Dave’s Blog for OC & The World

Is is always interesting to read investment books published years ago and figure out how someone would have done following the strategies post publication. History acquits Jim Rogers well; in the book he is bullish on oil in the mid $40s per barrel; it is trading over $100 now.
Rogers is an astute student of history - he sees spiraling oil prices as driven by the strong growth in the Chinese economy; not by the ‘terror premium’ that the media generally attributes to the continuing war in Iraq. He discusses King Hubbert’s “peak oil” warning back in 1974 that was dismissed at the time but has been gaining credibility ever since. Rogers describes in great detail the boom and bust cycles in the commodities markets and how pricing influences investment in production infrastructure to perpetuate these cycles. He describes how different commodities markets are linked; for example how Brazilian farmers switch their sugar crops over to ethanol when oil prices are high. Since the book there have been news reports about the green movement and how switching over corn to ethanol production is driving up corn prices; this story could be another chapter in his book.
Investors that are limited to stocks and bonds might do well to read the book; Rogers makes the case for investing in commodities - not the highly leveraged short term speculation on the direction of the market but as part of a long term portfolio diversification strategy; over the long term, returns in commodities compare favorably with equity returns; and commodities prices are counter-cyclical to stock prices (as commodity prices go up, profits and stock prices go down; ex. airline industry and fuel prices). Rogers has a commodities index fund, the Rogers International Commodity Index; the fund started in 2005 around the time the book was published.
I read the book when I came across it on the Liberty Valley website; a site put together by like-minded value investors of the Warren Buffett, Peter Lynch school of investing.

Tags: commodities, investment, Peak Oil

Just found out about a free conference for startups up at Stanford - Startup School ‘08 - and am sorry I missed out on it. While the approach of many startups seems to be focused on getting angel or VC funding, and spend months or years perfecting an application before launch, I think it makes a lot more sense to bootstrap your web startup and focus on creating highly useful apps that visitors can start using right away. Startup costs are ridiculously low - with Google’s AppEngine and Amazon’s EC2 you get scalability for almost nothing; all you really need is a laptop, an internet connection, some skillz, an idea for a web service and some sense of how to monetize it, and you have yourself a business. It doesn’t have to be perfect; as long as a visit to your site is mostly a positive experience; you can iterate to perfection. Offshore / outsource the coding, the QA and the design for ridiculously low rates - so you can focus on what real visitors are actually using - and how you can give them more value. As you iterate, you focus on how real people are using your site. Visitors are willing to give you a break, especially if your service is free. 37Signals’ David Heinemeier Hansson has it exactly right - find “peace and contentment in a life that nets you a few hundred thousand bucks a year and leaves you plenty of free time…it isn’t ‘rocket surgery’”. It doesn’t mean you’ll miss out on the IPO lottery; in fact I think that if you focus on making users in your niche really happy with your service, you will be in a much better position to catch the next big wave.

Tags: bootstrap, startup

The Rise and Fall of Long-Term Capital Management

An excellent history of the use of derivatives on Wall Street through the spectactular rise and fall of LTCM in four short years - from March 1994 through October 1998. The first modern swap took place in 1981 when David Swensen of Salomon, now managing Yale’s endowment portfolio, came up with the idea of of swapping IBM’s foreign currency exposure of European bond debt with another party (ultimately the World Bank). John Meriwether, a very successful bond arbitrage trader, gathered together some of the rock stars of theoretical finance including Myron Scholes who won a Nobel prize in 1997 for his model for valuing derivatives, and Robert C. Merton who was instrumental in bringing the math and finance models, including the Black-Scholes options pricing model, to Wall Street.
The “Rise” section of the book describes the storm clouds brewing even as LTCM easily surpassed Meriwether’s former employer Salomon Brothers in capital and profits. There are other events in the markets that are eerie forebodings of the current sub-prime mortgage meltdown:

• Banks complicit with customers in “renting out their balance sheets” to customers and circumventing the Regulation T margin requirements - allowing LTCM to put on trades without putting up any collateral.
• Fed Chairman Alan Greenspan pushing for more and more liquidity in the markets (and less oversight for broker dealers, p.106) which kept the economy running hot and the easy money encouraged speculators on Wall Street (derivatives) and Main Street (home buyers bidding up housing prices because money was cheap)
• Treasury Secretary Robert Rubin’s bailout of Mexico which fueled subsequent speculation in Asia (p.112)

The extent of LTCM’s leverage was mind-boggling; where you or I might get 2:1 leverage on stocks or 10:1 leverage buying a relatively stable investment like a home, LTCM got up to 28:1 leverage on much more highly volatile investments and as their portfolio plummeted in the final days leverage went to over 100:1 on the remaining capital. The trades they put on were brilliant for a normally functioning market but the positions were so large that there was no liquidity when other market participants rushed for the exits. LTCM was a huge buyer of volatility; essentially betting that over the long term the spreads between less safe and safe instruments would converge. The phrase was “vacuuming up nickels”. As they ran out of investment opportunities in their area of expertise - fixed income securities - they started investing in riskier situations like merger arbitrage, which is highly information sensitive and started taking on directional bets in foreign markets. Skeptics said they were “picking up nickels in front of a bulldozer.”
This time around, when Russia defaulted on its debt there was to be no bailout. And things only got worse for LTCM; with the spreads widening day by day. An irony of the situation is that if there were 10 LTCMs in the market, and others had been in a position to capitalize, in taking advantage of the situation they would have brought the spreads closer together and improved LTCM’s position. As it was, none of the other market participants were willing or able to step in, and in fact they traded in the other direction, in anticipation of LTCM’s demise.
Great book - read it!

Tags: derivatives, invesments, Wall Street