Komrade Kapitalism

The fundamentals are excellent, everyone hates it and the trend has turned up…this speculation is giving off all the right signals in Dr. Steve Sjuggerud’s opinion…we suggest you take note!

Komrade Kapitalism

“All the airports in the country are closed. Fogged in again.”

A private plane to hustle around Argentina two weeks ago seemed like a good idea…but what good is a private plane when every airport is closed for hundreds of miles?

“Let’s go ahead and go,” the pilot said. “I called some people up in Eldorado. They say it’s sunny.” He must have caught a glance I gave him, wondering why we’d fly when the airport was closed. So then he added…

“You do things by the law here until you can’t get any further. And then you don’t.”

We took off from Posadas (a large modern deserted airport – there wasn’t a soul around) and landed at Eldorado, a dinky deserted airport…no sign of anyone here either. “If anyone asks, we didn’t land here,” the pilot said as we got off the plane. But who was going to ask?

The pilot was right. There was no fog in Eldorado. And there wasn’t a single person at Eldorado airport. For all I knew, the guy in charge at Eldorado wanted to sleep in, and fog was the best excuse. With nobody else there, who would know?

Yukos: Argentina SOP

This was standard operating procedure in Argentina, and when you know what the Argentine people have been through, you can see where it comes from – the government.

The government failed its people. If the government won’t follow the laws that it makes, and won’t keep its promises, and will confiscate most of the citizen’s wealth, why should the citizens follow the letter of the law to a tee? Heck, the fact that they follow the laws at all, after what they’ve been through, is amazing…

The government failed the people of Argentina, culminating in a massive economic crisis that bottomed in early 2002. The stock market fell more than 90% in U.S. dollar terms from peak to trough in this time. The banking system collapsed, shutting down the banks for 60 days. Effectively, three quarters of the people’s savings were confiscated. On the streets, survival became more important than obeying the government, which saw five Presidents in three weeks.

Then a funny thing happened…things just started to get less bad. Argentina reached a point where things couldn’t get worse. Stocks became extremely cheap. By late 2001, the price-to-earnings ratio of the entire market was 5 (compare that to the P/E of the Nasdaq today of 62). Now the government has become just a little less ridiculous. And as things have gotten less bad, the stock market has risen by 292% in dollar terms (from the 2002 lows to today).

I tell this story because it relates to another interesting investment opportunity…

Yukos: Less Bad in Russia

As of June 17, things just got less bad in Russia. As of June 17, Russia’s President Vladimir Putin – after a year of mugging business tycoon Mikhail Khodorkovsky – just got a little less ridiculous. If you’ve got a speculative bone in your body, it’s time to buy…

“The Russian authorities, the government and the economic officials of our country aren’t interested in seeing [oil giant] Yukos go bankrupt,” said President Putin.

Over the last year Putin has been trying to settle a personal score against Mikhail Khodorkovsky. Khodorkovsky’s claim to fame was that he was the leader and largest shareholder of Yukos, the world’s second largest oil company in terms of oil resources. Khodorkovsky was dumb enough to break Putin’s unwritten contract between business and government, that says: Russian businessmen can have all the power and money they want, as long they don’t challenge the power of the Kremlin. Khodorkovsky used his economic and political clout to interfere with government reforms, and you don’t do that in Putin’s Russia.

Last October, Khodorkovsky was arrested at gunpoint and taken to jail. His trial on tax and fraud charges dating back to the mid-1990s is just beginning. He shrugged off the accusations as simply “business as usual” in Russia at that time. Back then, Russia was like the Wild West…and back then, just like Argentina in 2002, you did things by the law until you couldn’t get any further, and then you didn’t. This is a witch-hunt, and Putin will get what he wants.

Now Putin is going after Khodorkovsky’s fortune, even though the oligarch is already behind bars. Since Khodorkovsky is the largest shareholder of Yukos, Putin recently ordered Yukos to pay $3.4 billion in back taxes for the year 2000 – that would be a tax rate in excess of 100% of profits that year. And that’s just one year…there may be more bills for back taxes to come.

Yukos: Shares on a Roller Coaster

As you might imagine, shares of Yukos have been on a roller-coaster ride. Between April and mid-June, the shares fell by 60%. Then, shares rose by over 30% on Putin’s announcement that the government wasn’t interested in forcing Yukos into bankruptcy.

Two weeks later, and the shares were clobbered again. This time, the hit was prompted by the announcement that authorities has frozen Yukos’ bank accounts and threatened to seize its assets. Yukos, which produces 2% of the world’s oil, unable to pay customs for the right to pump, would have to halt production.

It still looks ugly…but the trend in Yukos shares and the overall Russian market is up in the last two weeks. As my regular readers know, the perfect time to buy a share is when everyone hates it, yet it’s starting to rise.

“YUKOS will continue to use all possible measures to arrive at a settlement that is acceptable to the Government,” said the company in an official statement and last Sunday, Yukos put its money where its mouth is…the company was reported to have offered to pay the government $7.5 billion if it’s given three years to make payments, and to have offered its 35 percent, $4.7 billion stake in Sibneft, a smaller oil company, as a deposit.

Even after this second bounce, the stock now trades at a forward P/E of – get this – 4. It’s like Argentina in 2002… stocks are super cheap… and things just got less bad.

If you’re not familiar with Yukos, you should be; Yukos has more oil than ExxonMobil, or BP, or RoyalDutch Shell, or ChevronTexaco, and anyone else you care to name.

As stocks are expensive in the States, the stock market value of ExxonMobil is nearly $300 billion ($293 billion, to be exact). But the stock market value of Yukos, which has more oil, only $24 billion. So ExxonMobil is over 12 times larger than Yukos in the stock market. Yukos takes in an estimated $400 million to $500 million a month.

Until Putin claimed he didn’t want to push Yukos into bankruptcy, the oil giant was either a zero or a home run. Now the prospect of a zero has been taken away. The 30%- plus move in the shares was a reflection of that.

I expect Yukos to have an Argentina-like run from here. And at a P/E of 4 based on 2005 earnings estimates, the downside in Yukos should be limited. The fear of the unknown is what’s holding down the stock. But we know what we need to know…Putin won’t send the company into bankruptcy. The rest (like the billions in back taxes) is really just details.


Dr. Steve Sjuggerud
for The Daily Reckoning
July 20, 2004

Editor’s note: Dr. Steve Sjuggerud has worked in the investment world as a stockbroker, the vice president of a $50 million global mutual fund, an international hedge fund manager, and the director of several research departments. An international currency expert, he is also a member of the Oxford Club advisory panel.

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Eric Fry, still in Cooperstown, NY…

– Another day of ‘nothing’ on Wall Street, which wouldn’t be such a bad thing if nothing weren’t so expensive. But the stock market’s quirky version of nothing always seems to wind up with a minus sign in front of it. Yesterday, the Dow lost 46 points to 10,094, while the Nasdaq managed a slim half-point gain to 1,884. Gold added 90 cents to $406.70 an ounce.

– As your Manhattan-based editor is still ensconced in Cooperstown, the Mecca of baseball, he is more in sync with America’s majestic home-grown sport than he is with the national pastime: speculation. Yesterday, the speculators had very little to show for their efforts, as most stocks either lost ground or registered very slight gains.

– Making a buck in the stock market has become a very tough task of late. So tough in fact, that it hardly seems worth the effort. For several days now, many of Wall Street’s most prominent bulls have been calling for a “technical bounce” from “oversold conditions.” Instead, the market has been sinking like a Mastodon in a tar pit…doomed by its very girth.

– Perhaps this financial pachyderm will struggle free from its sticky situation, but the struggle will not be easy. As we never tire of pointing out, oil is expensive, interest rates are rising and terrorism is pandemic. So maybe our beloved stock market will continue sinking for a while. Short-term, we’d agree that the stock market feels a bit oversold and is likely to rally a bit. But that’s hardly a reason to “back up the truck” and buy stocks…

– “Stones and gold; that’s all I ever invest in,” a friend confessed the other day. “I buy stone structures in Europe and I stash away a few gold coins here and there…no matter what happens, the stones will still be there.”

– “Can’t argue with that,” your editor replied. “But that’s not much of an investment strategy…how do you know that you have the proper balance of stones and gold to fulfill your long-term financial objectives? Has your financial planner ever created a pie chart showing your optimal asset allocations to stones and gold?”

– “No,” he chuckled. “No one’s ever done that. I admit; I don’t have much of a financial plan. But the stock market has always seemed kind of crazy to me. And besides, I just like stones and gold.”

– “Very well…you own more stones than I could ever afford. So you must be doing something right.”

– “I think the secret is that these assets are difficult to sell,” he said. “It’s not easy, for example, to be a panic- seller of an ancient French farmhouse. And if it’s almost impossible to sell something when everyone else is also trying to sell the same thing, you are protected from your own stupidity…you are protected against selling something at the worst possible time. That’s why I like real estate more than stocks.” – Perhaps stones and gold explain the market’s lethargy. Maybe investors are withdrawing their cash from the stock market and shifting it into other asset classes, like real estate or gold or long-term bonds. Whatever the reason, the American stock market seems to be losing market share to competing investments.

– Indeed, the entire U.S. economy seems to be losing market share as an investment destination. “China overtook the United States as a recipient of foreign direct investment in 2003,” reports China’s People’s Daily, “as companies broadened their strategies in emerging markets. The Organization for Economic Cooperation and Development said the United States was the worst hit by falling inflows of foreign direct investment to its 30 industrialized member countries.

– “Investment into the United States declined to $40 billion last year from $72 billion in 2002 and $167 million in 2001,” the People’s Daily continues, “while foreign direct investment in China dipped only slightly to $53 billion from $55 billion.”

– $40 billion of direct foreign investment into the United States is something more than nothing, but not by much. A great big economy like ours needs great big investments to maintain its health. It needs something more than nothing…

– Beware of nothing.


Bill Bonner, back in Baltimore…where the strangers continue their rediscovery of a very strange land…

*** Stones and coins!? We confess. Eric has just described a conversation he had with us just a couple of days ago. And yes, ancient stones and modern gold coins do figure prominently in our investment portfolio – they are practically all of it.

We’ve reflected on the apparent nuttiness of this and assured ourselves that it is less nutty than it seems.

“Why would we buy stocks,” we asked ourselves.

“In order to buy the things we want,” came the answer.

“What things do we want,” we continued the questioning.

“Old stones and gold coins!”

Some people have a weakness for old, stone houses. Others cannot resist a pretty face. Still others are prey to good liqueur or bad whiskey.

But put a pretty girl in front of a stone château, with a glass of Armagnac in one hand and a Krugerrand in the other, and we practically fall apart. We drop down to our knees in delicious agony and reach for our wallet.

We offer neither excuses nor apologies for this behavior. Nor do we recommend it to others.

Still, it has its advantages.

*** “I don’t believe in stocks,” said a friend at lunch yesterday. “I mean, I own stocks. But not many. And I think the average guy really is better off in real estate.”

“Yes, I know there’s a real estate bubble in many areas,” he went on. “But when a guy buys a stock – unless he’s Warren Buffett, he has no way of knowing what the business really is, or whether it makes sense or not. That’s why you get these huge swings in the stock market. One year a stock may trade for $50…the next, it goes for $100. And it’s the same stock, of the same company, doing the same business it was the year before. But the average stock buyer doesn’t do any analysis…he just buys stocks he hears about or reads about.

“Real estate is different. He can see it. And he can do the math. If he buys an apartment building, for example, he knows it will cost him so much to operate…and he knows how much rent he’ll get. In other words, he really does understand the underlying business…just like Warren Buffett understands the businesses he gets into. That doesn’t mean he won’t make a mistake, but it means he’s much less likely to make a spectacularly stupid mistake like buying one of those tech stocks that had no earnings.”

*** Real estate investors may be doing the math, but the math itself may be misleading. If your property is rising between 10% and 40% per year, it makes sense to borrow at 6% to buy it. But that doesn’t mean that interest rates will stay at 6%, or that property will continue to rise. Even at 6% there are costs to holding real estate. Upkeep, taxes, insurance. Many real estate investors seem to be losing money every month – while betting that their property will go up in price.

So far, they’ve been right. On both coasts, property prices are soaring. Even here in Baltimore, where real estate, in real terms, sank for most of the last 75 years, there is a boom underway.

*** “Hallelujah…”

“You mean, because prices are finally rising in Baltimore…?” we asked another friend while walking down Charles Street.

“No, ‘hallelujah’ because they finally cleared the riff- raff out of the old Stafford Hotel. It was Section 8 housing…you know, designed for poor people. But it ended up being a place where all kinds of drug dealers and riff- raff hung out. I talked to a policeman who works around here…he said that 80% of the crime in the area came from that single building…

“But now the Peabody Conservatory – the music school – bought it. They’re going to put their students in it. And you know, they’re all Korean or something.”

“What did they do with the people who lived there?”

“I don’t know, but they should have taken them out and shot them.”

*** What’s going on in Iraq? Hardly anyone mentions it.

“I read your commentary,” began a conversation with a Dear Reader the other day. “And it is kind of funny. I mean, this is a war that is costing, what $100 billion…and nearly 1,000 American lives. But people don’t really talk about it. They don’t really know anything about it, and don’t know what to say.

“The war was probably pretty stupid from the very beginning. But most people trust their leaders…and they don’t know anything about al Qaeda or Iraq. When 9/11 came, they just wanted the government to do something. So, the government did something. Everybody was more or less in favor of it. Even Hillary [Clinton] and Kerry voted for it.

“It kinda makes sense that most people…the people you refer to as the lumpen…would want to go and kick somebody’s butt. America’s supposed to be the biggest military power on earth. It just didn’t make sense that we couldn’t even protect ourselves from a group of guys with box-cutters.

“Of course, that’s the thing about a Republic. You’re supposed to elect people that are smart, sober and calm. And these guys are supposed to sit around in solemn debate at times like this. They’re supposed to carefully weigh the merits of various arguments and decide what is best for the country. They’re not supposed to be swept along by mob sentiment. They might do something dumb.

“But now you’ve got CNN and the Internet…and everybody gets whipped up at the same time…and the politicians just go along with whatever is getting high numbers in the polls. That’s not the way it is supposed to work, but that’s what happens…and it’s just what – who do you keep referring to – de Toqueville…warned about. Or maybe it was George Washington. I think you had the quote in the Daily Reckoning…’I leave you a Republic…if you can keep it.’

“Well, it turns out that we couldn’t keep a Republic any better than Rome could. Now, we have a circus in Washington and a clown in the White House. And I agree with you…Kerry wouldn’t be any better. In fact, he might be worse.

“You had a good line in the Daily Reckoning the other day…what was it…oh…that America will be great as long as she is good. I think that was from de Tocqueville too. But like ancient Rome, it looks to me that we stopped being ‘good’ a long time ago. Good people don’t go bombing other people just because they think they may be up to something. And they don’t let other people pay their bills for them either – but that’s another issue.

“But getting back to my point…I think most people still think that the war against Iraq was a pretty good thing. It got Saddam out of there. And we didn’t know what threat he posed…but at least we found out…and now he poses no threat at all.

“The scary thing is that almost no one was against the war for the right reason…and that’s still true today. People argued that it wouldn’t work. But almost no one said it was wrong to go kill people. If the war had gone well – almost everyone would be happy with it. That’s what I mean about America not being good. Everyone wants it to be great…and no one seems to care if it’s good or not. Maybe it was always that way…I don’t know. You reach a certain size and a certain power…and maybe you can’t help but throw your weight around. I think you’ve been saying something like that in the Daily Reckoning. Anyway…it’s only because it didn’t go well that people are now against it.

Heck, I guess it’s better that it didn’t go well. If it had gone well, we’d be in Damascus by now.”

The Daily Reckoning