Category Archives: Economics & Politics

Returns of 100 to 1? First Understand Returns on Incr. Capital; Reader’s Question

Cap investments

The best long-term investments tend to be companies that can reinvestment over and over again at high rates of return.  Those high rates of return attract competitors so you must also understand barriers-to-entry.  But first study how to calculate incremental returns on capital or marginal returns on invested capital (“MROIC”).   There are several links and documents below to help you.  The effort is worth it if you can find: WMT_50 Year SRC Chart (up to 2000). WMT had regional economies of scale until it out-grew them. 

From John Huber of Base Hit Investing

  1. Eridon855 says:

May 30, 2016 at 10:44 am

Is there a way to calulate return on reinvested earnings?

  • John Huber says:

May 30, 2016 at 2:57 pm

One quick and dirty way is to look at the amount of capital the business has added over a period of time, and compare that to the amount of incremental growth of earnings. Last year Walmart earned $14.7 billion of net income on roughly $125 billion debt and equity capital, or just under 12% return on capital. Not bad, but what we really want to know if we are going to buy Walmart is a) how much of their earnings will they retain and reinvest in the business going forward? and b) what will the return on that reinvested capital be?

10 years ago in fiscal 2006, Walmart earned $11.2 billion on roughly $83 billion of capital, or around 13.5%. But in the subsequent 10 years, they invested roughly $42 billion of additional debt and equity capital ($125b invested in 2016 and $83b invested in 2006), and using that incremental $42 billion they were able to grow earnings by about $3.5 billion (earnings grew from $11.2 billion in 2006 to around $14.7 billion in 2016). So in the past 10 years, Walmart has seen a rather mediocre return on the capital that it has invested during that time (roughly 8%).

We can also look at the last 10 years and see that Walmart has retained roughly 35% of its earnings to reinvest back in the business (the balance has been primarily used for buybacks and dividends). As I’ve mentioned before, a company will see its intrinsic value will compound at a rate that roughly equals the product of its ROIC and its reinvestment rate. So if Walmart can retain 35% of its capital and reinvest that capital at an 8% return, we’d expect a modest growth of intrinsic value of around 3% per year. Stockholders will see total returns higher than that because of dividends, but the value of the enterprise will likely compound at roughly that rate. And we can see that over the previous 10 years, Walmart’s stock has grown around 45% not including dividends. So unless you are banking on an increase in P/E ratios, you’re unlikely to achieve a great result buying a business that can only invest a third of its earnings at 8% returns.

This is a really rough measure, and this back of the envelope method works okay with a large, mature company like Walmart. But what you really want to know is what will the business retain going forward and what will the return be on the capital it retains and reinvests? Of course, there are different ways to measure returns (you might use operating income, net income, free cash flow, etc…) and there are many ways to measure the capital that is employed. But hopefully this is a helpful example from a general point of view.

Calculating Incremental Returns on Capital

ALSO, read and study these articles:

For extra study go here:

Reader’s Question

Hi John,
I love the “no hope” strategy for finding ideas. See

I suppose there is always headline risk with things that have been in multi-year bear markets.

I am curious if you have any thoughts about political consequences of increased isolationist sentiment in the US and Europe?   Reply: Actually, the recent sell-off in the shippers this past week (June 17th, 2016) has partially been (I believe) due to Brexit.  You always want to look where sentiment is the worst and then try to determine if the price reflects the known news.   So on the one hand the rising fears over isolation give me comfort that a lot of bad news is being priced in.  Also, if the EU breaks up, why should trade go down?   Britain already sells more to the EU than it imports.   Switzerland isn’t in the EU and it has one of the strongest economies in Europe.   The EU makes no logical economic sense–how can central planning EVER work?  Nations have a natural interest to trade with each other since individuals benefit. What Trump says and can do (even if elected) are two separate issues.   I really don’t know how to handicap.   What I want is terrible news to encourage ship owners not to order new ships and to scrap the ones that they have.  

Also curious about your thoughts on the surge in low-cost vessels that came from Chinese ship makers in the last several years.   Reply:  This has been one of the reasons this shipping cycle has been the worst in forty years.   Easy credit/subsidized loans created a boom in Chinese ship builders (See May 7th, 2016 Economist issue and  Now some Chinese ship builders are close to bankruptcy.   So, yes, this oversupply will make this cycle–already a long one–drag out, but who knows for how long?.

I subscribed to Trade Winds (shipping trade magazine) a couple of years ago, to keep abreast of the industry and try to find when industry sentiment started to pick up. So far, it’s still been abysmal, although this years spike in iron ore was pretty interesting. Especially because Wall Street analysts are still telling everyone iron ore is going lower and this is just a blip.  Reply: Wall Street just tells you AFTER the fact or projects the trend/obvious.    As one ship owner said (Diana Shipping) said, “The bulk shipping market will turn when no one believes it will turn.”   

Ordered the book just now. Really interested to learn more about the industry, and it’s cool that it’s in novel form. I think some of these shippers may start getting close to scrap value pretty soon.  Reply: The Shipping Man was an educational and enjoyable read.   I may even search for other book like Viking_Raid_Excerpt


Just remember that the shipping industry has big demarcations. A company like Navigators’ Holdings (an LPG shipper) has different market dynamics than a dry-bulk shipper like Scorpio Bulkers.   One shipper operates in more of a oligopoly market than a purely competitive one though both, obviously, are cyclical.

I highly recommend the 800 page opus, Maritime Economics (3rd Edition) by Martin Stopford. If you wish to dig into the shipping industry, then read the annual reports/presentations of several shippers.   I have a ways to go to understand this market. The author:

Speculating in shippers is a bit like playing poker.  You don’t want the ship owners to start ordering new ships if freight rates start to rise.   You want the other owners to disbelieve a sustained rise.  When supply is constrained for a few years coupled with a spike in demand, the shipping market explodes like in 2007–no wonder a large supply of ships eventually came into the market and the boom went to bust.  The SIZE of the prior boom has led the depth of this bust.

A Money Problem


We Don’t Have a Wage Problem; We Have a Money Problem

FYI: GAAP Acccounting gatech_finlab_lifo_42216

Coal’s Sunset/The Capital Cycle; Graham Bangs the Table

millenniumforce02wide was our last discussion on the capital cycle.


Now, look at these two excellent posts on Coal.

A perspective on current conditions in other markets:

The Big Long – Final Feb 28 2016 The writer promises a follow up to discuss catalysts–which, I believe, will be the change in supply and demand dynamics and the capital cycle. See article referred to here: 2_Buffett and Graham Call the 1974 Market Bottom

and for more historical and emotional perspective:


Door #1 or Door #2? You Choose.

The Dao of the Austrian Investor

DECEMBER 20, 2013Mark Thornton

TAGS Financial MarketsGlobal EconomyHistory of the Austrian School of Economics

[The Dao of Capital: Austrian Investing in a Distorted World. By Mark Spitznagel. Wiley Press, 2013.]

The economy is extremely complex. As Leonard Read taught, no single individual in the world knows how to make something as simple as a pencil. The level of complexity has only increased over time with the expansion of knowledge, technology, transportation, and international trade. Our individual labor is increasingly focused on a narrower slice of the overall process of production.

Even the static picture, if it could be seen, is complicated by the fact that our world is a work in progress dating back thousands of years. Look around you and you will see the savings, investments, and work of individuals who are long dead. Previous generations made their choices, some of which have been maintained, repurposed, neglected, or destroyed. Ownership of all that capital is recognized in the form of stocks, bonds, titles, and deeds.

Austrian economics teaches that understanding the “economy” can only be undertaken with the aid of economic theory. There is no formula or equation for understanding the economy. It cannot be measured in any meaningful scientific way. Only the logical construction of cause and effect aid us. A simple example of this is when John trades his three apples to Mary for her three oranges because both John and Mary think they would be better off from doing so.

Mark Spitznagel, a hedge fund manager, tries to take economic theory, specifically Austrian economic theory, and breathe life into understanding how the economy works and why it sometimes doesn’t. In his book, The Dao of Capital: Austrian Investing in a Distorted World, he uses these insights to explain the process of investment that he uses.

The title refers to the paradoxical Chinese philosophy of Daoism. In this philosophy, in order to achieve your goal you must do the opposite, or Shi. For example: “turn right in order to go left.” This is used, ultimately, to underscore the roundaboutness of the market process, where production processes become increasingly more complex in order to become more productive. In investing, for Spitznagel, it means to step back and take small losses in preparation for making larger gains, a variation of “value investing,” where you must keep your vision of the future as one of a process that takes place over time.

As a young trader in the bond pit at the Chicago Board of Trade, the author was lucky enough to come across Hazlitt’s Economics in One Lesson and Mises’s Human Action. He found in these books a theoretical explanation for the otherwise perplexing world of primary markets at the Chicago Board of Trade. He later partnered with Nassim Taleb ofBlack Swan fame and later still opened his own firm to employ his concept of “Austrian Investing.”

Spitznagel begins with the metaphor of the forest and the trees. Briefly put, conifers cannot compete with hardwood trees on the fertile plains so they retreat to higher ground that is less fertile and more intemperate where they can outcompete the hardwoods. Here they thrive under harsh conditions, even battling glaciers of various ice ages. This is an illustration of competition and comparative advantage in nature.

Fire plays a role in the competition between conifers and hardwoods, serving to clear small areas with dense underbrush free for new competitions among seedlings. This ebb and flow between conifers and hardwoods shows how apparent losses from fire can lead to strength and an overall growth in productivity. In the economy, firms go bankrupt, products are displaced, and new production processes emerge over time.

In a similar manner, he shows how fire-suppression policies of the government are like government intervention in the economy. Fire-suppression policy aims to put out most forest fires as soon as possible. This can lead to too much underbrush so that fires can become catastrophic is scope. This is an illustration from nature of the havoc caused by government intervention meddling in nature’s competition. In the economy, the government’s central bank can try to suppress recessions and deflation, but this can result in catastrophic depressions, like the Great Depression. As Rothbard showed in his America’s Great Depression, President Hoover’s interventions to suppress deflation and depression only made things worse.

In chapter 3, “Shi: The Intertemporal Strategy,” the insights of the famous military philosophers Sun Tzu and Carl von Clausewitz are discussed in support of the Daoist concept of Shi. This is the concept of strategic advantage in war where you do not hurl your troops headlong directly at enemy positions for an immediate victory. Rather, you conserve your troops and resources and take advantage of points with defensive and strategic advantages in a more roundabout approach to final victory. Military history has confirmed the wisdom of this approach from the battlefields of the American Civil War to the more recent guerilla wars fought against the modern empires of the United States and the Soviet Union. As applied to investment, this discussion is meant to make the reader prepared and even eager to take small losses in order to achieve the ultimate goal of growing your wealth into the future.

Normally, I do not like examples from nature and war to serve as illustrations of the benefits of roundaboutness of production, preservation of capital, and competition, but I will admit that in this case they are effective.

The book takes us on a trip through time to explore the character, history, and contributions of the Austrian economists. He begins with Frédéric Bastiat (the seen and unseen), and moves onto J. B. Say (entrepreneurship), Carl Menger (marginal utility and price formation), Eugen Böhm-Bawerk (roundabout production and interest), and even Henry Ford (the assembly line as an example of roundabout production). This is followed by a fascinating discussion of the critical role of time preference in life before he turns his attention to Ludwig von Mises (monetary and business cycle theories and the market as a process). According to Spitznagel, Mises was “perhaps the greatest economist of all time.”

Since I am not an investment expert, I will not comment on the chapters on investing or the author’s tweaks of Austrian economics that try to bring Austrian economic theory closer to the understanding of reality for the non-economist. However, I applaud the book as a look into the thinking process of a great investor, especially one that has a clear and consistent understanding of the market process, the dangers of government intervention, and the benefits of Austrian economics.

The roundabout path to profits: Mark Spitznagel on the Dao of Capital

How a hedge fund manager with floor trader roots embraces the Q Ratio, Austrian economics, tail hedging, libertarianism and Daoism to prepare for the next market crash.

Mark Spitznagel is an accomplished trader and hedge fund manager who has learned to take advantage of market distortions he blames on an overly involved Federal Reserve and government, while preparing for the consequences of those distortions. Instead of fighting what he knows is an illogical distorted market he has learned to ride those irrational markets while preparing for the inevitable snap back, where he then can profit in an exponential fashion through the perfecting of tail hedging strategies.

However, his book “The Dao of Capital: Austrian Investing in a Distorted World” is not an explanation of his trading strategy but an in-depth study of economics and human nature, the inevitable result of which is the philosophy of building a successful enterprise through the understanding of the roundabout, and learning to delay gratification to gain an advantage down the road. He does it through the study of Austrian economics and the application of the roundabout method of investing.

Spitznagel could have simply have written that investors need patience and must avoid the temptation of the quick profit; that building a successful strategy, and life, involves a longer-term approach foregoing instant gratification; that establishing a solid foundation while appearing not to create progress puts you in position for much greater success later on. He did not do that. Instead, he takes you on a tour of history and nature that illuminates these long held truths. Just as the technical trader delves into cycle analysis and Fibonacci numbers, Spitznagel illustrates how these truths are imbedded in history and nature and are not just platitudes to throw around. In the end his message is simple, but by providing the historical underpinnings he brings them to life in a much more vibrant way.

He travels a long way to come to a pretty simple message. It is through his vast research and study that he shows that this message, though simple, is essential. He has documented how it has been so throughout history.

Futures Magazine: Your book cites some of the most accomplished economists, military and historical figures as inspiration but at the top of your list is an old grain trader and family friend Everett Klipp. Why?

Mark Spitznagel: He was a close family friend, very close to my dad. I caught the [trading] bug from him early on and he said simply ‘to be successful you have to love to lose.’ Even at the[Chicago] Board of Trade, it is not like pit traders do this. But when I was 14 I thought that’s what trading was. This is the discipline of trading, loving to lose and nothing about winning.

I immersed myself in it and became obsessed with the grain markets. Through high school and even through college, I wanted to be a corn trader. I clerked for many summers in the grain [room] and ultimately the bond [room]. It slowly became obvious that is where someone’s got to be.

FM: It is no huge revelation that a lot of our recent economic problems can be blamed on short-term thinking; never looking beyond the next quarter. You take a circuitous route in your book to describe this. Is that on purpose?

MS: It is on purpose. The whole point is there is a lot you have to build up along the way. There is a path you have to follow to get somewhere and it is not the direct path. For instance, it is not enough to give someone an investment strategy, the key is what is underlying that investment strategy, why these things should work, what the thinking behind it is. It is very easy to say this is a strategy that works and it will continue to work. There are data mining issues with that. You need to approach trading in a much more deductive way. It was the point to build up the necessary tools to code to the strategy.

FM: It seems that we intuitively know some of these things but often don’t act on it.

MS: People say it is a long term thing. It is almost a cliché to say that. They use it as an excuse for what is not working at the moment. What I am talking about is not just about waiting, it is about working in the present to gain an advantage in the future as opposed to just putting something on and twiddling your thumbs and watching it work. Yes, we are all very short-term minded. Corporate managers are thinking about the next quarter. This is all very rational for them to do. There is the [Stanford professor Walter] Mischel study (an experiment to determine whether kids would be willing to wait to get more marshmallows or take one immediately). It turns out that the reason they don’t wait is not because of impatience, it is that they don’t believe you are going to come back with more. Any investment manager is right to think that if I don’t get my marshmallow now, do well now, you are not going to give me an opportunity to do better later. And they are right about that. It is a structural problem. These people are acting very rationally based on the structure of these industries. I firmly believe the big problem here is one of being trapped in the present and all that matters is that next slice of time. It is both a structural problem in history and our psychology.

FM: You successfully called the market turns of 2000 and 2008. Was your tail hedging strategy perfected or was it just forming?

MS: I was on the floor from 1993-97. In ’98 I was a swaption trader at Credit bank primary dealer arm. In 1999 I started a hedge fund with Nassim Taleb, who was at the [Chicago Mercantile Exchange] when I was at the CBOT; 2000 was our big play there. In 2005 I went to Morgan Stanley within its stat arb group. In 2007 I left to start Universa [Investments] and we all know what happened in 2008.

FM: A lot of people saw the 2000 crash coming as the market appeared overbought throughout the late 1990s but lost money by being wrong on the timing. Is your strategy a fix for that problem?

MS: Absolutely. You can’t short markets that are running like that. You are going to blow yourself up. It goes back to Everett. That’s the reason I approach market this way: the idea of taking a one tick loss. If you want to trade that market with S&Ps you would short it, but when you are wrong you will have a tight stop. And throughout the ’90s you would have taken a lot of losses. Eventually you would have been right, whether you would make up all your losses, I can’t say.

What I do with options is nothing more than a fancier way to do that. Right now I would say the market is massively distorted, we are going to see a huge sell-off but I would never advise someone to be short this market. You would blow yourself up. The market will balance itself; as it has in all the other bull moves caused by distortions in the last 100 years. It managed to right itself but the path there is difficult and there is no telling how far it can go.

In the late ’90s clearly [Fed Chair Alan] Greenspan was the driver of that boom. There was a nice believable theme behind it that we were in a new economy. The market went further than it ever had in recorded history. Here we are again on the cusp. If the market rallies much from here, now we are back in this territory like 1999. It is possible the market could double from here or triple from here. I happen to think it is not the likely path.

FM: Isn’t it different now. In the ’90s we had a booming economy. No one would confuse the last six years with a booming economy, we know it is struggling and the Fed is trying to keep us above water waiting for stronger growth to happen.

MS: Agreed. But I would argue in both situations ultimately there were delusions. The booming economy of the ’90s was happening but it was not based on anything real. At some point monetary distortion can easily lift asset prices but it also could make it look like there is activity in the economy that is artificial. They both had similar sources. The late ’90s look very different than today and for that reason it will probably be very difficult for us to go too much higher.

FM: What was the misallocation in the ’90s? It seem that they were constantly raising interest rates anytime growth went beyond 3.5%.

MS: It was the Fed keeping interest rates too low. Rates were too low in the ’90s. We don’t understand why Greenspan kept rates as low as he did in 1996. The general argument was rates were too low for too long. I know by today’s standards it seems benign. They were artificially low in the ’90s (see “Way to busy,” below).

FM: In 2002 when GDP was growing by more than 4% two quarters in a row, the Fed went from 1.75% down to 1%. Is that the seed of the current problem?

MS: Yes. The same thing happened. How people can’t see how that for instance created the real-estate boom is inconceivable. The question is how much do we bring Fed Funds back up again. In 1996, why didn’t you let rates go up more quickly than you did? And rates were lowered in ’02 all for the same reason. You change the structure of the economy when you artificially move them in the first place. When the government sets the price of things typically our culture is such that we don’t like it.

If the government set the price of LCD TVs we would think there is something weird about that, and yet we don’t think it is weird for them to set the price for the most important price in the economy, which is interest rates. We don’t have a free market in interest rates. When you do that, complex distortions happen.

FM: How patient would you have been if you developed this strategy in 1990 and had to wait a long time for the market to correct?

MS: You had to wait until the mid-1990s before the MS Index or Tobin’s Q ratio, put you at the levels where it is today (see “The Mises Index,” below). Let’s remember 1982 was a generational buy and then the market ripped. It wasn’t until 1995 or 1996 where it reached that level where every market topped in the last 100 years: 1917, 1929, 1937, (1973) and 1996. It wasn’t until 1996 if you were following this MS Index that you would have stated maybe it is different this time because the market screamed from there but throughout the first part of the 1990s, it was not terribly overvalued.

FM: Your philosophy is based on non-intervention but 2008 was pretty extreme crisis. Do you think the Fed needed to do anything?

MS: People who are Libertarian are always put in this unenviable position where we look like people who don’t care because we are saying you shouldn’t do anything; you should let the forest burn; let people suffer. It is unfair to start with the tragedy, you have to start with the build-up. It is interventionism that got us there in the first place. Go to my forest analogy that is central to my book. If you don’t allow any forest fires for many many years and then all of a sudden a little fire starts at that point you get painted in a corner where you have to put out every fire. And now if you step aside at that point now the whole forest could get destroyed. The mistake you made was not letting the little fires burn in the first place.

FM: To continue with your analogy; now there are houses built in the path and we can’t just let people’s homes burn down. Right?

MS: In the economy—and I have a 100 years of evidence to show this—if people are going to build homes in this parkland where we don’t let fires go, those homes are doomed regardless. We can continue to put out fires but that is only going to make a bigger fire later. It is inevitable that this thing is going to blow. The question is how long are we going to let it go and how many people are we going to let get trapped into building more homes in this tinderbox, to extend your analogy.

Should we have done nothing in 2008? I strongly believe that we should have let the market correct itself. I strongly believe that TARP (Troubled Asset Relief Program) was a terrible thing to do. I strongly believe that the auto companies should have gone through bankruptcy.

FM: So you are saying we need to go cold turkey on intervention? Haven’t we gone beyond the point of no return in Keynesian economics? This was not started in this administration or this Fed. It is a process that has taken decades. How would you get to where you want to go from where we are right now?

MS: To start off, what Bernanke has done is unprecedented. We haven’t manipulated the yield curve like this ever. While there have been monetary manipulation that has caused booms and busts—and I strongly believe that booms and busts are caused by monetary interventions and it is not a natural feature of capitalism—but what Bernanke has done has been an experiment the likes of which we have never seen. Look at the history of rates. The last four years will stand out. It is very extreme and it is scary and the move down will be worse.

Are we past the point of no return? I think we are. If this is the way the Federal Reserve Chairman will have to look at it. [New Fed Chair Janet] Yellen is going to have to deal with the consequences. All this talk of tapering. I don’t think it is going to be an option for the Fed. I don’t think the Fed can taper. If you saw a headline; ‘Yellen decides to let all interest rates float, free market in interest rates.’ Then you would see the market down 50%. Most people agree with me on that. I don’t know what the yield curve would look like but the market would crash. What they are doing now is waiting and hoping that something happens in the economy that allows them to taper. They are going to be waiting for a long time. You will end up with a situation that the Fed’s hand is forced or with what the Fed’s is doing stops mattering and that will come when more leverage in the system is not possible and we are probably not far from that.

FM: But the Fed is tapering.

MS: Those expectations keep on getting pushed back. I agree with your statement that we are passed the point of no return. I don’t think the Fed can taper without crashing the market. The market is only at where it is at because of the Fed. I don’t want to predict what the Fed will do but one way or another it won’t matter what they want to do. Unless the Fed is willing to crash the market, which I don’t think it is, I don’t see this big taper happening willingly.

FM: Jim Sinclair said to us two years ago that quantitative easing was the only tool Bernanke had to avoid a catastrophe and the only measure of success is that when the economy begins to grow more robustly whether or not he can drain the excess liquidity safely. Do you agree?

MS: I think you will be waiting a while for it. When companies start borrowing not to buy back their own stock, not just to raise their dividend but instead borrow in order to do more capital expenditures, then we will start seeing some growth but don’t hold your breath for it. I see his point: Will the Fed be able to drain the liquidity fast enough to avoid inflation?

FM: Was QE not necessary?

MS: It depends on what you are trying to do. If you are trying to prop up the stock market, if you are trying to save people who own risk assets like banks, it was absolutely necessary, in the short-term. There is no doubt that the Fed is capable of pushing risk assets. We shouldn’t be surprised that the market has gone up and continues to go up but it can’t go on forever. It is an artificial world we are living in. If we were able to manipulate it like this permanently than obviously this would be a formula that would work everywhere.

FM: I don’t think anyone believes that this is good policy in general just that it was necessary to avoid a disaster. We kick the can down the road to a point that growth improves and we can better handle the excess. Can it work?

MS: You certainly are looking for a precise, perfect scenario. I am not necessarily calling for hyperinflation but with the money being printed it is [possible]. Be careful what you wish for. If you start getting growth I totally recognize how we could get very high inflation, but first you have to have growth, you have to have people investing capital.

Interest rates are the most important economic variable out there. Entrepreneurs base their activities on that, whether you engage in production what is your return over your cost of capital. When interest rates are very low in a free natural market that means that there is a lot of savings, people aren’t consuming but they are saving. They call that a consumer recession, it is a very nice homeostatic system. Entrepreneurs respond to that. It incentivizes them to extend their period of production. Austrians call that more roundabout. They create more efficient production. The civilization and economy progresses and that production completes around the time that consumers are ready to consume again and save less. Remember we save to consume more later. There is a nice temporal structure that goes on in the economy. But what happens when interest rates are low for artificial reasons; actually the opposite happens.

The whole point of low interest rates is not only do central bankers want to goose asset prices but they are trying to get entrepreneurs to invest more and when they invest more, progress comes from them. But when interest rates are lower than what we natural want it to be based on our time preferences, it is now this weird thing where people are trying to chase yield just to make a little carry. Zero rates are unacceptable to people. So we are looking for dividend yielding stocks. At the end of the day investors are not looking for more roundabout production but instead are looking for companies with high dividends.

This is considered a puzzle by Keynesian Economists. [Paul] Krugman himself called it a puzzle. When Tobin’s Q is high and rates are low why don’t companies invest more? It makes perfect sense because it is a distorted environment. They are not low for natural reasons. This is why we shouldn’t expect the economy to progress just because rates are low. The opposite is happening now. Many government programs create the opposite affect [of its design].

[Economist Ludvig von] Mises says when a person gets run over by a car, the last thing he needs is for that car to then back over him. And that is the cycle that we are in. Each time the government intervenes, it is making things worse. We are worse off now than when we were in 2006-07, for no other reason than there is no more back stop.

FM: But these misallocations have been going on for a long time. Is there a way to do this gradually or does it have to happen all at once?

MS: I would be perfectly happy with a taper that ends over a period with a free market in interest rates. It doesn’t have to be that we close the Eccles (Federal Reserve) building over night. It could be gradual. [But] if the market caught wind of what they were doing it would crash. A taper [with a goal] of a market determined interest rate would force discipline on our fiscal policy. So much of the debt that we are running up right now is because our rates are artificially low. I would be all for that.

FM: Many experts suggested that regulations and policy needs to be countercyclical. Do you agree?

MS: They look the other way when everything is going well. I totally agree. But it shouldn’t be so much about them in the first place.

FM: Discuss your trading philosophy and how it can be used.

MS: You simply step aside when markets get distorted. What does that mean? You have to watch all your friends making money when you are sitting aside making nothing. You are no longer focusing on your returns today but the return opportunities you will have later when markets reset. I am thinking about the advantage that you will have with dry powder when the markets crash and not about return today. By doing nothing I am doing something real big. I am allowing myself opportunities later.

A higher level example of that is what I do, which is instead of doing nothing you actually have positions that will [create] a tremendous amount of cash. What is the hardest position to have right now? It is cash. The Fed knows what it is doing. It is pushing you out of something it doesn’t want you in. It is not an accident. If your focus is only on that next slice of time like all the professionals, then it is not an option. If you can plan for those other slices of time, they should be far more important to you than the current one.

If you had followed the strategy you would be far ahead of the market. You would have been out of the market since 1996, which is a very hard thing to do.

FM: In your strategy do you constantly have the same hedge on or do you increase and decrease it based on the MS Index?

MS: You can increase it or decrease it. I showed an example in the book that it is the most affective when there is a high MS index; when it is low there is not a lot of room for a systemic crash. When that is low a tail hedge is not critical. The great thing about what I do is that the more distorted the market gets, the cheaper my trade is and the better the risk/reward looks. It is a very convenient property. For instance the VIX tends to go down when the S&P rallies.

FM: How much do you underperform the market when things go well?

MS: It is complicated because I do some complex hedges and spreads. What I talk about in the book is a very simplistic naïve representation where you are just buying out-of-the-money puts. But it costs you a low single digit percentage a year—in that naïve case. I could be short premium meaning if the market shuts down I am earning premium but if the market crashes I am long gamma.

FM: There has been a lot of criticism of alternatives. Is this dangerous given that it will push people to long equity strategies?

MS: All bets are interconnected. There is one big systemic bet that everyone is taking right now. Diversification is hard to come by. It is a shame. We are very good extrapolators.

FM: How will the current distorted market be resolved?

MS: At some point whether it is quickly or not [there is so much leverage a system can take] markets will crash. In classical economic perspective they say that when interest rate get lower we have higher liquidity preferences, people don’t want to lend anymore, they don’t want to borrow anymore. That is why balance sheets at banks get so bloated. It will probably happen quickly when it happens but at the end of the day when markets are this distorted you will find your way back.

FM: What is your goal with the book? It includes concepts that are very easy to understand but difficult to execute in investing and in life.

MS: That’s kind of my thinking. It sounds like a cliché. These are the tools of what got us here in the first place. The idea of a roundabout. Focusing on the means and not the ends. It is so obvious but it helps to understand the role it has played. You can’t just focus on outcomes, you have to have something else to lean on. It is not empiricism that you should lean on because it can guide you down the wrong way so you need these concepts and in order to understand them and believe them [you have to see how they came about].

Half of it was good introspection for me. It is a travesty what the smaller investors go through so to me it was important to try and get people to understand this perspective. So much of Austrian theory is difficult to get through. Though I went about it in a roundabout way, my goal was to make it somewhat approachable.

FM: For people to adopt this is it just going to take pain? Another crash or event to reorganize ourselves?

MS: I think it will. And capitalism will be blamed again when it happens. All the scary stories that we heard when they jammed through TARP, a lot of it was overstated. I can’t prove it and I don’t think others can prove the other side of it. But this idea of the end of the world scenario is entirely wrong. We should look at this as a healthy process, as a cleansing process. We would be on the road to very healthy real growth today if we just let it cleanse itself. My ultimate message is one of great optimism. Seeing optimism in a crisis or a tragedy. It is a means to a much greater end.  We need to recognize that. Politicians can’t because politicians will not get reelected during a crisis. They are rational to try and stop all pain. …We should have had more banks fail.

Read the book :513atRougrL._SY344_BO1,204,203,200_


“Investors of all kinds will find immeasurable value in this convincing and thoroughly researched book where Mark champions the roundabout. Using thought-provoking examples from both the natural world and the historical world, The Dao of Capital shows how a seemingly difficult immediate loss becomes an advantageous intermediate step for greater future gain, and thus why we must become ‘patient now and strategically impatient later.’”—Paul Tudor Jones II, Founder, Tudor Investment Corporation

“At last, a real book by a real risk-taking practitioner. The Dao of Capital mixes (rather, unifies) personal risk-taking with explanations of global phenomena. You cannot afford not to read this!”—Nassim Nicholas Taleb, Author of The Black Swan

“You really should read Spitznagel’s book because you will learn a lot whether you agree with everything he says or not.”—Jim Rogers, Author of Street Smarts—Adventures on the Road and in the Markets

“Wall Street gamblers who believe the Fed has their back need to read this book. Mark Spitznagel provides a brilliant demonstration that the gang of money printers currently resident in the Eccles Building have not repealed the laws of sound money nor have they rescinded the historical lessons on which they are based.”—David Stockman, Former U.S. Congressman, Budget Director under Ronald Reagan, and Author of The Great Deformation

“A timely, original, right-economic principles and history-based approach to investing. Drawing on impressive philosophical building blocks, The Dao of Capital illuminates the wellsprings of capital creation, innovation and economic progress. Dazzling!”—Steve Forbes, Chairman and Editor-in-Chief, Forbes Media

“This is a magnificent, scintillating book that I will read over and over again. Every page is eye-opening, with numerous areas for testing and profits in every chapter. Here’s an unqualified, total, heartfelt recommendation, which coming from me is a rarity, and possibly unique.”—Victor Niederhoffer, Author of The Education of a Speculator

The Dao of Capital is an impressive work. Spitznagel’s approach is refreshing—scholarly without being tedious. What a broad look at economic history it provides!”—Byron Wien, Vice Chairman, Blackstone Advisory Partners LP

“Spitznagel has written an essential new book. Indeed, The Dao of Capital: Austrian Investing in a Distorted World might be one of the most important books of the year, or any year for that matter.”—Forbes

Travel to Cuba with Bridges/Investing in Cuba


As anyone who has met me knows that I am half Cuban.


Once you go Cuban, you NEVER go back. (A joke!).  However, there are two sides (of many!) to Cuba.

GranmaMyth1 I know the founder and he knows the many sides to Cuba. He can help make your trip more authentic and interesting.




We last spoke about SELLING THE RALLY in CUBA here: It doesn’t take investing brilliance to sell hype over reality and a 50% premium to the underlying assets.

Investing in Cuba: Opportunities Develop (BARRONS)
There haven’t been big breakthroughs since U.S.-Cuban relations were re-established. But investors should be aware of smaller signs of progress.

By DIMITRA DEFOTIS    November 21, 2015       Emerging Markets

In Cuba-U.S. relations, so much has changed in 2015. For U.S. investors, however, things have stayed much the same.

It’s been nearly a year since President Barack Obama and Cuban President Raúl Castro announced warmer relations. The U.S. removed Cuba from its list of state sponsors of terrorism. But Cuba still has a Marxist-Socialist economic model, a two-tiered currency system that favors locals, and no stock market.

What investors have, for now, is improved diplomacy: After a year of tense negotiations, Cuba is home to a newly opened U.S. embassy in Havana, and it opened its own embassy in Washington, D.C. More flights and mail between the countries could be imminent.

Still on the books: a trade embargo by the U.S. that may not be lifted ahead of the 2016 U.S. presidential election. Those who want the embargo lifted hope a Democrat wins the White House in 2016. Republican presidential candidate Marco Rubio, a Cuban-American from Florida, has promised to undo Obama’s Cuba detente.

Meanwhile, the number of U.S. tourists visiting the island may have spiked by 40% this year, underscoring the travel-related investing opportunity just 90 miles from Key West, says Pedro Freyre. The Miami-based attorney and Columbia University adjunct professor of law is a man with his bags forever packed. He consults with U.S. companies in agriculture, technology, health care, and other sectors where limited trade with Cuba is already allowed.

Cuba is actively courting foreign investment as it seeks to build its creditworthiness, and it’s already doing business with China, Russia, Brazil, and a host of nations that showed up at the annual trade fair in Havana earlier this month. Freyre was there; he likens U.S.-Cuba ties to those with Saudi Arabia, Vietnam, and China: diplomacy despite differing views.

PRIVATE-EQUITY INVESTOR Redux Capital Advisors, a London-based asset manager focused on Cuba, sees big opportunities. It hopes to close the first piece of a $300 million fund this year as the embargo slowly unravels. Just last week, the U.S. Treasury’s Office of Foreign Assets Control removed the names of a handful of Cuban bankers, mostly in Europe, from a list of banned business partners. Also last week: MasterCard (ticker: MA) and Stonegate Bank in Fort Lauderdale, Fla., announced their debit card can be used at select Cuba locations.

Both Redux and Freyre believe that other countries have a leg up on Cuban investment, and that the U.S. Congress needs to move. Cubans on the street hold American accomplishment in high regard, and seem delighted with the idea of doing business. That was the reaction Freyre got when surprising people with “Yo soy Cubano, mi hermano!” or “I’m Cuban, my brother.” The lawyer and the investor may be on to something. Regularly scheduled flights between the U.S. and Cuba could be negotiated within the embargo parameters by the end of this year, and unification of Cuba’s currency may also be imminent, Freyre says.

What’s an investor to do? The closed-end Herzfeld Carribean Basin fund (CUBA), a proxy for growth in Cuban tourism, soared a year ago. But it is down 24% this year, trading in line with its underlying asset value. While the travel and infrastructure stocks in the fund are not pure-Cuba plays, lifted travel restrictions could lift returns. Another top holding, Panama-based Banco Latinoamericano de Comercio Exterior (BLX) jumped nearly 5% last week.

Editor: Cuba will move forward but mostly after the Castro Brothers are gone. You can make a lot of money from a small base but you have to do it in the Black Market (about 60% of Cuba’s economy).


Too Much Debt, Too much Capacity (mal-investment), then Inevitable Bust/ King of Buy and Hold


The Western banks that financed commodity production are insolvent, though few yet realize it.


Like the flawed analysis of the CDO market in 2007 the conventional view is that the subordinated lenders may be in trouble, but the senior banks with the senior debt are safe. Deloitte has just punctured this myth with a report stating the obvious: “Not even a wave of oil bankruptcies will shrink crude production.” This is because oil companies go bankrupt not when the price of oil falls below the cost of production, they file much sooner: when the cash flow is no longer sufficient to pay the debts. After bankrutcy, the creditors become the equity holders and get any remaining cash flow–they don’t turn the well off. Not until the price sinks below the raw cost of production–and then for a time necessary to exhaust any capital reserves–does the well actually close. In other words, the oil spigot will not turn off until all residue of the debt is completely erased, and the same dynamic applies to the other commodity sectors.

Myrmikan has pounded the table since August that history is not rhyming but repeating nearly perfectly the 1929 model–first overcapacity drives deflation, then market collapse, then more deflation, until finally a dramatic devaluation of the currency to resolve unpayable debts. The value of capital falls to levels that seem almost inconceivable. This pattern has repeated without fail since the time of Solon, in 594 B.C. Athens, and it is doing so again now.

Deloitte study says 2016 is a period of tough financial and strategic choices for E&P companies

Published 17 February 2016

With more than $150 billion in debt on their balance sheets, nearly 35 percent of pure-play exploration and production companies (E&P) listed worldwide, or about 175 companies, are at high-risk of slipping into bankruptcy in 2016, according to a new Deloitte study, “The Crude Downturn for E&Ps: One Situation, Diverse Responses.”

The outlook is almost equally alarming for about 160 other E&Ps that are less leveraged but cash flow constrained.

Deloitte vice chairman and US oil and gas sector leader John England said: “2016 will be the year of hard decisions. We could see E&P bankruptcies surpass Great Recession levels as companies struggle to remain solvent.

“Access to capital markets, bankers’ support and derivatives protection, which helped smooth an otherwise rocky road for the industry in 2015, are fast waning. A looming capital crunch and heightened cash flow volatility suggest that 2016 will be a period of tough, new financial choices for the industry.”

Seeing the cash crunch, E&Ps worldwide have saved or raised cash to the tune of $130 billion, since the oil price crash. Surprisingly, two-thirds of the savings have come from non-capex measures such as asset sales and equity issuance.

However, considering further equity issuance and asset sales will come at much lower prices, the report notes that E&Ps worldwide are entering 2016 with the only option of cutting their already reduced dividends and share buybacks.

“Considering the industry will have fewer financial levers to pull in 2016, operational performance will be the key to sustainability and growth,” said England.

“There is still more that can be done by oil players, particularly large ones, to reduce costs. Prices will eventually rebound and companies need to focus not only how to survive, but also how to position themselves to thrive for when things turnaround and demand picks up.”

One of the key ways companies have managed to remain viable has been through the reduction of production costs, starting in 2015. Today, about 95 percent of production costs (lease operating expenses and production taxes) of U.S.-origin players operate below $15/boe, versus 65 percent in 2Q14.

The report states that questions on current breakeven prices and near-term cash flows should give way to the future return on capital employed (ROCE) potential of the industry. As the industry improves performance on costs/efficiency, its future emphasis will not be about its ability to make profits at low prices, but generating sufficient ROCE on a large base of devalued investments made in the past.

Further, economies of scale and scope appear to be benefitting natural gas players more, reflected in the widening gap between large and small gas-heavy companies and marginal cost differentiation between large and small oil-heavy players.

That noted, spending cuts in 2015 and 2016 – the first time since the mid-1980s that industry will reduce capex for two consecutive years – will likely have a substantial and long-lasting impact on future supplies and open new chapters in the geopolitics of oil. E&Ps risk slowing the conversion of resources to reserves in frontier locations and the capex required to maintain aging fields and facilities, the report warns.

The report further anticipates that future M&A activity will most likely go beyond the typical buying reasons of the past-preference for oil-heavy assets and buying for growth/scale. Companies that prioritize returns over size, have a balanced and flexible production profile over a deep inventory of non-producing asserts, and give thought to economies of scope over economies of scale will most likely thrive when the price environment improves.

Deloitte Center for Energy Solutions executive director Andrew Slaughter said: “There is no silver bullet solution that applies to the whole industry; in fact, the landscape has never been more complicated.

“Each company has its own set of unique factors to consider – from issues specific to each producing region and asset, to various states of financial circumstances. Staying solvent will require the same level of perseverance, innovative thinking and creativity as the technology breakthroughs that led to the boom in supply we have seen over recent years.”

MUST READ: Nick Train – The King of Buy and Hold

Learn from this author:   Track his other articles here

Analyst Quiz Part II


Part I: I will discuss in another post and send a gift to all who provided comments.

Mr. Ackman calls you into his office and tells you that he shorted gold three days ago, because he wants to make money to support his positions in VRX, etc. Goldman Sachs promised sub-$1,000 gold in 2015.  He ignored whatever you said because you are a “junior” analyst.   But today gold is up $50 +.   Pershing Square recently installed two hotlines: 1. for investor suicide prevention and 2. for death threats.   Phones are ringin’ off the hook.

Also, this morning Janet Yellen had a nervous breakdown during her testimony to Congress.  She told Congress that, “We have no clue what is going on.”  Then she asked Congressional leaders to join her in prayer, “God, Help us!”

Her testimony: Negative Rates a failed strategy so do it

You recently read:

  1. Misconceptions about gold
  2. What Determines the Price of Gold and What determines the price of gold_Blumen
  3. Murphy’s Law of Gold Analysis
  4. Gold and 1937 Depression
  5. Money Gold and Chaos
  6. Losing Control

The above readings you may or may not agree with but you press on to learn more. And you see this:

bank shit

What do you advise Mr. Ackman to do now?

God, Help us!

Analyst Quiz is Gold Overvalued Based on CPI–Go SHORT?

gold vs cpi

You just got promoted to advise Ackman; he is keen to improve returns.  He slaps that chart on your desk and then asks if shorting gold would be a good idea? Why or why not based on this brilliant analysis?  In fact, with “Deflation” fears rampant, Ackman feels gold could drop to $650.

Also, you read: The Golden Dilemma where two PhDs project a $350 price target.  If experts such as these predict lower prices, then should you join the pack?

Also, you find a chart that supports what your boss thinks. Yahoo!


Unfortunately, some nut-job sends you this link: The Positive theory of gold and the The ultimate extinguisher of debt

You have until this afternoon to report back.  This tests common sense and critical thinking skills. Good luck!

A prize to be awarded.

Analyzing Banks and Liquidity; Precious Metals and 2016


Katalepsis and liquidity  Understand what drives banking soundness and liquidity.

MM on Gold A different perspective


Monetary History: Should Legal Tender Laws Be Abolished?


The Supreme Court’s ruling

Hepburn v. Griswold reached the U.S. Supreme Court in 1869, five years after the war had ended. The Court ruled in favor of Griswold, holding in a 4-3 decision that legal-tender laws violated the U.S. Constitution.

The majority opinion distinguished between money and notes to pay money:

There is a well-known law of currency, that notes or promises to pay, unless made conveniently and promptly convertible into coin at the will of the holder, can never, except under unusual and abnormal conditions, be at par in circulation with coin. It is an equally well-known law, that depreciation of notes must increase with the increase of the quantity put in circulation and the diminution of confidence in the ability or disposition to redeem. Their appreciation follows the reversal of these conditions. No act making them a legal tender can change materially the operation of these laws.

The Court also explained that the power to coin money, which the Constitution delegates to Congress, did not constitute a power to convert promissory notes into money:

It is not doubted that the power to establish a standard of value by which all other values may be measured, or, in other words, to determine what shall be lawful money and a legal tender, is in its nature, and of necessity, a governmental power. It is in all countries exercised by the government. In the United States, so far as it relates to the precious metals, it is vested in Congress by the grant of the power to coin money. But can a power to impart these qualities to notes, or promises to pay money, when offered in discharge of pre-existing debts, be derived from the coinage power, or from any other power expressly given?

It is certainly not the same power as the power to coin money.

With the holding in Griswold, the federal government was left with the power to borrow to finance its operations but without the authority to force people to accept its notes at face value for the payment of debts. Thus, the American people could still protect themselves from a profligate government by expressly providing that notes and contracts could be repaid only in money (i.e., gold coin), not in federal promises to repay money.

We the people

Overturning Griswold

One year later, however, the legal situation changed dramatically. President Ulysses S. Grant, who had commanded Union forces during the war, appointed two new justices to the Supreme Court who promptly joined the minority in Griswold. In Knox v. Lee, decided in 1879, the Supreme Court voted to overturn the decision in Griswold and to uphold the constitutionality of Lincoln’s legal-tender law.

The new majority reasoned that the power to enact a legal-tender law was an implied power that fell under the president’s war powers and the power over monetary affairs that the Constitution had granted to Congress.

But as the dissent pointed out, the implied-powers doctrine cannot be used to create new powers. The war power, for example, entails the power to pay for war expenditures but the means by which to pay for such expenditures were limited to those enumerated in the Constitution, i.e., through taxes and borrowing.

As the dissent also emphasized, the congressional power over monetary affairs was specifically limited to the coinage of money and did not extend to the enactment of laws requiring people to accept federal promissory notes in lieu of such money.

In a separate dissenting opinion, Justice Stephen J. Field pointed out the obvious:

The power “to coin money” is, in my judgment, inconsistent with and repugnant to the existence of a power to make anything but coin a legal tender. To coin money is to mould metallic substances having intrinsic value into certain forms convenient for commerce, and to impress them with the stamp of the government indicating their value. Coins are pieces of metal, of definite weight and value, thus stamped by national authority. Such is the natural import of the terms “to coin money” and “coin;” . . ..

… The power to coin money is, therefore, a power to fabricate coins out of metal as money, and thus make them a legal tender for their declared values as indicated by their stamp. If this be the true import and meaning of the language used, it is difficult to see how Congress can make the paper of the government a legal tender.

Field placed the constitutional issue in a historical context:

The statesmen who framed the Constitution understood this principle as well as it is understood in our day. They had seen in the experience of the Revolutionary period the demoralizing tendency, the cruel injustice, and the intolerable oppression of a paper currency not convertible on demand into money, and forced into circulation by legal tender provisions and penal enactments.

Field also pointed out that the Constitution had not delegated to Congress the power to impair private contracts.

With Knox v. Lee the seeds were sown for a monetary revolution in American life — a revolution that would bring the inflationary plunder and moral debauchery that have characterized nations throughout history. The revolution began with Lincoln. But it would culminate in one of most massive assaults on private property in U.S. history — President Franklin Roosevelt’s nullification of gold clauses in contracts and his confiscation of gold from the American people.

It is impossible to overstate the significance of the Franklin Roosevelt administration’s confiscation of gold and its nullification of gold clauses in contracts. It is one of the most sordid episodes in American history. To get an accurate sense of Roosevelt’s actions, it would not be inappropriate to compare what he did with the domestic economic policies of a later 20th-century ruler, Cuba’s socialist president, Fidel Castro.

On April 5, 1933, newly inaugurated President Roosevelt issued Executive Order 6102, which prohibited the “hoarding” of gold by U.S. citizens. Americans were required to turn their gold holdings over to the federal government at the prevailing price of $20.67 per ounce.

Pursuant to Roosevelt’s executive order, anyone caught violating the law was subject to a federal felony conviction, 10 years’ confinement in a federal penitentiary, and a $10,000 fine. Soon after the confiscation, U.S. officials announced that the government would sell its gold in international markets for $35 an ounce, thereby devaluing the dollar by almost 70 percent and immediately “earning” a potential profit of almost $15 an ounce on the gold it had confiscated.

Two months later, Congress enacted legislation nullifying gold clauses in both government and private contracts, thereby requiring creditors in such contracts to accept devalued paper money in payment of such contractual obligations, even though the contract itself stipulated payment tied to gold.

Reflect for a moment on the significance of what Roosevelt did. Gold coins and gold bullion were private property, just like a person’s automobile, clothing, home, and food. On the mere command of the president of the United States, federal authorities simply confiscated gold holdings that were the private property of the American people and made it a grave federal offense to own such property in the future.

Read The Federal War on Gold

Your thoughts on a better monetary system. Why not let the market choose money and set the price?