Wednesday, February 18, 2015

More articles of interest


John Kemp writes a critical analysis of a 2004 academic paper, Facts and Fantasies about Commodity Futures. The paper found that commodity futures had historically delivered better returns than stocks and bonds with less volatility.

Kemp writes that since Facts and Fantasies was published, investors in commodity futures have lost money. He argues that this was the result of institutional investors crowding into an asset class that had previously been an undiscovered niche, forcing returns down. In other words, investing in commodity futures became what Credit Bubble Stocks calls an anti-strategy.

Frank Veneroso predicted this in 2007:

There is no getting around this: the buying pressure of the "pinstripe investor" has destroyed and will continue to destroy the return assumptions that led him to commodity futures baskets in the first place.

Ben Graham expressed similar sentiments about commodities as investments:

It is impossible for any really large sums of money-say billions of dollars-to be invested in such tangibles [gold or commodities], other than real property, without creating a huge advance in the price level, thus creating a typical speculative cycle ending in the inevitable crash.

Dart Group

Dart Group has sparked a lot of interest among value investors and has been written up twice on Value Investors Club. The bull case for the company is that it's a low-cost airline run by a dedicated owner-operator. Red corner demolishes this narrative, showing that Dart Group actually has much higher costs than competitors like Ryanair and Easyjet.

This is a worthwhile post for a couple of reasons: it show how to think about airline competitiveness, and it's also a warning about stories that are plausible but misleading.

Ben Graham

Ronald Redfield has archived copies of the Graham-Newman partnership's investor letters for 1946-1958. The letters don't include any investment commentary, but they reveal two interesting things:

• Graham's partnership owned dozens of stocks at any given time. Apparently there were more deep value opportunities in his time than there are today.

• Graham's performance was relatively consistent through both the late-1940s bear market and the 1950s bull market.

Interest rates

Michael Hudson writes that interest rates experienced a secular decline in the ancient world. The standard interest rate was 20% in Mesopotamia, 10% in Classical Greece, and 8.33% in Rome. This decline occurred independent of political cycles: Rome had lower rates at its political peak than Greece had at its peak, likewise for Greece versus Mesopotamia.

The decline was also independent of economic risk:

In the neo-Babylonian period we see prosperity rising and misharum or andurarum acts becoming a thing of the past, yet interest rates remained constant century after century. This suggests that there was no tatonnement between asset prices, changing risk premiums and interest rates.

Hudson suggests that interest rates fell as mathematical knowledge improved. That is, rates fell because each successive society developed a more precise way of calculating interest. This raises an interesting possibility: that while some market inefficiency is rooted in human nature and may never go away, financial markets have gradually become more efficient as our theoretical knowledge has improved.

I would argue that this dynamic wasn't limited to the ancient world and has occurred recently: classical arbitrage opportunities were common in Ben Graham's time, but they're rare today outside of periods of extreme stress like late 2008.

Hudson also mentions that there was a stark distinction between agrarian and commercial credit in the ancient world. Commercial lenders operated a continuous, relatively sophisticated system of trade finance. By contrast, most agrarian loans were issued after failed harvests by predatory loan-to-own creditors.


Undervaluedjapan argues that laziness can be a virtue for value investors. He points out that there isn't a direct relationship between effort and reward in investing: in many cases, investors can work harder without achieving better results. Under these circumstances, laziness is an advantage if it motivates investors to find more efficient, time-saving ways of finding good investments.


Oddball Stocks writes that an average company can be a great investment, stating that "the difference between a niche and an economic moat is the ability to scale." He gives a hypothetical example of a niche retailer with a unique location:

Consider an example, a bait and tackle shop on the only access road to a state park with a nice lake.  The shop has no pricing power over suppliers, has a low barrier to entry, and doesn't even require specialized skills.  Yet the location of the shop, being the only one on a specific road allows it to charge a bit more and earn above average returns.


A smart message-board poster, "Doggydogworld," offers his thoughts about oil. He mentions that oil-producing countries have accounted for much of the growth in oil consumption over the past decade, so lower oil prices won't necessarily spur demand the way one might expect them to.

The Opium Wars

Michael Pettis writes about the economic origins of the Opium Wars. In the 19th century, most European countries tied their curriencies to the price of gold-- in other words, they had a gold standard. By contrast, China had a silver standard. This made silver more valuable in China, so it was profitable for European merchants to export silver to China in exchange for consumer goods.

Latin America's wars of independence cut off the flow of Latin American silver to Europe, raising silver's price and making it unprofitable to export. British and European merchants responded by exporting opium instead, which led to a monetary shortage in China.

Predictions are tough

A Businessweek article from January 1998 discusses the merger of Meditrust, a nursing-home REIT, with La Quinta Inns. The article was published right before Medicare reimbursement cuts led to a collapse of the nursing-home industry. As a standalone company, Meditrust would have gone bankrupt-- the opportune merger with La Quinta was the only thing that saved it from insolvency.

At the time of the merger, however, La Quinta was seen as a much riskier company. Nursing homes were considered stable businesses, while motels were economically sensitive. The article quotes one Meditrust analyst as saying "a boring, reliable REIT became much more volatile."

Ed Thorp

An interview with Ed Thorp in which he talks about his career and the evolution of quantitative investing. He claims to have discovered Black-Scholes before Black and Scholes discovered it:

[W]hen I began Princeton/Newport Partners in 1969, I had this options formula, this tool that nobody else had, and I felt an obligation to the investors to basically be quiet about it. The tool was just an internal formula that was known to me and a few other people that I employed. Time passed, and Black and Scholes (1973) published this formula.

This raises an interesting question: if Thorp had gone public with the formula, and it had become associated with practitioners rather than academics, would it still have been considered a Nobel-worthy idea?


"Lincott" at Value Investors Club recommends shorting Turkish stocks. He writes that Turkey has an enormous current-account deficit, that much of its external debt is short-term, and that the Turkish banking system has high loan growth paired with declining loan quality.

I'm sympathetic to his pessimism: Turkey has had chronic hyperinflation in the past, so the country's success over the past decade is probably an anomaly.


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