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Posted on 16 May 2008 by Forager

Your weekend reading list

Sorry folks, it’s been a busy week and I’ve neglected you. What’s more, I don’t even have something special to make up for it. To tide you over ’til Monday, here’s a list of interesting stuff doing the rounds of The Intelligent Investor over the past week.

The Economist published a great briefing on energy efficiency, an interesting piece on electric cars and a scathing comment on Yahoo! and Microsoft’s inability to get together.

Gurufocus has published detailed notes from the recent Wesco annual meeting featuring Berkshire Hathaway’s Charlie Munger. We couldn’t make it over to California this year so were thrilled to lay our hands on Munger’s insightful comments. Speaking of Munger, Gareth Brown is spending his nights wading through Poor Charlie’s Almanac – it’s a difficult one to get your hands around, literally, but the back half has some of the best investing advice you can get.

Finally, you shouldn’t go through the week without reading what has to offer. Check out Martin Wolf’s article on the realities driving a high oil price, John Kay’s guide to the emotional cycles of a credit bust and some back and forth between Lawrence Summers, trying to protect the US from the forces of globalisation, and Devesh Kapur, Pratap Mehta and Arvind Subramanian sticking up for the developing world.

Enjoy your weekend and I promise something Monday … maybe a piece on the Dutch Disease damaging our economy.

Posted on 07 May 2008 by Forager

Gambling goes online

One of my earliest recollections of the race track is walking out of Sydney’s Rosehill Racecourse crying because I had lost $12. I was 13 and, ever since then, I’ve been trying, unsuccessfully, to get my revenge on the bookies that stole my money.

The battle between bookie and punter is something that’s always fascinated me, and it has provided the foundation for my obsession with value investing. Successful punters (not me, but there are a few) exploit the difference between price and value just like value investors. The price being the ‘odds’ the bookies offer you and the value being the true chance of a horse winning the race (the big difference is that the stockmarket goes up on average whereas punters have to be net losers). Like the stockmarket, the bookies are mostly pretty efficient. But with enough research and patience, professional punters will occasionally come across a situation where the bookies get it wrong.

Attractive model

The TAB, or totalisator, doesn’t face that problem. Here, you don’t know what price your horse is until after the race has been run and won. You can, of course, get an estimate of what it would be at any point in time but that price can change after you’ve placed your bet. The way a totalisator (the pari-mutuel system a TAB uses) works is simply to aggregate everyone’s money after the race has been won, take out the profit due to shareholders and divvy the remainder up amongst those that backed the winner.

Well before I started thinking about competitive moats, this struck me as an attractive business model: Australians love to gamble; the only place you can gamble, apart from a racecourse, is at the TAB; and the TAB can’t lose. Not only that, but the correlation between disposable income and gambling is strong – the more people have to spend, the more they gamble (the percentage has actually been increasing over the past 20 years, although racing’s share has been declining). In short, TABs were businesses you’d love to own. That, at least, is what I thought.

Whenever there’s a large moat around a business, it’s worth asking why that moat exists. In this case, the answer is simple: tax-inspired government regulation. The only reason there is only one TAB in each state is because the respective governments have legislated to have it that way. If there was an alternative that took less than the 15% the TABs take out of the pools, punters would use it. In a fully deregulated market, gambling would be a highly competitive industry like it is in the UK.

Despite the governments’ best efforts, we’re headed that way. The internet is slowly deregulating the gambling business, and there’s little governments can do about it without fostering a thriving black market.

Punting elsewhere

I’m a fair-weather punter these days, but still like to get involved at carnival time. I’ve had a bet on each of the eight weekends of Sydney’s autumn carnival – two days at the races and six from home or a friend’s house – and, for once, I’ve kept my nose in front. Apart from this unusual eventuality, though, what has struck me most is that I’ve hardly used the TAB at all. Of my total turnover, 80% would have been through online bookmaker IAS Bet and betting exchange Betfair. The remainder was bet on course; a small percentage with the TAB thanks to better prices on offer, but the vast majority with bookmakers.

Not only do I get better prices but, when I’m not at the racecourse, I get to sit in the comfort of a lounge room, bet at my own leisure and watch the races on television. For me, there’s no going back to the TAB. And if the statistics are anything to go by, I’m not on my own. Annual NSW wagering growth averaged more than 5% in the 20 years to 2003*. From 2003 until 2007, that growth rate dropped to 2% (pre-equine influenza)*. People aren’t punting less, they’re just punting elsewhere.
For Australia’s protected gambling businesses, this is bad news.

They’re not about to disappear overnight – massive distribution networks and familiarity will ensure that – but margins and market share are under threat and there’s no way the trend will reverse. Equine influenza and smoking bans have caused plenty of immediate problems but, underlying it all, the old grey mare ain’t what she used to be.
*Source: 2004 TAB takeover defence and Department of Gaming and Racing industry statistics

Posted on 30 Apr 2008 by Forager

Want to make a small fortune farming?

Want to make a small fortune farming?  If you want to make a small fortune farming, the saying goes, you should start with a large one. Everyone loves to poke fun at the poor old farmers, but it might finally be the farmers’ turn to laugh.

You can’t pick up a paper at the moment without reading about the global food shortage and the associated boom in soft commodities (ie the ones you grow rather than mine). We’ve seen rioting in Egypt, Mexico and Bangladesh, and Wal-Mart has taken the extraordinary step of restricting the amount of rice any one person can buy.

With increasing wealth in Asia comes increasing consumption of food. There’s only so much land in the world and large tracts of what is available have – due to some of the most idiotic government policy ever legislated – been devoted to the production of biofuels. Just as has happened in the world of hard commodities (precious metals, iron ore, oil etc) rising demand and limited supply will lead to sky-high prices: all we need to do is work out how to profit from it.

Or so the argument goes. But before you fall for the next investment bank marketing campaign (if we’re talking about it, they’re working on a product), there are some differences between soft and hard commodities that are worth bearing in mind.

Firstly, droughts and floods can periodically rock supply but, in stark contrast to the long development times in the mining world, farmers can adjust their production on an annual basis. Not only can they switch between crops depending on expected price, but they make decisions about how much to spend on fertiliser, water and more productive (but more expensive) seed varieties each and every year.

So, whereas it might take five years to add capacity to an existing mine or 10 years to build a new one, the supply of soft commodities can be altered significantly within 12 months.

Another crucial difference is that the substitution effect is a lot greater for food than it is for hard commodities. You need iron ore to make steel and, for now at least, you need steel to make buildings. But when it comes to choosing a fillet of steak or some prime lamb cutlets, most of us can be swayed by price. When there’s a shortage of one particular type of food, people use alternatives.

Farmers are already making the necessary adjustments. Plantings have increased, Australia’s prospects are looking better, the price of wheat is at a 5-month low and rice is 10% off its highs. If the world has a relatively trouble-free year of production, there will be plenty of food to go around – which would be bad news for the farmers but good news for everyone else.

Posted on 24 Apr 2008 by Forager

Rising Aussie dollar defies inflation logic

The Aussie dollar and inflation are rising in tandem. How long can the relationship last?Rising Aussie dollar defies inflation logic  It’s got me stumped why exchange rates go up when inflation goes up. I’ve heard the spiel a thousand times: higher inflation means higher interest rates and higher interest rates mean everyone wants to own the currency. I still don’t get it. Over a decent period of time, high inflation has to equate to a depreciating currency. That’s what inflation is – the depreciation of money. If the currency doesn’t depreciate, you end up with absurd situations where everything in the country with inflation costs ten times more, in real terms, than in the country without it. And you could in theory print as much money as you wanted and buy the rest of the world’s assets, goods and services. That’s the path we’re headed down, but I doubt the rest of the world will let us get away with it. Yesterday’s CPI data sent a strong message to the few remaining economists contending that inflation is not an issue: you’re wrong. Most of us have known prices are going through the roof for quite a while, but it seems even the official bean counters have run out of items to exclude from the ‘core’ number. The real number is undoubtedly higher than the 4.2% reported, but even that’s enough to have everyone concerned. In stark contrast to the US, growth in money supply (M3) here is rampant – it’s currently growing at a year-over-year rate in excess of 20% – and until the Reserve Bank slows it down, the problem is not going to go away. The dollar bounced this week, but the rest of the world won’t let us get away with printing money and running a huge current account deficit forever. There are a couple of arguments in favour of the Aussie. One is that we have a lot of stuff in the ground that the rest of the world needs to buy, and for that they need our money. Another is that inflation is a global problem, not a domestic one. Currencies are, after all, relative and if inflation is on the rise everywhere, we’re relatively fine. That doesn’t explain why the Aussie dollar rises when we report a high inflation number, but it does at least have some logic to it. I certainly agree that we’re in for a serious bout of global inflation, but I don’t know that it’s going to help our situation, even in a relative sense. It’s more likely that this only adds to our existing problems. There aren’t many attractive alternatives and it’s partly a case of picking your poison. But I’m bearish on the Aussie dollar.

Posted on 15 Apr 2008 by Forager

Worry not about the US economy

The US economy is looking rather sick. The IMF expects a recession, the Federal Reserve believes the economy is currently contracting, house prices are plummeting, unemployment is rising (although still at a historically low rate of 5.1%), the US dollar is buying 25% less euros than it was two years ago, the US current account deficit – despite the falling dollar – remains at a stubbornly high 5% of GDP, the recently tabled 2009 budget forecasts a deficit in excess of $400bn and Fed Governor Bernanke is doing everything he can to make the already worrying inflation problem worse.

If that’s got you sweating, you can relax. The US will survive and, given enough time, prosper. For all the excess, disasters and unfair distribution of the gains, the system works.

Real economic growth arises through improvements in productivity. You can fiddle with interest rates, money supply and government expenditure all you like, what really matters is increasing the amount of ‘stuff’ produced per person. And, thanks to its devotion to capitalism, increasing the amount of stuff it produces is something the US is better at than any other country in the world.

That’s because the capitalism encourages competition, and competition encourages innovation. The barriers to building something better are small and the potential rewards huge. It’s no surprise that the companies leading the technology revolution (think Google, ebay, Facebook and MySpace) are products of the US – it’s hard to imagine building the world’s most popular search engine while attending an Australian university. In fact, think back over the 20th century and it’s hard to think of too many revolutionary technologies that were developed outside the US (fire away in the comments section below). Plenty of the ideas came from elsewhere, they just don’t tend to get developed.

In a few (mostly Asian) countries, times are changing – there’s an excellent article in yesterday’s Fin Review about technology and innovation in Korea (page 62 of the hard copy, unfortunately not free online) and, with more than four times the population, China’s economy will overtake that of the US one day. But as long as the US remains the capitalism capital of the world, there’s no need to worry about its obsolescence. It’s been spending much more than is prudent and an adjustment is necessary, but in 10 or 20 years’ time, it will be bigger and stronger than ever.