A subscription newsletter enjoy nightowls
April 2008 Vol. II, Issue 4 - Recommendations that may surprise you
Welcome back.
Since last month, we have been really flat out. It was fantastic meeting so many of you in Scottsdale. We remain impressed and humbled by the caliber of the subscriber base. Many of you have sent us emails, so let us issue a blanket apology for not answering as quickly as we would like. Travel and a constant barrage of economic and market-related news have kept us on our heels when it comes to correspondence. We will catch up eventually, so please don’t be put off by our slow response.
Good news. Our portfolio has strengthened since the portfolio review last month. As we will highlight in the updates section, several of our picks have reported much stronger earnings even in the face of a flood of bad economic news and worsening market conditions. We are encouraged that our views are finally starting to bear out in the markets, and we reiterate our advice to stay the course.
This month, we highlight a couple of places that are probably too far afield for most of you. We admit they are places well off the beaten path and probably not suitable for any form of passive investment. Albania and the Kurdish region of Iraq have no ETFs for you to buy through your existing brokers, but they are important nonetheless. First, we often get emails from a handful of intrepid subscribers who say things like, “I am open to going anywhere in the world. I don’t have much money, but I will work hard and have an open mind.” We have a growing soft spot for these wildcatters, and both of these places hold an enormous opportunity for them. So if you fall into that category and want to create a grubstake that will allow you to be a full-time speculator with your own capital, then read on. If you are serious about setting up shop, then email us at
withoutborders@caseyresearch.com.
Even if this is not appealing or possible for you, you should know about these places because they are indicative of our favorite geopolitical trend. That is the trend of the further dissolution of present-day nation-states. Just a few months ago, there was rampant speculation that Russia would not allow Kosovo to declare independence. There was equal talk of a Greater Albania where the territory inhabited by ethnic Albanians would call for a new larger and more powerful state of their own.
This seems to be no longer the case; in fact, everyone we talk to says generally the same thing. “We don’t want another state… as long as we can travel freely and trade with our neighbors, then who needs more bureaucracy?” A similar thought process is taking place in the Kurdish provinces of Iraq. Those in the know think that Iraq will fracture into multiple states and the Kurdish region will be the “New Dubai.” It seems a United Kurdistan is something they are more than willing to trade away for diplomatic recognition. We love this and see it as the way of the future. More states mean less powerful states. Less powerful states must rely on trade. Stay tuned.
For those interested in a way to take advantage of the growing food crisis, we bring you what we believe to be an exciting way to capitalize on two trends. The first is the oft-mentioned rise of the consumer classes in emerging markets and the second is the growing shortage of food. Granted, rice and grains are a bigger “issue,” especially if you are concerned with people starving, as we all should be. However, as speculators, capitalists and investors, we see beef demand rising and supply weakening. Therefore we bring you our favorite way to go long beef shy of buying land and employing gauchos.
We set yet another precedent this month with our first U.S. citizen as Heiress of the Month. But don’t worry, this is not an inflection point. We believe her jet-setting lifestyle and residence overcomes her blue passport. Plus, she is pretty and talented and will be fun to watch over the coming years.
Thanks again and we look forward to your feedback.
Fitzroy McLean &
Simon Black
Senior Editors
Casey’s Without Borders
Albania, Albania: It’s on the Adriatic!
We can almost hear you decry our sanity, “Fitz, Simon, have you lost your marbles? Albania? You can’t possibly be serious!?” Oh, but we are.
www.youtube.com/watch?v=-F_tT-q8EF0
Albania is a chaotic conundrum -- lawless, remote, yet strangely cosmopolitan, and parts of it are as beautiful as a major Mediterranean seaside resort. The FBI’s New York City field office lists the Albanian mob as the second most violent organized crime group, just behind the Nigerian “Brothers of Blood.” We think, however, that Albania is the place for young, hustling entrepreneurs to turn $10,000 into $500,000 in a few years’ time, and we don’t think there’s too many places to do that these days. Burma is another. More on that in a future issue. Where there is chaos, there is opportunity, and Albania is long on both without the needless inconvenience of being engulfed in a civil war or U.S. occupation.
Like our previous article on Beirut in December, we must start with a disclaimer. Fitz has a special affinity for Albania based on a lot of time spent and relationships built there, and if he ever does find FitzroyMcLeanstan, then his first order of business will be to recruit Albanian women from the mountainous north to serve as infantry in his Foreign Legion. They may be the toughest humans on the planet. But alas, that is another story.
We were recently able to spend some time kicking around Albania, visiting state-owned assets that were for sale to anyone who would take them. Of particular interest were several small mining operations with full concessions that the government will literally give away to developers who pay to put them into operation and employ Albanians.
During this trip, we had a most enlightening experience where we were able to sit down with two influential Albanians on the same day. One was the honorable Deputy Minister of Finance (see
http://www.mfa.gov.al/english/aktivitete.asp?id=5015), Dr. Sherefedin Shehu. The other was… well, let’s just call him Seka because he is a prominent leader within the Albanian mafia, and all Albanians have code names that hark back to their tribal ancestry. Most of these tribal warrior names sound like ‘70s female porn stars, but we don’t point that out because we don’t want our throats slit.
We were introduced to the honorable minister by a friend at the U.S. Embassy, and Fitz already knew Seka from his experiences with the Kosovo Liberation Army in the late 1990s (one man’s freedom fighter and all that...) Both interviews ran pretty much along the same lines. We were interested in the situation in Kosovo and if the “Greater Albania” was making progress. Most importantly, we wanted to feel the pulse and determine if Albania is on an upward trend or a downward trend.
On the day of the interview, Albania was sweltering in the midst of a full-blown heat wave that made life uncomfortable for all. This was further compounded by the fact that there were major wildfires in Greece and southern Albania, which shrouded the capital in a thick cloud of ash. The fires were the result of a record drought that, in addition to killing crops and making the majority of the topography excellent kindling, left the country without power because most electricity in Albania is hydroelectric and the rivers were too low to generate power. The capital had seven hours of power a day. Packing your bags yet?
Tirana when the electricity is on
The first interview took place in the shabby but oversized offices of the Ministry of Finance. The minister, clad in his short-sleeved shirt, clip-on tie and shiny polyester suit, chain smoked and all but melted in the heat because the ministry was without power and thus had no air conditioning. We declined the offer of lukewarm coffee.
The second interview took place on a bench under a shade tree outside a small factory in a town an hour from Tirana. Seka was clad in a light-blue polo shirt, linen pants and “Italian” shoes manufactured in said factory. We partook in the proffered ice-cold, genuine Italian beer.
After going back through the transcripts of the interview, we were struck by the stark contrast in opinion and tenor of both responses to the identical or nearly identical questions. So, taking a page from the recently departed William Buckley circa 1959, we decided to write up the interviews as though the two interviewees were both present at the same interview but not privy to the other’s responses. The responses are genuine and in response to the same questions posed only hours apart. Only some of the more colorful expletives used by Seka have been omitted because he has a vivid and colorful imagination and uses the F-word as every part of speech ex-gerund. In a couple of instances, we inserted an extra follow-up question or two, which we hope is obvious and not confusing. This effort is all to show you the extraordinary contrast between leading Albanian minds; for the record, neither one of the participants knew the conversation would wind up in print, and neither has ever heard of Without Borders, so their comments were not framed for the media.
WoB: Thanks for taking the time to get together today. Your English is fantastic. I understand you spent some time in the States?
Minister: Thank you. I studied English at the University of Minnesota. I was there for two years in 1997 and 1998 when things were very bad here in Albania. It was very cold in Minnesota, but still probably better than being in Albania during that time. Now things are much better.
Seka: Yeah thanks, man. Much better than the last time you were here, eh? You need English. I was sent to do some stuff in Calgary, Los Angeles and then a little in New York. Upstate. Not the city. Man, it sucks there. Cold. Really cold. I mean this heat is bad, but at least it is not cold. I cannot believe people live in Buffalo and don’t have to. It’s like Siberia, man.
WoB: I see you are busy. What is atop the agenda today?
Minister: We are preparing for a ceremony with a trade delegation from Italy that is thinking of starting a ferry service between here and Bari [on the Adriatic coast of Italy]. These visits are very important to Albania and we have dinner planned with several government officials as well as members of the Albanian-Italian community.
Seka: Sh** man. This electricity problem is killing me. I am a thousand pairs of shoes behind schedule and we get penalized for being late. The Italians are going to be pissed. Maybe we should have stuck to knock-offs?
WoB Follow-up: What do you mean, the Italians? I thought these were all knock-offs?
Seka: No, man, most of our shoes go to the Italian shoe manufacturers. There is some law that allows them to call them Italian shoes because they were designed and packaged in Italy. They glue a little piece of rubber on the heel there and call them Italian. We used to sell only knock-offs, but we actually make more money this way once you subtract out the cost of smuggling them out. It’s funny, we started when the Italians had big problems with workers going on strike and the truck drivers going on strike. We did deals with several of the big Italian companies. They found us. Some Italian guy who worked for the real manufacturer found our counterfeits and said “These are pretty good. Who makes them?” He found some Albanian guy working in Italy who knew someone who knew someone and now, magic, we are legit. We still do the cheap knock-offs down in Vlore [a city in southern Albania], but those go straight to China and the States. Black business is still much more profitable and less of a pain in the ass, but it makes sense to diversify.
WoB: So how is the business climate in Albania today? Are the opportunities growing?
Minister: Oh, things are looking very strong, many of the formerly state-owned industries are being privatized and foreign direct investment is growing rapidly. We are planning a major infrastructure program that will make Albania a gateway between Eastern Europe and Western Europe. We are in talks with the World Bank on a major loan package and we are hoping your country will renew its economic aid package. We were just able to float our first international bond issue in lek [Albanian currency]. This is a major milestone for Albania and shows we are taken seriously by the international financial community.
Seka: Yeah. Pretty good. If the government ever gets out of the way, this place could really boom. But they are all crooks. They f*** everything up.
WoB Follow-up: Hang on. Are you really calling someone a crook?
Seka: Come on. You know what I mean. They are all crooks. They don’t add any value and they line their pockets. They don’t even make anything anybody wants. At least our shoes cover your feet and our CDs have music on them. These guys do nothing except get in the way. They are very good at making headlines and calling for reform, but they don’t do sh** man.
WoB Follow-up: But within Albania, are there more or fewer legal opportunities than there used to be?
Seka: Oh, definitely more. There is a ton of growth all over the Balkans and we are in between the rest of the Balkans and the West. Also, all the Albanians in Europe and the U.S. are sending money back. Not just “our people.” [Ed note: When referring to “us” or “our people,” he refers to the Albanian mafia, which he is fast to point out existed before the Sicilian mafia.] When you were here the last time, we were the only group that was out there making money and sending it back home. Now with the EU growing, the Poles and the Czechs won’t clean toilets and sweep floors anymore. You know that is a growing business right there -- smuggling Albanians into the EU to clean toilets. Forget the sex trade. Anyhow, there are tens of thousands of Albanians sending euros back and they are now in the local economy. They are building houses, buying mobile phones, starting businesses. And because it comes back to real people and not through the banks or the government, it actually counts. Those thieves in Tirana still haven’t built the port with the money they got from the European Development Bank four years ago.
WoB: If a foreigner told you he was interested in investing in Albania, where would you tell him to look?
Minister: Well, here at the ministry we are actively engaged in a program to encourage foreign investment. We can facilitate meetings with other ministries that have opportunities for foreign investors. There is a program with the Ministry of Industry that allows for foreign investors to buy a stake in Albanian companies in exchange for capital investment. We have a program called “1 Euro Albania,” where investors can buy 49% of a state-owned company for 1 EUR if they commit to investing enough money to get the company back in business. We are in the process of unveiling a major roads project that will connect Pristina [the capital of Kosovo] and Tirana. We have just reduced the time it takes to form a company from sixty-five days to just sixteen days.
Seka: You mean to just invest money? Fugeddaboudit.
WoB Follow-up: Did you just say “Fugeddaboudit?”
Seka: Yeah, I love Joe Pesci. But seriously, you can make a ton of money if you have half a brain and are willing to live here. I mean, they are building the road from Tirana to the rest of the Balkans and they need everything -- gas stations, strip bars and whore houses for the truckers, hotels, and restaurants all along that corridor. There is nothing there now, and those mountain people in the rural areas don’t have a clue. I mean, you could just show up and get to work. You want a great idea? Start a company that sells generators and propane in Albania. You know, those little tanks like they have in the States outside Wal-Mart for a gas grill? Like those, but bigger. You could make a fortune by installing those tanks in the rural areas. There are a lot of small mines with chromium, lead, zinc and iron ore. You can make a good living there, but there are two problems. One, the government is your partner. That kills the deal for us. Two, you have to truck the stuff out, and it is all bulk ore, not the actual product. There used to be smelters and processing plants here, but not anymore. They were stolen and sold for scrap. Man, we don’t even have electricity.
WoB: Well, obviously there is a basic infrastructure problem. How can someone invest in a factory or any business in the country if they are not sure there will be power?
Minister: Yes. Yes, this is a big problem. We are working on it. We have a plan. There are plans for a public/private partnership with a big Italian company for a thermoelectric plant. We are very proud that Deutsche Bank has taken a 20% equity stake in the project.
WoB Follow-up: When will the project be completed?
Minister: In just a few years. It would have been earlier, but we had a problem with another company that was involved in the project. They were not good partners for us. They were in business just to make money. [Yes, he really said that!]
Seka: You need your own system. Generators. Diesel is more expensive, but still better than relying totally on the grid. Look. See those? (points to two large generators inside a 100 x 100 ft cage) They are what keep us in business. And we are just a shoe factory with mostly manual labor. You can’t really have any real industry in Albania today.
WoB: What about taxation? I read in the newspapers that there is some controversy over a new law that is causing a big fuss.
Minister: I would not say it was a problem. It is simple, really. If the Ministry of Finance believes someone is not paying the full amount of tax, then they must pay what the government says is the proper amount of tax. But there is a system, via the courts, to dispute the government’s findings. It’s all very open and transparent.
WoB Follow-up: You mean if the Ministry says “You, company XYZ, owe one million lek in taxes,” then the company has to pay it, and then fight in the courts to dispute it? How long would that take?
Minister: I am not sure how long, but it is only fair they pay the right amount of tax. The court system is fair and open.
WoB Follow-up: Yes, but that seems arbitrary and you could put a business into bankruptcy if the government makes a mistake. Most companies, especially growing companies, don’t have excess cash to spare, and wouldn’t it hurt their banking relationships if they have a tax dispute with the government?
Minister: Well yes, maybe, but they should pay their taxes and there will not be this problem.
WoB Follow-up: But would it not be better if the government had to first prove through the courts that a business owed the money? You could erroneously ruin a company, create a loss of jobs and cause hardships to families if the government was wrong. It could cripple a business, but it is not as though the lack of that disputed revenue is going to keep the government’s lights on… oh sorry, bad example.
Minister: That’s not funny. The electricity problem is because of the drought. Surely you cannot blame the government for the drought. Do you like baseball? I am a Twins fan. I can now watch the games on satellite.
Seka:Taxes? Who pays taxes?
WoB: What about real estate? Is real estate a good investment for foreigners?
Minister: Yes. Foreigners can own real estate. In some places foreigners cannot own the land but can have a 99-year lease like in England. They can own the improvements. Real estate has been a good investment with the prices increasing rapidly. We have a beautiful seaside. There are many opportunities to develop resorts in the south. In some places in Tirana, apartments are selling for 2,500 euros a square meter, which is as much as property across the Adriatic in Italy. There is now a growing mortgage market that makes prices more stable. Plus, there is the benefit of future EU membership.
Seka: In Tirana? No way. It’s crazy. They are paying more than in Italy now. It is because all of these ignorant communists that have to put money somewhere, and they don’t trust the banks because of what happened in ’97, they just buy property. Plus, “we” buy property to clean money and that makes the property go up. So, for investors? No. Stay away from property in the cities. The same is true for the seaside. We are buying that for “other reasons” and we don’t want to share that. Someday you can stay at my resort. Now, like I said before, along the new road between here and Kosovo, there are bargains. If you know where the road will be, you can do well and you can buy that property for almost nothing.
WoB: Is Albania a candidate for EU membership?
Minister: Naturally we want to be members of the EU. It is a top priority of this government to bring our regulatory standards in line with the directives outlined in Brussels. We are still recovering from the crisis of the late 1990s but hope to be part of the EU as soon as is feasible. [He went on painfully for almost ten minutes with barely a breath taken, clearly in his comfort zone spouting off one EU regulation after another and outlining the Albanian plan to conform. We shall spare you the details.] We have been very careful in our expansion of the banking sector so as to not run afoul of the OECD or the EU. We are very proud of that.
Seka: Who cares? I hope not. I doubt it.
WoB: Many developing countries have successfully started economic citizenship programs to encourage foreigners to immigrate to their country, start businesses, supply expertise and of course generate revenue for the government. Have you considered such a program?
Minister: What do you mean?
WoB Follow-up: Well, there are nations, in the Caribbean for example, who offer citizenship and residency for a fee, or through investment into the local economy. This encourages entrepreneurship and generates income for the government.
Minister: Who would want to be an Albanian?
Seka: Well, I guess it might work if someone from, say, China or India wanted to be closer to the Eurozone and thinks that Albania will eventually be part of the EU. Or maybe if you are from Iran or another place where you are worried about war or something like that. Yeah. It could work. But this government would not get it.
WoB: Thanks for your time.
Well, that about says it all. Albania is wide open and we think a land of opportunity for those willing to roll up their sleeves and give it a go. The road from the deep water ports in Durres and Vlore will make an enormous difference to the Albanian economy and now, with Kosovo independence and EU support, it will likely get done.
The Durres-Prizren-Pristina highway should be completed by the end of next year, and the whole drive should take less than three hours. Today, fewer than 2,000 vehicles cross the border between Kosovo and Albania each day. The number ought to be in the tens of thousands if you just look at the number of trucks that presently take the long way through Macedonia. It is a natural and historic trade route that makes sense: raw materials going west and finished products going east. Enthusiasm for cross-border travel and trade is high following the declaration of independence and international recognition of Kosovo. Kosovo actually has finished goods for export and they do not want to rely on Serbia’s transportation network to get them out.
At present, the drive between the capitals (Pristina, Kosovo and Tirana, Albania) takes a grueling 10 hours or more, much of it on a bumpy, painful chiropractor’s dream of a road through narrow mountain passes in northern Albania. There is an existing Central European Free Trade Agreement (CEFTA), which makes exporting and importing to the EU relatively easy. Only the geography has kept it from flourishing. We think the road will make a difference and any entrepreneur could flourish with a chain of gas stations, rest areas or hot dog stands along the way.
But it is not just the road, it is the culture and the lack of entrepreneurial expertise, acumen, and drive. We firmly believe that an aggressive foreigner with a modest amount of money in his pockets could make a fortune in Albania… especially an American. Here are some of the ideas we had from our visit:
The Albanians love Americans. It is one of the few places left in Europe where being an American is a major plus. People still approach you in the street and want to talk to you. You are actually given the benefit of the doubt. Just by hanging your shingle as the “American Business Consultancy,” you would drum up business overnight. This was true in almost all of Eastern Europe fifteen years ago and we know people who made fortunes this way. One former Kentucky real estate salesman-turned-“management consultant” friend in Romania charged a daily rate of three hundred dollars a day plus 0.5% of the equity in the business per day (up to 25%) of the company for his services, which were mostly sales and marketing advice beginning in 1992, and walked away with about six million dollars in 1998.
There is an absolute void in the market for start-up capital. An enterprising entrepreneur could easily start five to ten profitable businesses ranging from courier services for international banks to relocation services for expatriates to import/export businesses for less than two thousand dollars each. Just stay away from nightclubs and bars as Seka’s friends have a corner on those and get touchy about them.
There are many multinationals moving into Albania and Kosovo. As a rule, they do not like or trust the Albanians. The chairman of a foreign bank, who worked in Serbia, Croatia, Romania and Bulgaria, said, “Albania is the epicenter of the Balkan mentality. Here they are just as stubborn but twice as lazy.” This may or may not be well deserved, but the reality is expats want to hire other expats. If we had the time and energy, we would start a “fixer” service where we hire a platoon of Albanians that speak passable English (of which there are many) and then offer the collective services to foreign companies. Your fixers then run errands, stand in ridiculous government office lines, pick up people at airports, go shopping for fresh vegetables or anything else, for that matter, for the expat community. You can double if not triple your markup on the labor and have more business than you can handle. Call it a “concierge” service instead of a “fixer” platoon and you can charge even more. The snobby middle-class German lady whose husband’s job transferred them to Albania loves having servants.
Go to Kosovo, cozy up to all the ridiculously lazy, overpaid NGO workers and find out what they want but don’t have. Fill up a truck with whatever they need, which can undoubtedly be found in Albania for a fraction of what it costs in Kosovo, and load up a weekly truckload.
Start a restaurant in Kukes, which is on the Albanian side of the Kosovo-Albania border, and call it the American Trucker's Club. Sell burgers and sandwiches and fries and Cokes. Have cute little waitresses. Play country music. Yours will be the place to stop, pee and eat on the journey now and even after the big road is built. Odds are you will become the center of deal flow for a good number of transactions in the boomtown. Think Al Swearengen in Deadwood.
Buy land in Kukes. It is remote and cold and right now almost deserted. But it is gorgeous, with big mountains and blue lakes. It has power because it is the site of a massive hydroelectric facility. Eventually it will get developed and you will be glad you did. It may take a decade for this to pay off, but it will. How much are you risking? Well, a plot of land of about five acres just outside of town along the main road, which will likely be the route of the new road, is for sale for a whopping $1,400.
So, in summary, Albania is one of the last safe places where chaos reins supreme and opportunity abounds. It is a cheap place to live, and hey, they can’t afford pesticides, so all the food is organic. We like it. It is gritty, pretty with lots of stupidity. For the single hard-working bachelor (or bachelorette) interested in making his/her speculating grubstake, there are few places without bombs, bullets or insidious tropical disease where you can accumulate so much in such a short period of time. And there are five flights a day from Tirana to Italy, so you can get your fix of “culture” on short notice. Try that in Angola. Think we are pulling your leg? We'll put down startup capital for hardcore entrepreneurs ready to go. We are not kidding.
Undervalued Exchange-Traded Commodities (LSE: CATL)
Thus far in our Without Borders journey, we have endeavored to build a portfolio of undervalued non-U.S. equities... and while these equities make up a large portion of our personal portfolios, we are also heavily invested in many of the speculative recommendations covered in other Casey Research publications. We believe wholeheartedly in the fundamentals of this commodities cycle, and especially in the rise of precious metals due to a looming, spectacular collapse of the international monetary system. But metals and energy aside (which are well covered by the International Speculator and Energy Speculator), we believe in a very compelling case that agriculture price growth may outpace energy... and right now, we are incredibly bullish on, well, bulls.
For those of you who subscribe to the International Speculator, you may recall reading Doug Casey's article titled "Cattle Call" from February 2008. Doug believes, as we do, that cattle are among the most undervalued commodities so far in this cycle. However, barring a crash course in the futures market or buying an estancia in South America to head up your own beef operation, your investment options have been limited. Recently, though, we have found what we believe to be a low-risk, highly liquid way to take a position in a variety of commodities, including cattle.
It's What’s for Dinner
Before we get any further, it is worth having a discussion about bovines. You are undoubtedly aware of the demand side of the equation; much has been discussed about the rise of developing nations and the change in their dietary habits (Hindia excluded, naturally) that will trend towards a higher proportion of daily beef intake. Steak has always been the rich man's food, and an expensive filet has been associated with the finer things in life, like a '97 Latour or Montblanc pen. The existing data is very compelling, both from developed and developing countries.
As a starter, consider that global beef consumption is presently about 70 million tons annually. Now consider that Russia, already one of the world's largest beef importers, is expecting an additional 190,000 tons of imports this year alone to meet growing demand; that’s 25% more than last year. Japan, already a massive beef consumer, is experiencing double-digit consumption growth, even in the face of a stagnating economy that has spanned two decades. Mexico, another of the world's top consumers, is experiencing 30% growth in beef demand. Both the EU and South Korea, large beef consumers, are expecting 10% increases in demand. While part of the demand increase may be due to the declining dollar and lack of beef price spikes, U.S. consumption is also up a significant 4%.
Overall worldwide consumption growth is estimated at 7%, and this does not take into account the continued rise of Asian consumption. In China, beef is becoming a weekly indulgence. With an emerging middle class of over 500 million in China, and another 100 million across the rest of Asia, we calculate that within 2-3 years they will create a 2-million-ton increase in annual beef consumption, equivalent to approximately 8 million beef cattle for slaughter.
The issue with demand is timing; wages, standard of living, and dietary trends change faster than the beef cycle can keep up. It takes a long time to build, manage, and grow a herd when you are constantly slaughtering your inventory; meanwhile, the newest Estonian tech millionaire wants to take 100 of his best buddies out for prime rib. That puts upward pressure on prices, particularly when there are so many new consumers entering the beef market.
Even in the event of a global slowdown or deep regional recessions, people still eat. At the macro-level, diets are influenced by culture, and the developed world eats beef. Consumers feeling the pinch may start choosing less expensive cuts, but at the macro level, overall beef consumption should still remain high in lagging economies.
She Walks, She Talks, She's Full of Chalk
Now for supply, and this is where it gets challenging. It is important to note that with advances in production, the average size/weight of beef cattle for slaughter has increased over the last several decades. We believe, however, that the development of new production methods to fatten up cattle will occur at a much slower pace than the increased demand trend. In fact, the latest figures released in January 2008 indicate that average cattle carcass weight at slaughter has been flat over the last two years. Consequently, in reference to cattle supply in this article, we discuss herd size, not weight.
World beef cattle supply is about 1 billion head, with major producers including China, Brazil, the U.S., EU-25, Argentina, India (religion only goes so far), Russia, Australia, and Mexico, each with over 5 million head slaughtered annually, and each averaging a herd size of over 25 million head. These nine countries account for approximately 80% of worldwide production (classic 80/20 rule), and they all generally experience the same production challenges, which include:
* Increased production costs due to regulatory requirements and feed
* Natural phenomena including disease, weather, and predators
* Consumer trends towards organic/grass-fed beef
* Lost-opportunity costs to utilize land for more expensive grain crops
* Government mandates like Animal ID, export tariffs, and anti-free trade legislation
* Climate zealots (fart farms coming your way)
The biggest problem of all: input costs are rising. One need only look at a grain chart from the Chicago Mercantile Exchange to see that feed prices have doubled. Considering that it takes roughly 8 kg of feed to produce 1 kg of beef, the cost of production is quickly becoming untenable for beef producers, especially for smaller ones who cannot achieve efficient economy of scale. Consequently, many beef producers are left to wonder whether their operations would be more profitable if they grew corn, wheat, or soy, given those commodities’ price run-ups. This quandary has taken a lot of small and medium-sized producers out of the game, which in many cases means they liquidate their entire herd, thus diminishing the supply of replacement beef to grow next year’s herd. This phenomenon is being realized in the United States in particular.
U.S. beef cattle herds total approximately 67.5 million head. This number supports a harvest each year of some 35 million animals, which represents about 11% of the world’s 300-million-head harvest. Overall, U.S. beef supply is falling, now below 2003 levels. One of the reasons for this trend is that micro-producers in the United States, those with 100 head or less, have been getting out of the business at a rate of about 2% per year since 2000. And when they leave the business, they liquidate their existing herd and cash out, and many times this means an all-out slaughter, rather than selling to another producer.
The number of medium-sized producers with herd sizes up to 1,000 has been relatively stable; these producers are large enough to absorb increased costs through their higher volume, but they are generally too small to turn a profit. Like a rental property that breaks even in a down market, the owner will likely decide to keep the property until the market cycles back since s/he is not in a losing situation.
Meanwhile, the number of large producers in the U.S., those with a herd size of several thousand, has actually increased… to us, this indicates that many medium-sized producers are consolidating and merging because only those with massive economies of scale have the appropriate cost structure to weather the rise in input costs. This effect of squeezing out the little guys creates tighter supply on the market over the medium term.
We see other signs of this trend by looking at the average age of cattle at slaughter; it is estimated that some 80%, or 28 million head, are 12 to 30 months of age, which indicates both a rising trend in the demand for younger, tender beef, and a rise in the liquidation of replacement herds.
Aside from rising input costs and producer consolidation, disease is another plague on herd size; there are scores of diseases that may afflict a herd, from the well-known Bovine Spongiform Encephalopathy (Mad Cow) to the obscure necrotic enteritis. Many of these can spread quickly across a herd, and producers sometimes find themselves in the unfortunate position of having to exterminate large portions of their livelihood, similar to the outcome of the UK’s foot-and-mouth outbreak last year. The costs of preventing, managing, and eliminating disease from a herd can be overwhelming, as can losses due to even minor infections. Higher population densities (heads per acre) and larger contiguous herds add to the problem of disease, and our data show the industry moving in this direction. Some producers cut corners with sick herds these days in order to realize a small profit; most recently in California, Westland Meat Co. was forced to recall 143 million pounds of beef when the USDA found out they had slaughtered and packed sick cows in their product. Upon hearing the news, wholesalers across the country immediately rejected and destroyed the product – and poof, there went the equivalent of 1% of the entire U.S. beef cattle herd. This type of news is relatively commonplace, and the political reaction generally leads to increased government regulation. Additional administrative processing, implementation of animal ID tags, and increased inspection processes requiring additional time and cost from beef producers, further eroding their already thin margins. The U.S. government adds insult to injury when it conducts raids against ”illegal immigrants” who work in the beef industry for sub-minimum wages. Now producers, in the face of an immigration backlash, have to contend with rising labor costs as well.
Meanwhile, consumers are trending towards cleaner, healthier, more natural beef… and rightfully so – what we put in our bodies is of tremendous importance. As this consumer trend progresses around the world, beef producers will fall under increased pressure to raise grass-fed, hormone-free cattle with increased transparency, and this will significantly lower production efficiency per acre as well as profit margins.
The Bottom Line
You’d think U.S. beef producers would prosper under the administration of a Texan (after all, only two things come out of Texas…), but this has not been the case. Bush’s stance on corn ethanol, one of the most ridiculous notions in the history of energy policy, has artificially inflated the price of corn, which has historically been quite precarious due to fluctuating weather conditions.
Due to the rising price of food, partially a result of corn-based ethanol, India’s finance minister recently called the use of food for biofuels a “crime against humanity,” and he fears widespread riots and starvation from the worldwide poor. We think, given the effect of feed prices, beef producers will be standing in the picket line with them.
Speaking of nutty government policies, the administration of Cristina Kirchner in Argentina, with a very significant 54 million head of cattle, has imposed another round of price controls through an export tax on Argentine beef. This export tax forces Argentine producers to sell their meat at an artificially low price domestically. A pimply-faced teenager in high school economics could tell you that this is a massive policy failure in the making. If you read our article on EDENOR, the Argentine power company that suffers from yet another government-imposed price control, you may recall that blackouts occur in Argentina because electric companies do not generate revenue under the mandated price to consistently meet their production costs. Similarly, beef producers in Argentina do not make enough money from the fixed price to raise cattle profitably, and the result has been steak houses with no steak, and butcher shops with no beef.
The overall net effect of all of these challenges is the restructuring and downsizing of the cattle industry, and we are starting to see the signs of this in the United States and around the world. Meanwhile, medium-term demand outlook appears quite strong. People in the developed world will maintain their beef appetite, while hundreds of millions of Asian consumers, influenced by a changing culture of new money, make beef part of their staple diet. The diminishing supply and rising demand will put upward pressure on prices over the next several years until beef producers can increase their herd sizes to keep up with demand growth.
How to Play It
The London Stock Exchange (LSE) has an interesting array of products under the umbrella known as "Exchange-traded commodities (ETCs)," which are publicly traded securities on the LSE that track the prices of underlying commodities. Similar to an ETF, an ETC is priced, traded, and settled just like a stock; in fact, investors can even margin and go short an ETC.
It is important to note that ETCs provide direct exposure to the underlying commodity, not a basket of companies that specialize in that commodity, i.e., the copper ETC tracks the actual price of copper, not the net asset value of a portfolio of copper miners. However, the ETC is not a futures contract or option. In fact, the structure is most similar to an exchange-traded note (ETN); in this case, the issuer is ETF Securities Ltd. (www.etfsecurities.com), an established UK company that listed the world’s first ETC in 2003. The ETC is really a debt obligation – an asset-backed, zero coupon note with no maturity date. The note obliges ETF Securities to pay a return tied to the return on the Dow Jones-AIG index for the underlying commodity. So let’s walk through an example of how this works:
To create a note as a publicly traded security, the “authorized participant,” usually a market maker, decides s/he wants to buy a block of ETCs… so s/he notifies the commodity exposure provider (AIG, in this case) and pays cash based on the ETC price set by the issuer (ETF Securities). In response, ETF Securities tells AIG, “Okay, please accept their cash, and purchase the appropriate number of futures contracts based on price X,” where X tracks the price of the commodity less a small management fee. Once the commodity/futures contract has been purchased, ETF Securities will issue a note in the account of the market maker, and this note becomes tradable on the secondary market under the appropriate ticker symbol for the particular ETC (there are a few dozen of them).
The reverse of this process would be the cancellation (retirement) of the note, in which the market maker redeems the note to ETF Securities, which would direct AIG to sell the underlying commodity and pay the proceeds, less management fee, to the security holder.
Remember, none of the securities issued confer any rights to the underlying commodity, i.e., you won’t have a bunch of cattle, corn, cotton, or copper delivered to your door. And like anything else traded on the London Stock Exchange, it’s all regulated by the Financial Services Authority (FSA) in the UK.
Risks
Some of you are probably wondering, who are these ETF Securities guys? Well, you’re correct in asking the question. The major risk here is counterparty risk, i.e., what if ETF Securities goes belly up and cannot pay what it owes on the notes?
Each ETC is issued by a “special purpose vehicle” whose assets are the futures contracts held in custody by AIG. ETF Securities does not have any claim to the assets, nor does it manage any investor money – all cash and asset custody is outsourced to AIG, so if ETF Securities went out of business, the value of the note would be unaffected. As a worst case, note holders would be able to lay claim against the assets of the special purpose vehicle, which would essentially be the market value of the futures contract. Either way, investors will be able to redeem their notes for the market value of the futures contracts.
The real risk we see is if ETF Securities mandates a liquidation of the holdings of the special purpose vehicles; from page 110 of the 217-page prospectus, there are specific stipulations in which ETF Securities may give notice (usually 30 days) of compulsory redemption, i.e., all note holders will be paid out at market value for certain, pre-specified reasons. The biggest stipulation is an event that changes the facility agreement with AIG, including a downgrade in AIG’s creditworthiness from the crystal ball rating agencies. Our assessment is that ETF Securities will do everything it can to not disrupt the stability of the ETCs it has created, or its reputation for administering them. For now, we do not believe this risk to be very high at all, though we will continue to monitor the situation.
Tax Rules—Uncertain Future
When they first came out, ETNs (and by extension, ETCs) were the darling of the investment community. ETFs pay dividends and are subject to special tax rules, while ETNs were initially only subject to capital gains because they paid no interest or dividends. iPath’s currency ETN, for example, which tracked the value of the euro vs. the dollar (NYSE: ERO), was an instant hit.
In December 2007, however, currency ETNs were ruled to be treated as ''debt'' for federal tax purposes, which means that all gains are taxable as ordinary income, just like interest income. But what’s really mystifying is that if an investor holds the note for, say, three years, s/he will be subject to annual taxes on the average annual gain (taxed as ordinary income) for each year until the sale, even though s/he hadn’t actually sold the security until year 3.
This is truly mind-boggling because unless an investor has a Masters degree from the academy of Nostradamus, it makes it impossible to compute taxes. This is the original issue discount (OID) rule. It was enacted in the high-interest rate environment of the 1970s to take the fun out of back-loaded bonds. Previously, accrual-method taxpayers would issue long-term notes that provided for all or most of the interest to be paid at maturity. Being accrual-method taxpayers, they would accrue the total interest expense year by year. Cash-method taxpayers would buy the notes and not recognize the interest income until they received it, at maturity. Treasury people, being incapable of taking a joke, didn’t like the mismatch between income and expense. The heart of the OID rule is that if a debt obligation does not carry stated interest at a rate at least equal to Treasury securities of comparable maturity, then the holder of the obligation must accrue interest income at that comparable Treasuries rate. There are further rules for debt obligations that carry “contingent interest,” which would apply to commodity ETNs.
Given the OID rules, the place to hold an ETN would be in an IRA, 401k or other pension plan, or in a variable annuity or variable life policy. That would eliminate the immediate tax problem and the accounting chore. These rules can change, so as always, consult your tax advisor.
U.S. vs. UK
ETF Securities provides ETCs in the UK, traded on the LSE, backed by AIG. To take a position in beef cattle, you can access ticker symbol CATL from either E-Trade or Interactive Brokers. As a disclaimer, ETF Securities makes it very clear that they are not registered with the SEC and consequently don’t particularly want the agony of U.S. investors. Rightfully so, American regulatory and tax authorities are very cumbersome. Despite the admonition in their prospectus, however, it is possible (and perfectly legitimate) to buy these securities through your regular broker. You get a highly liquid, low-risk, low-cost instrument to take a position in a commodity with fantastic long-term potential. Just bear in mind the difference in trading hours in the UK, so you might have to get up early if you’re looking to place an order based on intra-day pricing.
We would be remiss in our duties to you if we did not at least point out that iPath in the United States, backed by Barclays, provides a similar security traded on the NYSE: COW. This security is also a note structure but more complex, providing a 1/3 – 2/3 mix between lean hogs and live cattle, and with much higher fees (0.75% vs. 0.49% for the UK ETC).
This is a long-term buy for us, unless there is an immediate, rapid rise past 11, in which case we will consider temporarily taking our money off the table during a consolidation period. We are accumulating below $9.25 and buying on weekly dips.
Recognizing that we just wrote a massive portfolio update last month, we’ll keep the highlights short in this edition. Our recommendation from last month, West China Cement (AIM: WCC) released earnings about 10 days after we filed our report, which precisely captured our expectations and highlighted the company’s overall growth potential. Despite heavy rains and other adverse weather conditions that had beaten down its stock price for the last few months, West China still posted 74% earnings growth, giving the stock a nice pop. According to the company,
"Current demand for cement is strong, driven by continued urbanization, robust infrastructure investment, and new rural construction. On the supply side, the PRC Government is controlling the establishment of new cement plants and closing down inefficient and polluting plants. This provides a good basis for strong cement prices." -WCC earnings release
This is good news for West China, which has already converted to the new, cleaner cement plants that the Chinese government is requiring, and this gives the company a strong competitive advantage. We think the company has a long growth phase ahead of it, and can see it trading at 2 or 3 times current levels within a few years, so we are going to sit on it and accumulate additional positions on dips. Be mindful that this stock can have tremendous intraday volatility, sometimes with nearly 20% between the daily spread. But remember, there is a difference between the stock and the business. The business is fundamentally solid, and product demand is incredibly strong. The stock will also get a pop if the renminbi rises against the pound because the company reports earnings in renminbi, but the stock is priced in pounds.
In other news, Bladex (NYSE: BLX), the supra-national trade finance bank based in Panama, also reported earnings since our last edition, and once again had a banner quarter, exceeding expectations and demonstrating that their business model is a money machine. For those of you who heeded our call to buy on the recent dip, you may now have an average cost basis of $16.00 and show a significant gain from the recent price of $19.02, especially including the two dividend payments received since September. After the earnings release, Bladex was upgraded by JPMorgan.
Copa Airlines has also surged recently, back above our $40 initial recommendation. We still think the business is an excellent long-term buy due to increasing demand from the growing Panamanian economy, smart fuel hedging, and increasing capacity. If this is a long-term hold for you, then keep holding, but if you are in Copa with funds you might need or want to reallocate in the next few months, then the recent price may be a good exit. Airline stocks, unfortunately, tend to move in concert in the short term, and Copa may get hurt again if the other airlines start to suffer.
Travel Schedule
If anyone out there wants to catch up with us on the road over the next month, at least one of us will, at some point in the month, be in Croatia, Slovenia, Slovakia, London, New York, Vermont, Florida, Panama, Uruguay, Paraguay, and Argentina. Shoot us an email.
Simon and Fitz -- I am not good at music trivia, but I always like a contest and assuming I hit the right YouTube link, I may have your ironic answer. If the song is "Shut up and drive," it is very ironic that the more time people spend driving (or sitting in parking lot traffic like you mention), the more time they spend talking on the cell phone.
Have to say that I will blame Eskom power problems for me not writing this from South Africa as that was my plan -- if I ever had one. Instead, I have had such a good time in Argentina this year that I have stayed holed up here. Aside from listening to people banging pots and pans in BA the last couple days (if this president's stance on dealing with high prices is indicative of current females’ tendencies, the U.S. should be very concerned if Hillary ever did get elected).
Hope everything is well your way and do enjoy your monthly reports. Did make a bit of money on ATB, but as I do really like fooling with that sector, I think I do better with TBSI and DRYS on volatility basis.
Todd
Todd, close but no cigar. The irony in the song that we mentioned (http://www.youtube.com/watch?v=3soJJ-35fLQ) in last month’s Panama update is that the title is “Caribbean Blue,” while Panama City is on the Pacific. Not to mention, anyone who has been to Panama City can tell you that the presence of an additional lane on Balboa Avenue will not result in shiny, happy people driving down the road.
Thanks for the stock mentions, we’ll look into them. We wouldn’t necessarily characterize Cristina Kirchner’s policies as indicative of the entire female gender, just as we wouldn’t necessarily characterize George the W’s policies as indicative of the entire male gender… but we’re with you, reading an Argentine paper makes us scratch our head and pontificate about how long the good idea bus in Buenos Aires can keep rolling along before it drives off a cliff.
***
Hi Simon & Fitz,
Some experiences when traveling with bullion:
If you put a few smaller coins in your wallet, they just look like regular coins in the x-ray.
In 2005, I carried a couple of kilos through from LA to Auckland (NZ). They were of various sizes and all bound together in two rolls and looked like a couple of solid round bars (or nun-chucks). I had them in the zip-up front pocket of my carry-on day pack. They showed up on the LA x-ray... the TSA guy was a big chap, but with all the other stuff I had on top of them, you need to take it all out, or have a small hand. He tried and tried, took out some stuff, tried again and still couldn't actually find them. Amazing! They weren't hidden. My wife has had a lot of bad experiences at borders (she's Russian), and she was going through behind me and ended up right in front of this TSA guy who was getting frustrated. I had decided "not to speak until spoken to" and was getting anxious also (in the way that you try not to look or feel nervous at customs). Anyway, he couldn't get these two "bars" out. He looked at me and asked, "Have you got some spare change in here?" I looked and said (in my best not-nervous manner), "Yes." That was it. He politely handed me my pack and the few bits he pulled out and we were through. Have you heard about all the stuff that gets past the TSA screens by the guys testing the TSA screeners? Depending upon the airport, 40-50% of fake bombs, weapons, etc. are missed. My wife now refers to gold coins as "spare change"...
Exchanging physical coins (I haven't done bars) for local currency:
Sometimes when traveling, instead of going to the bureau de change, we find a coin dealer -- just to test. The price really is constant around the world, it's just the fees... it pays to have a spread of types and sizes of coins. Having everything only in 1 oz can be a problem.
In NZ and some other countries, if a gold coin isn't pure precious metal (24 kt), you have to pay a tax (goods and services tax in NZ = 12.5%) with a dealer on the buy and the sell -- OUCH! The Vienna philharmonica is a stunning 24 kt coin that often sells for less than maples or koalas (and certainly pandas).
Old European coins (particularly old British sovereigns and Swiss francs) work well in Eastern Europe and the UK, but there is no numismatic value to be gained -- if you had paid that and were looking for it on the sell (I stick to the old British sovereigns, Swiss and French francs and the Austrian corona as they are common, easily recognizable, contain varying amounts of gold to the new bullion coins, sell for close to spot and don't cause any problems going through customs). Krugerrands are recognized everywhere.
Unfortunately there are some countries/people where it is safer to pull out maples etc. than eagles. You'll know it -- just good to have the option.
Sometimes when entering a country (depending on the country and the real value of the bullion I'm carrying), before choosing either the "declaration or nothing-to-declare" customs path, I seek out a customs officer, tell them what I have and ask which line I should go through. To date they have always said "nothing-to-declare" -- comforting, so far.
Thanks for the BLX update!
Dave
Dave! This is fantastic info and I think our readers will be happy to benefit from your experiences. As for our own, we have never been hassled having transported precious metals across three continents so far; most countries that we have been to do not officially recognize gold and silver without face value as currency. Not yet, at least. We have been considering designing and developing our own secure storage facilities in Panama and Uruguay since there is an extreme shortage of private facilities in those locations, and we are comfortable with the jurisdictions. It’s tough to store physical wealth in a safe at “home” when you have no home – just ask Black, the guy lives on an airplane.
***
Dear Without Borders,
Love your publication. I subscribed to it literally a couple of days ago, and been going through archives so far. I've been thinking about relocating to Panama for some time (based on some other Internet research), but after having read your intelligence, I have come to the conclusion that this is the right place. Good work and thank you.
I hope you could help me with my inquiry. My timeline for moving to Panama is 3-5 years. But in the meantime, I'd like to get a foot in the door as soon as possible. As far as I can see it, there are two options available: a) buy a flat with a down payment and rent it out in order to (ideally) cover mortgage payments, or b) invest in a qualified reforestation project. Or do both if finances permit... I'd like to get your opinion on each. The pros and cons, as I see it, are: with a property investment, you put down a smaller amount of money, you've got a place you can move into on relatively short notice, plus, you have a potential upside if the property appreciates, but you've still got to cover mortgage and maintenance, and you still remain a "visitor." On the other hand, if you choose to go with a reforestation project, that would require a larger initial investment, a less certain outcome (12 years and more investment horizon is a heck of a lot to make any reasonable forecast), but you qualify for residency straight away, without a need to be physically present in the country, which is suitable to my situation, and this time also counts toward a 5-year residency requirement in order to be able to obtain citizenship.
What would you do? Your opinion, as always, is highly appreciated.
Kind regards,
Dmitrie
Dmitrie – welcome to Without Borders, and thanks for your letter. In regards to your question, there are a lot of ways to obtain Panamanian residency. The forestry visa programs are a cheap entry, but we don’t think the investment value is worth allocating the capital for – there are other, cheaper ways to obtain residency. In fact, unbeknownst to most, Panama has several bilateral agreements with other countries that provide for instant residency.
As for buying property, there is a solid market based on growing demographic fundamentals in Panama. We think that the Panama City market has likely peaked for this cycle, so be cautious if looking there. The real opportunities are just west of the city and on the Caribbean side, if you can find titled land.
Our man on the ground in Panama is Robert O’Neill (robert@overseasassistance.com); he can help you find property or put you in touch with the right legal team for immigration or offshore corporate structures like Panamanian IBCs and LLCs.
***
Hello, I need the email address for one or both of the editors of Without Borders, to ask them for some contacts in Uruguay, where I'll be for the first half of May. I've not been able to find the email in the issues themselves.
Mark
If you’re interested in real estate, contact David Gasparri at Antonio Mieres real estate (dgaspar@movinet.com.uy). He specializes in rural land and farms in Punta Del Este or Jose Ignacio. David Hammond at Paradise Uruguay (paradiseadvisor@gmail.com) offers relocation services ranging from real estate sales and rentals as well as just being a wealth of knowledge he is more than willing to share. He is an American who now lives in Uruguay. We have just recently met another very capable professional who also assists with relocation and residency issues. Her name is Margret Holzer de Baezand; her company is the Uruguay Property Partnership (www.uruguayproperty.com). Margret is originally from Germany, but was married to a Venezuelan diplomat for many years.
For legal questions, contact J.P. Damiani and Associates in Montevideo (i
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