Busting the Status Quo

Ripped from What Matters Now, page 7. Via Seth Godin with free download here. Graphic by Jessica Hagy of the blog Indexed and author of the book of the same name.

Mid Week Tune

Hundred Reasons - Silver

Seasons's Greetings

. . . . from your local brewery:

How they Roll in Saudi. . .

A screen grab of a Saudi Arabian Oprah-style chat show that has been allowed to air. You see nothing but eyes through the postal slot. . . . And what's up with the Mini Me in the back right of the photo?

Full story at The Sun here.

Late Friday Tune

It's been a busy couple of weeks moving house and probably another to go. . . So this is post-lite - some Gomez for your Friday. Turn it up.

Gomez - How We Operate

Sasha Litvinenko & Polonium 210: Beyond the Bullshiitake - What Really Happened

Alexander Litvinenko in hospital in November 2006, three days before he died

Borris Volodarsky, a former GRU officer, has just released his latest book The KGB's Poison Factory: From Lenin to Litvinenko. Volodarsky is fairly well known from his previous works on Russian government agency and arms-length state-backed espionage and assassinations.

Volodarsky's latest book reveals a lot more detail on what (supposedly) really happened in the lead-up to November 2006, Litvinenko's death and events that followed.

The Telegraph has published an excerpt from the book - it is a fascinating read and cuts through the misinformation and propaganda.

Volodarsky reaches the same conclusion that every other journalist and investigation not under the thumb of the Kremlin has reached - that Andrei Lugovoy and his two buddies are as guilty as hell beyond any reasonable doubt and that such an operation must have had Putin's blessing or was executed upon his orders.

The story is one David Cornwell would be proud to author. The Rule of Law is clearly alive and well in Russia - as the Telegraph excerpt conclusion illustrates:

Throughout 2007 a media war raged. On one side there was the Kremlin propaganda facility pulling its punches. On the other, a group of people in different countries did their best to learn and tell the world what happened to Colonel Alexander Litvinenko.

The conclusion of the CPS, based on a meticulous police investigation, was unequivocal – it was a murder and Lugovoy was charged with this crime. It was clearly 'Made in Russia’ but Russia refused - and still refuses - to extradite him. Instead, he was rewarded by being elected to the Federal Assembly and promoted. He is now Colonel Andrei Lugovoy.

Friday Tune

Some Post-Hardcore for your Friday. . .

Renee Heartfelt The Melodramatic

Hermitage Capital: Update - Death of a Lawyer

Back in October I wrote a post on FDI into Russia & Hermitage Capital, where I discussed the risks foreigners faced when investing in Russia. I also put forth the stranger-than-fiction story of Hermitage Capital and the systematic harassment that fund has faced in Russia.

The tale has taken another grim turn, only further exposing the Russian non-judiciary, the corrupt police force, and the void that exists where the Rule of Law should. Last week Sergei Magnitsky died whilst incarcerated at Moscow's Matrosskaya Tishina prison. Magnitsky was a key figure and instrumental in uncovering the largest ever tax repayment fraud in Russia.

Magnitsky refused to leave Russia, despite the strong encouragement of Hermitage management and his colleagues. As he had committed no crime, he maintained he had no reason to run; implicitly he put is faith in the non-judiciary. His choice killed him almost a year later.

The Telegraph has the story here. Here's a sample:

. . ."He said: 'I have nothing to fear. I have done nothing wrong. I haven't even signed any documents. What have I got to be scared of?'" said Mr Browder. "He was the hero who uncovered the fraud.". . . .

. . .In an emotional outpouring at his final public appearance before his death, Mr Magnitsky accused the authorities of turning his trial into a sham, complaining he was denied his most basic human rights. . . .

. . ."Magnitsky did not die by chance. He died because corrupt Interior Ministry officers killed him. They knowingly imprisoned an innocent man, destroyed his health and denied him access to medical treatment. . . .

. . .In court, after being held for much of the day in what Mr Magnitsky described as "a cage similar to the cages used to keep wild animals", the prosecution served late new evidence to the judge as it sought again to extend his detention. . . .

. . .His cell floor was sometimes flooded with sewage, the toilet was simply an open hole in the corner of the room, the squeak of rats kept him awake at night, he was rarely allowed to shower and was for a long time denied any visits by his wife, sons aged 17 and eight, or mother.

"Isolation from the outside world exceeds all reasonable limits," he wrote.

Sergei Magnitsky

Tasty Kebabs in Russia. . .

Scalped from ABC Australia:

'Body sold' to kebab shop

Posted Sun Nov 15, 2009 8:45am AEDT

Russian police have arrested three homeless people suspected of eating a 25-year-old man they had butchered and selling other bits of the corpse to a local kebab house.

Suspicions were raised when dismembered parts of a human body were found near a bus stop in the outskirts of the Russian city of Perm, 1,150 kilometres east of Moscow.

Three homeless men with previous criminal records have been arrested on suspicion of setting upon a foe with knives and a hammer before chopping up his corpse to eat, local investigators said in a statement on their website.

"After carrying out the crime, the corpse was divided up: part was eaten and part was also sold to a kiosk selling kebabs and pies," the Prosecutor-General's main investigative unit for the Perm region said in a statement issued on Friday.

It was not immediately clear from the statement if any of the corpse had been sold to customers.

- Reuters

Complex System Failures & the GFC

Nick Gogerty (of Lo-Fi Manifesto notoriety) reposted a ZDnet post on system failures and added comments. This is well worth a read. I'm reposting the repost, and adding my own $0.02 in green:

18 rules of complex system failure

This list below was on ZDnet and is a cut and paste job from this Brief Paper "How Complex Systems Fail" by Richard I. Cook. I suggest reading Normal Accidents if this field of extreme risk interests you.

In finance complex failure at the largest level is called systemic risk and it is what we are currently facing.

How many items below relate to a recent failure or proposed solution? (real estate, CDS and AIG, US DEBT bubble, stimulus...) the comments in parenthesis are my opinions. My own solution is a lo-fi finance approach.

1. Complex systems are intrinsically hazardous systems. The frequency of hazard exposure can sometimes be changed but the processes involved in the system are themselves intrinsically and irreducibly hazardous. It is the presence of these hazards that drives the creation of defenses against hazard that characterize these systems.

(Finance is nothing more than risk allocation).

Especially in the context of inflation-adjusted capital preservation.

2. Complex systems are heavily and successfully defended against failure. The high consequences of failure lead over time to the construction of multiple layers of defense against failure. The effect of these measures is to provide a series of shields that normally divert operations away from accidents.

(robust checks and balances need to be in place at all levels. Innovation is frequently a form of subverting these for the sake of efficiencies (capital, tax or otherwise). Risk eventually shows up.

We have recently witnessed the largest mobilisation and deployment of government resources in history dealing with the GFC (global financial crisis) system failure. Were the prevailing defences enough? Clearly no. Are the defences put in place over the last year enough to prevent another GFC or the current one turning into something worse? The Austrian School argues not - summed up nicely last week in The Man Who Predicted the Depression by the WSJ.

3. Catastrophe requires multiple failures - single point failures are not enough. Overt catastrophic failure occurs when small, apparently innocuous failures join to create opportunity for a systemic accident. Each of these small failures is necessary to cause catastrophe but only the combination is sufficient to permit failure.

(The media reflecting audience desire seeks to identify point failures. There is rarely just a bad guy or broken part. )

Indeed, and risk usually doesn't take the form of a linear process. And as it's now generally accepted, nor does probability (which supposedly measures risk as opposed to uncertainty) adhere to a bell-shaped distribution. Even one with fat tails. Reality has proved far less formulaically prosaic than this. Nassim Taleb's Black Swan theory, which illustrates this, has (rightly so) received much publicity in the last year. But he's not the only one who has proved prescient in identifying our restricted view of risk - not forgetting that risk is not only of the semi-variance kind - multi-sigma events go both ways. Four other theories that take an unconventional view of risk and reinforce point 3. are Munger's Lollapalooza Effect, Soros' Reflexivity, Frederic Bastiat's What is Seen & What is Not Seen, and of course Mandelbrot's fractal view of risk.

4. Complex systems contain changing mixtures of failures latent within them. The complexity of these systems makes it impossible for them to run without multiple flaws being present. Because these are individually insufficient to cause failure they are regarded as minor factors during operations.

(people and organizations fail all the time. All things fail eventually. Systems need to allow for system failure. To paraphrase someone else: Capitalism without failure is like religion without hell. It doesn't really function as social tool.)

This is the beef Jim Rogers has with how the GFC has been 'remedied'. He believes the system should have been allowed to fail - letting the over-leveraged and men-of-straw counterparties vapourise - thereby letting the system start afresh, unencumbered by zombies and without the after effects of the bail outs.

5. Complex systems run in degraded mode. A corollary to the preceding point is that complex systems run as broken systems. The system continues to function because it contains so many redundancies and because people can make it function, despite the presence

(Optimization comes at the expense of safety: 100:1 leverage or some other "innovation" may seem optimal, but may be unstable.)

6. Catastrophe is always just around the corner. The potential for catastrophic outcome is a hallmark of complex systems. It is impossible to eliminate the potential for such catastrophic failure; the potential for such failure is always present by the system’s own nature. of many flaws.

(Only the paranoid survive, find a culture or organization that is fat and happy and you will find un-acknowledged risks.)

Sounds an awful lot like Apparent and Actual risk, as explained by Seth Godin. Risk doesn't have to look like you think it should.

7. Post-accident attribution accident to a ‘root cause’ is fundamentally wrong. Because overt failure requires multiple faults, there is no isolated ‘cause’ of an accident. There are multiple contributors to accidents. Each of these is necessary insufficient in itself to create an accident. Only jointly are these causes sufficient to create an accident.

(See earlier comment in regards to the media, this also applies to congressional committees, which are typically witch hunts.)

Likewise, see earlier comments from 3. on unconventional views of risk. Oversimplification and subsequent deduction from which remedies are formed can render the cure worse than the ailment - a la Ludwig von Mises via the WSJ link above in 2.

8. Hindsight biases post-accident assessments of human performance. Knowledge of the outcome makes it seem that events leading to the outcome should have appeared more salient to practitioners at the time than was actually the case. Hindsight bias remains the primary obstacle to accident investigation, especially when expert human performance is involved.

(This is the forehead slap effect, that accompanies after a bubble event.)

9. Human operators have dual roles: as producers & as defenders against failure. The system practitioners operate the system in order to produce its desired product and also work to forestall accidents. This dynamic quality of system operation, the balancing of demands for production against the possibility of incipient failure is unavoidable.

(Unfortunately positive feedback in the form of earnings, bonuses and industry recognition, amplifies this bias. A fair assessment of skill rarely gets in the way of ego amplified by culture. Cultures be they national, organizational or group that assume instant monetary reward directly equates to insight or skill almost always fail due to this bias.)

In this case it is balancing the never-ending search for return via financial innovation and investment decision making optimisation, against market regulation.

10. All practitioner actions are gambles. After accidents, the overt failure often appears to have been inevitable and the practitioner’s actions as blunders or deliberate willful disregard of certain impending failure. But all practitioner actions are actually gambles, that is, acts that take place in the face of uncertain outcomes. That practitioner actions are gambles appears clear after accidents; in general, post hoc analysis regards these gambles as poor ones. But the converse: that successful outcomes are also the result of gambles; is not widely appreciated.

(Few do post-mortems on successful outcomes that deviate from the norm. These are better than post mortems on failures as they paid for themselves.)

And when investors do analyse successful outcomes ex post, it often results in self-affirmation of skill, rather than the recognition that the outcome was driven by luck or systematic market movements.

This point advocates for sensible diversification across asset classes, investment horizons/ maturities, currencies and geographic locations.

11. Actions at the sharp end resolve all ambiguity. Organizations are ambiguous, often intentionally, about the relationship between production targets, efficient use of resources, economy and costs of operations, and acceptable risks of low and high consequence accidents. All ambiguity is resolved by actions of practitioners at the sharp end of the system. After an accident, practitioner actions may be regarded as ‘errors’ or ‘violations’ but these evaluations are heavily biased by hindsight and ignore the other driving forces, especially production pressure.

(See CDO's, black boxes and any obfuscation. Wall street is excellent at packaging and selling things, fairly mediocre at purchasing them. See the mutual fund industry performance among others in these regards.)

And yet investors keep putting cash into developed markets managed funds - when endless evidence points to benchmark under performance after fees.

12. Human practitioners are the adaptable element of complex systems. Practitioners and first line management actively adapt the system to maximize production and minimize accidents. These adaptations often occur on a moment by moment basis.

(wrong incentives, confusing short term motivations versus long term risks are part of the system. We need to design, organizations and regulations with this in mind.)

Some human practitioners adapt more quickly than others - even at a larger group level. New Zealanders' ongoing insistence on investing in domestic housing and shunning other asset classes is a great example of this. Learn, adapt, survive.

13. Human expertise in complex systems is constantly changing. Complex systems require substantial human expertise in their operation and management. Critical issues related to expertise arise from (1) the need to use scarce expertise as a resource for the most difficult or demanding production needs and (2) the need to develop expertise for future use.

(Expertise is a false notion in complex systems due to their changing nature. For this reason anything seeking to "optimize" a system can make it unstable.)

A good reason to keep one's knowledge current.

Regarding Nick's comment - I wonder if the optimisation in this sense would include new taxes and market regulation?

14. Change introduces new forms of failure. The low rate of overt accidents in reliable systems may encourage changes, especially the use of new technology, to decrease the number of low consequence but high frequency failures. These changes maybe actually create opportunities for new, low frequency but high consequence failures. Because these new, high consequence accidents occur at a low rate, multiple system changes may occur before an accident, making it hard to see the contribution of technology to the failure.

(see above and regulatory reform etc. The law of unintended consequences runs deep in complex systems. The ratings agencies offering stamps of approval to structured products is a classic case of this.)

15. Views of ‘cause’ limit the effectiveness of defenses against future events. Post-accident remedies for “human error” are usually predicated on obstructing activities that can “cause” accidents. These end-of-the-chain measures do little to reduce the likelihood of further accidents.

(Establishing boundary conditions etc. that assume point failure, human error (greed,stupidity and crowd blindness) need to be built in.)

The re-regulation of some markets and the activities of some market participants by current governments has to be a good example of this. The overly-restrictive nature of SarbOx implemented post-Enron et al. is also a good example.

16. Safety is a characteristic of systems and not of their components. Safety is an emergent property of systems; it does not reside in a person, device or department of an organization or system. Safety cannot be purchased or manufactured; it is not a feature that is separate from the other components of the system. The state of safety in any system is always dynamic; continuous systemic change insures that hazard and its management are constantly changing.

(see above large stable systems are the results of small stable systems. Consider the role of audit integrity and other sub functions of the financial system.)

17. People continuously create safety. Failure free operations are the result of activities of people who work to keep the system within the boundaries of tolerable performance. These activities are, for the most part, part of normal operations and superficially straightforward. But because system operations are never trouble free, human practitioner adaptations to changing conditions actually create safety from moment to moment.

(System participants need to look out for changes, be they over or under performance of a system normal behaviour. Keeping an eye out for "innovation" in finance is highly recommended.)

18. Failure free operations require experience with failure. Recognizing hazard and successfully manipulating system operations to remain inside the tolerable performance boundaries requires intimate contact with failure. More robust system performance is likely to arise in systems where operators can discern the “edge of the envelope”. It also depends on providing calibration about how their actions move system performance towards or away from the edge of the envelope.

(More work needs to be done discussing multiple points of failure in a system, including the hubris or collective myopia that lead to the failure. My own belief is that a culture or group which reflects hubris, is obsessed with over optimizing or believes that today's profit means they are "right", are the things to watch for. For quants out there: beware of geeks baring gifts.)

Galco’s Soda Pop Stop

For those email subscribers who STILL haven't worked it out yet - my posts are often media rich - you will not receive the media content in your email delivery. So. . . you'll either have to click on the title above and access the blog on the web or move into the 21st century and spend the required 29 seconds figuring out RSS !

This is pretty cool and Nese is pretty interesting. Who would have known that there were so many boutique and unique fizzy drinks out there? Reminds me of lambic beer producers and how many different brews there are when you start looking.

Nese puts freedom of consumer choice into practice and monetises it. But unlike the likes of Amazon, he's working the Long Tail in a physical retail space.

Nese even fires a few shots at bottlers using corn syrup in their brews - both from a health and a taste angle.

Blurb on the video states (via Kim Kommando):

John Nese loves soda pop. I mean, he REALLY loves soda pop. He’s dedicated his life to the bubbly beverages. Nese owns Galco’s Soda Pop Stop in Los Angeles. He sells more than 500 varieties of soda pop.

Nese is also passionate about his customers and suppliers. He tries to avoid the big names. He seeks out small producers with unique, high-quality products. He believes when people have the freedom to choose, they’ll choose the best. Nese is one character you have to meet.

Original HT via Seth Godin.

Weekend Links

• Bill Gross (yes, of PIMCO) has released his NOV newsletter. He talks more about the new normal for which he is well known, and why most assets are currently overvalued. The paragraph below forms the basis from which he explains what is likely to come next:
  

Let me start out by summarizing a long-standing PIMCO thesis: The U.S. and most other G-7 economies have been significantly and artificially influenced by asset price appreciation for decades. Stock and home prices went up – then consumers liquefied and spent the capital gains either by borrowing against them or selling outright. Growth, in other words, was influenced on the upside by leverage, securitization, and the belief that wealth creation was a function of asset appreciation as opposed to the production of goods and services. American and other similarly addicted global citizens long ago learned to focus on markets as opposed to the economic foundation behind them.

• A couple of weeks ago Charlie Rose interviewed Stephen Roach on his show. Roach for years headed economic research at Morgan Stanley. For the last three years he has been Chairman of Morgan Stanley Asia. The interview is a must read for anyone who follows China - how can anyone afford not to? Well worth a read. Transcript here;

• I came across an interesting article by James Montier published in The Hedge Fund Journal in 2006. Montier lays out an argument for the superiority of models over human judgement. Montier's views will excite black box traders and econometricians alike. As Montier lays it out, models take the wisdom of behavioural finance one step further and manifests it in a tool that can be used. But most of the article argues for the quant in a range of settings - not just finance. Montier writes:

What could baseball, wine pricing, medical diagnosis, university admissions, criminal recidivism and I have in common? They are examples of simple quant models consistently outperforming so-called experts. Why should financial markets be any different? So why aren't there more quant funds? Hubristic self belief, self-serving bias and inertia combine to maintain the status quo.

• For those of you interested in Value Investing - Value Stock Plus has a page on Seth Klarman, the legendary fund manager and author of Margin of Safety - Risk Averse Investing Strategies for the Thoughtful Investor. This book has been out of print for a long time now and is much sought after - copies that do reach the market have recently traded at up to USD3k per copy via Amazon re-sellers and Ebay. This page has a Rapidshare link to a PDF version - very useful.
  

Late Weekend Links

• Roubini thinks the next crisis is being sown in commodities. This couldn't be further from Jim Roger's view

• Wolfgang Munchau in last week's FT explains why the markets are in a bubble, why bigger problems lie ahead and whether governments attempt to exit their stimulus packages or stick with them

• An interesting article over at Seeking Alpha on India targeting poor consumers and reverse innovation

• Another Seeking Alpha article on investing in water and the coming global water shortages. I've written before about potential for increased tensions between China and Russia; the author of this article adds another angle to matters: I’ll go further and speculate that the next horrific war, and the one the United States would be wise not to meddle in, may well be between two superpowers, China and Russia. Here is the amount of Internal Renewable Water Resources (IRWR) that China has per capita: just 2,173 cubic meters IRWR per person. Russia, on the other hand, with 1/5th the population (and declining), has 30,001 cubic meters IRWR per person, nearly 15 times that of China.

• Business Insider on why the USD will remain world reserve currency for some time yet and why talk of another currency or basket of currencies taking its place is way too premature

• Crossing Wall Street points out a Norwegian tax policy that even Helengrad wouldn't have pushed for - I wonder if Norway could've done this if a full EU member?

• Transcript of the FT's George Soros interview from Friday

• The world will have to find four Saudi Arabias by 2030 if it wants to maintain its oil dependency, the International Energy Agency says. The article continues at The Epoch Times. Yet another Peak Oil supporter

• And Art Cashin being interviewed on CNBC - he gives views on the USD, world economy, China and why he believes in the double dip:

• Just what is it that makes a razor better by adding more blades to it? The Guardian investigates
  

• And for something completely different. . . . Pomplamoose covering Beyonce's Single Ladies. This is rather clever. Via Kottke.org
  

"The Cove" - What the Japanese Government Don't Want You to See

Late Weekend Viewing

You may ask yourself. . . Placebo with Frank Black of the Pixies Where Is My Mind live:




And an entertaining set of vids from a law professor/ criminal defence lawyer and a cop on why you should never ever ever talk to the cops without your lawyer there. Never. Ever. Even if you're innocent. Well worth watching - and may even keep you out of jail one day.

Weekend Diversions

• The no control cafe kottke.org

• Predictably irrational. A talk by the author of the book of the same name TED.com

FDI into Russia & Hermitage Capital

Email subscribers will have to follow the title link to the web to see the media content in this post.

It's well known that deploying capital in Russia presents a range of difficulties to be overcome and threats to be thwarted to achieve investment success. Regulatory, legal and bureaucratic hassles, and sometimes corrupt officials, are just part of the landscape. Expropriation of control and/ or equity by dubious judicial means and other quasi-state backed strong arm tactics are rarer. They are however still pulled from the quiver when a particularly obstinate investor, Russian or foreign, won't acquiesce to their partners wishes. Prospective investors need look no further than the experiences of Yukos, Telenor, Shell, TNK-BP, and Exxon to realise they can be parted from their equity with a nod from the Kremlin.

Apparently the Kremlin has turned a new leaf and PM Putin is now spreading the love for some new FDI into Russia. In the last week of September, Putin spoke at length at two different forums to reassure prospective foreign investors that Russia was a fine destination for their capital. From the first outing he stated:

"We would like you to consider yourselves participants in our undertaking," Putin told a meeting in Salekhard, the capital of the Yamalo-Nenets region. "The main condition from our side is that partnerships should be stable and long-term."

Yes, he really said this. Of course the problem is precisely that previous partnerships didn't end up being "stable and long-term" because the foreign investors involved were forced to accept 'renegotiated terms' or have their equity expropriated.

In his later outing of last month, Putin stated:

“We will continue the line of encouraging private initiative, integration into the global economy and the creation of a favorable investment climate”

There is a reason Russia is lagging far behind the performance of its fellow BRIC members: foreign investment. The way the Russian state and agents of the state have treated foreign investors, Putin's ongoing geopolitical rhetoric with The West, and the invasion of Georgia, have all persuaded foreign investors to look elsewhere and that Russia is not worth the trouble.

Russia desperately needs more FDI to grow. Infrastructure and large commodity assets (oil wells/ mines) are in urgent need of technological upgrade and fresh development. Hence Putin's siren call for new foreign investment - he knows it can't be done without foreign equity.

So have things really changed? Is Russia really now less risky for foreigners to invest in and the aforementioned threats reduced? It doesn't seem like it. A mere few days after he was wooing foreign investors with the words above, Putin gave the following ultimatum to Renault regarding their investment partnership in Russian auto maker Avtovaz:

“Either they (Renault) participate in funding the enterprise or we will have to agree with them on dividing up our stakes”

Which leads me to the ongoing saga of Hermitage Capital and the systematic harassment they have suffered by apparent agents of the Russian state. Hermitage Capital is an active investment manager co-founded by William Browder. Their first fund, "The Hermitage Fund", founded in 1996 was at one time the largest foreign investor in Russia. The story of Hermitage is remarkable. And one where reality really is stranger than fiction. The following three pages published in the July 2008 Hermitage investors newsletter make fascinating reading:

Hermitage Investor Letter July 23rd


But matters have progressed from over a year ago and the plot has thickened - all whilst Putin has been declaring Russia a great place for foreigners to invest. I was reminded of the Hermitage saga by a recent post over at Zero Hedge. This is what Tyler Durden had to say:

Additionally, after a protracted fight with the Russian government, today an arrest warrant was issued against co-founder William Browder under the pretext of the ever prevalent and Russian favorite allegation of "tax fraud." Recall this is precisely the reason why Yukos founder Mikhail Khodorkovsky is currently serving jail time. Hermitage has prepared the following video explaining the series of fascinating events that have led to the current fallout and today's arrest warrant. And for a more extensive overview of Hermitage's travails under Putin and now Medvedev, these two profiles by the Economist and the NYT are an entertaining read.

Despite the setbacks and the apparent state-backed harassment, Hermitage continue to fight. Clearly this isn't easy in a country with little rule of law and a corrupt judiciary - as the video shows:




So considering returns in Russia are typically a lot less than in other large emerging markets where investing is easier and less risky, does Russia offer risk premia commensurate to the real risks entailed? Probably not. Putin is going to have to do much more than offer words before FDI into Russia returns to levels last seen in 2007.

Michael Moore: Jesus Wouldn't Play the Stock Market

For those Feedburners who can't see the embedded movie - here is the URL

Pinko alert. Worse: Religious pinko alert. This is one very clever demagogue.

Moore's recently released movie Capitalism: A Love Story is nothing but socialist propaganda for the lowest common denominator. It over-simplifies the issues and is of dubious documentation. And people pay to see this crap. . .

I would spend time illustrating how Moore selectively frames his 'facts' out of context for effect and in insufficient detail. But a decent deconstruction has already been done by Vitaliy Katsenelson over at ContrarianEdge. Here's a sample:

Moore spends the bulk of the film going through our country’s [USA] trash and presenting it as the main course. . . Really, if you want to make a successful propaganda movie, you must evoke emotion and rightly or wrongly direct it at your subject of hate – in Moore’s case, capitalism. . .

. . . Ayn Rand said it well in Atlas Shrugged: “But you say that money is made by the strong at the expense of the weak? What strength do you mean? It is not the strength of guns or muscles. Wealth is the product of man’s capacity to think. Then is money made by the man who invents a motor at the expense of those who did not invent it? Is money made by the intelligent at the expense of the fools? By the able at the expense of the incompetent? By the ambitious at the expense of the lazy?”. . .

. . . He offers no alternative to our “broken” capitalism system other than let’s have “democracy.” This is laughable, as democracy is not a market system, it is a political system. What he wants is a command-based economy – the Soviet Russia that failed so miserably. He wants Mr. Mouch from Ayn Rand’s Atlas Shrugged, a mediocre bureaucrat who failed at everything in his life, to be put in charge of Mr. Moore’s version of a “democratic” economy (still not sure what that means). Mr. Mouch decided how much everyone produced, at what prices goods were sold, and what “fair” wages everyone got paid. In the end, despite sacrifice after sacrifice, Mr. Mouch’s economy collapses. Mr. Mouch’s visible “fair” hand fails to accomplish what the invisible “impartial” hand of the free market accomplishes so effortlessly.

Katsenelson knows about socialism first hand. He grew up in the USSR.

Twittering Idiots. . . .

Click on image to enlarge. Source URL here for those Feedburner subscribers who can't see Dilbert.

Snowmobile Skipping

Some awesome snowmobile skipping - yes these guys are riding on water. Flat out. Or you sink !

Here is the URL for those Feedburner subscribers.

“China Isn’t Conquering Russia, It’s Just Leasing It.”

This was said by geopolitical expert Parag Khanna during his spot at TED, July, 2009. Khanna was speaking about sovereign borders and how they evolve.

Now I'm not so sure about the "leasing" theory. Ironically, like the Russians, when the Chinese want something, it's often merely expropriated. I've written before about Russia's dramatic population decline and related headaches with territorial integrity. The Kremlin regularly gets upset about The West not meddling in its so-called Sphere of Influence and having a pathological need for a buffer between it and Europe. But this supposed territorial threat is at least secondary to the one posed by the Chinese in South-East Russia. Putin surely realises now that the Chinese don't play as nice in the sandpit as The West. Alarmingly (for the Russians), Russia desperately lacks the population, (non-nuclear) military, internal infrastructure and other resources to do much about all of this than put on a good show of plugging the holes as they appear. As Khanna says, "independence without infrastructure is futile".

The "lease" he speaks of is much more a very long leasehold. And as any property valuer knows, in practice a very long leasehold is analogous to a freehold.

The Rise & Rise Of Tyler Durden. Now Unmasked:

The financial markets blogosphere has been on fire the last 48hrs - superstar blogger Tyler Durden has been unmasked as a 30yr old Bulgarian immigrant who is an ex-hedge fund employee and who has previously been prosecuted for insider trading.

Durden's posts over at Seeking Alpha and his blog Zero Hedge have long been followed by this one.

New York Magazine has a news breaking piece on Durden, his blog, and how he became so big. It will be interesting to see how the loss of his anonymity affects his blogging. Worth a read.

Investing In Range-Bound Markets: An Interview With Vitaliy Katsenelson

Barron's have just published the delayed release free-access copy of their interview with Katsenelson over at Smart Money.

Katsenelson is becoming rather well known for what he calls his Active Value strategies. He has written a book on his methods (Amazon link) and also writes a blog with plenty of archive material over at ContrarianEdge.

Whilst I'm not a huge believer in being able to beat the market through stock picking (without superior skills and access to information) and certainly not by giving your money to an active manager, his Active Value ideas make good sense.

Katsenelson is convinced we have entered a range-bound market and will remain here for some time. Hence his enthusiasm for Active Value - which he explains in the interview.

He also suggests that some investors are falling into a relative value trap:

In today's environment, investors should favor absolute-valuation tools, like discounted-cash-flow analysis or breakup analysis, as opposed to relative-valuation analysis -- i.e., Wal-Mart is cheap at a P/E of 14, because it used to trade at 45. Relative valuation is a backward-looking tool, and anchors on valuations that we'll not see again for a long time. That will lead investors into a relative-valuation trap, and lead to overpaying for stocks.

Wise words if markets end up remaining stagnant for some time and his range-bound prediction becomes reality.

He also talks about how Margin of Safety has never been more important in stock choices. Something no one should leave home without.

Australian Population Growth To Exceed India's

The SMH published an article yesterday stating that Australia will be the world's fastest growing industrialised nation over the next four decades, with a rate of population growth higher even than India.

Only Saudi Arabia is projected to have higher population growth. And unsurprisingly the two countries with by far the lowest rates are Japan and Russia.

Notably New Zealand does not register a figure on the graphic above. As Australians and New Zealanders are free to live and work in either country, it will be interesting to see how such strong population growth in Australia alters demographics and population in New Zealand, and whether the current open immigration policy between the two nations survives.

As long as education levels, standard of living and decent urban planning are maintained, it can only be a good thing for economic growth. More throughput for most businesses, all things being equal, means asset prices will do fairly nicely from the population increase. A higher critical mass of population will also mean higher levels of internal demand - this is useful when your economy is currently largely predicated on exports and has a volatile commodity driven currency.

BMD and the Post-Post-Cold War World

An old Soviet map of Europe - de ja voodoo ?

Yesterday George Friedman of STRATFOR published an excellent post on Obama's decision to withdraw the planned ballistic missile defense shield installations in Poland and Czech Republic, and what it now means for the US, Russia, CEE, Israel and Iran.

George explains in detail how this decision flows through the geopolitical landscape between these players and how we now exist in a post-post-Cold War era. Of particular interest, he explains the faults in the US thinking on Russia and what motivates the Kremlin. For those regular readers who don't much care for the bent of STRATFOR's analysis, you too may find the piece a worthy and insightful read.

African Trade Links and Poverty - Chicken or Egg ?

A couple of weeks ago AidWatch of NYU posted three interesting graphics depicting the dearth of African trade links with the rest of the globe, then extrapolated causation for African poverty.

Indeed the pinkos would have you believe that if these trade links and infrastructure magically appeared, it would solve the problem. A form of "build it and they will come".

It's easy to see with these propositions that there is certainly positive correlation between trade linkages/ infrastructure and poverty. But there is much less visibility on the causation - and this is what's important.

I posit that the rule of law, an independent judiciary, property rights, lack of corruption and other similar constructs that support an open and free market are: a) the first step in establishing a prosperous society and economy; and b) will result in increased levels of foreign direct investment and trade links - which will both then lead to reducing poverty. Egg before chicken. . . .

The graphics are well worth a look (link at top).

"We should seize whatever opportunity we are given to be racist"

Rob Liddle had another amusing piece published in last week's Spectator magazine, entitled as above. Rob's writing is always worth seeking out and he's never afraid to offend the Pinkos - an admirable trait in its own right. The sub title of the article continues. . . .

Rod Liddle reflects on a recent poll which says that Russians are the world’s worst holidaymakers. Brits are just as bad, he says, leaving a trail of blood and vomit from Biarritz to Dolman.

The article then begins. . . . Who are the worst people in the world, do you suppose, based upon your first-person contact with them? I always assumed it would be nigh on impossible to get any worse than a Somali — until, that is, I met a Saudi. . . .

The whole thing is well worth a read - here (this is the link for the 'print view' so the full text appears on one page - hit 'cancel' on the print dialogue box when it pops up).

XSR Interceptor

Now this would be fun. . . . will hit 85 knots and packs a few .50 cal's to deal with any nasties you come across whilst water skiing. Definitely dishes up some Margin of Safety. It is the XSR Interceptor - currently on show in London, at the Defence & Security Exhibition @ ExCel. Not sure of its claim of the fastest boat ever built, but I'd like one anyway. Check out some pics here.

Friday Tune

Here's a Friday Tune from The Tutts off their debut album Get In The Club. Here's the first single from it - K

The Trouble with New Zealand

The NZ Herald published an article today on the banking inquiry panel and the structural problems of the NZ economy. Worth a read for those interested in NZ. Some choice quotes:

New Zealand is "using the credit card to pay the mortgage" and if it continues we will lose our sovereignty to Australia, politicians were told today.

Commentators told opposition MPs holding an inquiry into bank pricing that New Zealand's obsession with property was the cause of most economic problems.

Bernard Hickey, managing director of interest.co.nz, told the inquiry the New Zealand economy was not an economy but a "housing market with a few other things tacked on".

I've written before on this blog how stupid New Zealanders are and their addiction with residential real estate as an asset class. For those that are interested and missed these, you can find them here, here, here and here - I won't bother reposting the facts. Those New Zealanders invested in residential property who lose their shirts and their pension pots will have no one to blame but themselves and their own ignorance. No doubt they will then vote the Labour party in with an election pledge to bail them out of their misery.

Concentration of Ownership and Correlation Risk

Inside Science published an interesting article last week on recent research revealing shares around the world are owned by relatively few entities.

The article states "A recent analysis of the 2007 financial markets of 48 countries has revealed that the world's finances are in the hands of just a few mutual funds, banks, and corporations. This is the first clear picture of the global concentration of financial power. . ."

As the article mentions, there are fairly scary implications for correlation risk between different (anglo-saxon) exchanges, never mind asset classes. The results of the research also tie in nicely with Soros' theory of reflexivity. Because owners or owners' agents wield such concentration of power, when they act there is the clear potential for reflexivity to become super-charged into a geometrically progressive feedback loop, further perpetuating market disequilibrium which Soros is so fond of talking about. Perhaps this is one of the reasons why markets become so wildly inefficient for shorter periods when momentum gathers quickly in one direction or the other. The research conclusions also sit nicely with Mandelbrot's fractal view of the markets and the power law based self-similar processes that govern his theory.

The results also have implications for the 'wisdom of crowds' theory - when the 'crowd', at least on a ownership/ control basis, is anything but.

(HT GM)

Inefficient Capital Allocation

In my last Russia Reading List I bemoaned Putin dictating how banks should operate and their lending policies. There are a number of problems with this sort of state meddling, but one I did not touch on in this post was the resulting inefficient capital allocation. Over at SA, Peter Fuhrman has authored a cut-to-the-chase post on how state meddling in banks' lending policies can skew the efficiencies of the free market - in a China context. Now obviously Russia and China are different beasts - but there is an uncanny correlation in how state authorities in both countries apply pressure to banks resulting in how debt is deployed to who for how much. I misquote Peter Fuhrman: Capital is not a problem in Russia. Capital allocation is.

Hitler Misses the Bottom

This is fantastic. And probably the best of the series these guys have done. We might have seen the bottom. But I'm not sure we won't yet see the lows again. The second dip is nigh. (HT MGJ)

Russia Reading List

After almost a month, I am back online.

Much has happened with Russia the last few weeks. . . .

Back on the 25th of July Joe Bidden, US VP, was interviewed by the WSJ. Biden said that “Russia has to make some very difficult, calculated decisions. They have a shrinking population base, they have a withering economy, they have a banking sector and structure that is not likely to be able to withstand the next 15 years, they’re in a situation where the world is changing before them and they’re clinging to something in the past that is not sustainable”. Whether this eventuates will remain to be seen. But Biden echoes what has been written on this blog in the past - that the Russian Federation has a serious and perhaps terminal population problem. Obviously for such a xenophobic and anti-immigration government and society, immigration isn't going to provide a solution without a structural shift in attitudes. And the secondary problems that arise from a shrinking and horridly aging population trickle down to become territorial, fiscal and economic growth based too. It's difficult to have a sustainable growth economy without a growing or at least stable population base and all that comes with it. The long run outlook could be better. Much better. But we don't live in the long run. Can Russia (read: Putin) turn this party around? Watch this space. Giving an opposing view, there is a good piece over at Seeking Alpha on why Biden is wrong. Seeking Alpha also curiously points out that the state of California is a more risky investment proposition than the Russian Federation - at least measured by CDS pricing. And Time points out Medvedev's latest initiative to reverse the shrinking Russian population - stop them boozing. Obviously Mr Medvedev has not come across the Borg or he would already know that with such matters resistance is futile.

Two Russian Akula class fast-attack hunter-killer submarines have been tracked on patrol off the Eastern seaboard of the USA. The NYT reports that such activity has not been reported for about 15 years. Writing on matter, STRATFOR stated (05.AUG.2009) "These are the most modern and capable attack submarines in the Russian fleet, often compared to the U.S. Los Angeles class". Russia continues to ensure its power projection efforts are not missed. But as STRATFOR has more recently noted (10.AUG.2009), this was an interesting event and perhaps part of some form of wider Maskirovka strategy, but ultimately of little importance.

STRATFOR also wrote (10.AUG.2009) that most of Russia's other sabre rattling was ultimately of little consequence to the US too. However, two potential events present potential global geopolitical structural breaks of the highest order. Firstly, if Germany were to ally itself with Russia, rather than the Europe/ US. This is not entirely out of the question considering the increasing cosiness of the Merkel government with that of Putin's, largely and at least initially predicated on energy trade. Secondly, if tensions with Iran escalated to a serious level. STRATFOR on this second scenario states "If the Iranians were to successfully mine these waters [Strait of Hormuz], the disruption to 40 percent of the world’s oil flow would be immediate and dramatic. The nastiest part of the equation would be that in mine warfare, it is very hard to know when all the mines have been cleared. It is the risk, not the explosions, which causes insurance companies to withdraw insurance on vastly expensive tankers and their loads. It is insurance that allows the oil to flow". This reference to the importance insurance plays in the movement of petroleum products cannot be understated. The piracy situation off the coast of Somalia in the last 12 months has shown on a smaller scale how insurance and re-routing costs can rapidly spiral upwards and perhaps affect the end cost of the shipped goods. Interestingly this is a key reason encouraging Israel not to bomb Iran's nuclear facilities unilaterally - Iran would immediately respond by mining the Strait of Hormuz using small water craft, rendering the blame for the resultant global oil crisis firmly at Israel's feet.

It appears that Russia is also facing the possible beginnings of a grain crisis. Put in the context of the global financial problems, Russia's dramatic recent slowdown in mineral/ petroleum based revenue, the deepening of the global food shortages, and the slump in Russia's federal reserves, this is a real concern to the Kremlin. Circumstances have not yet begun to approach the fictional scenario laid out in Frederick Forsyth's "The Devil's Alternative", where almost all of the Soviet grain crop is decimated. But the butterfly effect can take hold and go the distance swiftly and without warning. Stranger things have happened. STRATFOR wrote (18.AUG.2009) "Several Russian grain-producing regions have suffered serious problems during the winter harvest, the period from June to August when grain crops planted during the previous winter are harvested. Severe drought and scorching hot temperatures have caused fires that have reduced the year’s wheat output, particularly in southern Siberia east of the Ural Mountains, on the eastern frontier of Russia’s grain belt. In particular, Chelyabinsk oblast (or district) has reported that 80 percent of its grain harvest has been burned away, Sverdlovsk oblast has lost 40 percent and Tyumen oblast 30 percent". Because of this, Russia faces at least an 12% grain deficit on this year's harvest. Historically Russia has exported 20% of its grain harvest to Europe on average, which constitutes a considerable 17% of global grain production. This will probably result in two things to varying degrees. Firstly, Russia will likely become, at least temporarily, a net importer of grain this year. This has implications for an already troubled Ruble. Secondly, if supply of grain for sale on world markets is reduced, all things being equal, equilibrium price will move North. Of course all things aren't equal - despite the general trend for demand across the board having decreased contemporaneously with the recent global economic downturn, demand-supply drivers are very firmly in place to fuel the soft commodity super cycle.

Last week the Russian Federal Statistics Service reported that foreign direct investment (FDI) into the Russian Federation for H109 had decreased year-on-year a whopping 45%. Obviously the massive capital flight following the Russian invasion of Georgia last year has not reversed. Interestingly in Q209 the RTS index recovered considerably from tumbling values of the previous 9 months. Prima facie it would appear that there is a weak correlation between the RTS and FDI. Certainly a number of prominent investors have recently opined that the Russian investment proposition is merely a beta-tracking play on oil & gas. Clearly such comments refer to investment in the Russian stock market and even the most superficial of analyses will reveal that (on a cap-weighted basis) this market is significantly driven by the fortunes of its oil & gas constituents, giving the thesis immediate merit. Seeking Alpha has yet another article on the Russian authorities bullying foreign investors. Not the smartest way to encourage fresh FDI and engender faith in the Rule of Law. The article states ". . . another cautionary tale for investors: what’s theirs is theirs, and what’s yours is theirs–if they want it. Given Russia’s dependence on foreign capital flows, this is a counterproductive attitude that will impede Russian progress for years to come". And if you thought that Medvedev was the vanguard of corruption fighting in Russia, a detailed article on the Medvedev-Putin show over at Seeking Alpha might change your mind.

Last week Business Week published an interesting article on Putin's statist and increasingly centralist moves to control how commercial banks lend to their customers. Namely he was dictating how interest rate levels were set. Hardly free price equilibrium and certainly not a mechanism central bankers/ democratic governments would use in influencing interest rates. The article states "In economic terms, this was an extremely debatable decision. Banks had been keeping interest rates high not only out of greed, but because the crisis makes it very difficult to distinguish between good and bad borrowers, i.e. those who are able to pay back their loans and those who will soon go bankrupt. So if the interest rate on loans is kept high, the inevitable losses from unpaid debts are to some extent covered". Putin's actions actively detract from any free market policy and at best muddy the waters of an efficient finance market. It will be interesting to see how this affects the interest rate swap market for longer dated terms vis-a-vis property debt. Sure, the big Russian banks are backed by one government hand while being told how to conduct commercial enterprise with the other. This set of affairs will continue to deliver as long as the government is a willing donor with its reserves and can garner international credit. The article goes on to discuss the congenital weakness of the Ruble, the lack of faith all parties have in the national currency and what it means for Russia. Well worth a read. (HT Mister Gupta).

The August edition of the McKinsey Quarterly has an excellent piece on the state of Eastern European banking. This is a must read for anyone involved in any way in the CEE/ Russia/ CIS market space. Especially those in an asset-backed capacity. The whole article is worth quoting, though some choice bits are "Over the longer term. . . a reemphasis on careful [cost of debt] pricing, brought about by a higher cost of capital and liquidity, will actually help reinflate [banking] margins. We expect that banks will successfully pass on to customers their higher cost of funds; margins correlate well with funding costs". This is followed by an insightful graphic showing the uptrend in the risk free rate. Obviously this has ramifications for asset values. The article goes on to state "To reflect the higher cost of funding and the risk their clients face, banks must adopt a new pricing discipline. . . Many have already begun efforts to improve pricing but are stumbling because they lack capabilities. Specifically, they need to react quickly to market changes in funding costs. They will need the ability to calculate, in real time, a target credit margin for each customer, taking into account the up-to-the-minute cost of financing, the client’s business climate (its size, macroeconomic conditions prevalent in its geography and industry, and so on), and its risk exposure". Clearly there are opportunities for those with the expertise and market insight to position themselves to proactively provide this information to banks in the region. Perhaps even more so for asset-backed lending. Moving from solely a client instructed position providing the end product to the banks, to creating a true go-to/ supplier-partner of choice for the banks. For additional reading and for those who can't get MQ access, Seeking Alpha has a brief article with links to not so brief reports on the fast approach of the death spiral of CEE heavy lending banks.

Finally, two last articles from Seeking Alpha on the state of the Russian economy, consumer spending, consumer lending, inflation and the Ruble, here and here. Both well worth a sobering read - as the second article states "Russia faces extreme difficulties. Its political brittleness, and the rigidity of its labor market (due in large part to the monocities, the legal and institutional nihilism and state capitalism that stifle small business and encourage large, cumbersome enterprise, and other Soviet inheritances) make it very difficult to adjust to large economic shocks; in this system, large enterprises serve as welfare agencies. But this threatens to turn them into zombies–and take the rest of the Russian economy with it". Clearly, those who will make money in/ from Russia in the years to come will have true connectedness to those who can/ will pay for their offering and a clear understanding of why it will be demanded. Naturally for real assets, these factors will be key in ultimately driving income yield.

mulletover

It's been a frenetic couple of weeks and will be at least another one or so to come. . . . Hence the dearth of posts.

So until then I leave you with the trusty sounds of mulletover (hat tip MGJ).

Eats the F430. . .

The new Ferrari 458. You can see more pics here.