Drinks With Kuppy...

April 13, 2011 4:25 AM

Every year, my friends and I get together for a few casual drinks the friday before the Berkshire Hathaway annual meeting in Omaha. I thought it could be fun this year to open things up to AIC subscribers. In the past, we have chosen a local bar. Depending on the number of people coming, we may have to find a larger venue. Please RSVP if interested (note how many people will be attending) and you'll be contacted in a few days about where the event is. Email Genevieve at info@mongoliagrowthgroup.com I will have limited access to email over the next week. DO NOT EMAIL ME!!

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Why I Would NEVER Invest In Early Stage Infrastructure Projects

February 9, 2011 12:36 AM

From time to time, one of my friends really out-thinks a topic. Rather than trying to paraphrase someone else's thoughts, I bring them to you as written. If you enjoy the following, check out capitalistexploits.com for more of the same. With that said, I pass the microphone to my friend Chris.....


I’ve been troubled by China and how to best invest for some time now. I relocated to the Asia-Pacific region 8 years ago in order to take advantage of what I saw as a tectonic shift of wealth that was underway.

There is an enormous amount of infrastructure build-out taking place across Asia, but especially in China. This project being the latest installment in a long running theme of a state-planned economy. In my mind there is no doubt that we’re experiencing an overbuilding boom inspired by easy monetary policies throughout the world. A lot of this infrastructure build out adds to GDP growth. GDP growth however is easy to achieve while real wealth growth is something altogether different. In parts of Asia we have office blocks going up in areas enjoying 25% vacancy rates. This is far from the worst either. It adds to GDP growth but certainly doesn’t add to new wealth.

This build out has the potential to be a real positive, although not for early stage investors. When you look at the construction of the railroads in the US in the 1800’s there was, at the time, massive over capacity but it laid the way for a much easier process of building wealth once the infrastructure was in place and the railroads had all gone bankrupt and been restructured.

To illustrate the point, about 95% of all railroads in 1895 were bankrupt and all canal companies went bankrupt. The building of the Chunnel is another example. The guys who invest in the first, second or third equity tranches in these projects all lose their shirts. Not to belabor the point, but the laying of all the fibre optic cable is another example. It is there for all of us to use and helps lower the costs of business massively, much the same way the railroads lowered the cost of business in the late 1800’s.

I think that we will have a similar setup in Asia, and the opportunity will lie in buying distressed debt of infrastructure projects for cents on the dollar. Naturally we may have to wait a long time for that… or maybe we won’t have to. I’m not smart enough to know. I do know that buying into them now is likely to be very painful and I therefore have zero interest in doing so. PATIENCE is required. Now is NOT the time to be buying these things!

The revenues generated directly from the infrastructure that has been put in place are rarely enough to provide for the return of capital let alone return on capital.

Ultimately the beneficiaries of infrastructure projects are many and diverse. Consider for example the Chunnel that links London and Paris. It is now possible for a flower seller in Paris to have fresh flowers on corporate breakfast tables in London’s offices each morning. This would not have been possible to the extent that it is today without the aforementioned Chunnel.

The Chunnel provides enormous benefit to industry throughout Europe and the United Kingdom; however the financiers of this are not so happy.  My focus is not on the Chunnel or Europe for that matter, these are merely illustrative points I make.

Among the factors that I generally look for before making any investments are, importantly, a lack of government intervention. Infrastructure is often politically sensitive, so I’m wary of government stepping in to save banks that have lent to the particular companies involved in the construction. If this happens then we don’t get the opportunity and instead will likely witness a Japanese remake.

If on the other hand the deck is cleared and the debts restructured two things will happen.  One is that the foundation for building real wealth will be laid. In this respect I think China is in a similar position to the US in the 19th century.

The second thing that is important is that for once buying infrastructure debt will be a road to riches.  As my friend Kuppy says. “The real big money is in buying the collapses”.

Here’s to waiting…

By Chris, February 3, 2011

“Get the important things right.”

- N. P. Collingwood

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Back To Mongolia

October 13, 2010 7:50 PM

Investing is about indentifying trends before others do and capitalizing upon them. You don’t need to catch the bottom or the turn. You want to find a trend already in motion and latch on with everything you have. You need a trend that can go on for years and most importantly, you need to be early. The thing about trends is that they always overshoot to the upside. As long as the trend is correct and you’re early enough, the trend will bail you out of your mistakes. The trick is to buy the best assets in the industry. You are never going to buy the absolute lows. The best assets will move first. Buy those. Don’t be a value investor playing catch-up with second tier assets. The best assets will dominate the industry. Focus on those.

Throughout the last decade, I have been successful at doing this. I got into gold at $330. It took me some time to figure out what assets I wanted, but by $380, I had a good basket of companies. I’ve been on this trend for seven years now. It isn’t ending any time soon. After overshooting, mining assets have moved sideways for years—they’re cheap again. The same goes for silver. I got involved when silver was $4. I had my Pan American Silver (PAAS: Nasdaq) appreciate 6-fold before I sold it (thanks Fleck). I watched my Western Silver go up ten-fold before it eventually turned into Glamis. I still have thousands of ounces of silver bullion. Even that is up 5-fold. You buy the best assets in a trend—even if they’re expensive on current metrics. If you had bought the cheap stock, you’d own a bunch of Coeur D’Alene (CDE: AMEX). Yuck!

I was ungodly early on Uranium. I bought my first shares when uranium traded for $12/lb. At the time, there wasn’t much to choose from. I bought all 9 publicly traded companies and held on for the ride of my life. A few were duds, but most went up at least 10-fold. One even went up 30-fold. I unfortunately sold out too soon. My companies had overshot the fundamentals and I knew it. A year later, they came crashing back to earth. They are still grinding lower. The price of uranium is now $46, down from $136 at the peak. The trend is still viable and I know I need to revisit this

UXC uranium

Source: UX Consulting Company, LLC

I’m early on mining services. Large mining companies are just now realizing what I have known since early 2007—as an industry, they have depleted more than they have discovered for at least twenty years. The elephant mines in the industry are running out and there haven’t been many sizable new discoveries. The majors bet big on the juniors finding something. They didn’t find much. Now the majors are scrambling to overpay for what few good assets exist in the world. There is about to be a massive boom in exploration—the majors have no choice. I started with six companies in the mining services industry and after getting to know them all; I have narrowed it down to the two. I think that 2011 is the year that I am vindicated. The good thing about being early is that I have been able to sit on the bid and become the largest shareholder of each of these businesses.

Sometimes, you cannot figure out how to play the trends you see. I have been a long term believer in agricultural commodities. I spent two years trying to find an intelligent way to invest in the industry. I owned equipment makers and fertilizer companies. I even owned a company doing GPS for tractors. I tried everything, but it never felt right. Agricultural prices will go much higher over time. Farmers will have a whole lot more disposable income, but I have relegated myself to the fact that I will not make any money off this trend.

Sometimes, you get scared out. I spent three weeks in West Africa. The economy in Ghana is booming. The Burkina Faso economy will soon boom as a few large mines come online. In Ivory Coast, they decided to put down their guns and end a civil war. Their economy will also boom. I wanted to go and play it. I bought into the Ghana stock exchange, but I didn’t really put my mind into it. It seemed too distant and too chaotic. Nearly dying in Ivory Coast didn’t endear me to the place either. West Africa felt like it was seconds from anarchy. I think it will be a boom, but it was too scary to put real money to work.

mr housing bubble

Sometimes, I have just been too early on a trend. Starting in late 2005, I saw the housing bubble for what it was. I live in Miami—it was obvious that this would be a disaster. I shorted all the home builders. I shorted Fannie Mae and Bear Stearns. I was a huge short in Lehman—it just looked like a fraud to me. I was short CountryWide and AmeriCredit. I heard there was a company that guaranteed mortgages—MGIC Investment Corp (MTG: NYSE). You can be sure that I was short globs of that. Unfortunately, companies can go higher before they collapse. I got run over on some of these. I saw my puts go off to put heaven each quarter. Finally, I analyzed my results for 2006 and 2007. I was up over 100% each year on my longs and I gave back a good chunk of my gains on the shorts. Forget it. I no longer short. It’s too hard. I got it right conceptually, but only lost money. You can be early on the long side and nothing happens. If you are early on the short side, you will get hurt.

Sometimes, it pays to ride the trend when you have a hiccup. The accumulation of political power in Washington DC feels unstoppable. Following the terrorist attacks on 9/11, small regional hotel stocks collapsed. Many were down 70% or more. Some looked like they could go insolvent. I focused on a few that were clustered in the downtown Washington DC area. People were scared to visit the capital—for good reason. However, I knew enough about politics. Eventually, lobbyists would flock back to the capital like flies to poo. I kept buying as these shares dropped. I made friends with the reception ladies at a number of hotels. I’d call once a week and they’d tell me how bookings looked. 10% occupancy is a disaster. When I saw the turn, I bought the snot out of these stocks. Not only did they return to their prior highs within two years, they then exceeded those highs by large amounts. I had huge gains but, as always, I sold too soon.

I can go on and on. The key is to find a trend. Spend time to make sure you are correct. Buy the best assets as long as the prices are reasonable. Then make sure you don’t get shaken out. I always sell these trends too soon. I forget that they always overshoot. I am not about to complain though. In a decade where the market has gone nowhere, I’ve made well over 100-fold on my investments—isn’t compounding exhilarating? Clearly, there’s something to this trend investing.

the trend is your friend

The funny thing about these trends is that I have looked at hundreds of potential trends over the years. Usually I print out some materials. Maybe I visit a few trade shows. Eventually, I just get bored. It’s not that dental equipment is dull; it’s just that I slowly realize that it isn’t a trend with enough momentum for me. I know myself. I’m excited when I can feel something that is about to go parabolic. When I really feel like I’m onto something, it’s intoxicating—I cannot sleep. I cannot think of one of these trends where I felt this way and then got it wrong.

I got back from Mongolia a month ago. I cannot get it out of my mind. Gold is up $150 since I got back. That’s boring. Will bonds collapse or yield one basis point? I don’t know or care. The normal minutiae of investing cannot hold my attention any longer. Until I figure out Mongolia, everything else can wait. So far, I’ve put some money in a savings account to play the local currency. I bought a few shares on the exchange. There’s nothing like waking up in the morning to learn that over night, you executed a combined 19 shares in three different companies valued at $115. I’m not going to make big money investing on the exchange—I cannot get any money to work. I am back in Mongolia because I want to see if there are other ways to play the coming boom. I spent two weeks looking at public companies. That isn’t the way to play it. Now I am broadening my horizons.  

I’ve been on these crazy odysseys in the past. I remember when I Googled uranium investing and nothing popped up. Most information on the industry was classified. Out of desperation, I started cold calling nuclear power plants and uranium mines looking for information. I’m sure I’m still on some terrorist watch list because of it. There was no way to play uranium oxide itself, but I played a basket of explorers and figured it out over time. I sold the duds and focused on the winners. I don’t yet have a plan on Mongolia. I hope that I’ll figure it out on the fly. You never know when that epiphany will strike. Investor, Jordan Calonego is here with me. He thinks I’m right about my quest for the perfect Mongolian asset.  We’ve chosen to take our womenfolk in the hope that they will have the special insight that five finance guys lacked on our last trip. Thus it begins… Mongolia redux.

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Mining Exploration--Here Come The Big Boys

October 1, 2010 11:55 AM

Most analysts are too stupid to actually analyze financials; therefore mining stocks are usually valued on a multiple of current cash flow. Two decades ago, mining companies had an epiphany. Exploration costs money. If you explore, it reduces cash flow and hence your valuation. Rather than spend your own money, it’s better to overpay for junior miners who have found something as share dilution isn’t expensed through the income statement. From this notion, an uneasy symbiosis was formed. Large mining companies would focus on cash flow—juniors would handle the risky business of finding deposits. The quid pro quo was that if a junior found something, a major would overpay for it.

Then two problems developed. It turns out that most juniors aren’t very good at finding stuff. Even worse, every major has the same game-plan. All the big boys are fighting for the few good discoveries. Suddenly, we have a big problem—how do you replace two decades of depletion in a hurry?

gold rush cartoon

Let’s take a step back and look at junior mining for a second. It is a pretty silly business when you think about it. You have to wonder why the majors pinned their hopes on these guys. So you have two geologists and an interesting patch of dirt they want to explore. First you go public. That costs money. Next you raise more money to explore. Say you raise $5 million. $500,000 is gone in broker fees. Corporate costs will eat up another $1 million. You need to think ahead about how you will raise your next $5 million. Even if you’re frugal, a good promotion campaign with conference booths, site visits and glossy mailings will cost $500,000. You’re left with $ 3 million to spend on actual exploration—most of that gets wasted on sloppy planning.

If you’re a big company looking to get value for your exploration spending, you have a set method to exploration. First you do mapping and soil sampling. Then you do geophysics. Then you poke a few drill holes in it. You analyze the data and determine if you want to continue. As you gain confidence in what you have, you slowly ratchet up your spending. Drilling is expensive; it’s the last thing you want to do.

If you are a small company, you are always thinking about how to keep investors excited and prepared to fund your next exploration campaign. Drill results produce press releases—soil samples will not cut it. Juniors have no choice but to drill—even if it makes no financial sense. They are burning matches and they know it. If they don’t have press releases, no one will fund their salaries.

gold prospector

Juniors tend to have terrible resource utilization. A general rule of thumb is that after paying for drilling and assaying, you will pay $300 a meter drilled. You should add another $100 a meter in local administrative costs. Say you do a $1 million dollar drill campaign. That gets you 2,500 meters drilled. Next you shut down for two months and analyze the data. If it’s any good, you then spend another month traveling around Canada trying to find investors for the next round. It’s just a terrible use of everyone’s time.

Should you keep paying your drillers for standby time? Should you demobilize and remobilize three months later? It all costs money. Should a top geologist be wearing a cheap suit negotiating with investors in New York? Should you keep drilling when you have no idea what you’re doing? In the end, less than half the money spent actually gets into the ground and what should take a year to accomplish, instead takes three years. It’s the least efficient, most expensive way to find minerals ever conceived. No wonder most juniors have not found much. I don’t know why anyone intelligent ever expected them to.

Even with all the bureaucracy of a large business, the major mining firms have much cheaper costs for finding resources than the juniors. Just overcoming the start-stop nature of junior capital raising and spending accounts for a lot of this. The majors are not desperate for press releases. They take their time and make sure they get the bang for the buck that they deserve. They do soil sampling. When they have something interesting, they spend money on geophysics. Geophysics will tell you where to put your drill holes. You would be amazed how many juniors poke holes all over the place with little more than hunch about where the ore body extends to. It’s insanity. Saving a few bad holes will more than pay for your whole geophysics program. If some junior tells you that they intend to drill something without having done geophysics, they better have a damn good reason for wasting their money. Usually their reason is that press releasing a large anomaly will not get them more funding—a good hole will—even if it takes 20 holes before they find the good one. (Keep in mind that I am a bit biased as my fund is the largest shareholder of a firm that does aerial geophysics).

helicopter takeoff

Once you get the drill program going, a major will contract for a half dozen drills and tell them to get at it. Most juniors will only have one or two drills going—it takes longer and costs more as you get no economies of scale. Unfortunately, the juniors have no choice but to proceed slowly. Majors have long term funding, juniors are always watching the bank account and the equity markets for more capital. That’s not how you want to run a capital intensive business.

Large mining companies do not care about small ore bodies, even if the grades are high. They want big deposits that can produce big resource and production growth. There just aren’t very many of these deposits controlled by juniors. The ones that aren’t in production usually have issues. Either they’re in the wrong countries, in environmentally sensitive areas, are horribly remote or have challenging metallurgy. These are problems that can sometimes be overcome—sometimes they cannot. Mining houses want safe assets in mining friendly jurisdictions. There really aren’t many of these assets left to acquire. If you look at the prices paid for some recent acquisitions, you can sense their desperation. If the majors want to grow, they will need to find it themselves. Heck, if they want to just keep production constant, they need to find resources and fast.

The majors are suddenly becoming desperate. 2009 was the year that everyone used cash flow to pay down debt. They didn’t look at acquisitions when prices were down. They didn’t spend on exploration. Many of them didn’t even spend on mine-site exploration to upgrade resources. They paid down debt and stockpiled cash. After a year of high metal prices, some of these companies are so flush with cash that they are going to have to do something.

energold drill rig

I feel a pendulum swing coming in how exploration is done. The majors are frustrated. They know they can do it better, cheaper and faster. They might not have the entrepreneurial zest of a geologist with 5 million options, but they have the cash and infrastructure to get the job done right. When I look at resource company guidance, they keep increasing their exploration budgets each quarter. They are being more adventuresome. They are starting to explore in places that they would ignore in the past. They are taking the reins on exploration. 20 years of mining orthodoxy is being overturned. The major mining firms will begin preparing their 2011 budgets in the next month. Metal prices are high and balance sheets are robust. Reserves are at dangerously low levels and there’s nothing to buy. The Metals Economic Group estimates that 2010 exploration spending will clock in at $11.5 billion, up from original guidance of around $9 billion at the start of the year. I have a hunch that 2011 budgets will be shockingly large from the majors. After barely spending for two decades, the majors are about to embark on a major campaign of exploration.

Whenever you have a tectonic shift in an industry, there are winners and losers. Who benefits? If you do work in crazy countries that have not been adequately explored, you win. If you do greenfield exploration, you win. If you are large enough to service the majors, you win. After giving the juniors two decades to explore for new deposits in their helter skelter manner, the majors are now going to take that over. There are lots of brown field projects that juniors will keep drilling to generate stock promotion schemes. These assets aren't mines because they have 'issues.' The real work of exploration will now switch to greenfield work. Every year, a few juniors will get lucky and find something, but the real spending and discoveries will now come from majors. If you listen to conference calls of mining service companies, you can see the change in order books from just two years ago. The majors are now ready to spend. They certainly have the cash flow to spend big. If you service this type of business, the next few years will be quite lucrative.

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The Trend Is Your Friend

August 13, 2010 12:27 AM

I am always amazed at how value investors tend to fixate on backwards looking metrics and conclude that a business is undervalued. Investing in a business is all about the future. When I invest, I always want the wind at my back. I know that I sometimes make mistakes and I want to be sure that the macro backdrop will bail me out of those mistakes without too much pain.

Usually, the macro backdrop has meant that I wanted to be in a growing business sector that was experiencing margin expansion and increased returns on capital. I wanted to know why there was a secular reason for this trend having occurred and I wanted to be confident that this trend would continue for a long period of time.

When I first started investing, I would repeatedly lose money trying to invest in things that seemed cheap. Look at regional bank stocks today. There are dozens of these that optically appear cheap. They trade at discounts to book value, they’re growing their businesses and not saddled with bad loans. Maybe if you chose well, you’ll make some money. Maybe a stock at .7 times book value will eventually appreciate to 1.5 times book value. That’s a healthy return. However, that’s not for me.

In FDIC we trust

Despite rosy outlooks issued by brokerage houses, the banking sector is mired in bad loans. The US economy is shaky at best. Interest rates will remain low for an extended period of time which will hurt net interest margins. Finally, regulators are out for blood and it seems that smaller banks are going to be the losers because they cannot afford the lobbyists and extra compliance people that the larger banks can. Can you make money in banking? I’m sure you can find the cheap banks that have been ignored, but that’s too hard. In investing, you are not given extra credit for difficulty. I want to find the obvious investments. To do that, I want to make sure the wind is at my back. Even the best managed bank in the US is merely “king turd on crap island,” to quote a good friend.

In the past, I’d consider whole sectors of the economy to be toxic. I just didn’t want to bother finding the bottom in a declining business. Now I’m thinking that whole countries may be toxic to investors as well. There will always be interesting investments in every country, but what if the macro, tax, regulatory and geopolitical environments are so highly stacked against you that you do not want to try?

Public Sector Debt

Look at the data above. The top group consists of highly leveraged nations with stagnant growth, unfunded liabilities, high taxes, unfavorable demographics and rapidly increasing debt burdens. In the near future, there will be a day of reckoning—I don’t know how it will all shake out, but it will be a tough time for investors. The bottom set of countries have young populations, low debt burdens and growing economies. Where do you want to invest?

I’ll admit the rule of law is questionable in some of these places. Many of them have their own unique issues to muddle through. For the longest time, that was why I avoided them. But compared to the issues that we now face in the Western World, maybe some of these emerging markets do not look as bad. Most importantly, these countries have growing economies and growth eventually creates premium valuations for assets. I’m not sure if these are the seven growing economies that I’d focus on, but I think it is time for all investors to broaden our horizons and look further overseas.

Tomorrow's gold

It would be one thing if you were adequately compensated for taking risks in the Western World. If assets were cheap, I’d find the best industries and take my chances on the best companies in those sectors. I’ve done that in some industries like asset management, mining and mining services. However, on most valuation metrics, Western Markets seems fairly valued at best. Many companies are overvalued. What’s the right price to pay for a slowly growing business experiencing margin compression? That’s the issue today in the Western World. 

At the same time, you can look overseas at businesses that are growing 20% a year and end up paying 5 times earnings for that business. In many cases, you even get a 5% dividend to go along with it. I’m not saying this is all foolproof, but it is worth investigating further. For a decade, I’ve heard that this is going to be Asia’s century. Besides buying commodities, I’ve mostly ignored that advice. However, I’ve never disagreed with it. Two weeks ago, a good friend of mine, who happens to be a very successful Asia focused investor, invited me to go explore a few countries with him. I never pass up an opportunity to have an expert share his wisdom. I’ve rounded up a posse of other successful investors and on Sunday, we’re off to go visit Asia. We are landing in Beijing and from there; we will go where the opportunities will take us. Stay tuned—I will share whatever I learn.

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