Toro's Running of the Bulls Market Blog

On Gold and Intrinsic Value

One argument one hears about why you should not invest in gold is because it has no intrinsic value, i.e. gold cannot be valued based on future cash flows.

And that is true.  Gold has no intrinsic value.

My retort is … so what?

We humans are funny beings.  We have innate preferences for things that may or may not be rational. 

What is the value of a diamond?  Diamonds are purchased primarily as gifts for women.  There is no cash flow from diamonds.  Yet every year, men across the world spend several thousand dollars on a refined rock as a tokens to demonstrate their worthiness for marriage.  Try telling your bride-to-be “I was going to propose to you with a diamond, but a diamond has no intrinsic value as it does not throw off cash flow.  So instead, I spent the $5000 on a waste-hauling stock with a 6% yield.  Will you marry me?”  See how that works.

Likewise, why do we insist on spending so much money on homes with a view?  What is the intrinsic value of over-looking a lake, an ocean or a mountain?  Lakes, oceans and mountains do not generate cash flow.  We pay a lot of money for a view because we like the views.

There are many things in which we humans engage that have no intrinsic value but amuse and entertain us nonetheless – sports, movies, the opera, sailing, horrible reality TV shows (that describes all of them – ed.)  There is nothing “intrinsic” about going to watch a hockey game, a play or a concert.  The value is pleasure derived from the activity itself.

What is the value of a sporting event?  There is no cash flow that derives from attending a sporting event if you are buying the ticket.  Yet, tell the sports fan that the ticket has no value.  Experienced scalpers can make good money ascertaining the supply and demand dynamics for sporting events. 

It is no different for gold.  There are properties that make gold desirable as a currency – it is extremely durable for example.  However, the reason why we value gold is because it is shiny and pretty.  It has the same intangible to humans as diamonds or football tickets or the condo with a view overlooking the bay. 

Similarly, there is no such tangible thing as a “dollar.”  A “dollar” is an intangible unit that we humans have ascribed a value of exchange.  Yes, there are bonds denominated in dollars, but those bonds are backed by cash flow.  The $1 trillion in Federal Reserve notes outstanding, i.e. “dollars,” generate exactly $0 in cash flows.  Yet, they have value to us because we believe they have value.

Gold is the same.  There is no cash flow that derives from gold, but gold has an intangible value that we humans desire, and the price for gold is determined by supply and demand.

Simple as that.

I am long gold.

 

You Can Buy a Condo in Saskatoon or ... the Silverdome!

 

It was announced on Monday that the Pontiac Silverdome - former home of the Detroit Lions (when they were still respectable), and host of Super Bowl XVI, the 1994 World Cup, and the 1988 and 1991 NCAA men's basketball Final Four tournaments - was sold on Monday for $583,000, to a Canadian firm no less!

An anonymous Canadian firm has bought the Pontiac Silverdome for $583,000 and plans to use the site for sports, including a soccer league that it hopes to bring to the stadium.

Fred Leeb, Pontiac's emergency financial manager, told The Detroit News that the winning company's name won't be released until terms of the deal are finalized. The company was one of four bidders that were considered for the Silverdome, which has been vacant since the Detroit Lions moved to Ford Field in 2002.

The purchase includes the 80,300-seat stadium and 127 acres of land next to the building.

By happenstance, I was perusing condo prices in Saskatoon today for fun.  Now, I have written about the silliness of real estate prices in Saskatoon - a city in the middle of nowhere, surrounded by nothing, with balmy temperatures of -40C in the winter (a lovely city otherwise) - here and here, but I was flabergasted by what I saw.  A condo of less than 2000 square feet and not even on the river going for $659,000!  With less than two full baths nonetheless!

I attended undergrad at the University of Saskatchewan in Saskatoon, and I am blown away at how far the global liquidity bubble has reached.  Unless the fixtures are made of gold and the floors of marble in the condo, that is a stunning valuation to me. 

I am currently in the process of closing on a piece of land, which I will detail in the coming weeks, assuming everything goes as planned.  This piece of land, too, is being sold at a stunning valuation, only this is stunning on the downside.

In the meantime, I will not be buying any real estate in Saskatoon until it crashes.

As it inevitably will.

South African Gold Mine Deathwatch

In my never-ending quest to pimp my book and make myself wealthier, as an owner of a lot of gold, I present to you yet another argument for the highly dubious yet incredibly self-serving thesis of Peak Gold - the death of the South African gold mining industry!

The apparent bottom line in a paper published in the South African Journal of Science is that South Africa's gold industry is on final deathwatch, despite claims of massive existing below-ground reserves. Chris Hartnady, research and technical director of Cape Town earth sciences consultancy Umvoto Africa, has found that South Africa's Witwatersrand goldfields are around 95% exhausted, and anticipates that production rates should fall permanently below 100 tonnes a year within the coming decade.

Gold production from the Witwatersrand, the biggest known gold field in the world, peaked at around 1,000 tonnes in 1970 and has declined ever since. Hartnady says that while initially (1970-1975) the decline was "quite precipitous", it has been interrupted by only short periods of slight trend reversal (1982-1984 and 1992-1993).

Leon Esterhuizen, a London-based specialist analyst at RBC Capital Markets, has reacted to the research by saying that "South African gold is dying -- this is not new news", but adds "that it may be dying faster than we currently believe is novel". On the levels of reserves, Hartnady finds that the South African "residual gold reserve" after production through 2007 is only 2 948 tonnes, a little less than three times the 1970 production figure, and much less than 10% of the officially cited reserve.

The country's gold reserves are less than half of the current United States Geological Survey (USGS) estimate of 6 000 tonnes, and the country is not first, but fourth in world rankings, after Australia (5,000 tonnes), Peru (3,500 tonnes) and Russia (3,000 tonnes), Hartnady's research shows. The USGS currently cites South Africa's gold reserves at around 6,000 tonnes, while SA claims a 36,000 tonnes reserve base figure (or about 40% of the global total). Hartnady's findings are based on Chamber of Mines figures and mathematical modeling pioneered by the distinguished American geologist M. King Hubbert.

Thanks to Paul Kedrosky for helping me whip up the gold hysteria!

Peak Gold?

From The Telegraph

Aaron Regent, president of the Canadian gold giant, said that global output has been falling by roughly 1m ounces a year since the start of the decade. Total mine supply has dropped by 10pc as ore quality erodes, implying that the roaring bull market of the last eight years may have further to run.

"There is a strong case to be made that we are already at 'peak gold'," he told The Daily Telegraph at the RBC's annual gold conference in London.
 
"Production peaked around 2000 and it has been in decline ever since, and we forecast that decline to continue. It is increasingly difficult to find ore," he said.

Ore grades have fallen from around 12 grams per tonne in 1950 to nearer 3 grams in the US, Canada, and Australia. South Africa's output has halved since peaking in 1970. ...

Ross Norman, director of theBullionDesk.com, said exploration budgets had tripled since the start of the decade with stubbornly disappointing results so far.

Output fell a further 14pc in South Africa last year as companies were forced to dig ever deeper - at greater cost - to replace depleted reserves, not helped by "social uplift" rules and power cuts. Harmony Gold said yesterday that it may close two more mines over coming months due to poor ore grades.

Mr Norman said the "false mine of central banks" had been the only new source of gold supply this decade as they auction off reserves, but they are switching sides to become net buyers.

Barrick is moving fast to wind down the remaining 3m ounces of its infamous hedge book over the next twelve months, an implicit bet on rising gold prices over time.

I am long gold.

On Insider Trading

From Cafe Hayek

If insider trading (on non-proprietary information) causes asset prices to reflect more accurately the true, long-run values of those assets, then insider trading should increase confidence in markets.

Put differently, ordinary investors would be less confident in markets that take an average of t units of time to incorporate into asset prices a piece of relevant information than these investors would be in markets that take an average of t+1 units of time to achieve the same adjustments to asset prices.

To the extent that insider trading causes prices to reflect asset values more quickly and more accurately, general investors should be more confident in asset markets and, hence, more likely to invest their earnings in such markets.

The issue is what is more relevant to the market, material information or the buying and selling power of insiders? Or, what moves the market more, what insiders are saying or what they are doing?

Most of the capital stock of a publicly traded corporation is in the hands of outsiders, people who have little idea what is truly going on in a corporation.  Insiders hold very little company stock in most publicly traded companies.  If the issue is price discovery, because insiders usually hold a fairly small percentage of stock, insider transactions will have a minor effect on stock prices.  For companies where insiders hold a lot of stock, then insider transactions will have a greater effect on price discovery.  However, take a look at the ownership rosters of most publicly traded companies and you will see the same thing - stock ownership is dominated by large pools of capital such as mutual funds, pension funds, hedge funds, insurance companies, etc.  Rarely do you see insiders on that list.  What matters more for price discovery is whether or not Fidelity or T. Rowe Price is getting out of a stock than the CEO since the Fidelity's and the Price's of the world own far more stock than the CEO. Thus, for most companies, insiders buying and selling their stock will have a minor effect on price discovery. 

This incentivizes insiders from disseminating material information as it is in the best interests of insiders to either withhold or even mislead the market.  Management has every incentive NOT to disseminate material information while they are currently buying or selling their stock.  If the stock price is $50, and management has material information that will knock the stock price down to $20, then insider selling will not knock the price down to $20 because insiders do not own enough stock to knock the stock price down to $20.  Insider selling might knock the price down to $48 but it won't go to $20.

One could counter, "Yes, but $48 is still closer than $50," but that misses the point.  Management is incentivized to not disseminate information until after they have dumped their shares.  If management discovers the $20 material information at time T, rather than disseminate it into the market at time T, they will withhold the information until time T+X after they have sold all their shares at $48.  Between periods T and T+X, investors will have purchased the stock from management that they would have not bought had the information been disseminated at time T.  The people who bought the stock between times T and T+X will not care if they bought it at $48 or $50 if it plunges to $20 after they bought it.  They will have been used by management as buyers of insiders' stock at $48.  If it is illegal for management to trade on material non-public information, there is less incentive for management to withhold disseminating information beyond time T.  Thus, it would be management who would ride the stock down to $20, not the investors who bought the stock at $48 from management.

Some might argue that there is more information in insiders buying and selling, but I have never seen a stock price get cut in half on news of insider selling whereas I have seen it happen too many times on the release of material information.

Decriminalizing insider trading is more likely to distort markets and lead to less confidence in the market by the public as it will incentivize insiders to withhold information.  This is clearly a bad thing since it would lead to less efficient capital allocation and thus higher costs of capital and slower economic growth.

Jeff Matthews has a great retort to de-criminalizing insider trading. 

S&P 500 Operating Cash Flows Strong

One of the more amazing graphs I have seen is the graph of operating cash flows of the S&P 500. 

 

Operating cash flows are the cash flows from operations derived from the upper third of the Statement of Cash Flows.  It includes profits, depreciation, changes in working capital, changes in deferred taxes, non-cash charges to profits, and other operating items.  It does not include investing cash flows such as capital expenditures, nor cash flows from financing operations.

Amazingly, at least to me, operating cash flows are higher than before the recession began.

This is primarily because companies have laid off workers and worked down inventories.

It also means that if sales start growing, profit growth could be very strong.  It also could mean that hiring will pick up faster than we - including me - expect.

"A Huge Mistake"

From an academic

Former Federal Reserve Governor Frederic Mishkin, a professor at Columbia Business School, said it was "a huge mistake for the government to think it knows the best size of financial institutions." At the same time, he acknowledged that financial institutions are encouraged to get too big "because they are likely to be bailed out."

And I suppose allowing banks to get as big as they wanted such that they threatened the economic viability of the world is a "minor mistake?"

It's Getting Stupid Again

The oceans of global liquidity are making their way to the usual places.

The World Bank warned Tuesday that the sudden reappearance of billions of dollars in investment capital in East Asia is "raising concerns about asset price bubbles" in equity markets across Asia and in real estate in China, Hong Kong, Singapore and Vietnam. Also Tuesday, the International Monetary Fund cited "a risk" that surging Hong Kong asset prices are being driven by a flood of capital "divorced from fundamental forces of supply and demand." ...

"This is the beginning of another big and excessive run-up in asset prices," said Simon Johnson, a former IMF chief economist.

The symptoms of a frenzy are most evident in Asia and the Pacific, where economies are recovering most quickly. In Hong Kong, high-end real-estate prices are soaring. A luxury flat in the tony Midlevels district is expected to sell for US$55.6 million, or $9,200 a square foot, said developer Henderson Land Development Co. Elsewhere, a bidder at a city-run auction to operate food stands at February's Lunar New Year celebration recently paid a record US$63,225 for the right to occupy a 400-square-foot stall to sell fish balls and other snacks. Prices in the auction of 180 stalls were up 33% from 2008.

Over the summer, a Singapore condominium developer raised prices 5% the day before units went on sale. After dozens of would-be buyers lined up on a steamy night, the developer -- a joint venture of Hong Leong Group and Japan's Mitsui Fudosan -- held a lottery for a chance to bid on the units. Singapore home prices rose 15.8% in the third quarter, the fastest rate in 28 years.

Australian real-estate markets also have heated up. After a Melbourne property-research firm recently predicted that average home prices will double over the next 12 years, a news report in Australia's Herald Sun said: "The staggering prediction shows the importance of buying a home as soon as you can afford it because the longer buyers delay, the more chance there is that their dream will slip out of their reach."

It is like a bad movie that we have seen all before.

In the meantime, I am under contract to buy a piece of land, which I will expound upon in the coming weeks.  One might as well take advantage of the world's policymakers' attempts to reflate the global economy and asset prices.

Runs in the Asset Backed Commercial Paper Market

From the Fed

Abstract: The $350 billion contraction in the asset-backed commercial paper (ABCP) market in the last five months of 2007 played a central role in transforming concerns about the credit quality of mortgage-related assets into a global financial crisis. This paper attempts to better understand why the substantial contraction in ABCP occurred by measuring and analyzing runs on ABCP programs over the period from August 2007 through December 2007. While it has been suggested that commercial paper programs, like commercial banks, may be prone to runs, we are the first to conduct a comprehensive empirical analysis of runs in the ABCP market using a rich and novel issue-level data set for all ABCP programs in the U.S. market. A program is defined as being run when it does not issue new paper during a week despite having a substantial share of its outstandings scheduled to mature, and then continuing in a run until it issues. We find evidence of extensive runs: more than 100 programs (one-third of all ABCP programs) were in a run within weeks of the onset of the turmoil and the odds of subsequently leaving the run state were very low. We interpret this finding as an indication that the ABCP market was subject to a bank-like "panic." We also find that while runs were linked to credit and liquidity exposures of individual programs, runs were also related importantly to non-program specific variables in the first several weeks of the turmoil, indicating that runs were relatively indiscriminate during the early part of the panic. Thus the ABCP market may be inherently unstable and a source of systemic risk.

New Estimate of Global Poverty Reduction

At least until before the financial crisis.

We use a parametric method to estimate the income distribution for 191 countries between 1970 and 2006. We estimate the World Distribution of Income and estimate poverty rates, poverty counts and various measures of income inequality and welfare. Using the official $1/day line, we estimate that world poverty rates have fallen by 80% from 0.268 in 1970 to 0.054 in 2006. The corresponding total number of poor has fallen from 403 million in 1970 to 152 million in 2006. Our estimates of the global poverty count in 2006 are much smaller than found by other researchers. We also find similar reductions in poverty if we use other poverty lines. We find that various measures of global inequality have declined substantially and measures of global welfare increased by somewhere between 128% and 145%. We analyze poverty in various regions. Finally, we show that our results are robust to a battery of sensitivity tests involving functional forms, data sources for the largest countries, methods of interpolating and extrapolating missing data, and dealing with survey misreporting.