bonus: 2 months
Housing Loan: S$800 per month over 20 years
What You Need to Save per Month for the next 17 years: S$1692.34
Scenerio 2
Savings: S$40,000 (earning 1% p.a.)
Monthly Salary: S$8,000
Rate of Increase in Wages: 3% p.a.
Number of Months in Bonus: 2 months
Housing Loan: S$800 per month over 20 years
What You Need to Save per Month for the next 17 years: S$1582.63
At the age of 45, things will get tougher if no plans have been made yet for retirement. After all, the time horizon till the retirement age of 62 is less than 20 years. Assuming that there are no savings in the savings account, you would need to save S$1692.34 per month. And even with savings of S$40,000, you would still need to save S$1,582.63 per month.
If You're 55
Scenario 1
Savings: S$0
Monthly Salary: S$10,000
Rate of Increase in Wages: 3% p.a.
Number of Months in Bonus: 2 months
What You Need to Save per Month for the next 7 years: S$5319.54
Scenario 2
Savings: S$40,000 (earning 1% p.a.)
Monthly Salary: S$10,000
Rate of Increase in Wages: 3% p.a.
Number of Months in Bonus: 2 months
What You Need to Save per Month for the next 7 years: S$4937.02
The lesson is to start early. The later you drag your retirement planning, the higher the cost. You would need to save over S$5,000 per month (over half your salary) from the age of 55 to 62 to ensure that you have S$2,500 per month during your retirement days.
Wednesday, August 12, 2009
Taking a break.
The organization will be taking a break. Any problems or questions do feel free to email the one in charge at nwcigotbetter2009@live.com.
Wednesday, August 5, 2009
Newshighlight (6)
Today's new highlights will be featuring companies with long history, how they managed to survive for so long and the tips and trades of doing so.
Boustead Singapore celebrates its 180th year of existence last year and continues to make record profit; remains today as the only Singapore-based company which can boast about their unbroken lineage of almost two centuries. The current chairman and group CEO Wong Fong Fui cities abaptability, business cycles have been getting shorter and tighter and a company's survivability depends largely on its ability to adapt to the changes thrown up by these cycles,' he says.
Mr Wong first bought up Boustead Singapore in 1996, the company then was a struggling gem having only earning of $1million out of $60million and was bought at a price of $85million when its net worth then was only $27million.
Mr Wong said’ This was a company with great history and pedigree, it was all about how it could be restructured to adapt to a new marketplace' I therefore was quick to set about the transformation of the company, building up its capabilities in design,engineering,resource management technology and specialist construction. According to Mr Wong, the survival of his company has been due to its ability to adapt to the new realities after each upheaval:"A company that succeeds does not simply accept its fate when it hits a very thick wall, instead it finds not one but several ways around the wall" Another expert on the subject Arie de Geus author of 'The living company' argues that successful surviving companies exhibited four key factors.
1) Is sensitivity to their operating environment which enables them to learn and adapt quickly to changes occurring around them.
2) Is a cohesion and identity. This defines a company's ability to create a strong sense of identity and persona for itself which is essential for survival amid challenges.
3) Longevity is also dependent on the company's ability to tolerate decentralisation of control and diversification, and yet maintain strong and cohesive relationships within and outside of itself.
4) Companies that survive tend to be those which are financially conservative. They are frugal and do not risk capital gratuitously. By keeping their proverbial gunpowder dry, they are well equipped to pursue new opportunities and also attract third party financiers. But Mr Wong adds more point
5) Being a master over Technology. By doing that, it propels your company forward and now can become an albatross around your neck for the next decade.
Going back to Boustead, Mr Wong says that his company was starting to change some parts of its business model yet again! Like Mr De Geus, Mr Wong is a believer in the theory of corporate evolution for survival."There are times when you have to let go of your pass glories" he explained "it is the same with companies; a highly successful product/service today may not be successful tomorrow. A stubborn company will try its best to hold onto those products and services even when they are irrelevant. The companies that enjoy longevity do things differently. They simply evolve creating different businesses each time and adapting to prevailing times.
Going on to another business Fj Benjamin, the one in charge says changes in the business environment are inevitable. The ability to adapt to these changes quickly however will determine if a business has staying power. Fj Benjamin has been around in Singapore for about 50 years. "After 50 years, we put in place policies and practices that will keep us nimble so that we can adjust swiftly to changes in our external environment. This principle of staying fleet=footed and fit for all cycles applies to all functions across our business" says the CEO of FJB.
During the 1997 crisis which taught them to never put their business in a position where sudden unexpected external events can threaten their future. They learnt to be conservative and to pay more attention to risk management. They learn also to be prudent with their capital (debt/equity) and to keep their gearing low. Not to reply inordinately on short-term credit or to be overly invested in assets that they do not need for our core business. Expansion is still vital to growth of any business. However businesses does not have to be BIF in order to survive, it has to be well managed, etc understanding the consumers' needs and be able to deliver what they are looking for, this means having strong leadership and key management who have their fingers on the pulse explains the CEO of FJB.
Investors could look out for some of these 'longevity' chacteristic before putting their hard earn money into their prospective companies, increasing therefore the chances of successful investing in the future.
Friday, July 24, 2009
Portfolio Update :July 2009
Every half a year, I will do a simple summary update on my companies; what have they been doing during this past six months and if possible what are they going to do for the imminent future. So to start off a simple recap on my current holdings are as follows
1) Capital Commercial Trust (CCT)
2) China Milk Products Group Limited
3) China Essence Group Ltd
4) First Shipping Least Trust (FSLT)
5) China Paper Ltd
Let's begin with..
Capital Commercial Trust (CCT) has a portfolio consists of 11 quality office buildings primarily situated in the prime location - Central Area - of Singapore. The properties are Capital Tower, Six Battery Road, One George Street, HSBC Building, Starhub Centre, Robinson Point, Raffles City Singapore (60% interest through RCS Trust), Bugis Village, Wilkie Edge, Golden Shoe Car Park and Market Street Car Park. In Malaysia, CCT holds 30% stake in Quill Capita Trust (QCT), a commercial REIT listed on the Bursa Malaysia Securities Berhad that owns commercial properties in Kuala Lumpur, Cyberjaya and Penang. CCT also has 7.4% stake in the Malaysia Commercial Development Fund. Going forward, CCT will unlikely be acquiring new assets/buildings due uncertainties of the future, until such that the latter proves otherwise, CCT will continue to expand seeking out good assets to enhance shareholder value according to Lynette leong CEO of the trust.
In addition, CCT has recently issue rights to pay down their current debts in doing so reducing their debt ratio from 40%+ to a low of 31%, the rights was issued in May-June period and was oversubscribed by 1.35times.
CCT’s latest quarter to quarter distribution per unit increase 29% from 2.58cents to 3.33cents after factoring in the rights unit. Which give an 8.2% annual yield using June 2009 share price of $0.81 and a 9.5% yield for my own holdings in the company which averages out to be $0.64 per share? This is because of improved operating margins, higher rental rates and good cost cutting measures.
Net asset value after rights issue is $1.54 which gives me a 140% margin of safety which in my view is substantial enough to continue to hold on to CCT.
In debt aspects, CCT has 8 assets to secure additional debts, strong balance sheet due to the rights issues and about $665million untapped balance from S$1.0 billion multicurrency medium term note programme. This is important to know, because it shows that CCT has at least defences against downward risks for the coming future. The ability to refinance is therefore in my opinion decent. About $900million of debts will expire in 2011.
A question was posted to the CEO of CCT during the Asian investment conference on the new supply of offices in Singapore, what is CCT going to do about this in light of new supplies that might push down rent rates and entice tenants to switch. Her reply was that the government have been reducing new supplies of A graded office spaces about 8million sq feet in total for the next 5 years and should the time to get new good valued office buildings comes, CCT will not let the chance go by.
On overseas acquisitions, CCT unlikely be buying foreign office buildings because of reasons such as “not in vision”, “the lack of influence and economics of scale”, “political issues” and “the lack of expertise”.
Comparing CCT with my requirements of holding is as follows
* The trust must focus on office rentals in Singapore
* The trust must have good debt management
* The trust has to actively enhance DPU
* The trust must build good relationship with tenants
* Share Price must be significantly below NAV
* Share Price must allow a yield of more than 8%
China Milk
The only company whose annual report is that of a glass of milk. :] A quick look at their finances
Total revenue for 2009 is 723million RMB, up 25.5% from 2008, net asset value per share up 0.5cents to 2.96 RMB which equates to $SG0.59so far so good ya, but as we look at other components net profit dropped by a whopping 20.4% and EPS from 65RMB cents drop to 52.0cents..Why arh? Upon closer inspection of the P/L account, the accounts "Change in fair value of derivative financial instruments" dropped from a positive 76.9million at a negative 12.6million RMB. Just to keep things simple, this account has something to do with repaying their zero coupon convertible bonds that are due 2012. , as stated in their notes to financial statements "The fair value loss resulting from change of the derivative component of convertible bonds...blahx3"
China Milk's Chairman 2009 message indicated the effects of the melamine scandal the on the company. The bad effects are poor public confidence in some local brands thus giving more opportunities for foreign brands to enter the market which they are perceived as safer. Stricter government controls have resulted in higher cost for the farmers, thus they who are clienteles of China Milk will scale down their herd size thereby reducing the demand for bull semen and cow embryos. The positive effects is that most small milk companies in China are either wiped out or having a hard time coping with the strict high cost requirements, therefore China Milk has a n increase opportunity to build their own brand "YinLuo" instead of relying on others for their milk processing business.
On another aspect, the balance sheet of China Milk at first got me worried, because their receivables increased substantially from 60.2million to 119.3million, management reviews that some of their customers were facing tighter cash flows...however the management stated that 2/3 of this balance has been subsequently received. Whatever that means, I will be subsequently reviewing this matter, the thing about S-shares is that once receivables start building up, something is really wrong...soo as an investor of the company must really take note of such figures. Operational cash flow remain healthy ,cash balance stays at 1.6billion rmb and once their convertible bonds mature in 2012, the convertible debts will amount to 1.4billion or less.
Comparing China Milk with my requirements of holding is as follow
*Company must maintain their profit margins
*Company must take care of their high debts with their also high cash holdings
*Company balance sheet must be healthy with receivables in check (looking into it)
*NAV must be increasing
*The usual must also be strong /Operational cash flow/EPS/ROE/Net margins.
China Essence
The business involves selling potato starch/protein and products related to that commodity.
The company is expanding very rapidly since the beginning of this year, the expansion is so rapid that a huge chunk of their cash reserves are gone and there have to take up extra loans and debt related instruments. A quick look at the latest balance sheet/cash flow highlights indicates the following
-Cash balances from FY 08: 484.3million drops to FY 09:168.3million
-Gearing shot up to 61.8% in FY 09 from 36.5% in FY 08
-Debtor Turnover up 77 days from 34 days
-Inventory turnover up 85 days from 53 days
-Operational cash flow drops from a positive 217.3million to a negative 62.5million
-Net decrease in cash flow 314.3million due to heavy investment inputs
Have to keep a vigilant eye on the coming quarters of China Essence, especially its trade receivables that have increased to about 150% from 104million to 269million. Yes no doubt it could be good for a commodity linked company (especially in China) such as essence to expand fast, but if they compromise their capital management because of their rapid expansion then it's not worth holding on to this stock as this might result in bad debts in turn casing troubles like banks demanding back their money, thereby draining the company's cash balances and it could be a going concern problem.
First Ship Lease Trust (FSLT)a.k.a (FSL)
FSL Trust owns and leases vessels to maritime companies (lessees) on a long-term bareboat charter basis (7 years at least), with a total of 23 vessels in their portfolio all of which the trust does not operate thus saving on operational cost and are diversified among different vessel types and of course different clients.
FSLT has the highest debt to equity ratio among the companies under my holdings, with 67% DER; $544 debts vs. $366millio in equities. Refinancing will be needed by 2012 $265million of expiring debts that is..In light of this situation the trust have already started reducing their distribution pay outs per unit (DPU) since 4th quarter of 2008. Previous policy was 100%, now it has been reduced to 75%, 15% of which will be used to repay debts. Total DPU for 2008 was $0.17 Singapore cents. Estimated DPU for 2009 will be $0.17*0.75=$0.12 holding other things constant like current exchange and DPU payouts for the 3 other quarters. OCBC mentioned that they believe the Trust will further reduce their DPU payouts to 50% in the near future, so my estimated DPU should be around 0.08-0.09 cents for this year. This ultimately gives me 17-19% yield for this year and 14-15% next. Well, some people might find the yield high but my previous expected yield was 34% when i bought it at $0.47 during sept 2008... lol. Kudos to those who bought below $1. Going forward, the trust will probably not acquire new ships, more reducing of DPU to be expected and hopes that the shipping industry will recover asap.
FIY, none of FSL clients have delayed payment or negotiated payment on rentals.
Comparing FSL with my requirements of holding is as follows
*Trust must still have diversified clients and rental of ships (Duh...)
*Trust must take measures with regards to its high debt levels
*Trust's policy of not incurring operating cost must still be implied
*Whether or not the company is even able to sustain this dividend payout has yet to be tested in this strong bear market. However, setting a limit of tolerance, of 7 cents, if company dividend should go below that payout for 2009 and 2010, activate sell.
*Any default by the clients, have to be taken noticed. Consider a sell; if there are two or more defaults in 2009.So far, clients have not created any problems.
I had at first difficulty completing this post, because there are so many annual reports and analyst report to read T_T. Imagine those people with 50 or 60 companies in their portfolio! How hard will it be for those people to keep in touch with their companies?
Monday, July 20, 2009
The next coming crisis. Beware.
ARROYO GRANDE, Calif. (MarketWatch) -- "Charlie and I believe Berkshire should be a fortress of financial strength" wrote Warren Buffett. That was five years before the subprime-credit meltdown. "We try to be alert to any sort of mega-catastrophe risk, and that posture may make us unduly appreciative about the burgeoning quantities of long-term derivatives contracts and the massive amount of uncollateralized receivables that are growing alongside. In our view, however, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal."
That warning was in Buffett's 2002 letter to Berkshire shareholders. He saw a future that many others chose to ignore. The Iraq war build-up was at a fever-pitch. The imagery of WMDs and a mushroom cloud fresh in his mind.
Also fresh on Buffett's mind: His acquisition of General Re four years earlier, about the time the Long-Term Capital Management hedge fund almost killed the global monetary system. How? This is crucial: LTCM nearly killed the system with a relatively small $5 billion trading loss. Peanuts compared with the hundreds of billions of dollars of subprime-credit write-offs now making Wall Street's big shots look like amateurs.
Buffett tried to sell off Gen Re's derivatives group. No buyers. Unwinding it was costly, but led to his warning that derivatives are a "financial weapon of mass destruction." That was 2002.
Derivatives bubble explodes five times bigger in five years
Wall Street didn't listen to Buffett. Derivatives grew into a massive bubble, from about $100 trillion to $516 trillion by 2007. The new derivatives bubble was fueled by five key economic and political trends:
-
Sarbanes-Oxley increased corporate disclosures and government oversight
-
Federal Reserve's cheap money policies created the subprime-housing boom
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War budgets burdened the U.S. Treasury and future entitlements programs
-
Trade deficits with China and others destroyed the value of the U.S. dollar
-
Oil and commodity rich nations demanding equity payments rather than debt
In short, despite Buffett's clear warnings, a massive new derivatives bubble is driving the domestic and global economies, a bubble that continues growing today parallel with the subprime-credit meltdown triggering a bear-recession.
Data on the five-fold growth of derivatives to $516 trillion in five years comes from the most recent survey by the Bank of International Settlements, the world's clearinghouse for central banks in Basel, Switzerland. The BIS is like the cashier's window at a racetrack or casino, where you'd place a bet or cash in chips, except on a massive scale: BIS is where the U.S. settles trade imbalances with Saudi Arabia for all that oil we guzzle and gives China IOUs for the tainted drugs and lead-based toys we buy.
To grasp how significant this five-fold bubble increase is, let's put that $516 trillion in the context of some other domestic and international monetary data:
- U.S. annual gross domestic product is about $15 trillion
- U.S. money supply is also about $15 trillion U.S. government's maximum legal debt is $9 trillion
- U.S. mutual fund companies manage about $12 trillion
- World's GDPs for all nations is approximately $50 trillion
- Unfunded Social Security and Medicare benefits $50 trillion to $65 trillion
- Total value of the world's real estate is estimated at about $75 trillion
- Total value of world's stock and bond markets is more than $100 trillion
- BIS valuation of world's derivatives back in 2002 was about $100 trillion
- BIS 2007 valuation of the world's derivatives is now a whopping $516 trillion
Moreover, the folks at BIS tell me their estimate of $516 trillion only includes "transactions in which a major private dealer (bank) is involved on at least one side of the transaction," but doesn't include private deals between two "non-reporting entities." They did, however, add that their reporting central banks estimate that the coverage of the survey is around 95% on average.
Also, keep in mind that while the $516 trillion "notional" value (maximum in case of a meltdown) of the deals is a good measure of the market's size, the 2007 BIS study notes that the $11 trillion "gross market values provides a more accurate measure of the scale of financial risk transfer taking place in derivatives markets."
Bubbles, domino effects and the 'bad 2%'
However, while that may be true as far as the parties to an individual deal, there are broader risks to the world's economies. Remember back in 1998 when LTCM's little $5 billion loss nearly brought down the world's banking system. That "domino effect" is now repeating many times over, straining the world's monetary, economic and political system as the subprime housing mess metastasizes, taking the U.S. stock market and the world economy down with it.
This cascading "domino effect" was brilliantly described in "The $300 Trillion Time Bomb: If Buffett can't figure out derivatives, can anybody?" published early last year in Portfolio magazine, a couple months before the subprime meltdown. Columnist Jesse Eisinger's $300 trillion figure came from an earlier study of the derivatives market as it was growing from $100 trillion to $516 trillion over five years. Eisinger concluded:
"There's nothing intrinsically scary about derivatives, except when the bad 2% blow up." Unfortunately, that "bad 2%" did blow up a few months afterwards, even as Bernanke and Paulson were assuring America that the subprime mess was "contained."
Bottom line: Little things leverage a heck of a big wallop. It only takes a little spark from a "bad 2% deal" to ignite this $516 trillion weapon of mass destruction. Think of this entire unregulated derivatives market like an unsecured, unpredictable nuclear bomb in a Pakistan stockpile. It's only a matter of time.
World's newest and biggest 'black market'
The fact is, derivatives have become the world's biggest "black market," exceeding the illicit traffic in stuff like arms, drugs, alcohol, gambling, cigarettes, stolen art and pirated movies. Why? Because like all black markets, derivatives are a perfect way of getting rich while avoiding taxes and government regulations. And in today's slowdown, plus a volatile global market, Wall Street knows derivatives remain a lucrative business.
Recently Pimco's bond fund king Bill Gross said "What we are witnessing is essentially the breakdown of our modern-day banking system, a complex of leveraged lending so hard to understand that Federal Reserve Chairman Ben Bernanke required a face-to-face refresher course from hedge fund managers in mid-August." In short, not only Warren Buffett, but Bond King Bill Gross, our Fed Chairman Ben Bernanke, the Treasury Secretary Henry Paulson and the rest of America's leaders can't "figure out" the world's $516 trillion derivatives.
Why? Gross says we are creating a new "shadow banking system." Derivatives are now not just risk management tools. As Gross and others see it, the real problem is that derivatives are now a new way of creating money outside the normal central bank liquidity rules. How? Because they're private contracts between two companies or institutions.
BIS is primarily a records-keeper, a toothless tiger that merely collects data giving a legitimacy and false sense of security to this chaotic "shadow banking system" that has become the world's biggest "black market."
That's crucial, folks. Why? Because central banks require reserves like stock brokers require margins, something backing up the transaction. Derivatives don't. They're not "real money." They're paper promises closer to "Monopoly" money than real U.S. dollars.
And it takes place outside normal business channels, out there in the "free market." That's the wonderful world of derivatives, and it's creating a massive bubble that could soon implode.
Comments? Yes, we want to hear your thoughts. Tell us what you think about derivatives: as "financial weapons of mass destruction;" as a "shadow banking system;" as a "black market;" as the next big bubble dangerously exposing us to that unpredictable "bad 2%."
By Paul B. Farrell, MarketWatch
Monday, July 13, 2009
News Highlights (5)
Is there still trust in Reits?
