Saturday, May 29, 2010

Memorial Day

In my town, there's usually a very moving ceremony at a Memorial in a public park by a lake. Last year, there was a WWII veteran, a Vietnam-era veteran, and a recent graduate of Eden Prairie High School who returned, badly wounded from Iraq. Having had some dinner guests who had recently been in Central Asia, as we discussed events in Afghanistan and Pakistan, I realized that I could not describe the mission of our troops in the Central Asian theater in a simple sentence.

We've heard endless discussions about tactics like the surge, and we've had photo ops with President Karzai at the White House. But, what is our mission and when do we know that we've acccomplished it? Let's take a stab at guessing: 1. Prop up the Karzai government; 2. Drive out the Taliban and eliminate their leadership; 3. Replace poppy as a cash crop; 4. Change the hearts and minds of the Afghan people; 5. Establish democracy and free markets?

Look at the BP disaster in the Gulf. The short-term mission is to stop the flow of oil, and multiple solutions are being thrown at it, some simultaneously; the company has partners, including its industry peers and government experts, working on ideas with them. Failure isn't an option, and containment of the damage is also proceeding. We know that if the mission succeeds, the aftermath and the digging out will be long and costly. But, we all know what we're after: shut off the oil.

Here are my thoughts on the guesses for what we're trying to do in Central Asia: 1. Not worth it; 2. Not possible; 3. Economics will drive this, not our politics; 4. We may be inadvertently changing it the wrong way; 5. These modern concepts are foreign to them.

As valleys in Pakistan and Afghanistan have been won at great cost and are strategically ceded back, and as our troops continue to work and die under intensely difficult and traumatic conditions, let's be grateful for their commitment and pray for their safety. They are doing good work, along with private citizens and relief agencies.

But, let's demand of our political leaders an answer to the question that Country Joe McDonald asked many years ago, "It's 1-2-3-4, what are we fighting for?"

Tuesday, May 25, 2010

A Value Investor's View on Rates

My equity strategist friends continue to predict strong GDP growth in the back half of the year and into next year. The Fed continues to see no reason to raise rates, despite the private sector's optimistic forecasts. Meanwhile, it is beginning to appear that European inter-bank lending will impose some disciplines on the weaker players, despite the most dovish pronouncements. All of this continues to make me uneasy---it's the sense of complacency.

Seth Klarman, who worked for Max Heine at Mutual Shares (my first mutual fund and a seminal value investor), gave an interesting talk to the CFA Society in Boston. The site Market Folly has a fine set of notes on his talk. I think his perspective is really spot on. Rahm Emanuel is reported to have said, "A good crisis is not worth wasting." So, the global financial system is saved as it circles the drain, and this gets us financial regulation, consumer protection, TARP, Cash for Clunkers, and universal health care insurance.

Klarman points out that, unlike the Great Depression, we didn't get anything lasting out of our recent crisis. The post-Depression mentality--skepticism, frugality, a savings mindset--influenced parenting for generations and helped to fuel a sustained prosperity. For us, Klarman says the current crisis has been "a few bad weeks." That's certainly what it seems like reading the Fed Governors comments and private forecasters.

Add to that the fact that the Fed has insisted on keeping rates near zero, which Klarman says has forced market participants to take on more risk in the inevitable search for higher return. The government he says is feeding the public a "Hostess Twinkie" market--eye catching, delicious with no nutritional value. Everyone is seduced into going long so that confidence can be restored. The results, like eating the Twinkie, will not satisfy, as they seem not to be now.

Have a look at Klarman's talk--definitely nutritive value for the mind there. You may retune your asset allocation as a result also!

Wednesday, May 19, 2010

Indian Pills

Concern has been expressed about the quality of ethical drugs being marketed in India. A recent private survey showed that about 7% of the pills being sold are tainted in some way, or are sold beyond the expiration. About 2% of the pills had no active ingredient at all. If one were to focus a survey more heavily on rural areas, I surmise these percentages are very low compared to the population mean.

Much the issue is cultural ,unfortunately. Since my uncle started a successful pharmaceutical company in India back in the Sixties, I learned a lot about the business riding shotgun with him on his sales calls to retailers and wholesalers. Pharmaceuticals were considered no different from any other kind of merchandise, like powdered milk, rice or bath salts. Turnover and margin are what the astute shopkeepers care about. So it was very common to find adulterations in all of these products. A big tub of crystalline bath salts, treasured by moms and grandmas, often had fine, white sand integrated into the mixture. There was a big scandal in New Delhi when the biggest purveyor of powdered milk was caught putting non-food extenders into its tins.

Few people complain, and even fewer would go back and demand a refund, and absolutely nobody was silly enough to take a company to court. Pharmaceuticals are just another product, because India doesn't have 24 hour "investigative" media (Dr. Sanjay Gupta, come home!), nor does it have an efficient court system that can prosecute companies for harming the public health.

Now India has companies like Ranbaxy Labs that are recognized leaders in generics and nutritionals. Competing at this scale and in the global pharma regulatory environment brings discipline and efficiency. No such mechanism exists locally in India, especially in the rural markets. Hopefully, this will come with time.

Monday, May 10, 2010

Shale Gas Isn't The End All

The Wall Street Journal today carries a breathless article from the Baker Institute at Rice University trumpeting the gas embedded in shale deposits as being the key to everything from global geopolitics to greenhouse gas emissions. In the entry "Exxon Strikes A Good Deal," we thought the acquisition of unconventional gas resources, including shale, from the XTO acquisition was a bold strategic move. In addition to acquiring properties, it was valuable for Exxon to acquire technological know-how and people. However, much of the acquired resource base is unconventional and unproven, that's why it's a longer-term play.

Production technology will still have to improve, and extraction will have to be extremely sensitive to issues like potential infiltration of the water table in certain locations. In the meantime, there is a very large, more conventional, resource base in LNG and PNG, about 9 trillion cubic feet of gross reserves held by Exxon alone. Natural gas does have lots of attractive features as a fuel for electricity generation, and it could develop some potential in the transportation sector as well. It is obviously a clean burning fuel compared to oil.

However, shale gas alone being the key to the future is an oversell at this point.

Monday, May 3, 2010

Renewable Energy

The May issue of Scientific American is built around the theme, "Boundaries for A Healthy Planet," and there are lots of interesting articles, coordinated by leadership from the Woods Institute of Stanford University. On the subject of ethanol, the authors write,
"The explosive growth in the production of ethanol as a biofuel is greatly aggravating nitrogen pollution. Several studies have suggested that if mandated U.S. ethanol targets are met, the amount of nitrogen flowing down the Mississippi River and fueling the Gulf of Mexico dead zone may increase by 30 to 40 percent. The best alternative would be to forgo the production of ethanol from corn. If the country wants to rely on biofuels, it should instead grow grasses and trees and burn these to co-generate heat and electricity; nitrogen pollution and greenhouse gas emissions would be much lower."

Although there are some promising indications from cellulosic ethanol, I find it hard to see how a large scale cellulosic ethanol plant is going to work economically. Growing the feedstock on marginal land, harvesting and transporting it to the plant, producing the fuel and transporting it again would seem to be very expensive and perhaps not net energy efficient. We'll have to wait and see until Biogen's process or some other comes up to commercial scale.

ExxonMobil is committing funds to researching biofuel production from algae, but this is just moving beyond the lab bench phase. Biofuels may supply some proportion of transportation energy demand, but alternative energy, including biofuels, as a percent of total energy demand will just be above a marginal share by 2030, according to ExxonMobil estimates and those of other groups.

For power generation, hydrocarbon fuels will still be dominant over the ten year horizon, unless nuclear plants come on line in large numbers, which is nigh impossible in the political environment. Natural gas as a feedstock has potential to reduce greenhouse gas emissions compared to the current mix of fuels.

On the subject of wind energy, I find an ironic connection between the discussion about drilling in the Gulf of Mexico and the approval of a large scale offshore wind farm near Nantucket. Operating in coastal or deep ocean waters is immensely difficult. The offshore oil industry regularly overcomes operating issues in a harsh and hostile environment for men, equipment and machinery. The BP accident, like the Toyota incidents, seems to lack details on what exactly went wrong and why the well seems to be spontaneously bringing forth oil after so long. It seems like the gusher Jed Clampett found by shooting his gun into the ground. We need to know more, and again our press coverage is abysmal.

Back to my point, the laying of cables and the building of support structures for a large scale wind farm will be no picnic. The externalities imposed on fisherman, recreational boaters, and other users of the waterways are not known yet. Servicing the giant blades will not be easy either. Whether it's offshore oil, or offshore wind, there will be costs and risks. With the long history of offshore oil and gas production, we know and understand these generally, but we'll learn by doing for the wind farm, and expect to find the Commonwealth of Massachusetts complaining about the project some years down the road.

Sunday, May 2, 2010

Leadership Lessons from the Bundesliga

Louis Van Gaal's leading Bayern Munich to the Bundesliga title this weekend provides good leadership lessons. Being Dutch, one would have expected some cultural difficulties in coaching the equivalent of the New York Yankees in the German top division. In the era of globalization, perhaps this is less important than in the past, but it's still not a given; I am sure that Van Gaal was greeted with some suspicion given the turbulent history between the nations and the national football sides.

Dutch footballers, like their German counterparts, tend to have very strong fundamental, technical skills, unlike U.S. players, for example. So this probably provided a common link in the coach's role, because German sides respect good technique, like a great first touch, passing with both feet, and the ability to hold the ball in traffic.

Bavarian full back Philip Lahm, who has played for the German national side since U19, excoriated Van Gaal's roster selections and his alignment of players in the German press. This is verboten for a German professional athlete. Van Gaal, who is likened by ESPN to Bill Parcells, did not explode into a sea of expletives like the Big Tuna, but instead left it to the team President, Franz Beckenbauer, to levy a large cash fine and say that the behavior was intolerable.

Meanwhile, Van Gaal listened to what Lahm way saying, because he was absolutely right. Soon afterwards, certain players were dropped, certain others played in different positions, and the team's performance took off. Unlike U.S. managers, there was no recrimination against Lahm--business as usual after the fine was paid. Van Gaal, if he came in with a master plan, he must have changed it on the fly a half dozen times, by learning and by dint of circumstance. These are good traits for a coach, teacher, or manager.

Unfortunately, I have a Schalke04 replica jersey that I have to put into the closet next year, as they finished second to a well coached Bayern side.