The Sane Investor

August 20th, 2008

Today´s EIA Petroleum Status Report announced that crude oil inventories in the United States went up 9.4 million barrels, way more than the expected 1 million increase predicted by analysts. In fact, according to that same Bloomberg article, it was ¨the biggest gain since March 2001¨ in crude inventories. By any means, this is definitely bearish news if you´re trying to go long on crude like me.

But that´s not what I wanted talk about. In fact, instead of looking at the crude data, I think that you should look farther down that article at the information on gasoline inventories. According to Bloomberg:

¨Supplies of [gasoline] declined 6.2 million barrels, more than double the 3 million-barrel decline analysts predicted…Pump prices haven’t increased since July 19, according to the AAA, the nation’s largest motorist organization. Regular gasoline, averaged nationwide, fell 1.3 cents to $3.717 a gallon, the AAA said today on its Web site. Prices reached a record $4.114 a gallon on July 17.¨

In fact, as I´m writing this, crude oil changed its downward turn and instead looked upward because of the news that the gas inventories fell. This marks the fourth straight week that gas inventories have fallen, and they´ve fallen by quite a lot (almost 10% in the past month). But instead of investing in crude, I think you should look at gasoline.

Something Isn´t Priced Right

Although the gasoline reserve numbers would seem to be bullish news for crude, I think it might actually be that gas prices are lower than they should be. Otherwise, I´m not quite sure how there could be such opposite results in the crude and gasoline inventories. In order to keep reserves from continuing to fall and risking shortages, I think the price of gas has to go up.

Because of this, instead of pouring more money in to crude, I think you should take a look at the United States Gasoline Fund (AMEX: UGA) (ETF Connect page here). The fund works by trying to:

¨track, net of expenses, the changes in percentage terms of the price of gasoline. The trust will invest in the futures contract on unleaded gasoline delivered to the New York harbor traded on the New York Mercantile Exchange that is the near month contract to expire.¨ (see Yahoo! Finance)

This is the only fund I´ve been able to find that tracks the price of gasoline, and I would say this is your best bet in terms of trying to caputre rising gasoline prices. (You can find a more detailed explanation of how the fund works here)

Regrettably, You´ll Profit Off of Misery

One of the biggest reasons that I suggest that you pick up a fund like UGA, in addition to what I anticipate to be innaccuracy in prices, is the fact that lower reserves increase the possibilities for spot shortages and gasoline lines.

The whole purpose of the gasoline reserves is to make it such that we´re not immediately dependent on the next shipment of crude or production from refinieries. Theoretically, if there were to be a storm, or demand were to unexpectedly go up, there would be extra supplies for us to cut in to so that the price of gas would not bounce around relentlessly. Basically, to reduce volatility.

The only problem is, the lower the reserves go, the greater the threat that an external supply shock poses. This is what I imagine the crude reserves are for: to provide another barrier of protection. But without sufficient reserves in gasoline it doesn´t matter how many barrels of crude we have.

The ¨hoarding¨ mentality of a supply shock would cause people to start buying as much as possible, and the result would be a huge spike in prices and insufficient short term supply. Because you´d make the most money in this sort of scenario, I think UGA is definitely a guilty investment.

Better To Think of It as a Hedge

Because I think an all out supply freeze and panic is unlikely in our information era, this type of fund would be a great hedge against a long in an automotive company like Ford (NYSE: F) or General Motors (NYSE: GM). In the short term, the biggest thing that could derail one of these ¨companies in transition¨ would be really high fuel costs. You can offset that risk by picking up a fund like UGA.

(If you´re a fan of Ford like me, you should check out this article. I personally think under $5 Ford is a buy, under $4 strong buy. I really believe they have a great company tradition, and hopefully getting pushed up to the wall like this will help them purge all the bad crap they have left from their days trying to resist change and maintain the status quo from the 1970s and 80s).

The Bottom Line

Whether you´re expecting gasoline prices to correct themselves, the apocalpyse in the form of spot shortgages, or you just want to hedge yourself a little bit, I think this fund is probably your best bet. Crude has had a lot of traffic lately, and to get yourself off the beaten path might help you increase your returns. Gasoline has been really quiet, and you might be just a step ahead of the next big Bloomberg article.

Questions? Comments? E-mail me at thesaneinvestor@yahoo.com

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© 2008 Andrew Jarmon

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August 19th, 2008

If you´ve taken a look at Bloomberg today, a prominent article clearly spells out the apocalypse of financials, with the bugle in the hand of Kenneth Rogoff, a Harvard professor of economics and former chief economist of the International Monetary Fund (IMF).

Now academics, and especially those at top institutions like Harvard, are typically the only types of market commentators that I truly listen to when it comes to the economy. This is because:

(1) They don´t have any personal stake in which direction the markets move (unlike traders and bankers)

(2) They usually have piles of data lined up to support them.

This doesn´t necessarily mean that they are always right, of course. But, if you´re looking for a voice that can move markets, his is one of them.

Not a Lonely Voice in The Sea

Besides the occasional upswings lately in the market, it has not been terribly difficult to find a plethora of negative commentary regarding financials. Financials have been so volatile, and investors have gotten burned so many times trying to spot a bottom, that it definitely feels like everyone is going to stay out of them until some seriously positive news comes out (i.e. from the Fed or super star economists like Rogoff saying things are ok).

Until then, words like Rogoff´s are not reasurring:

¨¨The worst is yet to come in the U.S.,”…¨The financial sector needs to shrink; I don’t think simply having a couple of medium-sized banks and a couple of small banks going under is going to do the job.”…

Freddie Mac and Fannie Mae ¨should have been closed down 10 years ago,” …¨They need to be nationalized, the equity holders should lose all their money. Probably we need to guarantee the bonds, simply because the U.S. has led everyone into believing they would guarantee the bonds.”…

¨Like any shrinking industries, we are going to see the exit of some major players,” …¨We’re really going to see a consolidation even among the major investment banks.’¨…

¨Rates are too low,’¨…¨[The Fed] must realize we’re going to get inflation if things stay where they are. They need to raise rates but I don’t think they are going to because they’re way too nervous.”

¨The only way to put discipline into the system is to allow some companies to go bust,” Rogoff said. ¨You can’t just have an industry where they make giant profits or they get bailed out.’¨¨

Ex-Fed Chairman Alan Greenspan has also jumped in to the fray, saying that:

¨¨Our country has long since abandoned the notion that we should leave crises to be resolved solely by the marketplace,”…

¨To minimize the impairment of market efficiency from bailouts, the critical need, in my judgment, is to formalize and somewhat revise the procedures improvised” in the rescue of Bear Stearns Cos.¨ (from ¨Greenspan Says Federal Company Would Best Ease Crisis¨, Bloomberg Aug 8 2008)

The combination of what Greenspan and Rogoff are saying to me indicates that at the same time that academics and economists are looking backwards and trying to learn from mistakes, they´re definitely suggesting that we need to prepare ourselves for more failures.

So Are Financials Only for High Risk Day Traders?

As of 12:04 PM Eastern, the SPDR Financial Select (AMEX: XLF) ETF, which tracks ¨banks, diversified financials, insurance and real estate¨, was down $0.74 or 3.60%, culminating in a year to date return of -28.74%.

The way that financials have been moving, it would seem that you´d be best served to just get out unless you´re in the mood to do some gambling. This could be extremely profitable if you can pick the right stocks, for instance if you bought Lehman Brothers (NYSE: LEH) and they ended up not posting the $4 billion writedowns that are predicted.

But what do you do if you´re a ¨Sane Investor¨, and you´d like to go for the long term?

Always Go With The Top Performer

Whenever you find yourself in a market that has a bearish outlook, the typical position would be to go short the sector as a whole and go long a couple of shining stars. In my opinion, this is the type of trade you should be looking at for financials, since I think the overall outlook for the industry down the road is positive.

This is a type of hedge that works well, since if your ¨shining star¨ takes a massive stumble, you´ll end up making it back with the sector short, since chances are if your rockstar stock isn´t doing so hot the sector will be doing even worse. Thus, although you´re losing money on your long position, you´ll make some of that back with your short.

Now for financials, the sector short is pretty easy. Just go with an ETF like Proshares Ultrashort Financials (AMEX: SKF) or Proshares Short Financial (AMEX: SEF). The Ultrashort tries to perform 2x the regular short, so you could theoretically provide the same hedging protection for yourself with half the money.

Now the superstar performer is the hard part in financials. For me, the outperform has to be something that has good valuations, feels like it´s fallen a lot historically and has solid fundamentals behind it. In an article a couple of days ago, I mentioned Goldman Sachs (NYSE: GS) as ¨the only [financial] I´ve ever touched¨. For me, this is the superstar.


Simple Fundamentals

My reasons for picking GS are fairly simple, but they also involve some experience as well. As a student in finance, almost all of my friends are going in to investment banking. Because of this, I´ve become pretty familiar with the investment banks and their relative prestiges/track records as employers.

From my experience, I can tell you that the one place that everyone wants to work (because the smartest people go there) is Goldman Sachs. It seems so simple and petty, but I go with Goldman Sachs because they are the place where the best and brightest want to work. They´re called the ¨revolving door¨because so many of their top executives take high position jobs in the government, and many of their top people are currently running other banks. They´re also the only ones who called the subprime crisis right.

Since investment banks are very mysterious in their operations, you really have to invest in the people running the bank and working for them. Since Goldman Sachs has the best people working for them (by far), I think they´re best adapted to handle challenges up ahead.

Let´s Talk Price

As of today, GS has been moving down, currently around $158. With that price, they´re sporting a PEG (price to earnings growth) ratio of 0.64 (below one is considered to be undervalued) and a P/E (price to earnings) ratio of 7.54. As far as comparisons, Merrill Lynch (NYSE: MER) and Lehman don´t even have P/Es because ofnegative earnings, and JP Morgan Chase Co (NYSE: JPM) has a 11.57. JPM doesn´t really count though since they´re not an exclusive investment bank and have a commercial banking division.

In my opinion, historically GS is well priced. If you´re hedging yourself properly, I´d say Goldman is a buy under $160, and a strong buy under $150. I might space out your buys, since if some more serious write downs start taking place, or if some major banks fail, expect Goldman shares to fall on momentum.

Questions? Comments? E-mail me at thesaneinvestor@yahoo.com

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© 2008 Andrew Jarmon

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August 14th, 2008

Although the timing of the announcement was a bit dubious, especially after Moody´s announced yesterday that it was lowering GM´s debt further in to junk status, General Motors (NYSE: GM) released photos of their electric plug in car the Chevy Volt today, assuring investors that the car was on schedule and would be released in November of 2010. Not to be outdone of course, Toyota (NYSE: TM) released their own release, claiming that they would be doing it cheaper and more efficiently (of course they would say that).

Now I´m not an automotive expert, but I can tell when people are trying to take the focus off of the now and put it in to the future. Like Ford (NYSE: F), GM has been caught in the headlights of a market that has veered dramatically away from larger SUVs and pickups that allowed the two to more or less dominate the American market. However, unlike Ford´s Focus, GM hasn´t really had a small car that they could push successfully.

Putting Your Eggs In One Basket

Based on the timing of this release, it seems as though GM is putting the future of the company in the Chevy Volt. It´s flashy and it sounds cool, but for me the proof will be in the pudding. According to Tom Krishner of the Associated Press:

¨The Volt, GM says, can travel 40 miles on a single electrical charge and will get about 150 miles per gallon of gasoline. Ward [Toyota] said standards have not yet been developed on how to calculate miles per gallon for plug-ins, so he would not say how fuel-efficient Toyota’s plug-in would be.

Bob Boniface, the Volt’s design director, said he could not comment on Toyota’s system, but he said GM is building the Volt because of expertise it learned from building the EV1 electric car in the 1990s.

“We had the knowledge base from the EV1. We knew how to do electrically propelled vehicles,” Boniface said.¨

GM is benefiting from the fact that they´re the only ones providing numbers right now. That makes a much stronger case for them being ahead of the curve, since Ford has been more or less silent and Toyota seems to be speaking in vagaries (¨some time in 2010¨…alright, cool…). It´s more a question of who puts out the better product, and just because you´re first doesn´t mean you´ll be the best. A whole lot more goes in to buying a car than just gas mileage.


The Bottom Line

If I´m wrong on this one then I´m more than willing to take the bullet for my underperform on GM. However, based on their track record, I´ll believe it when I see it. The fact of the matter is, if Chevy´s product ends up being more expensive and Toyota ends up making it more consumer friendly, you can frankly kiss Chevy and GM good buy. Although the crude crisis we just experienced put oil prices back on the minds of American consumers, those that can afford a $30-40,000 car can likely afford $4-5 gasoline. It sounds cool, and it´ll definitely make good headlines and help their stock price, but for me this stock is dead until 2010. Ford has the Focus in the meantime, and Toyota has the Prius, but what does GM have? Only dreams, apparently.

Questions? Comments? E-mail me at thesaneinvestor@yahoo.com

All material copyright

© 2008 Andrew Jarmon

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