Scrap Heap

2 Jul

Legend has it that during a downturn in the oil market in the late 80’s/early 90’s Jim Tisch of Loewes fame assessed the relative valuation of a drilling rig by jumping aboard and proclaiming ” I can buy all of this for $5MM”. The valuations at the time were below actual scrap value, and those purchases would  later form the basis for Diamond Offshore (ticker symbol DO). Fast forward to today where the scrap heap for this type of metal exists on the NYSE where some rig operators are trading at as much as an 80% discount to book.  The movement from deepwater to onshore/ shale combined with a  renaissance in technology just over the last 5-10 years has left a lot of floating and land based steel facing almost sure obsolescence. The question becomes: In a world where credit is endless and virtually without cost, does the question of next best use ever  enter into the equation?. We ask this because Weatherford International filed for bankruptcy protection yesterday,  and it would appear that bankruptcy attorneys will be quite busy in this sector for quite some time. What becomes of the steel we wonder, does the excess ever get scrapped for its possible best use as scrap steel? Or, does the never ending process of workout, de-leveraging, re-leveraging keep this metal “working” in some form in perpetuity.

Real Rates?

29 Jun

The records for negative rates of interest across the sovereign debt world just keep on falling. The front end of the Spanish yield curve is now in negative territory, Spain, a country whose banking issues threatened the very existence of the Euro just 5 years ago, now is charging creditors for the luxury of lending them money. Italy, the bastion of quasi-socialism and who is currently threatening to leave the EU, has rates on the front  end threatening to dip into negative territory. These types of “lending” rates defy any kind of logic and what defies logic even more is that fact that the EU is promising more of the same if economic activity doesn’t pick up. If the definition of insanity is doing the same thing over and over and expecting different results, negative interest rate mortgages (something now being offered in Denmark) might signify new levels of delusion. The question for investors is So What? In a world where the “risk-free rate” of return offers no touchstone as to where real safety or value may lie, what’s an investor to do? This question becomes particularly acute as the race to the bottom in rates is intimately tied to a competitive devaluation amongst the largest global economies. Who needs to even feign interest in a strong currency when one can borrow at negative rates of interest. The bottom line is that with both rates and currencies completely untethered from both reality and reason, it behooves investors to align themselves with an asset class which will maintain portfolio stability given the likelihood of a re-pricing of risk. We believe that the ultimate winner in this new environment will be Commodities/Hard Assets.

Good Old Days

19 Jun

Some political pundits have opined that part of the reason that populist rhetoric has become so pervasive of late is the wish to return to the “good old days”. As some have so aptly pointed out, while we have our problems today the good old days probably were not that good. By any metric: poverty levels, mortality rates, rates of democracy, etc.. things have improved measurably just over the last 20 years. We are nominating one particular area where a return to yesteryear might do us all some good: Central Banking.  In the days when QE was something that would have been positively unheard of, the goal of Central Banks was to gently lean into the business cycle utilizing the Fed funds and discount rates. In the olden days, recessions happened every so often,  capital markets declined as they are wont to do,  and somehow the global economy survived and even grew at a reasonable rate of  growth. Those days are long gone, along with the credibility of an institution that touts itself as above reproach as well as political rancor. This Fed, along with all other Central Banks around the world, has become a tired one trick pony. On this day, we listened to the Fed Chairman when asked about what a rate cut  would even accomplish given that  we have:unemployment  at multi-decade lows,  unbelievable lax financial conditions, and Government bond yields at multi-year lows and his response was that “they were pretty sure they know how these cuts filter through into economic activity”. Really!, a look at the charts below showing financial conditions as well as the yield on the 2 year Treasury would argue that lower rates are not going to accomplish much given where they already are.


Our intuition tells us that the talk of imminent rate cuts is less driven by weakening economic activity and more by a weakening in the backbone of those stewarded with guarding the  very credibility of our entire financial system. We talked about how The Donald would find a new boogey man and it appears to be Central Banks, though not confined to the Fed however as he threw some shade at Mario Draghi yesterday in response to a possible resumption of ECB QE. Interesting times, not better, just more interesting.

The Cure For Low Prices

18 Jun

Everyone knows the old adage ” The cure for low prices is low prices”, but I would amend this time tested salvo to read ”  Low prices, in a credit environment where risk premia is completely divorced from reality, may possibly, eventually, result in prices slightly above the cost of production”. If the new era of Modern Central Banking has taught us anything, it is that credit and liquidity are the great equalizers, and more specifically they effectively bridge the gap between unprofitability and the natural selection process of bankruptcy and capital asset liquidation. Traditional economic theory involving the darwinian process of capital formation-innovation-imitation-destruction has been supplanted by something much more damaging in the long term in our opinion.

Nor Any Drop To Drink

29 May

Although it hasn’t gotten much press until recently (no surprise given the non-coastal location), the flooding situation in the Midwest, Upper Midwest and Central Plains is threatening to set long- time records for both duration and severity. In order to provide relief for much of these areas, levies are being utilized, some of which had not been used since the 1920’s. Not surprisingly, this deluge of liquidity got us thinking about the global deluge of liquidity and how the ramifications of both floods look  similar. In many of these stricken areas, they are opening up levies that have not been used in over 8 decades, thus upsetting existing delicate ecosystems. For some reason, Uber immediately came to mind when contemplating the effects on the economic ecosystem of the flood of global liquidity. Much like the levies, the flood of liquidity gave rise to the unprofitable, omnipresent Uber phenomenon, and virtually overnight the transportation system here and globally was changed forever. You notice I say changed, with no judgement of good or bad, but the fact is that the technological advances necessary to give rise to such an enterprise would not even exist if it were not for the capital streams flowing to money losing ventures such as this. The fact that it is unprofitable, is not the point, it is highly unprofitable and firmly entrenched in a business model with no barriers to entry. Sporting a $66Bln market cap, the deluge unleashed on the transportation ecosystem has  left a trail of destruction in its path: Taxi cab medallion prices, additional urban traffic congestion, public transportation ridership decline, etc.. The differences in the two surges in flow primarily lie in the system of levies themselves. The corps of engineers and other forward thinking folks respected both the power and unpredictability of the flow of water, unlike the other kind of liquidity whereby virtual dams and levies are constructed only after the worst of the damage has already occurred.

Freedom Is Free

29 May

In another installment in the “you can’t make this stuff up” category, U.S. Department of Energy officials referred to an export shipment of LNG as “molecules of freedom”. We weren’t aware that molecules could have a political affiliation, but nonetheless, those molecules still are essentially “free” with the spot natural gas market in West Texas firmly entrenched in negative territory.

Stop Making Sense

22 May

Was struck by the comments of a large quant group when complaining that his stock selection factors were no longer working,  leading to recent sub-par performance. “Join the club”  is probably the refrain from almost every corner of the investing world. We have been pondering the question of correlation and causation lately and I think I’ve come to the conclusion that in a post QE world, we are finally seeing the detritus of years of capital mis-allocation. Bitcoin is not an anomaly in this environment, but rather is indicative of the kind of excesses that masquerade as technological “breakthroughs”.  As we have talked about previously, (admittedly to excess)  governmental overreach, under the guise of targeted Central Bank Policy,  has skewed and permanently altered economic relationships in a very profound way. These disconnects are too numerous to list: inflation/unemployment, low and even negative rates/economic growth, Treasury rates/deficit spend. One has to begin to wonder whether the resultant mis-allocation of resources has permanently unmoored reality from its own fundamental underpinnings, and if so is this new reality to be taken as the norm; Modern Monetary Theory is one perfect example of such skewed perspective.