Failure by design

Well… I am back from my personal hiatus.

Topic of the day is GDP, and what has changed. The last consumer led recession in the US occurred in 1978. A consumer led depression occurs when the consumer no longer has cash to spend and the economy seizes. This is different from a producer led recession where they cannot sell their product (normally overseas) and are forced to cut work at home.

Now the US on a Federal mandate, has transformed from the producer of all high-level high margin items, to the producer of virtual wealth. Instead of making cars, TVs, appliances, ships and steel… they make websites, retail everything, and “value added financial products” that are hard to value but get AAA-rated anyways.

So people used to make high margin items and now are in the service industry…who cares. Despite having a lower standard a living, and a less skilled labor force it’s not that big of a deal right? Well… 70% of the US GDP is now consumer based. A large portion of that was fueled by Home equity loans. The savings rate was negative for the last few years. People largely have negative net worth and 3.5 adjustable rate loans are going to reset this year.

Ok, so now there are more people who live paycheck to paycheck, no longer have access to credit and the economy is based on consumer spending…. does anyone else not see a problem with that? Bankruptcies are going to get worse… much worse.

Let’s just make up a simple example where you employer experiences a revenue downfall of 10%. In scenario A) you work at a factory that makes widgets and has a gross margin of 50% in B) you work for a retail store (Walmart) that makes 20% if they are lucky and they are the best. As side from the fact that you would make half or less working for Walmart, the impact to their business will be much larger, fixed costs are much higher in retail/service than they are in manufacturing.

So people lose their jobs quicker, businesses can’t get loans to help people finance things (which I think at this point is good, but not for the economy)…the economy will shrink.

This last week the media has been misreporting the Warren Buffet investment. He is not bottom feeding he is leveraging his money to make massive guaranteed gains that most people cannot do. HE IS NOT BUYING COMMON STOCK. He is also not getting normal preferred stock. If you buy into GE just because buffet did you deserve what is coming to you. The fact that GE and Goldman Sachs needed to sell to buffet at such undesirable terms speaks volumes. AIG has almost maxed their credit lines, and with Congress fumbling what used to be a $700B but is now a $1T buy-in… I don’t believe anymore in the US gov’t than I did last year.

Buffet got preffered stock which is stock that pays a dividend that is agreed upon by the issuer and the buyer. It does not appreciate like common does. It is basically a bond, with preferential tax treatment (bond income is taxed at normal income rates, dividend is capital gains). It is a perpetuity, the dividend does and can increase, and if Goldman or GE wants it back they need to pay all of his original capital plus 10% premium and Buffet keeps the dividends… which are twice what normal investors would get for preffered capital.  And for his good deed of providing capital, he gets the option (warrants) to buy common stock for below market price and at no risk to ANY of his original capital.

These companies were desperate to shore up their balance sheets, and Buffet was not willing to take a risk.  He basically has protected capital, guaranteed at 10% dividend and also has the chance to enjoy upside on the common stock through the warrants he received, which are already in the money…. and if you subtract their current value from his capital contribution reduce it dramatically.

Which is why they markets didn’t see it as a sign of confidence… Buyer beware. I almost bought in as the bottom yesterday. Glad I didn’t. AA, AAPL, SVC, MRVL, BRCM and RIO looking real good though…

ERI is set to soon IPO under the ticker symbol ERII. It is a filtration company that specializes in desalination. Particularly salt water reverse osmosis (SWRO), an area growing much faster than the desalination industry as a whole. Last year the company made $5.4 million on sales of around $34 million. While in the previous year net income was only about $900K. For the last five years the company has been showing an average growth rate of 72% and is positioned as one of the leaders in the industry. The majority of new desalination plants have been SWRO plants since innovations in more efficient membranes and energy recovery techniques have made the technology more competitive.

Short post, but just thought I would put it out on peoples radars.

This is part 1 of a x part series in which I will investigate and try to determine major economic trends that will lead the way into the 21st century.

Commodities

we live a world in which commodities and natural resources are limited and demand is ever growing. The following is a list of commodities that I have singled out as showing impressive growth in the future.

Lithium – With the world of mobile electronics, plug-in hybrid vehicles and travel based lifestyle; batteries are an ever growing part of the occasion. As the current mass produced battery is based on lithium ion / polymer technology these resources will be faced with ever rising demand. Especially with the onset of electric cars, trucks and buses starting in 2010. The adoption rate for these technologies will likely be parabolic especially with growing energy prices. Despite other solution being on the horizon these first generation of products will produce exceptional demand for lithium.

Barium/Titanite – the next generation of battery technology. This will likely begin commercial adoption in 2012 – 2015 in increasingly higher rates. The batteries are dry, lighter and carry a much higher energy density than lithium ion.

Platinum – is a precious metal commonly used in electrodes for batteries. FUEL CELLS, catalytic converters, and electrical instrumentation. Demand will rise with the increasing attention to environmental issues and the rising middle class in India/China now capable of affording vehicles. Also used to convert CO2 to gasoline see below.

Coltan (Niobium & Tantalum) – used heavily in capacitors for electrical equipment. During the great silicon valley boom of the late 90’s the illiquid market for this metal saw producers charging amount based on word of mouth. There was no exchange and the price shot up from $30 to over $200. With the perceived shortage causing many electronics producers to hold large inventories. The economic slowdown following the dot.com bust and the large inventory caused a decline in prices back to $35 region. The inventories are beginning to run low and many analysts expect a run up in this mineral.

Uranium – Peak oil and export land model will cause a rapid deterioration of of net exports in this post peak world. Uranium despite it’s high capital costs is positioned well to supply the world it’s electrical needs. As plug-in hybrids eat away at gasoline market share, there will be a growing trend away from day-time electrical consumption to nighttime consumption for charging America’s batteries. This will cause an increased demand for nuclear power. Solar energy is not positioned well to supply nighttime loads or as a peaking power plant due to their highly non-linear production capacity. China is planning to bring 20 nuclear reactors online by 2020 quadrupling their capacity.

Electronics

WiMax / Fiber to the home – the new broad band technology aimed to be implemented alongside fiber to the home. Look for all major laptops to include WiMax in complement to Wifi. Broadband demand is growing at a exponential rate thanks to the likes of Youtube who as of now consumes more than 10% of all internet bandwidth. This is an amazing feat given all the IP technologies consuming bandwidth today. HD content will likely quadruple this figure in the following years. A bluray dvd is approximately 40Gb look for content providers to moving to an online ondemand format.

Hard Disk manufacturers – we live in a information rich society. Facebook, Youtube, Myspace, Google and Yahoo have hundreds of petabytes of storage and are always looking for more. Western digital, Maxtor and others will reap the benefits. Hybrid drives are on the way combining flash and platters. Benefits include high capacity, storage based on frequency of use, and better reliability. Flash has issues with rewrite capabilities, if flash is used to store highly volatile data it begins to fail.

Wireless Power – MIT is leading the way with efficient technologies to transfer electricity short distances wirelessly. Imagine sitting at home with a laptop that never died, a cellphone that was always charged when you left home and remotes that didn’t need batteries. REALITY. I am waiting for the company to go commercial and spinoff.

The world has massive coal reserve that can be converted into a readily usable substance with high efficiency. 1 BTU of coal can be converted to 0.8 BTU of gasoline or natural gas substitute. This is already being done in Australia, China and in high volume in South Africa. Coal to liquid and Coal to gas is a way to leverage out resources and existing infrastructure. It is much more sustainable than ethanol and solar. I am not arguing that ethanol doesn’t have it’s place but it will never be a replacement for gasoline in either corn or cellulosic varieties. If every acre of land in the United States was used to grow biomass for ethanol production it would still not be enough to produce enough energy to meet our fossil fuel needs. If the entire food supply of the world was used for ethanol it would also not meet our energy needs. We need time to transition and change our consumption habits move closer together, grow food locally, and build things locally as energy prices rise.

Hybrids are a show piece for the media. They are part of the problem and not a solution. Jevon principle, whenever someone or something causes an increase in the efficiency of the use of a resource, the consumption of that resource will increase. People don’t get it and the media is fooling people into thinking their are doing something good. Granted it is pretty counter intuitive. Capitalism. When something gets more efficient, you get more work per dollar (resource). People will conserve now, but today’s conservation will temporarily lower prices but stimulate people to do what they are currently doing. Living 30 minutes from work, having a huge house…etc. Hybrids merely allow people to live status quo as growth continues to trump away gains.

Solution!

Carbon Dioxide to Gasoline – Yes, you read that correctly. The Sandia National Laboratories in New Mexico is working on a way to convert carbon dioxide into gasoline equivalent using solar radiation. The technology is still 15-20 years away, and is what we should be working toward. It kills two birds with one stone. For now lets just focus on not starving 3 billion people to death by fermenting the worlds food supply.

By Thiago Avila

Next Part:

Public Transit

Water purification and infrastructure –

Health Sector

With United Airlines ( UAL ) and American Airlines down 25% today, when will the carnage end. In a recent trip to Mexico, I was discussing the airlines industry with a friend and how they will react to higher energy prices. We came up with a few ideas but all involved higher passenger density or lighter aircrafts.

It appears that we were on the ball with one of the suggestions actually hitting the newswire today. American Airlines will now be charging a fee for even 1 piece of luggage ($15). This is on top of their recent fuel surcharge. This will act to discourage travelers from bringing luggage and operating on a asset light plan, with only carry on pieces.

I seriously don’t blame them, on this recent trip some of the travelers brought different pairs of shoes and outfits for each day. This is completely unnecessary and I sympathize with the airlines who are struggling to survive and have never had margins higher than 5%. … Now what next. Hedging oil is creating its own problems for the industry by allowing airlines to undercut each other depending on when they happened to have bought the oil futures and when they expire. I see airline traffic becoming increasing more expensive as traffic lessens and people (americans) stop traveling because they realize their Peso is worthless outside of the US.

Forecast: Patriotism, Localizing and efficiency will be the name of the game for the foreseeable future. The US has accomplished the greatest mismanagement of resources in the history of the world. For every unit of GDP the US uses twice as much energy as Germany. The days when fruit grown on the East coast will be driven over to Florida or Tangerines from China brought over to Ontario.

Long consumer non-discretionary items, fertilizer, and rural real estate. I think that local farms will become much more competitive with imported food as energy prices continue to increase driving up farm land by the acre.

Aside: “Following AMR’s announcement, Standard & Poor’s Equity Research cut its price target for AMR stock to $2 from $10 and reiterated its hold rating for its stock.”

I will never understand analysts. If the stock is currently higher than $2, and you set your price target at $2… why would recommend people hold the stock…