Forgiving - Or Forgetful?

The Daily Reckoning PRESENTS: ‘Pay attention and learn from the mistakes of the past, they are likely to repeat themselves,’ we say to our dear readers at least once a week. Unfortunately, very few people heed that warning. Chris Mayer explains…


“Investing in Russia [is] like entering a rich gold field studded with land mines: laced with veins of rich treasure, and riddled with pockets of pure poison.”

– Mark Mobius, Passport to Profits

In my more optimistic moods, I look out over the world and think about places like China and India. I look at the bubbling-up emerging markets in Africa, the Middle East, Eastern Europe and South America. And I think of all the potential in places like that. I think of all the economic growth ahead of them, all the untapped and budding investment opportunities.

Investing In Russia: Progress?

Then I read what investors were thinking 50 years ago. And I get pessimistic, because they were thinking the same thoughts. Indeed, their comments still retain their freshness today, decades later. That shows you, among other things, how progress is hard fought and far from certain.

Worse, the same moves tend to replay over and over. And always with a bad ending for investors.

It was only a couple of years ago, 2004, when investors lost their shirts in YUKOS – the biggest oil company in Russia. The Russian government seized YUKOS for back taxes totaling more than $30 billion. The move was widely regarded as a political act, checking the ambitions of its billionaire CEO. Investors howled, but at the end of the day, foreign investors lost over $6 billion.

You would think after that experience, any mention of Russia would be like (as P.G. Wodehouse once wrote) trying to cheer up Napoleon by talking about winter sports in Moscow. You would think any mention of Russia would hurl investors into alternating fits of rage and despair. Not so. Investors are forgiving or forgetful or both.

Investing In Russia: The New Belle

Now there is a new Russian belle capturing moneymaking imaginations. It is state-owned oil giant OAO Rosneft. What makes this all the worse is that this, in part, is the old YUKOS. Rosneft is the company the government folded YUKOS into. In other words, it stole this asset from investors and is now going to turn around and sell it back in an initial public offering.

The Rosneft IPO could be the biggest in history – at more than $20 billion. This for a 49% stake in Rosneft, while the government retains a controlling 51% stake. Vladimir Putin as your partner? Not me.

Incredibly, investors are lining up to get a piece. As The Wall Street Journal reported, “Advisers including Morgan Stanley and J.P. Morgan took Rosneft President Sergei Bogdanchikov to London in February for a presentation. So many fund managers and analysts turned up that some had to stand through lunch.” I hope these people aren’t investing your money.

Admittedly, the Russian stock market has been among the best performing in the world of late – over the last 12 months, the RTS index (a common benchmark of Russian stocks) has risen 137%.

I came close to recommending a Russian company last year. One year ago, when I prepared the Five Cheap Stocks special report, there was one Russian company that made the list of 16, but did not make the more select cut to the final five (which, again, produced an average gain of 87% in one year). That company was Tatneft, a Russian oil and gas company.

It’s true. Tatneft was actually an NTAV stock a year ago (trading for less than its net tangible asset value). It closed on April 1, 2005, at a price of $34.30. Yesterday, it was $120.82. That would have made it the top performer of the group, better than even Imperial Sugar.

Yet I don’t regret the decision to pass over Tatneft. For one thing, the financial statements available were old and the disclosures were terrible. It was hard to know what you owned if you bought Tatneft. Over time, passing on companies like this will save you a lot of money – because your winners won’t compensate for the inevitable disasters.

Also, I didn’t buy technology stocks in 1998, either – even though they went up in 1999 and finally flared to their glorious peak in 2000 before getting seared like the wings of Icarus and tumbling back to earth. Russia is a snake pit, where you can lose your entire investment seemingly overnight because of government confiscation and corruption.

Investing in Russia: Why?

Why the enduring attraction to Russia? Russia’s magnetism can be summed up in two words: “cheap assets.”

Russia is still the largest country in the world, in terms of land area. The expanse covers 11 time zones and nearly every conceivable type of landscape, from frozen tundra to hot deserts, from lush wet lowlands to high dry mountains, from dense forests to open plains.

And buried amidst all that are rich veins of natural resources – Russia is a veritable storehouse of Mother Nature’s useful goodies. Russia is the largest, or among the largest, producers of palladium, platinum, diamonds, nickel and gold. Russia is also rich in oil and gas. Rosneft, for example, has more proven oil reserves than Exxon. It’s bigger than any oil company in the world on this basis save for its sister company Lukoil. It is also the world’s biggest producer of natural gas.

I like Jim Rogers’ line in his most recent book, Hot Commodities: “The bright spot in the world’s oil picture, according to most analysts, is Russia – additional proof, in my opinion, of how bad things really are.”

To me, investors lining up for a shot at an old dilapidated outfit like Rosneft – with all its shady aspects – is a sign of a market that is getting up there in the thin air of speculation. Investors have more money than they have good ideas. Someone is bound to lose.

Hint: It won’t be the Kremlin.


Chris Mayer
for The Daily Reckoning
April 25, 2006

P.S. In Capital & Crisis, our focus is on understanding the individual investments we are in and getting them on the cheap. Even so, this doesn’t mean we have to stick our heads in the sand and whistle out of our rear ends.

Our battle plan is largely unchanged: to invest in sturdy businesses with valuable assets, lots of resources and proven capabilities, able to survive and even prosper in difficult environments. It also helps to have smart people at the helm. Do all this at good prices and you’ll make a lot of money, even in a soft economic environment, even in a flat market. Our track record proves it. We had a great 2005, even though the market went nowhere.

“From here on,” said Francisco, stopping the car and pointing, “everything you see is part of the ranch.”

What gave this statement its force was not the way he said it, but where he said it. We looked to the right. A range of mountains presented itself about a mile away. We looked to the left. Another range of mountains, further away, established the northern border. What lay between was ours.

“But Dad,” Henry observed, “there isn’t anything at all in between. It’s just wasteland.”

“I feel a little ill,” said Elizabeth.

“Can we go back to Colome?” Maria asked.

“Oh ye of little faith,” we replied. “Let’s push on.”

We had arrived at Gualfin at 10:35 on Monday morning. We took note of the time just to see how long it would take for Francisco to drive us from the main road to the house itself.

It was another 20 minutes.

“See, it’s not so bad,” we said, long before we actually arrived and long before anyone in the family had a chance to see enough of the ranch to form an opinion, good or bad. After managing expectations downward for so long, we now thought it would be prudent to steer them in the other direction.

In this effort we were aided by nature. It is autumn in the Southern Hemisphere. The house stands in a grove of trees, planted in neat rows so as to frame it on three sides. From a distance, we thought the trees were aspens – for they had turned bright yellow, the way the aspens do in Colorado. But these were Alamo trees, we were told later. For the moment, they seemed remarkably bright and remarkably welcome. Without them, the huge valley would be empty and almost colorless.

“It doesn’t look that bad,” was Elizabeth’s cautious first reaction. As we drew closer, we saw that there were actually two rows of trees, one on each side of the road up to the house. The effect, this time of year, was surprisingly stately, almost elegant. If we focused our eyes only on the road itself we might have thought we were in Virginia or even England. But as soon as we looked out beyond the trees we realized that we were in an oasis in the middle of a vast, high valley.

In this oasis, stood the house itself. Built of granite, it is a large rectangle with a central courtyard, which – should it fail as a habitation – might perfectly suit it to be a prison for the criminally insane, far enough from civilization that they would pose no threat even if they got loose.

Francisco introduced us to the caretakers: Jorge and Maria, a couple in their 50s, with cheerful demeanors and dark, weathered faces. While Jorge gave us a tour of the house, Maria went back to her cooking.

The house is a large place, nearly abandoned ever since it was built 50 years ago and Jorge and Maria use only a few rooms. The rest waits for the very occasional visits of the owner. The bedrooms had been aired in preparation for our visit…and furnished with brightly colored blankets. The beds themselves looked like the sort you’d find on the streets of Baltimore after a “put out” of a tenant who failed to pay the rent, except that they had rawhide strings holding up the mattresses rather than metal springs.

As we made our way around, we noticed the bloody skin of a goat hanging from a tree. There were also pieces of meat and internal organs hung up – to keep them away from the dogs, we guessed. Flies swarmed all over them.

All of the rooms in the house are dark and antique in appearance, with whitewashed walls and concrete floors, but the kitchen stands out as not merely out of style but practically prehistoric. The stove is fired by wood, which sends up clouds of smoke that, over the years, have completely blacked the walls and ceiling with soot. The smoke was so thick we could barely see the women working inside. Maria was in front of the stove and another, younger woman, later introduced as Clemencia, stood by her side.

Outside in the courtyard, an open fire had been built. It smoked and sizzled, too, with drippings from meat that had been placed on a grill directly on top of the flames.

“We’ve prepared some young goat for you,” Francisco told us. “Do you like goat?”

“Yes, of course we do,” we replied.

“And we also have some wine that my grandfather made 26 years ago. It was made at Colome before the Swiss bought the place.”

After lunch, a couple of gauchos appeared, bringing up horses from the corals. They were sturdy looking animals, various mixtures of Peruvian and Spanish horses. There was also one very solid looking horse with a huge head.

“Oh, he’s a Percheron,” said Francisco. “And we also have a couple of mules.”

While Edward mounted one of the mules, the rest of us took the horses, matching them to riders by size and temperament.

Thus did life at Gualfin begin to take on a pattern which was to last only a couple of days. But they were glorious, sunny days spent discovering the ranch on horseback. The first day we rode out across the open plains – like outlaws after robbing a bank. We rode from one side to the other – that is from the hills on one side to those on the other – following the course of a river that drains the valley and then cuts through the mountains to an adjoining property. We wanted to keep going so we could meet our neighbors, but Francisco reminded us where we were.

“There is only a small trail that follows the riverbank. It is very dangerous in some places. Not even the horses can pass. You’d have to go on foot. Besides, it would take you at least five hours to get to Pucara.”

The next day we had a longer trip in mind. We were riding to visit some Indian ruins that were so far way we wouldn’t be able to get back the same day. We’d have to camp out overnight, sleeping out under the open stars.

“That should be fun,” we all agreed.

“Yes, it is what gauchos do all the time,” Francisco told us, looking vaguely satisfied with his profession, “but you have to remember that we are very high up – about 2,800 meters (9,000 feet). It gets very cold at night, but don’t worry, we bought sleeping bags for you that are good down to minus 12 degrees. It won’t get colder than that.”

Our patient readers may be wondering why we spend so much time recounting the details of our holiday in Argentina. The Daily Reckoning is, after all, concerned with money, not with travel.

But here we point out that there’s more to money than just making it. You also have to get rid of it. No dollar was ever made that was not subsequently unmade. For many people it is the unmaking that is the important part; they only make so that they can unmake later in the way most agreeable to them. Others prefer the making…and leave it to future generations to do the squandering. Your editor tries to take a middle road.

The accountant in him tells him to carefully protect every penny by making sensible long-term investments, but the poet in him reminds him that the very flowers that bloom today will be dying tomorrow. So, he tries to find ways to hold onto wealth in ways that are amusing to him. Buying a ranch in South America seems to satisfy his requirements. He can imagine himself riding into the sunset – literally as well as figuratively – and leaving the ranch behind him, worth as much as when he bought the place.

More to come, dear reader…more to come.

For now, the news according to The Rude Awakening…


Eric Fry, reporting from Manhattan:

“The crude oil market is throwing off more mixed messages than a budding romance. Crude’s alluring price profile seems to be saying, ‘Come and get it.’ But at the same time whispering in our ears, ‘I think it’s time for you to go.'”

For the rest of this story, and for more market insights, see today’s issue of The Rude Awakening.


Short Fuse, reporting from Charm City…

*** We never cease to be amazed by the “what, me worry?” attitude prevalent in the United States. Case in point: good friend and officemate James Boric pointed out a CNN Money survey today that asked, “How are your personal finances, compared to last year?”

The possible answers were “improved,” “worsened,” or “not sure.”

Forty-nine percent of the survey-takers answered “improved.” Interesting.

Then, we see that, according to New York-based Conference Board study, despite everyone’s expectations, consumer confidence is at its highest level in four years. Most believed that the recent highs in crude prices would make consumers a bit more wary, but not Americans. Nothing can crack through our rose-colored glasses.

“Consumers overall assessment of the economy remains favorable. The percent saying the economy is good rose to 29.7%, from 27.9%,” reports the study.

“Improving present-day conditions continue to boost consumers’ spirits,” said Lynn Franco, director of The Conference Board Consumer Research Center in a statement. “Recent improvement in the labor market have been a major driver behind the rise in confidence in early 2006. Looking ahead, consumers are not as pessimistic as they were last month.”

So, improvements in the labor market, huh? As Chris Mayer pointed out in his recent DR essay, “Shadow Statistics,” the government, since the time of the Kennedy administration, has been changing the definition of “unemployed.” If you back out the changes, you get an unemployment number closer to 12%, not 5%, as our government likes to claim!

Just goes to show…don’t believe everything that you hear or read.

*** Here’s another piece of news to help build Americans’ confidence…

Last Friday, Sweden’s central bank became the first among the developed economies to announce a major reserves shift, saying it had raised its euro holdings to 50 percent of its $20 billion-plus reserves from 37 percent and cut dollar holdings to 20 percent from 37 percent.

“The dollar’s dominance of all currency reserves…is basically coming to its conclusion and ultimately this puts a lot of pressure on the U.S., because of its very large current account deficit which has, until now, been supported mostly by central bank buying.”

Hmmm…once the foreign central banks stop buying the dollar, we are in some deep you-know-what. Stay tuned…