Tuesday, October 23, 2007


The "turn around" continues and it is showing up in ways that might surprise you. For example, oil pipelines that flowed from the Gulf Coast to the Midwest a couple of years ago are now flowing from the Midwest to the Gulf Coast. The amount of "new oil" flowing from Canada to the US is one of those facts that do not fit the stories being told by the media. The media has been forced to mention that refineries in Indiana and Illinois are expanding but the story they tell is about the additional pollution these refineries will cause. Even the TransCanadian pipeline is a pollution story. Of course, an underground pipeline is much cleaner than transporting fuel in railroad cars but again that fact does not fit the story being told. The plan to build a new refinery in South Dakota has been mentioned a few times but again with a focus on the fact that this refinery will process the dirties to oil out of Alberta. In truth, the doubling of capacity at Port Arthur would not be going forward without the reversal of several pipelines. In one case, a pipeline is flowing from the US to Alberta to send the "lubricants" needed to "liquefy" the tar sand goo. Since oil reserves are only reported if the price supports the actual recovery of the oil, Canadian reserves are about to increase dramatically. There is as much oil in Canada as there is in Saudi Arabia. Indeed there is more oil in Colorado and Wyoming than there is in Saudi Arabia. This oil puts a lid on price.

There are many "turn arounds" in progress.

Aluminum is falling in price. Copper will follow. Silver is falling in price. Gold will follow. The British Pound is falling. The Euro will follow. The Yen appears to have finally bottomed, the US Dollar will follow the Yen higher. The Chinese Yuan has appreciated better than 6% against the dollar, US manufacturing exports grew at better than 16% over the past 12 months. Imports grew at less than 4%. The price of lumber has fallen as has the 30 year mortgage rate, new homes are becoming more affordable. US interest rates are falling, which is in and of itself disinflation. Over in Mossel Bay, natural gas is being converted to liquid fuel, "turn arounds" take many forms.


Growth stocks are soaring while value stocks are rolling over. QLD which is largely composed of big cap growth stocks is enjoying one break out after another. APPLE is leading the way but on other days it is RIM or EMC or GOOGLE or others. I bought the biggest chunks of QLD at or below $68 in July of 2006, yesterday, this basket of 100 stocks traded at $115. While it is certainly true that individual stocks within the basket have gone up much more but hitting the best of the individual stocks is always only easy in hindsight. I have had confidence in the QLD to perform and it has.


The legacy carriers are telling the story one after another. Today it was UAUA that blew the doors off. Its profits were up 76%. It beat the street estimates for revenues, for costs and of course for bottom line results. As you all know, the amazing part of this story is that the legacy carriers have recovered even while the price of fuel has soared. Fuel prices will be tight until the industry gets one barrel extra. The next big surge of supply will be the start up of the Cuban refinery in December. No, Cuba will not start exporting oil to the US and indeed this refinery is relatively small but Cuba will no longer be bidding on the same oil that supplies the US. It appears that the turn around in Vietnam will be delayed, but when both refineries are on line, Vietnam will have gone from importing 100% of its fuel to a fuel exporter.

In case you have not noticed, there has been a relative cease fire in US airfare wars. Instead of battling to offer the lowest priced domestic flight, the carriers are finding ways to expand without going head to head. The profits just announced by UAUA were partially the result of cutting out low margin competitive domestic routes. Assets have been sold to the far east or they have been redeployed to international routes. International growth should continue for many years and delays in the production of the next generation of planes will give a boost to current earnings. In another year or so, the average price of the average ticket will be back to the highs reached in 2000. Of course, the price adjusted for inflation is still very low. Today, even the "middle class" of the third world nations can afford to fly.


For two days in a row, energy stock prices have fallen. I expect oil stock prices to rise over but not like growth stocks. Those who do not follow markets closely do not realize that commodities out performed the stock market from 2000 to 2007. Over long periods of time, stocks go up but commodity prices go down. Many say that this time is different or that this move will last 25 years or so. While it is true that nuclear plants need to be finished before we are once again on the surplus side of energy, the substitution effects are starting to make a difference.


Based on the perfect 18.3 year real estate cycle, the tax simplification turn is past due. However, the real world real estate cycle is routinely a 17 to 22 year cycle. The Kemp-Roth tax went into effect in August of 1986, 21 years ago. Until a few days ago, Charlie Rangel, (Chairman of the House Ways and Means Committee where all US tax laws must start) was unwilling to separate the committees bill to fix the AMT from his "mother of all tax reform bills". Now it must be seen how big a reform will be built around this lesser bill. It appears that democrats will break their pay-go rules in order to get out of hot water. The congress simply does not have the votes to increase other taxes enough to offset the AMT. The congress does not want to stick 19 million tax payers with the automatic AMT increases that would average better than $3,000 this year.

Assuming that the change in the law is put off, similar to what happened in 1969, the pressure will be on the new congress and president after the election. The way it worked in 1969 was that successive bills made progress toward "simplification". By the time the third bill was passed, the tax advantages enjoyed by real estate investors were dramatically reduced and there was a heck of a real estate recession in 1973-74. The reform in 1986 was sure and swift but the big real estate recession still did not happen until 4 years later. Chances are that real estate will take relatively minor hits as a part of the AMT one year patch. The next bill, no mater who is president, will simplify the tax rates which means that real estate deductions will be devalued.


Many investors are finally starting to turn around. One fellow I know moved 100% of his 401-K to fixed income after 9/11. Now he is about to retire. For the past 5 years I have encouraged him to move at least a portion into equity. The last time we spoke, he talked about being on a fixed income. I pointed out that he needs to avoid being on a fixed income by putting a chunk of his funds into equity. He sheepishly admitted that he is now up to 30% in equity. Folks, this is the nature of the human beast. His account should have been moved to 100% equity more than 5 years ago. The date to move large sums out of equity and into fixed income is approaching. Over the next two or three years, the flow will continue in the equity direction. Of course, about the time that most people finally go "all in" it will be the exact wrong time. If you have not gotten on board the equity train, it is time to do so now. Do not gradually get on at ever higher prices. Once the prices begin to get unreasonable, it will be time to get off the train.


My old friend just sold his Baidu. He enjoyed a two year run and decided that the China market is now too hot. What can I say? I missed the great ride and acknowledge that this market looks like a bubble that could easily break. On the other hand, tops are very difficult to call. I suspect that there is even more to come and long term Baidu is the Google of China, "we ain't seen nothing yet".

As you all know, I can hardly wait for the day of the true Internet phone. I believe Google will offer the best of services. It marketing power of an Internet phone scares most people. Most would say that they would not want to be solicited by Star Bucks when they are near the store. The key is that we will be much in control. The big story about Google adds is that they are not forced upon us. I continue to wonder how long it will take folks like Time Warner to understand that they lose when they force commercials down our throats.

The major point for investors is that the potential revenues from mobile Internet far exceed the revenue potential from desk top Internet. There are more phones in the world than computers and one is almost always near ones phone. The world in turning into a new place.