Cardboard

The CDN$ is now at around $0.91 to the USD this morning. This is from $0.82 just a month ago. What I am getting worried about is a cataclysmic move driven by speculators that will really hurt our economy. Not to mention the impact on any investment exposed to the exchange rate. Even the British pound is appreciating against the USD. Does that make sense to you? Is there a country on Earth with its banking system and real estate more screwed up than England? Last time I looked its debt to GDP was quite a bit higher than the U.S. even after all the Fed actions. I can't recall any innovation from England in recent past, their manufacturing costs can't be any better than the U.S. and cost of living is retarded. Well, maybe that I have been too harsh with England. I suppose that Spain would also have an appreciating currency if they still had their own!!! I find that hedging properly for such moves is very difficult. You can borrow USD as some mentioned and put the proceeds into CDN$. However, if your U.S. investments don't perform right away and weaken along with the CDN$, you can be in for some trouble. It is not real insurance and you have to be sharp at getting in and out. It is more the game of George Soros vs value investors. I do some of it, but when you realize that you are also exposed via Canadian companies profits being hurt by the dollar you hit some limitations. I have looked at currency options available on the TMX, but they are really expensive. Then you can buy only purely domestic exposed equities. I have a hard time finding interesting ones and maybe that I am not alone since I have rarely seen on this board many being recommended. Even Northbridge was a little USD exposed. Say I propose to you a double exposed to USD and a 50% gainer not exposed, which one do you pick? This is an easy answer under fairly stable exchange rates, but now that you need to know where oil is going to be or after considering the cost or risk of hedging it becomes a little trickier. Luckily my energy and precious metals exposure alleviates some of the pain. It is also true that my CDN$ are now buying me more of the same US securities, but is it really the case? If the USD is going to devalue for good with these speculators not being that crazy and there is no real rebound in the foreseeable future then my share of the World's wealth has effectively shrunk by making these investments unless they appreciate massively. Has the game really changed with this crisis? Is it possible for the CDN$ to go to a new trading range between $1.20 and parity or more for the next decade? I keep hearing that currency effects wash out over the long term, but if we are in it for 10 years it could be life changing. I have noticed that John Paulson and David Einhorn now own large positions in gold/gold stocks. A big call for them. It seems to have been a great move as American investors although, for a Canadian investor the result is so far less so. Cardboard

Hi Viking, Higher treasury yield on the long end is a big issue for the U.S. since it's increasing the yield on mortgages. The causes for the move are probably a combination of the three points that you mentioned and maybe what Aberhound mentioned although, I think that they were mostly bluffing at the time. I read that article today which brings nothing new, but still reminds me of the long term implication of this debt overhang. http://money.cnn.com/2009/05/27/news/mortgage.overhang.fortune/index.htm?postversion=2009052716 I don't have figures for Canada, but I am convinced that it is similar since I saw a chart previously of debt to personal income and it was very similar to the U.S. The implication should be low growth going forward for developed nations especially if interest rates are higher. Now you have oil rebounding and more importantly gasoline prices. Two big taxes on a levered consumer somehow worried about his or her job. The Fairfax guys must have a lot fun. I am sure that they are taking gains in financials and probably also into these munis. We have to remember that Prem became a bull after the market corrected massively in November. The bad news was priced in. However, he was still cautious not to say negative on the economy going forward thinking that it would be a long recovery process. If security prices move more rapidly than the economy, you can be sure that he is looking for the exits. Cardboard

I am not a fan of large diversification: things need to move the needle, good ideas are not that frequent and we have so much time. Although, I have a hard time understanding how someone interested in investing cannot find 5 to 10 stocks with similar upside potential or undervaluation. If they have been researched properly, then you should be confident in their own merit and prospects. If that is the case, I would say that you will have a hard time overweighting significantly in any one of them. If you consider Fairfax like a hedge fund or mutual fund and don't want to continually look/find individual securities, then putting 50% of your assets in it may make sense, but if you are an investor then its merit should be assessed against all other available opportunities. If Fairfax is already a core position and represents 10 or 20% of your assets, I would suggest that you buy calls if a large stock price discontinuity occurs. In other words, the price moves so much that it increases the upside potential quite a bit vs your other stocks. So instead of going "all in" and abandoning other excellent opportunities, buy calls to effectively overweigh your position. Your risk will be much less, you will sleep at night and you will benefit the same way if things work out as you think. The market is not that dumb. Give them a year and they will jump in to if the value is truly there. If options are not available, then you can sell your other companies to buy more, but you have to be extra careful because sometimes it is your analysis that is flawed and you are averaging down into a loser. It has happened to me a few times on companies that I was "sure" of my thesis. It has also happened a few times that I did not invest my full "quota" to see the price significantly appreciate. Cardboard

CRM does look expensive at $36 even if you look at Jan 2011 earnings forecast of $0.80. However, the low for the stock in the past year was $20.82. So it tells me that the Street loves this company and is not going to take it down to a more reasonable multiple anytime soon. This typically happens with techs only when growth slows due to competition/obsolence or when they own the entire market like Microsoft. It is probably easier and more profitable to find stocks that have rebounded with the market rally, but that have problems: major debt renewals, declining sales due to competition, oversupply or businesses in secular declines. Broxburnboy proposed U.S. commercial real estate and I think that it makes a lot of sense: debt issues, oversupply, consumers that are tightening. I have looked at JP Morgan as a short term short, but it is true that Dimon is excellent. Although, I am wondering if one great chief makes out for the team. It is not like Wells Fargo or US Bancorp where there has been continuity in great leadership for a very long time. There could be interesting shorts among drilling companies. Oil & gas companies are not drilling much and many are cancelling rig contracts. Gas fundamentals are pretty terrible at the moment with inventories being sky high. Their stock prices have rebounded along with oil & gas producers, but their sales & earnings have not improved. With the large number of land based rigs that have been built in the recent past, I am thinking that drillers that still own older equipment with old technology could be in for a rough ride. Gas producers could be shorts too. We keep hearing about high depletion rates for these wells, but it seems that there are always very large new fields available to be developed at fairly low cost. I am also surprised that switching between oil & gas at utilities is having such little effect. Either it is not happening or the impact is negligeable. Cardboard

"The reality is that a strengthening CDN is a vote on the credit worthiness of Canadian sovereign debt vs. its US counterpart." If that was the case, I would be happy since I think that the CDN$ would trade very tightly to the USD. It could trade up a bit, but nothing like what we have seen. Our standard of living would be also improving relative to the Americans. However, what is really going on, is that a few large speculators are moving the CDN$ up whenever oil is going up and down whenever it is going down. I would appreciate if someone could demonstrate the direct correlation between a higher price for oil and an increased ability for this country to repay its sovereign debt. Is it worth a penny for every move of $1 in oil? Give me a break! This reminds me of the correlation that almost put in ruins Switzerland because the Franc moved in tandem with gold in the late 70's. If oil goes to $200 or more, which is possible if we really hit some kind of peak oil, a CDN$ that doubles over the USD could kill our economy.... and forget about some kind of advantage buying BRK or whatever at $0.95!!! What about long term holders of FFH here? Would you like FFH to be worth $400 U.S. because they are doing well and seeing a share price in Toronto of $200 CDN? Ever thought about the impact of such USD/CDN$ move on your margin requirements? What about those who are working for large U.S. multinationals? How many shares of IBM or GE do you hold and what would be the impact on your retirement if their value got slashed in half? Cardboard

Over the last couple of years, I have been watching the climb in the CDN$ from $0.60 and I have tried to identify beneficiaries. I have found very very few. It was supposed to help importers and consumers, but what we are seeing instead is a middle man trying to scoop a bigger margin. This has encouraged cross border shopping in a country that has something like 90% of its population within 100 km of the other. Then if you look at manufacturers who are importing goods/machineries for their plants, they see a cost saving there only to get hit more when they sell their finished product since they sell in North America and not just in Canada. If you are a Canadian investor, there is really no benefit at all to a strengthening CDN$. If you invest in USD$ you are screwed and if you invest in Canadian based companies, it is very likely that their operating results will be negatively impacted by this phenomenon. There are very few places where you can hide. The only real beneficiaries that I have found are "the snowbirds". They see an increased purchasing power when they go down to Florida, Texas and Arizona. This could benefit the Canadian economy if they were using these extra dollars by spending more in this country, but what is happening instead is that they increase their trip duration and go to nicer U.S. golf courses. On a net basis, I firmly believe that a strengthening CDN$ against the USD$ is a strong negative for the Canadian economy. We are way too tied to the U.S. economy and our way of living is too similar for us to afford such divergence in our medium of exchange. Another way to think about it, is to imagine that Texas would have its own currency because it is a large exporter of oil & gas, high tech and agriculture to the U.S. Would that be a benefit to them? Some say that massive inflation is coming in the U.S. due to the various things that have been done to resolve this crisis. Do you really believe that Canada will avoid all or most of it? If that is the case, then I would think that Canada would have come out much better off than the U.S. at the end of the 70's. I see absolutely no indication that this has been the case. Therefore, I believe that the solution is some kind of pegged currency at a level which will ensure that our purchasing power is close to parity. Stability is key to economic growth and I see no reason why tying up the CDN$ to the USD would be any different. Cardboard

Granitepost, I am not with TD, but I am pretty sure that you can too. Check this web page: http://www.tdwaterhouse.ca/services/assd.jsp It says that you can hold: "• Eligible options to purchase eligible securities. " The thing is that you need to have the option feature selected in your account application. Cardboard

Broxburnboy, If you are a Canadian (may work also in the U.S.), you can buy options in a registered account. You can also write covered calls. What you can't do is anything that requires margin. To be able to do this, you have to setup your account for this feature with your broker. This may open other alternatives than simply buying reverse ETF's. Cardboard

Something tells me that we are going to experience some weakness in the stock market in the not too distant future. I am a value investor, but I can't help myself thinking that many will just be too tempted to take some nice profits under a still uncertain outlook. Hedging at this time may not be such a bad idea. If the hedge is good, it will offset some portfolio losses and provide cash to redeploy in attractive opportunities. JPM on a P/E basis looks awfully expensive. First quarter earnings were $0.40 or $1.60 annualized. Analyst estimates for this year are $1.49 a share and $2.73 in 2010. It does look better on a price to book standpoint if you compare their current market cap of $130 billion with their stated book value of $170, but that is before backing out $32 billion in preferreds and $48 billion in goodwill. Technically, the JPM chart is a classic. It has made a wonderful half shaped inverted parabola since the low in early March. Looks to be stabilizing around $36 only to reverse sometime in June. Now, I don't believe that you can predict the future by looking at charts, but so many do trade based on that stuff that it must influence the future in the short run. Also, remember that these guys bought WaMu and Bear Stearns after their collapse or about the worst crap imaginable in the financial sector. However, they have secured government guarantees and the integration seems to be working well. They also control the biggest pile of derivatives of all kinds on the planet. Even if they don't hit some air pockets due to these, I have a hard time envisioning a huge upside to JPM share price in the next year or two. Your thoughts? What shorts or other hedges are you considering at this time? Cardboard

I have been looking for new ideas lately and I must admit that it is a lot more difficult than it was in the recent past. Maybe that I have been spoiled with incomprehensible bargains and must now contend with regular bargains. One that I am starting to revisit is KFS. The CFO resigned yesterday, many changes have been implemented and I am wondering if there is real value there. That company was also written off in the early part of this decade only to see its shares go back from $2 to $20 if I am not mistaken. What do you think are the odds of new management to turn around this ship? Cardboard

First of all, I have learned at my own expense that "normalized earnings" are among the most dangerous words in the investment world. The stock market rarely if ever pays for normalized earnings. Instead it pays a multiple against immediate, tangible earnings. Second, 18 times earnings on Wells Fargo in 2012 is like assuming that we are going into another debt binge in just 3 years from now. This won't happen. High growth, shadow banking system, securitization, that is all history. By that time, I suspect that bank survivors such as Wells Fargo will be slow growers trading at around 12 times earnings. If you go back in history during periods where banks were growing slowly, you will find that this multiple is actually agressive. So, it is a $48 stock at best in 2012. Discount that by 10% and it is worth 36$ today. So not a huge amount of upside short term for a company that pays little dividend, has the government in its affairs and is likely to post depressing earnings reports with write-offs over the next little while. If Prem bought close to the low and is selling now. He is doing the right thing for Fairfax shareholders. He will likely find better bargains with more certainty, more upside. Cardboard

Hi Pof4520, How have you been? You are absolutely correct. These 2X or 3X ETF's are mostly garbage. SRS is one among many. If you have been following the financial sector, look at FAZ for fun! If there is a relief rally going against you with these instruments, you will lose all your gains and likely more even if the sector is going up only 10% after being down 30 or 40%. You have to be dead on with your timing and capable to get out quickly when the momentum shifts. Very quickly! This seems especially true with the short ones. It is highly frustrating to be dead on with your predictions and weeks if not months of sweating, then to see all your gains evaporate in a matter of days. Dengyu was saying that there is a downward bias on these instruments and it seems to make sense due to frictional costs and their inability to deal with high volatility. So shorting or buying puts against them seems to be the way to go. You can't sit long on these things. So if one thinks that commercial real estate will go down, short the IYR or buy puts on it. If you are right, at least you will make money for sure. Then to "juice up" your returns, get ready to buy SRS puts once the downtrend seems exhausted. If you are good at judging the spike, puts with 2 to 3 months in duration seem enough. Cardboard

I wish we could know more about this man. His performance is simply amazing and I thought that he would get hit last year, like so many quant funds, while he delivered over 80% to his investors in his Medaillon fund. And if I am not mistaken that is after a 50% management fee!!! How can someone with such a large fund switch so fast into a short mode? What kind of instruments did he use to get this kind of return for his overall fund? On the net-net thing, there is one small cap that I own since early last year which he owns too: QLT Inc. It is a biotech trading around net cash generating enough profits to support its current research on a promising drug delivery system. It was a liquidation play and kind of still is. The problem is that they are now defending a new lawsuit which could eat a fair bit of that cash. What surprised me is that Simmons owned it before me and he is still an owner. So it means that he is not rotating all his holdings that quickly. Kind of surprised also that the news of the lawsuit did not force him to kick it out. His computer would tell him that this increases risk and could reduce returns. Cardboard

Santayana, That is actually a very interesting question and one that bugs me greatly. My "market call" question is actually tied to this question. Intrinsic value is tied to many things including interest rates, growth rate of the economy, the type of valuations assigned to businesses, etc. It becomes a very wide range hence Buffett mentioning that he prefers to be vaguely correct than precisely wrong. This bear market has given me an opportunity to buy businesses at such a discount to intrinsic value that there is simply no way that I did not have a large margin of safety. However, with the rally that we have had, and that seems poised to continue, we may reach a point where we hit intrinsic value for many stocks, but we don't realize it if we keep using yardsticks from the recent past. For example, is a P/E of 10 all you can hope for in the next 5 years for small caps? Is a slight discount to book value something reasonable to expect? Considering that time is money, it is probably worth thinking about what valuations will tend to be going forward. Cardboard

This powerful rally was way overdue, but seeing what was going on with the Financials today made me feel just like the opposite of the insanity that prevailed in late November and early March. Irrational exuberance? It is hard for me to imagine that we will unwind all the stock market and economic pain that has been endured in just a few months. Personally, I have been selling stocks that offer the least potential vs others in my portfolio. This is mainly to repay debt that I have incurred in early March when I essentially went "All in". Margin at this point is ultra cheap and if I could find bargains as juicy as I had in early March to plow back in the proceeds, I probably would not repay it that quickly. However, what was selling at 1 or 2 times earnings is now at 4 or 5. What was selling at 0.5 to 1.0 times net cash is now quite above net cash. There are still some stocks selling at these crazy multiples, but I detect issues which were not there in the early issues. We could be going back to regular Ben Graham where 70% of net-net working capital and P/E's around 3 means something. Or we are going to re-enter a period of deep pessimism in late Summer/early Fall where multiples will be slashed again. Therefore, are you raising cash at this point, staying put or still finding enough new opportunities to rotate out of your cheap stocks into cheaper ones? Cardboard

Scott, You can find the price to book relationship all the way back to 1985 in a data table at P.157 of Fairfax's annual report. http://www.fairfax.ca/Assets/Downloads/AR2008.pdf Personally, I feel that the risk of the owner disappearing is a greater risk at Berkshire. Warren still makes the big investment decisions while it is a team at Fairfax. However, I am pretty confident that Warren will find a solid investment manager. What I find to be a bigger risk is the market premium paid for Warren. Who knows what it is now since the market premium has shrunk in recent years due to more and more attention paid to this issue. One has to remember that this guy attracts 40,000 people to his shareholders meeting. I would tend to believe that the attendance will shrink once he and Munger are gone. See, I have never been to a Berkshire meeting, but I am thinking about it because I like Warren. If he was not there, I would not even consider attending. To me it means that the market will take a wait and see approach once he is gone and that the company will be considered more or less like any other. While I agree that Berkshire's operating performance will likely continue in a similar manner following Warren's departure. There is a market risk on the timing of the "event" which is impossible to predict. If it is far out in the future, then the impact on returns is likely negligeable. If it is tomorrow, then you could look at a 20, 30% haircut? Who knows? Honestly, I don't understand why Warren is not considering to replace himself while capable to ensure a smooth transition. As Chairman, he could still be there to monitor what is going on and ensure that his selections are right on. It is pretty hard to "tweak" some details that you have forgotten once you have passed away. Previously, he did not want to give away anything to charity before his death because he could keep compounding money. He has changed all that. So I figure that he could come out and decide at some point to initiate the transition while alive. On volatility, Fairfax share price has been quite volatile in my book. Their results are also quite volatile and more so than Berkshire. I would say that Berkshire has a diverse stream of reliable operating earnings while Fairfax operating earnings are almost entirely dependent on the investment decisions since they generate little underwriting income and they still have non-negligeable interest payments. Cardboard

Kawikaho, I think that there is an opportunity here, but the exact opposite of what I believe you are thinking: writing these puts. While I agree that GM shares are essentially worthless and I was previously short the stock, I don't believe that they will trade right to $0 following the June 1 restructuring deadline imposed by the U.S. government. If you look at other companies that have worthless stocks that have essentially been taken over by the U.S. gov't: FRE, FNM and AIG, they are all trading in the $1 range. And this has been going on for a long time since their "default event". So considering this weird phenomenon, the time that it will take for GM to get a reasonable restructuring plan together and the slim possibility for GM shares to recover, I would not buy these puts. Cardboard

"The chips will continued to get supplied, but now at a much lower cost, and sooner. The question is whether it'll be through a long term contract, sale/lease back through an intermediary, or via an outright acquisition. Our own inclination is some kind of lease and future buyout." Sorry SD, but I am having a hard time sharing your enthusiasm. Abitibi is supplying 80% of the fibre to the St-Felicien mill and they are now disputing pricing which is linked to the price of pulp in their 20 year contract. However, it is not only the price of that supply that bothers Abitibi, but the supply of it all together. Most of Abitibi sawmills are operating in the red these days with lumber in crisis. On top of that, Quebec is now known as a very high cost producer of lumber due to restrictive harvesting rules, high labour cost and small/slow growing trees due to its climate. Then you have a very punitive trade agreement with the U.S. during tough times. Unless some conditions change dramatically and quickly, it is quite likely that Abitibi will permanently close these unprofitable sawmills during its bankruptcy proceedings. Cardboard

I still firmly believe that Prem has made a big mistake by investing in these guys. They have been extremely slow at curtailing their production during previous downturns and have piled up an unsustainable amount of debt and other liabilities. He will likely end up with a large stake in the company (if things go right with secured debt holders), but the average cost per share will be heavy relative to what it could have been. New management seems better, but the legacy is heavy. My money is on Catalyst Paper. The management is top notch. They have no debt due until 2011 other than a small non-recourse amount due this year. They generate free cash flow and that number is growing fast. They have renegotiated with their union and their relationship seems way better than the one at Abitibi. Their costs are coming down and management seems relentless about it. A very different situation with ABH if you ask me. Yet, the share price has been decimated offering insane potential. If you are interested in the sector, please compare the two before investing. By the way, Third Avenue owns around 38% of CTL which they acquired in the public market. Cardboard

Hi Mloub, Honestly, I was quite worried for a while that this stock would end up being a zero: 1- DHL was not willing to negotiate at all. 2- The economy was down hard making it difficult for their non-DHL business to obtain decent lease rates. 3- The term loan could have been called if the banks had determined that DHL discontinuing their business in the U.S. represented an event of default. 4- With the stock market tanking, their pension liability has grown significantly weather you look at ABO or PBO. So I did not average down in the $0.20 area (my market position being large enough relative to my portfolio and considering the risks), but should have once I saw management buying some shares and seeing that they were able to re-lease planes in this tough environment proving that their B767's are truly worthwhile. Still, I will be happy to see my money back (around $1) and some more as things are improving. Their latest moves tell me that management is better than I thought and that they are unwilling to dilute shareholder equity unlike so many other firms when things got tough. Cardboard

oec2000, Thanks for the opinion! ;) I agree with you on everything (including the $200 thing) and that is how I will treat it. The only part that I don't bother doing is the following: "Strictly speaking, you have to compute the capital gain both assuming the FX rate stays constant during the holding period and also using the actual rates. You then use the first number as your cap gain on the trade; you use the difference between the two numbers as the FX gain on the trade." I have read about the need to do that somewhere else too. However, on an economic standpoint there is no difference for the CRA, so I don't break it down. I figure that I waste enough time for them already including the stupid T-1135. StubbleJumper, If you have a $US account and you carry a negative cash balance at some point, it will be like short selling U.S. dollars using the math that oec2000 and I have discussed. Cardboard

Hi guys, I am sorry to come back to the forum with a question on income taxes, but this is the season! Say that you buy a U.S. stock with $10,000 CAD. Based on the exchange rate, you now have in your account $8,000 U.S. worth of this company. A few weeks later, you sell this company, but keep the proceeds in USD in your account. The stock is now worth $9,000 U.S., so you calculate your capital gain translating this $9,000 U.S. to CAD using today's exchange rate vs the original $10,000 CAD. The exchange rate is at 1.30. A few weeks later, you find another attractive U.S. stock and decide to reinvest the $9,000 U.S. into it. The thing is that the exchange rate is now 1.40. Your cost basis for the new shares will be based on $9,000 U.S. times 1.40. Is there a capital gain on simply holding USD in the "out of shares" period? The way I see it, is that you acquired $9,000 U.S. at 1.30 and then disposed of these same USD at 1.40 to acquire the new shares. In other words, the balance of U.S. dollars in your account is similar to any other security having a cost base and value upon disposition which will generate a capital gain or loss depending on the variation of the exchange rate. Does that make sense? How is the tax man treating that? Cardboard