petec

Current Chinese wage inflation might be the start of a reversal in a) the mix change due to offshoring and b) the downward pressure on worker wages due to competition from Chinese and Indian workers. This paper has some good stuff on a) analyst expectations for margins and b) the impact of the government deficit on margins: https://www.gmo.com/America/CMSAttachmentDownload.aspx?target=JUBRxi51IIBtbYEu0yy2D233Qql0krF9YIWDpyU9bC1DsIW9OxrQN38JW598obIegPVL5Vm43jTd74zJ0R1rY2lRRYvkFggPe%2bdZF4oUF%2bEun279ii1ThA%3d%3d Personally my view is that even if the mean is slightly higher than it was, it is not different this time.

+1 Actually, + about 10!

MrB: any business fitting your description will be a good investment, I think, but I don't think it is how Buffett thinks. Not exclusively, anyway. He understands that the vast bulk of the value of long lived companies is in the out years, not the first 3-4, and occasionally pays a lot more than a 10% yield. BNSF, for example, and Coke for nearly all the time he has held it (I'm not surer what he paid initially). He also covers this concept in his assessment of managers who use stock to buy other companies and claim that they have achieved value because the deal is 'accretive' - Buffett points out that it may be accretive in year 1, but whether it is accretive in year 10 depends on the growth rates of the two companies. So while your framework is a very good one, it will miss a lot of great investments.

Zach, my read on the Volatility article is that in the Weimar Republic stocks appreciated hugely, but did not keep up with inflation. This makes sense to me, and it would result in a huge win in real terms for holders of way out of the money index calls, but not for stock investors. Pette

I don't think Fairfax has an answer for this. My guess is that they are worthless in a breakup. Certainly any counterparty with any sense will delay and drag the issue through the courts if it can. I guess it is all in the small print. Do we actually know *exactly* what the contracts are - i.e., can we read the small print anywhere?

Is that the current yield or the yield to maturity? Because the YTM can go below zero if people are willing to take a capital loss if they hold to maturity.

I think equity indices tend to give negative real returns but strongly positive nominal ones in hyperinflationary periods. So yes, an OTM call on the SPX would be a way to protect yourself against hyperinflation. The author also discusses volatility derivatives as a way to do this but the discussion went rather over my head!

I'm referring to this: http://www.artemiscm.com/wp-content/uploads/2012/04/Artemis-Capital-Q12012_Volatility-at-Worlds-End1.pdf "Today most investors purchase tail risk insurance on the premise that long-term deflation is the primary risk. With the complete opposite idea in mind I asked several dealers to quote me a price for an over-the-counter 10-year out-of-the-money European call option on the SPX with a strike rate of 10k (spot is at 1,400 so 700% OTM). The price of the call option ranged from a low of "are you insane" to a high of 20 cents. The median price was about 10 cents. What many fail to realize is that a far-OTM call option will exhibit powerful double convexity during an inflationary shock. The premium will be heavily influenced by both rising volatility and interest rates and these two variables are self-reinforcing in hyperinflation. The key point is that during the rare inflationary event large payoffs would accrue for sufficiently long-dated OTM calls even if the SPX is nowhere near the strike. The convex payoff is astronomical in consideration of the small upfront premium demanded."

Packer, I've been thinking the same about wage inflation. If wages are not rising with inflation I don;t see how inflation becomes hyperinflation. But if they are rising with inflation... What I don't understand is what will trigger wage inflation. Do we need a recovery? Or just a long enough period of 2-3-4% inflation? (Historical note: in the Weimar Republic, banknotes were printed every morning and trucked to factories to be given to workers who got half an hour off to go and buy something before their money became worthless. Not that I think we're going back to that!) On another note, hyperinflation protection is also very cheap to buy. I wonder why the Fairfax team haven't built barbell protection.

I'd say there are two key differences. 1) After you stop spending capital, ships take longer to rust than gas supply takes to decline. So overrsupply of gas will be addressed by falling supply but the same cannot be said of shipping. 2) Gas demand is price elastic, as we can see from power and transport switching etc. Is shipping price elastic? I think not - I think people ship when they need to ship, regardless of price, and don't when they don't need to. So shipping is much more macro-driven. I think this means gas cycles reset quicker, meaning gas prices come to the marginal cost of new production quicker, meaning low cost producers get to make >their cost of capital most of the time. Not all companies are shy about breakevens: UPL and Peyto, which have been mentioned here and are the only two I follow, are but very clear about it. But they are low cost, so no need to be shy ;) As a UPL holder I will be delighted if Berman is right and $7 is breakeven, but I don't think he is. That presentation was notably short on detail and I suspect $4-5 is the likely breakeven with $6 as a top bound. But I'm guessing.

+1

Just watching 'natural gas' - superb. Can anyone see a way to download the presentations too? (As in the pdf/powerpoint with the graphs, not just the video.)

Parsad, something I have been wondering about. The US government has a lot of debt but not so much that it would be a huge problem on its own. The problem is the deficit, which in large part is driven by inflation-linked entitlements spending. So why does anyone think the government can inflate its way out of the problem? I accept that a bit of inflation would help over-indebted homeowners, but not the government, not without cutting the deficit, which might well trigger deflation. Thanks!

Hi all, I have very recently started looking at Chinese small caps. Most of my investment experience to date has been in big and very high quality companies so I am slightly out of my depth. Example: ZST Digital Networks is off 68% today as their auditor has resigned. That's clearly not good news but the company has (or claims to have) $55m in cash and no debt and trades for $8m market cap, or 0.9x TTM PE. How easy is it to fake cash on a balance sheet? My instinct says the income statement is easier to fake than cash on the balance sheet but maybe I am wrong. And how little does one pay for a company that has exhibited steady growth and buildup of cash? Excuse the braindump but if anyone has experience of investing in companies like this (Chinese smallcaps or those under an accounting cloud) I'd be very interested to hear what you have to say in general or specific to this case. Many thanks Pete

Has anyone looked at ACS, the Spanish construction company that has a majority stake in Hochtief as well as a complicated non-recourse-debt-funded stake in Iberdrola? I looked at it a while ago and decided it was too complex but it is a lot cheaper now, on under 5x headline eps and yielding over 10%. Just wondering if anyone can save me some work on it ;)

TXLaw: I should clarify that by 'tens of cents' I mean 10-99c, not 'teens'! The comment stems from a distant recollection that input costs for Qatar and Gorgon LNG projects are in the $0.40+ range but a quick websearch has failed to come up with evidence for this. I will let you know if I find anything more.

I would say that the market, by and large, looks at NAVs of proved resources plus risked unproved (i.e. maybe 50% of unproved). The key determinant of the NAV is then the gas price assumed, and IMHO the gas stocks are only just starting to look cheap if you use a conservative estimate of the marginal cost as the long run gas price. I'd be very wary of assuming that there is value in the creation of a global gas market for several reasons. First, the liquefaction and gasification of LNG is very expensive and eats a lot of the delta between current US gas prices and 'global gas' (i.e. Asian LNG) prices. Second, shale gas reserves are being found all over the world so there's no reason to assume that global gas prices will be high in 10 years (i.e. when the infrastructure is starting to gain scale). And third, the US is not a particularly low cost gas producer globally: many of the LNG liquefaction plants operating today have supply costs measured in tens of cents, I believe. That's not to say that the startup of 1-2-3bcf/day of liquefaction in the US won't shift the supply/demand balance for a year or so occasionally, but supply will respond and ultimately the price will be set by the (currently falling) marginal cost of gas. Rather, the opportunity in US stocks comes when they are pricing in a below-marginal-cost price of gas for eternity, which they might be beginning to do. (IMHO the real significance of a global gas market, and of demand shifting from oil to gas, and of shale oil and other new sources of oil, is that we might be entering a 20-30 year period of declining energy costs. Hope so.)

eclectic, who are MOI and do you have a link to the video? I personally can't see value in CRESY unless Argentina lifts its ag price restrictions (and even then I'm not an ag bull) but I see opportunity in IRSA, the property subsid.

I don't think natural gas tanking is a global phenomenon; it is local to the US/Canada. Gazprom's problem is government control.

I personally would not value JPM at 12x earnings. In some ways it is a great franchise, but it is highly levered and leverage = risk. I'd cap out at 10x in a market where I can get unleveraged great franchises on 14x (e.g. 3M).

I like the fact that he is using BV and TBV as his measures of intrinsic value rather than normalised earnings, because book values are far more knowable than normalised earnings. I think he's hit the nail on the head with his buyback thinking. Buying back anywhere near $60 would be very aggressive in my opinion: I can't stand management teams that buy back above a conservative estimate of IV and you have to make a lot of assumptions to get to an IV of $60. (I'm long JPM on a low cost base.)

Depends on your time horizon. How does the dollar do if treasury yields rise (inevitable at some point) and shale oil significantly reduces oil imports, which account for >80% of the trade deficit?

Thanks. I think he's dead right but just maybe not on a 2013/4 timeframe. It takes years to build LNG export infrastructure and lots of it will have to be built to overcome the current localised supply/demand imbalance. Plus, a $9 global price does not translate into a $9 local one once infrastructure and operating costs are taken into account. Will be interesting to see how it plays out!

bmichaud - the shale technologies have dramatically lowered the marginal cost because production growth at the low end of the demand curve shoves the whole curve to the right, making the high cost stuff unnecessary at the same level of demand. I'd be very interested to know what your friend thinks will link the North American market with the global one. Currently the North American natgas market can't export much and very little demand can switch from oil to gas, so I don't see how global pricing is relevant until one of those things changes. And that's way further out than 2013/4. I don't see gas much above $4-5 in 2014 unless production declines are severe, and I doubt they will be. Does anyone have any data on how much associated gas is being produced by 'liquids' wells? Because there seem to be differing opinions on this point.

I've just begun a position in UPL, more because I have known it for years than because I've scoured every other option. I think it trades on roughly its proved NAV assuming a marginal cost of $4, and its 2P NAV assuming a marginal cost of $3, so I don't see long term downside. I do see, and am hoping for, short term downside because there is a lot of optimism out there and I'd love to buy in size as others throw in the towel. Here's hoping. On the long term view I'd caution people not to confuse demand increases with price rises. I'm very bullish on long term gas demand (due to the oil/gas differential) but not necessarily on the price (because the marginal cost continues to fall - in other words, supply can meet demand). The marginal cost is king and it's very hard to work out what it is and how much further it can fall.