Baltimore – (TFN): All eyes and ears are on the Fed this week. With Bernanke in New York discussing potential new bubbles and the New York Fed getting heat for overpaying AIG’s many creditors, investors are having a tough time knowing exactly who to follow.

For those of you who hold up the “Fire the Fed” signs, move over. I am thinking about joining your camp.

First, the real bad stuff. According to Neil Barofsky, TARP’s special inspector general, New York’s Fed (under the leadership of Tim Geithner) failed to use its leverage as the top-banking regulator to tell AIG’s lenders to take less than they were owed.

Instead of taking an across-the-board “haircut” as Obama and Pelosi told us we all should, finance giants like Goldman Sachs, Merrill Lynch and Societe Generale said they want 100% of what they were owed.

The only holdout, UBS, said it would be willing to take 98%. But after tough looks from the guys from across the table, that offer was quickly rescinded.

According to Barofsky, the move cost the country billions of dollars and much, much more in confidence for the nation’s banking cops.

Thanks, Tim!

With that bit of news in today’s headlines, it is tough to find the confidence in some of the Fed’s latest plans to help pull the country from financial failure.

As the nation slowly recovers from last fall’s economic collapse, Bernanke and his troops at the Fed are now facing the difficult task of unwinding massive expansionary policies.

One trick discussed today is shortening the length of emergency loans from 90 days to just 24 days starting in January. It’s a pretty mundane move that will have little tangible effect on the markets.

But what could have a much larger impact, with much less transparency, is Bernanke’s recent discussion of paying interest on the reserves banks place with the Fed.

A popular move with many overseas central banks, the interest rates paid on reserves helps to establish a rate floor that regulators can gradually increase without raising overall interest rates.

Essentially, the move is a way of mopping up excessive liquidity without draining or lowering the water in a much larger pool of lending capital.

Like many things, the idea sounds great on paper, but so did letting the Fed negotiate with AIG’s trading partners and we now know how much that cost us.

Let’s face it. The markets like transparency and predictability. Anything less gives us what Friedrich Hayek called “malinvestment.”

As the Fed gets more and more creative in its efforts to boost the economy without creating deadly bubbles, transparency will go out the window.

Toss in growing political pressure from the folks from Washington and one thing is certain.

Anything the Fed does will cost you and I more money.

“Absolutely,” replied Argentina’s president. “We would never give up the peso-dollar link. It is too important to our economy. Without it foreign investors would leave and the economy would collapse.”

Five years later, Argentina cut the peso loose from the dollar. Foreign investors fled and the economy collapsed.

What lesson can you draw from this narrow set of facts? If you say, ‘politicians can’t be trusted,’ you are merely stating an obvious, universal truth, like ‘public toilets stink.’ But do they stink more on the pampas than, say, in London or New York? That is the question before us.

We begin by posing other leading questions: can investors depend on the money custodians north of the Rio Grande more than they could depend on those south of the Rio Plata? Why do people do things they oughtn’t do – because they are stupid or because they are just bad?

Today, Argentina is a mess. But it is an adulterated mess. The restaurants in Buenos Aires are still full. The beef is tasty. The women are pretty. The weather is nice. But so distrustful of Argentina’s public finances are investors that you could earn as much as 70% yield on a peso bond – the implied yield at today’s heavily discounted prices. If everything goes according to plan, you will get your money. But the 70% yield is a measure of how often things don’t go according to the plan. Investors here are used it. It is as if they got on a flight to Sao Paulo and ended up in Cordova or Brisbane. Or they turned on the hot water and got molasses.

It is these adulterations that make an investor’s lot so treacherous. Argentina’s main source of revenue is agriculture. Farmers are blessed by nature and cursed by politics. Nature gives them the richest, flattest, best-watered dirt in the world. With these advantages under their feet, a fair sun overhead, and a hugely expanding population around the world, agriculture on the pampas should be as easy as rolling tourists in Buenos Aires or selling stolen autos in the ghetto. Instead, the farmers go broke. Why? Math…and popular democracy. For every lonely hick on the pampas, there are 10 voters in the big city eager for other peoples’ money. That’s why farmers pay 40% export tax on their products to the feds in Buenos Aires and as much as 30% more to their local governments. By the time the tax collectors are finished with them, they are out of business.

But even at this level of public larceny, the feds are still faced with a crisis. The country doesn’t have the problems of North America or England. It was spared the credit crunch by its own incompetence and the collective misjudgment of lenders all over the world. Instead of giving credit to people with little of it, they lent to people with too much. The problem here is not the credit crunch, it is a cash crunch. Local economists say the trouble will begin in late June when the government won’t be able to pay salaries. Then, the country may enter another crisis – similar to what it went through in the period of 1999 through 2002. In anticipation, the ruling husband and wife team, the Kirchners, have pushed the elections forward 4 months, hoping to be re-elected before the voters catch on.

When a big guy in a dark alley says, “I don’t want to hurt you…” it is time to run. But the Argentine parliament offered a similar assurance to citizens in 2001. A law was passed guaranteeing that bank deposits would be protected.

A few days later, the bankers revealed that they lacked the funds necessary to keep up with depositors’ withdrawals. Meanwhile, the government needed to refinance its debt…but investors, growing wary, demanded higher and higher rates. In the end, depositors and lenders were hurt after all. The government froze bank accounts and defaulted on its foreign debt. By the time the accounts thawed out, the peso had been cut loose from the dollar and both lenders and savers had lost about two-thirds of their money.

There are times, we conclude, when despite the best of intentions, people do naughty things. Carlos Menem and Fernando De la Rua are probably no dumber or badder than Barack Obama and Gordon Brown. Both might have preferred not to freeze accounts or to devalue the peso. Likewise, Barack Obama and Gordon Brown might rather keep their currencies strong…reduce their fiscal deficits, honor their nations’ commitments at home and abroad, and join the community of saints. Maybe they will succeed in these things. But what trapped Menem and De La Rua was the relentless logic of debt and popular democracy. Mr. Menem fixed the peso by gluing it to the dollar. But there were other things that needed glue too. The urban voters, for example. They still needed their fixes of bread and circuses. And those cost money. Mr. De la Rua’s deficits ran to 5% of GDP. The weight of them finally came down on the gauchos’ necks like a guillotine. But 5% seems like a problem from another era. In France, the fiscal deficit for 2009 is expected to be over 8%. In Britain, it is nearly 10%. And in America, the feds’ excess spending will equal 13% of GDP.

As far as we know, Mr. Obama speaks no Spanish. Whatever mischief is forced upon him, it will have to be declared in English.

Enjoy your weekend,

Bill Bonner

Source: Cry All You Want

Greenspan’s reputation – like AIG’s share price – is already in shambles. In fact a move to zero might be an uptick. Warren Buffett, on the other hand, still boasts a rabid following, as well as a few billion dollars in the bank. So let’s weep not for Warren.

Even so, this formerly glistening icon of “buy and hold” has become a bit tarnished. Buffett’s genius, we are now discovering, correlates quite highly with the S&P 500 Index. His genius is not quite as highly correlated with the S&P 500 as, say, Bill Miller’s, the former investment genius at the Legg Mason Value Fund. (For a little background, please click here). But an observable relationship exists, nonetheless.

Your editor would not dare to minimize Buffett’s investment acumen, nor to detract from the man’s considerable financial achievements – that’s Mr. Market’s job. Your editor would only point out that “buy and hold” works brilliantly in rising stock markets, and works particularly brilliantly in the rising stock markets of post-World War II Superpowers in the midst of a once-in-a-lifetime economic boom.

By contrast, “buy and hold” works poorly in falling stock markets, and works particularly poorly in the falling stock markets of pre-Great Depression Superpowers in the midst of a once-in-a-lifetime economic collapse.

We would remind our readers that Warren Buffett, an investment genius, learned his craft at the feet of Benjamin Graham, also an investment genius. Warren Buffett applied Graham’s principles during the greatest economic boom in American history and became a multi-billionaire. Benjamin Graham applied Graham’s principles during the greatest economic disaster in American history and became bankrupt.

Look behind almost any investment genius, dear investor, and you would be likely to find one or two coins that came up heads. That’s why your editors here at the Rude Awakening tend to distrust genius, especially their own. But they do trust the potential for adverse outcomes…and therefore, attempt to make money by not losing it. We have never been fans of buy-and-hold, even when it appeared to be working during the last 15 years.

Buy-and-hold worked well for most Japanese investors until 1989, when the Nikkei reached its all-time high. Since then, however, buy-and-hold has produced a loss of 81% – that’s a return of MINUS 8% per year…for 20 years!.

Buy-and-hold also worked quite nicely for Warren Buffett, at least until last September. Since then, this tactic has produced less than optimal results. Berkshire Hathaway’s stock has lost more than half its value since then. But more to the point, the stocks that Berkshire Hathaway owns have also tumbled in value.

In fact, according to blogger Jeff Matthews, Buffett’s massive investment portfolio, accumulated over more than two decades, is nursing a loss. That’s right, Buffett is posting a “down number.”

Publicly, Buffett claims not to care about the daily [or weekly, or monthly, or yearly, or decadely] fluctuations of Berkshire’s investment portfolio. “The market value of the bonds and stocks that we continue to hold suffered a significant decline along with the general market,” writes the Oracle of Omaha in this year’s annual letter to shareholders. “This does not bother Charlie and me.”

Ummm…right. We would guess that Buffett, in private, might be a wee bit annoyed that his net worth just dropped by more than $34 billion.

Not so, says he!

“We enjoy such price declines,” Buffett claims, “[assuming] we have funds available to increase our positions. Long ago, Ben Graham taught me that ‘Price is what you pay; value is what you get.’”

Cute phrase. Marginally delusional.

Value is a moving target, determined by millions of investors in dozens of countries. Furthermore, value is influenced by booms, busts, wars and government caprice. Admittedly, share prices tend to fluctuate more than underlying economic values. But an investor who buys “value” without acute sensitivity to price is an investor who will spend a career behind the counter of McDonald’s. (Or if he’s really, really lucky, such an investor might spend a couple of decades running a legendary mutual fund and THEN working behind the counter of McDonald’s).

But we suppose that Buffet can afford to write such claptrap. By our count, the man’s wealth still totals more than $29 billion – and that’s based solely on the price [not the same thing as “value”] of his Berkshire Hathaway stock. We’d guess he also holds billions of dollars more in assets in the form of houses, cars and cases of Cherry Coke.

So we do not gather here today to weep for Warren Buffett, but rather to mourn the death of “buy and hold.” Which leads us to wonder, what tactic is likely to take its place? What process/strategy will create the next generation of investment geniuses?

Buying low is certainly an important component. But unless you remember to sell high, you’ll never be a genius. Furthermore, it is important to remember that you have to take what the market gives you. And if it only gives you falling stocks, you won’t find too many investment geniuses. Doing nothing at all is sometimes the best course of action. The Oracle himself says as much. “Lethargy bordering on sloth remains the cornerstone of our investment style,” Buffett once remarked. Pity he did not apply a greater dose of lethargy to his recent investment activities. If he had, he might have avoided his woefully ill-timed purchases of ConocoPhillips, General Electric and Goldman Sachs.

Perhaps, therefore, we should begin doing what Buffett SAYS, not what he DOES.

To emphasize the value of lethargy, we would remind our readers that a hypothetical Japanese investor who moved his money into a passbook savings account on January 1, 1990, would have amassed about seven times as much capital as an investor who left his money in the stock market. Closer to home, buying the Vanguard Prime Money Market Fund on any day since June 30, 1995 would have produced a greater return than buying the Vanguard S&P 500 Index Fund.

To be sure, many stocks here in the US and elsewhere are now cheap enough to warrant making some initial buys. And probably, many of the stocks that an investor buys today will be worth holding for many years. But that’s not “buy-and-hold.” That’s “buy and watch out.”

A final point: For those investors who are still resisting the urge to buy anything, may we suggest one sale: Treasury Bonds.

Please check in this week as we examine the parlous state of American public finances, and why the best trade ticket to write on Treasury bonds for the next few years might be the one that says “SELL” at the top.

Source: The Death of “Buy-and-Hold”

This time we’re going to detail three energy stocks with the potential for double-digit – or even triple-digit – profit gains. Admittedly, these are longer-shot, speculative plays. But we used a special energy indicator to help ferret out these energy plays.

This indicator is known as the “crack spread.”

In case you’ve never heard the term before, the crack spread is the difference between the price of crude oil and the value of the petroleum products that refiners can make from it. The crack spread can widen or narrow over time, depending upon various combinations of supply and demand.

If the spread is positive, that means the price of the products that result from the refining process – gasoline, diesel fuel, aviation fuel, heating oil, kerosene and asphalt, to name a few – is greater than the cost of the crude oil needed to make them. But if the spread is negative, it suggests that the cost of crude is higher than the end-game value of its derivatives.

Right now, the crack spread is narrowing. In fact, it has been for some time as governments around the world and gasoline companies actually try to hold down the pain motorists feel at the pump.

Granted, governments and major oil players make for strange bedfellows. But they have a common interest right now: Both are trying to prevent “demand destruction,” the plunge in oil demand that would result if millions of motorists – fed up with high oil and gasoline prices – just stopped driving. Governments want to prevent an economic collapse, while the integrated oil companies simply want to avoid being branded as the “bad boys” of the soaring-oil-price era – making it much easier for the incoming presidential administration to slap the entire sector with an “excess-profits tax” (something that’s already being discussed by Washington insiders).

But we can also see another scenario, one that’s very different. Peering into our crystal ball, we can see a situation in which the crack spread begins to widen, and gasoline prices run away anyway – eventually reaching $7 or even $9 a gallon.

For motorists, the pain would be excruciating. For investors, however, there’s a chance for double or even triple-digit profit gains.

Let me explain…

The Subsidy Gambit

It turns out that a number of Asian governments – most notably Taiwan, Malaysia and China, for instance – are actually reducing or eliminating fuel subsidies designed to shield their consumers from crude oil’s relentless march. Ostensibly, this is designed to control demand, but history suggests this will merely give those with the money access to increasingly large supplies that they’ll gobble up. In other words, we believe that demand may be growing fast enough to override the prices that governments around the world still believe to be inelastic.

Combine that possible new reality with the fact that a developing Asia accounts for as much as 70% of the increase in global oil consumption, this end of subsidies would probably hammer worldwide markets, including our own.

Given that Asia represents a mere 20% of current global usage, Asia’s growth is critical to how the rest of the world uses and prices petroleum-related products – particularly gasoline. Incidentally, this stands in stark contrast to how Japan and much of Europe do things where high taxes on fuel and transportation are used to blunt demand.

The economic forces that will be unleashed when these subsidies are removed have the potential to make the Great Tunguska Blast that took place 100 years ago this month look like a wet firecracker.

Indonesia, for instance, spends nearly 20% of its budget to underwrite fuel costs and has telegraphed a 30% hike in fuel prices when those subsidies are removed. It’s much the same story in China, India and the Philippines, where separate figures for fuel subsidies are hard to come by, but where it’s safe to say that the net effect of these price controls have contributed to artificially low prices and artificially high levels of demand.

In China, where the government caps gasoline prices, for instance, motorists pay about half of what their U.S. counterparts pay. All in all, governments around the world will spend about $100 billion on oil subsidies this year – meaning about half the world’s population is benefiting from “cut-rate” petroleum prices. This year, those folks will account for all of the growth in global oil demand, equal to an additional 1 million barrels of oil per day, says Deutsche Bank AG (DB).

Now, pressure is escalating globally for countries to end the subsidies the world economy can ill-afford. The International Monetary Fund (IMF), for instance, is “calling on governments to let consumers face market prices in order to kick-start conservation and reduce official spending,” says The Christian Science Monitor.

As I hinted earlier, this change has the potential to jam a lot of consumers personally. But it would allow world markets to function as, well, markets. And that, in turn, would afford investors one of the biggest turnaround opportunities available in the energy sector today. The reason: As the subsidy removals, pricing changes and demand shifts work their way through the global economy, the crack spread would widen again… and fast.

And the biggest beneficiaries could well be the oil refiners, which have seen their profits get zapped along with crack spreads in the past year.

The Best Way to Play the Shift From Subsidies

If there is a sector turnaround, the upside could be huge. And the three firms in line to benefit are Western Refining Inc., Valero Energy Corp. and Holly Corp. Let’s take a closer look at each of the three:

• Western Refining Inc. (WNR): The El Paso, Tex.-based Western is an independent crude-oil refiner that owns and operates four refineries, and that also owns and runs 155 retail service stations and convenience stores in the Southwest. Although Western’s shares rose 77 cents each, or nearly 7.1%, to close at $11.66 yesterday (Thursday), the stock is down 82% from its 52-week high of $66.13. Independent researcher Soleil Securities Group Inc., this week initiated coverage of Western with a “Sell” rating and a target price of $8, contending that the company is highly leveraged and has seen its shares suffer in concert with its peers as part of a general sector downturn. That underscores the sentiment these companies face. But a return to its 52-week high would represent a 467% gain.
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