Saturday, July 30, 2005

Eventually The Truth Is Revealed

7/30/05 Eventually The Truth Is Revealed

Some weeks back I wrote a piece on the U.S getting kicked off a strategic Uzbekistan base. The story did not make the papers until this morning when it was noted in the Seattle Times. The paper stated “Uzbekistan formally evicted the United States yesterday from a military base that has served as a hub for combat and humanitarian missions to Afghanistan since shortly after the Sept. 11 attacks, Pentagon and State Department officials said. In a highly unusual move, the notice of eviction from Karshi-Khanabad air base, known as K2, was delivered by a courier from the Uzbek Foreign Ministry to the U.S. Embassy in Tashkent, said a senior U.S. administration official. The message did not give a reason. Uzbekistan gave the United States 180 days to move aircraft, personnel and equipment, U.S. officials said…Scores of flights have used K2 monthly. It has been a landing base to transfer humanitarian goods that then are taken by road into northern Afghanistan, particularly to Mazar-e-Sharif — with no alternative for a region difficult to reach in the winter. K2 is also a refueling base with a runway long enough for large military aircraft. The alternative is much costlier inflight refueling. In May, however, Pentagon spokesman Bryan Whitman called access to the airfield "undeniably critical in supporting our combat operations" and humanitarian deliveries. The United States has paid $15 million to Uzbek authorities for use of the airfield since 2001, he said.”
Brad Setser: “By the end of 2008, if nothing changes, China may have about $2 trillion in reserves.”
Wal-Mart’s July comp store sales rose 4.4%. That’s an excellent performance.
China had a grain shortfall of 20 million tons in 2004, and this may rise to $25 million tons this year.
World-wide copper supplies have declined 46% in 2005.
The CRB Index has risen almost 10% this year and the Goldman Sachs Commodity Index just under 30%. Naturally, the Fed states inflation is modest.
GDP growth between 2002 and 2004 was revised downward to 2.8% from 3.1%. I don’t know about you, but a 10% revision makes U.S. government figures suspect. Why should I believe that 2nd quarter 2005 GDP growth was 3.4%? Will it be revised in a few years?
The government reported that 2nd quarter consumer spending rose 3.3% and that savings rose less than 1%. Meanwhile, the employment cost index rose only 0.7%. Thank goodness for home prices rising. Otherwise, consumers would be sucking on a hind teet.
The yield curve continues to flatten with the 2-year at 4.02% and the 10-year at 4.286%.
With crude at $60.57, will prices at the pump soon rise again?
Lyndon Johnson: "Did you ever think that making a speech on economics is a lot like pissing down your leg? It seems hot to you, but it never does to anyone else."

Friday, July 29, 2005

Evaluating Risk And Value

7/29/05 Evaluating Risk And Value

It might surprise you to know that Chevron is the Caspian region’s leading oil producer. With its partner, Tengizchevroil, the company operates one of the world’s largest oil fields at Tengiz, Kazakhstan. That’s right. Kazakhstan. Chevron has been operating there for decades. On the other hand, PetroKazakhstan has been there for less than a decade.

Denis Waitley: “Life is inherently risky. There is only one big risk you should avoid at all costs, and that is the risk of doing nothing.”

As I mentioned yesterday, PKZ reported its second quarter results and also held a conference call that lasted almost 2 hours. It was quite informative. The company intends to achieve its target potential average of 170,000 bopd by some time in the latter half of 2006. This is not a pie-in-the-sky goal since in the second quarter of 2004 production was 151,400 bopd. It should be noted that in this year’s second quarter production was only 105,947 bopd due to the April 26th government-mandated elimination of gas flaring from oil wells. Some production will be restored in a month or so, and the balance within 12 months. In 2003, the company entered into a oil-hedging program. In this year’s first quarter 120,000 barrels per month were hedged between $26.30 and $26.52 per barrel, and this reduced revenues by $38.2 million. In this year’s second quarter 40,000 barrels per month were hedged at $25.92 per barrel, and this reduced revenues by $39.5 million. The hedging program ends in December 2005. The unrealized loss under the remaining hedges at June 30, 2005 is $84.5 million, but that will be more than offset by the unrealized deferred net income from crude in inventory amounting to $95 million. In spite of the government mandated elimination of gas flaring and the hedging program, cash flow amounted to $350 million in the first half of 2005, an outstanding achievement. Management has exhibited an ability to operate successfully under difficult circumstances.

Based on recent drilling activities, there is reason for significant optimism in the Northern area of the Kyzylkiya field and the Kolzhan license. It should be noted that shipments destined for China increased by 63% in the second quarter in comparison to the preceding quarter as the state operated Karakoin to Atasu pipeline was re-opened, and volumes destined for China amounted to 24% of total shipments. When the new pipeline to China becomes operative in about 6 months, transportation costs will be reduced by almost $7 per barrel. The savings will be shared by China and PKZ. Should PetroChina purchase PKZ, all of the transportation savings would accrue to PetroChina. This has the potential to become a significant amount of money, and this statement does not include management’s belief that there is the potential to discover approximately 1.2 billion barrels of oil on the properties where it owns exploration rights. It should be emphasized once again that the company’s exploration costs for generating oil reserves are exceedingly low—one of the lowest on the planet. When production gets to 170,000 bopd, utilizing the new pipeline to China, and assuming oil remains above $48 a barrel (today it is trading above $60), PKZ has the potential to earn over $15 per share and generate cash flow of close to $1.3 billion. Returns to PKZ shareowners could have large upside potential, and that is with or without a sale of the company. Management is dedicated to maximizing the returns to shareowners, and they have exhibited an outstanding ability to manage the risk factors in the Caspian region. In this respect, they share a commonality with Chevron’s management.

Andre Malraux: “Often the difference between a successful person and a failure is not one has better abilities or ideas, but the courage that one has to bet on one’s ideas, to take a calculated risk- and to act.”

Recently, there have been nearly 200,000 of high-profile large U.S. layoff announcements in May and June. Yesterday, Morgan Stanley announced cutting 1,000 employees. John Challenger, CEO of Challenger, Gray & Christmas, stated “we may have reached the tipping point for this period of lackluster economic expansion. If the summer surge (of announced layoffs) proves to be the first sign of an eventual economic slowdown, this would be among the weakest expansions in recent times, particularly when compared to the boom of the 1990s. Summer is typically a time when we see a drop off in cuts, but this year…five out of the six largest cuts announced so far this year have occurred in May.” Investors seem unperturbed by the recent surge in job cut announcements. They are focusing on the 11% gain in announced second quarter earnings and the belief that similar results will be forthcoming in the second half of 2005. Earnings have propelled the S&P 500 and the Nasdaq to four-year highs. Meanwhile, the Conference Board’s Help-Wanted Advertising Index stood at 38 in June, exactly the same number as one year ago. Ken Goldstein, the Conference Board’s labor economist, stated “hiring intentions have turned more cautious as the economy is poised to lose some steam in the second half of 2005.”

Yu Liang, managing director of China Vanke Co. Ltd, China’s biggest property developer, stated “the appreciation of the yuan will have a wealth effect and help boost consumer sentiment. It could have a negative impact on manufacturing, but the pressure for interest rate rises will be less.”

At $136 per share, Whole Foods Markets has a market cap of $9 billion and the shares trade at 30 times cash flow. By comparison, Albertson’s has a market cap of $8 billion and its shares trade at 4 times cash flow.

The NAR’s Housing Affordability Index for June was 117.1, the lowest level since August 1991, and this despite lower mortgage rates being lower in 2005 than in 1991. It comes down to wages. They have not kept up with the rising price of housing.

Standard Pacific, a homebuilder, raised its earnings per share estimate for 2005 to $12 on anticipated revenues of $3.9 billion.

According to the U.S. Department of Labor, the price of cement is up about 12% nationwide in the past year. Of course, the Fed says inflation is modest.

There was another blast at BP’s Texas City refinery, and this has served to hold crude prices around the $60 per barrel level.

Chevron reported earnins for the second quarter of $1.76 on revenues of $47 billion. Based on the present low evaluation for Chevron shares, shareholders of Unocal should have plenty of upside potential.

Thursday, July 28, 2005


7/28/05 Updates

I was most impressed by the quarterly earnings statements issued by Apache ($1.76), ConocoPhillips ( $2.19), PetroKazakhstan ( $1.86), and Phelps Dodge ($4.52). I have placed these in alphabetical order. I have a great deal more to say about PKZ but the report was 33 pages and I want to give more time to its reading. The highlights are: the Board of Directors has set up an Independent Committee to consider the approaches by a number of parties concerning the merger or acquisition of the company; despite the April 26th cut backs initiated to comply with instructions from the Kazakh regulators to stop gas flaring immediately, which caused the reduction of 60,000 bopd, cash flow still jumped to $164.4 million in the quarter or $2.20 per share, up from $1.80 per share in the second quarter of 2004; the company had significant exploration and appraisal successes in the Kyzylkiya and Kolzhan licenses; net income rose to $1.86 per share up from 2004’s second quarter of $1.54; and construction of the enhanced Akshabulak production facilities has progressed and should be completed during this year’s third quarter giving a processing capacity of at least 64,000 bopd (gross).

The median price of a new home fell 5.5% in June and is down 0.4% in the past year.

PMI Mortgage Insurance Co., a residential mortgage insurer based in Walnut Creek, California, stated in a new report that much of the Bay Area faces a greater than 50% chance of housing price declines, and the Sacramento region is not far behind. Mark Miller, chief risk officer with PMI, stated “we are continuing to witness record-home appreciation in may markets without the necessary gains in income, home affordability, and rent inflation. This is causing the home price environment to diverge from long-term economic fundamentals, which cannot be sustained indefinitely.” California has 8 of the top 12 slots for cities most at risk for price declines.

Crude is trading around $59.41 a barrel.

The S&P 500 is at a 4-year high.

A record monsoon hit Bombay.

Computer Associates is cutting 800 jobs.

Delta Air’s CEO gave a downbeat assessment for avoiding bankruptcy.

It’s getting to be SOP time for CNOOC. The clock is running down on their opportunity to buy Unocal.

Tuesday, July 26, 2005

Do The Math

7/27/05 Do The Math

I received many inquiries as to why I believed PKZ presently offered more value than any other public company-- especially on a risk/reward basis. I can't expect others to do the work. After all, they are only paid to do that. It's not difficult. According to John S. Herold and Harrison Lovegrove & Co., in 2004 the price paid for oil and gas reserves rose by 40% over 2003. The median price for 1 barrel of oil equivalent was $9.78. The volume of deals in the first half of 2005 has already exceeded all of 2004, and figures will show the price has jumped to about $12 a barrel. PKZ has proven reserves of 550 million barrels. Maybe some folks think Kazakhstan is not as safe as say Wyoming. We will take a 50% haircut on the $12 and now multiply the 550 million barrels by $6 a barrel. In addition, we will take another haircut on the other 300 million possible barrels of reserves and this does not count even one barrel on the three to six wells they will be drilling by year-end. The company has found paydirt in the previous wells drilled in this region earlier this year. We will multiply the 300 million+ barrels by a 75% haircut or $3 per barrel. The total of $4.2 billion equates to $56 a share. If there is no takeover by either PetroChina or ONGC or any other company, you own shares in a company whose stock is selling at 4 times 2006 earnings or less and providing a dividend yield higher than most public companies. If that is not to your liking, you can always buy real estate in Manhattan. Just an aside, PKZ reminds me somewhat of Anadarko Petroleum in July 2003. The stock had almost no fans. I thought it represented the best value in the market on a risk/reward basis. I would buy it almost daily at $41 to $42 a share. Someone bet me it would not go to $50. It went there on the way to $90. The trip took two years and the person never paid his bet. Sore losers have a way of doing that. I wouldn't have taken his money any way. Being right is the prize.

The price of West Texas Intermediate(WTI) crude, as assessed by Platts, increased $3.045 for August delivery to$58.36-58.38 per barrel. "This is a market essentially without bearish news at this point," saidJohn Kingston, global director of oil at Platts. "Every time it looks likeChinese demand might be softening, there is evidence pointing the other way.Every time there's a significant move down, a new rush of speculative moneyseems to appear to act as a prop. Signs pointing to a slight softening of USdemand may be the one bearish factor in the market, but whether that becomes atrend is still indeterminate."

The Conference Board's ConsumerConfidence Index, which had increased in June, dipped in July. The Index nowstands at 103.2 (1985=100), down from 106.2 in June. The Present Situation Index decreased to 118.5 from 120.8. The Expectations Index declined to 93.0 from 96.4 last month.The Consumer Confidence Survey is based on a representative sample of 5,000 U.S. households. The outlook for the labor market was mixed. Consumers expecting more jobs to become available in the coming months edged up to 15.8 percent from 15.4 percent, while those expecting fewer jobs also edged up to 16.8 percent from16.4 percent in June. The proportion of consumers anticipating their incomes will increase in the months ahead declined to 18.6 percent from 19.9 percent last month. Consumers' overall assessment of ongoing conditions was somewhat mixed inJuly. Those claiming business conditions are "bad" increased to 16.9 percentfrom 15.3 percent. However, those claiming conditions are "good" improved to 28.7 percent from 26.7 percent. The employment picture was also mixed. Consumers saying jobs are "hard to get" increased to 23.8 percent from 22.5 percent, but those claiming jobs are "plentiful" held steady at 22.5 percent. Consumers' outlook for the next six months was marginally less favorable than in June. Those anticipating business conditions to improve declined to17.6 percent from 19.5 percent. Consumers expecting business conditions to worsen edged up to 9.6 percent from 9.0 percent.

The pace of mass layoffs accelerated in June, exceeding levels recorded in May and June 2004, the U.S. Bureau of Labor Statistics said Tuesday. Ohio employers initiated 62 mass layoff events in June, according to the bureau, which led to 11,541 initial claims for unemployment compensation. The bureau reported 42 mass layoffs, accounting for 3,349 initial claims for unemployment, in May. Ohio employers cut 6,755 jobs in 61 mass layoffs in June 2004. The bureau defines a mass layoff as 50 or more jobs cut from a single location within 30 days. Nationwide, U.S. employers cut 120,463 jobs in 1,157 mass layoffs in June, up from 101,358 jobs in 986 mass layoffs in May. U.S. employers initiated 1,379 mass layoffs in June 2004, which led to 134,588 initial claims for unemployment.

The pace of mass layoffs accelerated in June, exceeding levels recorded in May and June 2004, the U.S. Bureau of Labor Statistics said Tuesday. Ohio employers initiated 62 mass layoff events in June, according to the bureau, which led to 11,541 initial claims for unemployment compensation. The bureau reported 42 mass layoffs, accounting for 3,349 initial claims for unemployment, in May. Ohio employers cut 6,755 jobs in 61 mass layoffs in June 2004. The bureau defines a mass layoff as 50 or more jobs cut from a single location within 30 days.
Nationwide, U.S. employers cut 120,463 jobs in 1,157 mass layoffs in June, up from 101,358 jobs in 986 mass layoffs in May. U.S. employers initiated 1,379 mass layoffs in June 2004, which led to 134,588 initial claims for unemployment.

According to the Grandfather Economic Report, a 1950 dollar is now worth 12.6 cents, an 87% decline in purchasing power.

According to LexisNexis, bankruptcy filings rose 12% in this year's second quarter above year ago levels.

International Business Machines said Tuesday that it plans to repatriate about $9 billion in foreign earnings.

Tthe Bluetooth Special Interest Group announced Tuesday the selection of Bellevue, Washington for its global headquarters based on the city's proximity to key international markets, growing wireless technology industry, and infrastructure and overall quality of life, as well as the presence of many Bl uetooth member companies in the area.

Americans now prefer wine over beer. Since I don't drink, iced coffee and Sport tea are for me.


7/26/05 Acquisitions

Significant acquisitions can occur and get little press coverage. Yesterday, 3M announced it had entered into a definitive agreement to acquire Mercury Online Solutions Inc., a provider of hardware and software technologies and network management services for digital signage and interactive kiosk networks. Terms of the transaction were not disclosed. Digital signage networks enable centrally controlled delivery of digital content to vast networks of display screens and interactive kiosks. The trend toward in-store digital signage networks is accelerating driven by the desire to improve shopping experiences and influence purchase decisions by providing relevant information and promotional messaging nearer to the product shelf where purchase decisions are made.
This acquisition accelerates 3M's entry into the rapidly growing digital signage network marketplace. "The addition of Mercury Online Solutions Inc.'s digital signage networks is a natural extension of 3M's existing graphics business and allows us to use our global services platform," said Robert Doughty, division vice president, 3M Commercial Graphics Division. Mercury Online is the fastest growing company in the state of Washington.

Yesterday, Hershey’s announced the purchase of nine-year-old Berkeley, California artisanal chocolate maker Scharffen Berger. Hershey’s sees the premium chocolate segment as a key growth opportunity. Scharffen Berger posted revenue of $15 million in 2004, a 75% increase, and earlier this year predicted a further 50% increase in 2005.

The U.S. is expected to delay the review of CNOOC’s bid for Unocal. Meanwhile, the vote on the Chevron acquisition of Unocal is in 16 days.

With respect to PetroKazakhstan, the company will report second quarter earnings on July 28. It will become increasingly apparent that current earnings estimates for 2005 and 2006 are too low. In fact, with the new pipeline coming on stream on Jan. 1, 2006, it is quite conceivable that earnings for 2006 could jump 40%. In addition, three new wells “established the presence of a significant new dual reservoir field, separate from the Northern part of the Kyzylklya field but close to the main Kyzylklya production facilities…The company expects to drill an additional 3 to 6 wells in the area before the end of the year.” Should these wells prove similar to the three drilled earlier this year, it is quite possible that reserve estimates could be increased to 1 billion barrels of oil. Given the current market cap of $3 billion, there may be other public companies offering more value, but I don’t know of any. I feel quite certain that PetroChina and ONGC share that viewpoint based on their announced desires to acquire PetroKazakhstan. In order for such an acquisition to be consummated, I believe it would need to come at a significant premium to the current market price.

Paul Kasriel: “I think a good argument can be made that the FOMC will be cutting the funds rate sometime in the second half of 2006. I also see a good chance that the Treasury 10-year yield will be trading below 4% on a consistent basis in the first half of 2006, if not sooner. As for real GDP growth in 2006, a "2" handle is beginning to look likely if the FOMC actually does follow through with a 4% funds rate by yearend.”

India accounts for 18% of the annual global gold demand. According to estimates, India owns approximately $200 billion worth of gold. In my view, this provides more solid value to their currency.

Yesterday, crude climbed back to the $59 per barrel level. Gold rallied close to $426 an ounce.

With existing June home prices having risen 14.7% over year ago levels, homeowners must be feeling pretty wealthy. Their wages may not be climbing much but their homes are doing just fine. Yet, the head of the NAR mentioned that a slowdown seems to have occurred in July. Homes on the market are taking longer to sell. Maybe it’s just the summer doldrums and the buyers are at the beaches. It could also be that the offering prices have reached levels characterized by poor risk/reward. On the other hand, Greenspan is not concerned. Something tells me better value will be realized in Mercury Online Solutions, Scharffen Berger, and PetroKazakhstan.

Countrywide Financial reported second quarter earnings of 92 cents a share, down from last year's $1.29, and 7 cents below analyst estimates. The company lifted its 2005 earnings outlook to $3.85 to $4.60 per share, up from $3.60 to $4.60. Current analyst estimates are $4.21 a share.

Monday, July 25, 2005

Multi-year Trends Leading To Undesired Results

7/25/05 Multi-year Trends Leading To Undesired Results

Doug Wakefield: "From June 1999 to March 2005 we have seen national savings increase from $1,619 billion to $1,819 billion. 6 To place these numbers in context, this is a 10% rise during a period where national incomes went up 34%, consumer credit went up 58%, and total mortgages went up 72%... From June 1999 until June 2005 we have seen the amount of money, as measured by M3, in our country increase from $6,237 billion to $9,727 billion. This is an increase of 55% in 6 years."

Wal-Mart will have 90 stores in China in 2006 or double the amount anticipated at this year-end.

Teva is reported close to acquiring Ivax for approximately 47.5 billion in cash and stock.

Crude remains above $58 a barrel.

China's crude oil imports rose 3.9% in the first six months of 2005, but they slowed dramatically in June.

Volvo is Europe's largest truck manufacturer. In the second quarter their truck orders declined 10%.

Pepsi will repatriate $7.5 billion in foreign earnings. That will provide another $400 million to the U.S. government in tax receipts.

John P. Hussman: "Inflation is not a monetary phenomenon but a fiscal one – it occurs always and everywhere when fiscal authorities create government liabilities in excess of economic growth."

Shanghai copper futures rose over 3% to a record 34,530 yuan a metric ton. China is the world's largets consumer of copper.

Greenspan: "Future price performance will be influenced importantly by the trend in unit labor costs." In recent years, inflation has been smoldering without the workers' wages outpacing the inflation rate, and the government numbers mute the real rate of inflation. What else is new?

I want to re-emphasize a point I recently stated. Two-year Treasury bonds are approaching a 4% yield. There is only a small yield pick up in the 10-year and that differential in no way pays you adequately for the increased risk. I strongly believe all 10-year Treasury holdings should be converted into the 2-year, and that means now. In addition, over the long-term, the risk in holding U.S. dollars has increased markedly with China converting the yuan peg to a basket of currencies. The landscape has trouble painted on the front cover. When in doubt, sell to the sleeping point.

Sunday, July 24, 2005

Calm And Order

7/24/05 Calm And Order

What happens to the innocent during times besieged by terrorists? If you are an American journalist, you are sent to jail and your Fifth Amendment rights are eliminated. If you are an electrician of Egyptian descent on your way to work, you are the victim of shoot and kill orders. If you are an individual investor in the stock, bond, and commodity markets, you are dumbfounded by the calm and order generated by professional money managers who dominate day-to-day trading volume and overtake the remnants of volatility. But, wait, there is a different vision on the Washington State ferry system. You can walk on and off the ferry and/or drive onto or off the ferry without any check of a person or a vehicle. However, five minutes before landing in Seattle, out of nowhere will come two speeding Coast Guard gun boats each manned by four Service personnel. They will accompany the ferry into the port with one boat on each side of the ferry. Has this rush of activity helped to reduce the terrorist threat? Has calm and order been restored? Does this represent our billions spent on Homeland Security? Actually, I feel much better. I can rest easy now. Our ports are safe from harm.

John P. Hussman: “The further the market gets away from normal valuations – especially when it's overbought, the more the distribution of future expected returns tends to skew. You get a high probability of small further gains, coupled with a small but above “normal” probability of damaging losses.”

The PBGC estimates that total corporate under funding is roughly $450 billion. That does not include another $700 billion for municipal and state pension funds. Should the stock market not show a gain for 2005, what will the combined under funding total?

Mike Burk: “ In the first year of the presidential cycle the last five trading days of July have been up 70% of the time.”

There appears to be an oversupply of stainless steel and hot-rolled coil steel. Production and prices are being cut. China is rapidly building up capacity in lower-grade steel products. It is difficult to compete with China in this segment of the steel market. The current revaluation of the yuan will not be of assistance.

Nouriel Roubini: The more China will let its currency will move over time, the larger will be the appreciation of other Asian currencies.”

Since we invaded Iraq 28 months ago, at least 1,775 U.S. service personnel have been killed.