Foreign Stocks

Last week the internet was buzzing with rumors of Apple coming out with an iPhone that would work on the Verizon Network. If you decide you wanted to trade this rumor what would you do? Would you buy Apple (AAPL) or would you buy Verizon Communications (VZ)? What if I told you Apple didn’t pay a dividend, while Verizon had a 6% dividend yield. Would that make a difference?

As it turns out, I decided I wanted in on this trade. I’ve been wanting to buy an iPhone for a while but the AT&T network is severely congested in major cities and the sound quality for calls is terrible. So I’ve been holding out for the iPhone until it’s available on the Verizon Network.  I did however get myself a 32GB iPod Touch that is simply amazing.

I didn’t buy either of these two companies. Instead I bought Vodafone (VOD) with a dividend yield of approximately 5.3% based on my $23.10 purchase price. It’s not widely known, but Vodafone owns 45% of Verizon Wireless. The remaining 55% of Verizon Wireless is owned by Verizon Communications.

Verizon Wireless borrowed billions of dollars from its parent company to build out its infrastructure and for the $30 billion purchase of Alltel. It’s been generating nearly $10 billion a year in free cashflow and has been paying back the loans. These loans will be completely repaid in a few months. So what will it do with all the money its generating? It’ll start paying dividends to VZ and VOD.

Verizon needs the money for its own dividend payments. In addition to the wireless division, it runs a landline division that isn’t anywhere as profitable as Verizon Wireless. And last week, Vodafone publicly asked Verizon to either spin off Verizon Wireless or to start paying dividends as soon as it was done with the loan repayments.

By itself, Vodafone generates $8 billion a year in free cashflow. It’s 5.3% dividend seems pretty safe and has the potential to see a massive increase if Verizon Wireless decides to pay out a major portion of its cash flows.  In addition to its stake in Verizon Wireless, Vodafone owns a tiny stake in China Mobile and a 44% stake in some French Telecomm company who’s name I can’t pronounce.

This way you get exposure to a global Telecomm player with exposure to the growing US wireless market and no exposure to the US landline market.  You also get a 5%+ dividend yield with exposure outside the the US and the US Dollar. If we do see inflation, this dividend is likely to keep up with it and is probably a better bet than a treasury bond (which would lose value if we saw high inflation).

For the time being, the “Can you hear me now?” dude is a little less annoying!

Disclaimer: I entered a 50% position in VOD. If the price drops from my purchase price I’ll double down.

Gold Dinar Coin

If you’ve been reading the popular press for the past 6 months, there’s been a slew of articles talking about deflation. I’ve been somewhat skeptical of the long term probability of deflation and have been investing in gold and commodities in anticipation of inflation. Looks like I was a little early to the game (which, on Wall Street is just the same as being wrong!).

Now however, it looks like we are warming up the printing presses and gold has hit $1,000 twice in a week in anticipation of future inflation. Legendary hedge fund manager John Paulson, who made $2.5 Billion last year from his trades, has been betting heavily on gold and his fund has nearly 50% of its assets in gold or gold-related investments like gold mining stocks and ETFs. The gold ETF, GLD reportedly makes up 30% of his fund! He has also taken a large 12% stake in AngloGold Ashanti (ANGJ.J) making him the largest shareholder. According to Reuters, this is not a bet on the company being acquired but rather a bet on inflationary pressures pushing up the price of gold. As opposed to the popular theory of rising prices being a cause of inflation, I like to consider it as an effect of inflation, which is caused by printing money, a side-effect of fiat currency. If you’re unaware about the effects of inflation and how it can ravage the economic (and social) structure of a society, I strongly recommend watching the excellent videos on hyper-inflation.

Another fund which has done well with the gold mining ETF is David Einhorn’s Greenlight Capital, which picked it up at the lowest point of last year and which has more than doubled its investment so far.  They both join China in being bullish on gold. Between Paulson’s bullion dollar gold ETF purchase and China’s multi-billion gold bullion purchase, it’s no wonder gold prices have been trending upwards.

I’m a fan of Jim Rogers. He wrote a book ten years predicting a run in commodities. He also wrote one of my favorite books, Adventure Capitalist, a fascinating story of his journey around the world where he talks about the macro-economy of each place he visits.

Here’s a recent video on Bloomberg. He thinks US stocks suck and the US Bond market is the last bubble left and mentions TBT. Here’s my post on my short bond trade. There may even be a currency crisis in the US and other countries. I still think its a good time to buy gold!

The media has been going on and on about deflation. Long-term bond prices have also been trending up and long term yields have been dropping, which means that the market thinks there will be long-term deflation. Even the Consumer Price Index numbers that came out claim that inflation is under 2% annually!

(Of course, if you’re one of the unlucky 533,000 people who lost their jobs last month, you really couldn’t care less about deflation).

Let’s first look at the Government reported numbers.

                      May   June  July  Aug.  Sep.  Oct.  Nov.   ended     ended                      
                             2008  2008  2008  2008  2008  2008  2008 Nov. 2008 Nov. 2008

All items..........    .7   1.2    .9   -.2   -.1  -1.2  -2.1     -12.9        .7

Food and beverages    .3    .8    .9    .6    .6    .3    .2       4.2       6.0
Housing...........    .5    .5    .7    .0   -.2    .0   -.1       -.8       3.1

Apparel...........   -.2    .0    .8   1.0    .0  -1.2    .2      -3.9        .2
Transportation....   2.1   4.0   1.8  -1.7   -.7  -6.0 -10.9     -52.1     -10.4

Medical care......    .1    .2    .1    .3    .3    .1    .2       2.7       2.7
Recreation........    .0    .2    .4    .5    .2    .0   -.1        .8       1.9

Education and
  communication..    .3    .5    .5    .2    .0    .2    .2       1.6       3.4

Other goods and
  services.......    .5    .6    .5    .2    .2    .3    .1       2.4       4.4

Special indexes:Energy............   4.5   6.8   4.0  -3.2  -1.7  -9.0 -17.8     -70.8     -14.3

Food..............    .3    .8    .9    .6    .6    .3    .2       4.1       6.2
All items less
food and energy    .2    .3    .3    .2    .1   -.1    .0        .1       2.0

Lets start with the largest expense for most people, housing.

Yes, house prices have decreased. However, if you’re already a home owner or a renter then you’re probably not seeing any benefit. The only people who’re benefiting are those people who can actually qualify for a home loan and have enough cash for a down-payment. The 100% financing loans have disappeared as a result of the tightening of the lending standards. As I mentioned in the last post, it’s not the cost of credit, buts the availability of credit that is important.

Energy prices actually have dropped down from $147/barrel to around $40/barrel in the past 5 months. However, I heard billionaire T Boone Pickins on the radio today say that OPEC is going to keep cutting production until oil is back up at $75/barrel. In the long run, I agree with him. While a global recession might reduce the demand for oil, there are 3 billion people in Asia who are getting a little richer every day and want air conditioning, cars, motorbikes and other luxuries that consume oil. Without alternate energy sources, oil prices have to rise. The current price drop is likely to be short-lived.

According to official numbers, education costs have only gone up 1.6%-3.4% in the past year. However, my MBA program has seen a much higher percentage increase in tuition than last year, and it might see another increase next year (according to a letter I received from the Dean of my Business School).

Likewise, medical costs have also gone up only 2.7%, but my health premiums and medical costs seem somehow higher than that.

And while food and beverage prices have only seen an official 4.2-6% inflation, prices of food items that I consider my staple diet like Tyson Chicken Wings and Sirloin Steak Burgers at Costco have gone up about nearly 50% in the past 2 years.

Meanwhile, the Federal Reserve is printing money like its going out of style. (And at this rate, it actually might). In theory, increasing the money is inflationary. That’s one reason why a house that cost $30,000 in the 70’s costs $300,000 today. More money in circulation means every existing dollar is now worth less. At least thats the theory. Increases in productivity and technology have managed to improve our standard of living despite this inflationary pressure, but there must be some point at which you start seeing inflation. Maybe we’re at that point now.

The government has committed to more money on financial bailouts than its ever spent in its history. According to an article in the SF Gate, the Financial Bailout may end up costing the taxpayer $8.5 trillion dollars.

According to an article on CNBC, that’s more than the cost of almost everything else the US government has spent on even adjusting for inflation!

Here are estimates for the major US government expenditures (all figures inflation-adjusted):

Hoover Dam: $782 million

Panama Canal: $7.9 billion

Gulf War: $98 billion

Marshall Plan: $115.3 billion

Louisiana Purchase: $217 billion

Race to the Moon: $237 billion

Savings & Loan Crisis: $256 billion

Korean War: $454 billion

New Deal: ~$500 billion

Iraq/Afghanistan/War on Terror: $597 billion

Vietnam War: $698 billion

NASA Budget since inception: $851.2 billion

World War II: $3.6 trillion

Total = $7.63 trillion

I thought this was the most interesting section of the SF Gate article:

The Fed’s activities to shore up the financial system do not show up directly on the federal budget, although they can have an impact. The Fed lends money from its own balance sheet or by essentially creating new money. It has been doing both this year.

The problem is, “if you print money all the time, the money becomes worth less,” Rogers says. This usually leads to higher inflation and higher interest rates. The value of the dollar also falls because foreign investors become less willing to invest in the United States.

Today, interest rates are relatively low and the dollar has been mostly strengthening this year because U.S. Treasury securities “are still for the moment a very safe thing to be investing in because the financial market is so unstable,” Rogers said [That’s Diane Lim Rogers, chief economist with the Concord Coalition, not Jim Rogers!]. “Once we stabilize the stock market, people will not be so enamored of clutching onto Treasurys.”

At that point, interest rates and inflation will rise. Increased borrowing by the Treasury will also put upward pressure on interest rates.

In the past 10 years gold is up 300%+. That’s about 300% better than the return on the S&P500 over the same time period! This is not an indication of deflation.

And what does veteran investor Jim Rogers think about this? In a recent Bloomberg interview he predicted that the dollar is “going to lose its status as the world’s reserve currency,” adding, “It will be devalued and it will go down a lot. These guys in Washington, they want to debase the currency.”

“They think that if you drive down the value of your money, it makes you more competitive, now that has never worked in history in the long term,” said Rogers.

Paul Watson of the Prison Planet states:

The head of the International Monetary Fund, Dominique Strauss-Kahn, warned that advanced nations will be hit by violent civil unrest if the elite continue to restructure the economy around their own interests while looting the taxpayer. Strauss-Kahn’s comments echo those of others who have cautioned that civil unrest could arise, specifically in the U.S., as a result of the wholesale looting of the taxpayer and the devaluation of the dollar.

How long will it be before Americans realize the looming specter of hyperinflation spells disaster for their life savings? How long will it be before we see rioting in the streets on a par with the scenes witnessed in Iceland over the weekend, where the Icelandic krona has lost half its value in a matter of weeks?

I’m not buying the deflation argument. In fact, I wouldn’t be surprized to see 10-12% inflation for the next several years. I’ve been buying gold coins since gold was $500/ounce and I’ve adding to my position on pullbacks. Maybe in a few years time, $850 gold and $12 silver may look like a bargain!

Previously I had mentioned several ways to invest for a recession or a major downturn in the US economy. In that post, I stated that one of the ways to hedge against the declining dollar (apart from my favorite method of buying gold) was investing in foreign currencies.

Several people emailed me asking how to buy foreign currencies.

A few were concerned that they would have to travel overseas and open a foreign bank account. Luckily, it isn’t so difficult. You have 3 choices.

1. Buy Currencyshares ETFs. You can choose between several currencies like Australian Dollar (Ticker: FXA), Swiss Franc (Ticker: FXF), Japanese Yen (Ticker: FXY), Euro (Ticker: FXE), etc. If you have a brokerage account, its as easy as buying stock. This is probably the easiest method. They also pay monthly dividends and are quite similar to buying a foreign currency CD.

2. Open on account with Everbank and invest in their foreign currencies CDs or directly open an account in a foreign currency.

3. Open on account with Interactive Brokers and directly buy foreign currency (this is probably the most hassle so you’re better off sticking with the top 2 methods).

If you’re interested in buying foreign stocks, the easiest way is to buy the ADRs (American Depository Receipts). However a lot of foreign stocks do not trade in the US as ADRs. A good way to play the foreign markets is to buy foreign ETFs. For example, if you’d like to buy blue chip dividend paying swiss companies, the Swiss Helvetia Fund (ticker: SWZ) is a great investment. (I also happen to like the Swiss Helvetia Gold Coins too!). If you think Singapore’s economy is doing well, you can buy the iShares Singapore Index ETF (ticker: EWS). Or if you like Brazil, you can buy the iShares Brazil Index (ticker: EWZ).

For a more comprehensive list of foreign ETFs check out How To Conquer The World For Fun & Profit. If you’re interested in learning more about currency trading or investing in foreign currencies, I strongly recommend Everbank’s free daily newsletter about the currency markets, the Daily Pfennig. It’s really good.

Not exactly fresh news, but its been reported that Dick Cheney, our beloved vice-president is betting against the US Dollar. He has tens of millions of dollars in foreign government bond and currency funds and international and emerging market stocks. His excuse is that it’s in a blind fund and he doesn’t know what his advisers invest in. That sounds like complete rubbish to me. I can’t imagine someone as intelligent as Dick Cheney not knowing what a huge chunk of his reported $95 million networth is invested in.

I’ve believed for sometime now that the government actually wants a weaker dollar and have been investing accordingly, but having the vice-president profit from it is a bit too unethical. The fact that he’s been profiting from the war in Iraq through no-bid contracts to Halliburton (in which he still retains a large amount of shares) is bad enough. If this had been China, he’d have been executed for bringing dishonor to his country!

Ethics aside, at least he’s good at investing. By being bearish on the dollar and the US economy he joins the ranks of supermodels, billionaire investors and sovereign wealth funds!

But there’s significant conflict of interest. Rather than spending $2 Billion a week in Iraq, if the government was spending that money on infrastructure development we might have a better economy. A stronger economy wouldn’t need this rate cuts and government deficits wouldn’t be in the trillions of dollars. This might have conceivably led to a stronger dollar.

Instead we have a dollar that is the weakest its ever been. For the first time in history, the Swiss frank is stronger than the US dollar. Most foreign currencies have appreciated considerably against the dollar over the past 2 years and I don’t see any signs of this trend reversing.

So are you going to follow the leader and bail on US investments too? Or are you going to stick your guns and weather the storm?

When I first heard about LOR, I thought it meant Lord of the Rings, but no, the topic was on Lazard World Dividend & Income Fund(LOR).

I got this email from a reader:

I love your blogs. Please tell me what to think about an odd stock – LOR. They make money from high dividend stocks AND from some sort of forward contracts involving emerging market currencies.They had a 25% yield last year but are extremely volatile ( and I don’t know why!). They have a lot of institutional investors and it looks like a good dividend pick but I don’t understand how reliable the currency contracts are. Could you do an analysis of LOR?

I’m not exactly a stock picking expert, but I’ll give it a shot. First of all I looked for LOR on Yahoo! Finance to see what it meant. I got the name of the company, the stock price graph but not much other info. That’s because it’s not a stock, but rather an ETF. Ah ha! That explains the high dividend, since I don’t know of any company that is so generous with their dividends.

Accordingly, I headed over to ETFconnect, which is a great site for finding information on ETFs. I see that its in the category of “global equity” which means it invests in world-wide stocks, just the kind of thing you’d expect from its name!

It states their investment objective:

The Fund seeks total return through a combination of dividends income and capital appreciation. The Fund may pursue this objective through a world equity strategy and a short-term emerging markets and debt strategy. The Fund may invest substantially all of its net assets in between 60 to 90 world equity securities that are financially productive and high dividend yielding. It seeks to enhance income through exposure to short-term emerging market forward currency contracts and other emerging markets debt instruments, limited to 33.3 percent or less of the total leveraged assets of the Fund, which will provide exposure to emerging market currencies.

The first part seems pretty straight-forward, but I’m not too sure what the last part entails. But at least they’re not leveraged 10 to 1 on some Subprime Real-estate Mortgage Backed Securities (RMBS) & Collateralized Debt Obligations (CDOs)! Being overleveraged is what caused Bear Stearns’ Hedge funds to collapse last July.

I also see that it’s currently trading at an 8.5% discount to its Net Asset Value (NAV). This means you can buy the basket of its shares for less than what the shares currently trade for! The current dividend yield is reported to be 8.43%. That’s strange because Yahoo! finance reported it to be 25%, a fact that I verified on Google Finance by looking at the distribution in the stock chart. It seems that in addition to the dividends, there were  long and short term capital gains distributions in December 2007, which boosted the yield.

While this isn’t a bad thing in any way, one shouldn’t buy LOR expecting to see a similar 25% yield in the future. If you’re buying it for the dividend, you should expect to receive 8.5% and be happy with it. The only concern I have is whether or not that  dividend is safe.

The ETFconnect site informs us that the fund is diversified by invested in the US (35%), th UK(23%) and other countries (42%). While it doesn’t say which other countries, looking at its top holdings we see companies like Taiwan Semiconductor, ENI and Tesltra, so we know its investing in South East Asia, Brazil and Australia. I like that global diversity.

It also seems to be diversified across various industries like finance, telecom, energy, materials, consumer staples, and so on. However, from the mix of industries it’s invested in, 32% is in the Financial Sector. That I don’t like at all. Considering that Bank of America, HSBC and Citigroup are also featured in its top holdings, I’d say thats a little to much for me. While the stocks in finance sector are currently rising on the backs of the Fed’s rate cut, I expect this joy to be short lived. And I still haven’t seen any information on its’ currency trading, debt-instrument contract or whatever it was.

So I guess it’s time to look at the company’s website, Lazard Asset Management. Here we get a little more insight to the investment objective:

*The Fund will invest substantially all of its net assets in between 60 to 90 world equity securities that are financially productive and high dividend yielding.
*It seeks to enhance income through exposure to short-term, emerging market forward currency contracts and other emerging markets debt instruments (limited to 33.3% or less of the Fund’s total leveraged assets), which will provide exposure to emerging market currencies.
These two strategies are complementary, with historically low correlation to one another, which may reduce volatility.

They may have a low correlation, but as we saw with LTCM and the recent global stock market correction, all markets are correlated to the downside. I’m highly skeptical of these statistical models that tout low correlation since they always seem to fail at inopportune moments. But at least their leverage doesn’t seem excessive. At least they’re honest and inform us that

There can be no assurance that the Fund will meet its investment objective.

But the rest of their site is actually quite informative. We already know that the stock portion of the fund is diversified across various countries, industries and capitalizations so I’ll skip over that part. But we haven’t seen much info on the currency & debt portion.

The Fund’s emerging market currency and debt strategy will also be broadly diversified across countries and regions, offering the potential for portfolio diversification- with the possibility of credit and duration protection and limited interest-rate sensitivity.

Not really sure how they’re implementing this strategy, but if it works, it would be pretty useful in current economic conditions!

They also have an interesting snippet about their dividend strategy too.

While the Fund’s equity investments are not chosen for yield alone, they will generally include the highest dividend-yielding stocks on Lazard’s equity platform, as well as a selection of stocks that may potentially have significant dividend growth. This is important because:

*Typically, dividends are real earnings, not hoped-for earnings based on the potential, future growth of a stock. They also offer the potential for stable income.
*The 2003 tax bill significantly lowered the U.S, tax rate on qualified dividend income of U.S. taxpayers.

Investing in companies with a track record of long term dividend growth is a sure fire way to beat the index averages [source: The Future for Investors by Prof. Siegal]. Investing for tax savings is not something I generally consider. First the investment has to make sense. Then you look at the taxes. If you’re so rich that you’re really worried about taxes, then maybe tax-free munies are the best route for you.

Finally, there seems to be some information on the currency trading aspects.

The Fund’s unique leveraging strategy allows greater flexibility, risk management, and economic efficiency. To enhance the income potential for investors, the Fund intends to employ financial leverage, initially up to approximately 33 1/3% of total assets, by investing in forward currency contracts and/or borrowings. Leveraged assets will be used for investing in emerging market currency or debt instruments.

It should be noted though, that the Lazard World Dividend & Income Fund, does not seek to profit from utilizing a leveraged spread-play. That is to say, the Fund is not borrowing at the short-end of the yield curve in order to invest at the longer-end of the yield curve (and profit from the spread). On the contrary, the leveraged portion of the Lazard World Dividend & Income Fund invests in very short duration instruments (typically, less than 12-months), and instead seeks to profit from accessing the high yields available in emerging market local currency debt.

Using leverage is a speculative investment technique and involves certain risks.

While its commendable that they aren’t borrowing short-term and lending long-term (remember the RMBS & CDOs I mentioned?), I get the feeling that they’re trying to profit from the carry-trade. Of course, I’m not 100% certain that’s what they’re doing, but it definitely sounds like that to me. With the Swiss franc nearly at parity with the US Dollar and the Yen up 26% in the past year, it strongly looks like the carry-trade is unwinding. In fact, they could start losing money on these kinds of trades.

To conclude, I think this is a very interesting fund. I would be amazed if they could continue to deliver 25% annual dividend yields, but 8-9% definitely seems achievable.

However, I’d look at ALPINE DYNAMIC DIVIDEND FUND (ADVDX) and even American Capital Strategies (ACAS) before I allocated any funds to LOR. Note, I’m not recommending either of the 2, I’m just saying I’d take a look at them before I made any decision.

As a continuation to Part 1, the Reliance Power IPO was over-subscribed . There were 3 slices, retail investors, high networth individuals and qualified institutional buyers. All three were over-subscribed by more than 75 times.

In Indian IPOs, you need to send in a cheque for amount you’d like to buy at the IPO price. The company encashes the cheque and then if the issue is over-subscribed, there’s a lottery to see if you’re allotted any shares. Right now, with the intense enthusiasm for investing in IPOs, most issues are over-subscribed. You’re most likely to receive a small fraction of the shares you asked for. Typically, the company gets to sits on your money for about 3 weeks while they figure it out and issue you a full or partial refund.

Anil Ambani’s Reliance Power which was trying to raise $3 Billion, received checks worth $200 Billion! Considering that they might be able to get 5% interest, that works out to around $625 million! Note: all numbers are in US dollars not Indian Rupees. 1 USD = ~40 Rupees.

It is widely speculated that the stock will open about 70% higher when its listed. This will make Anil Ambani the richest man in India, maybe even the world. He’s currently worth about $45 Billion after his networth tripled last year due to the exuberant Indian stock market.

However, the Indian stock market dropped 10% last Monday and a further 20-30% on Tuesday. Its been extremely volatile this week with the markets opening higher and then trending down. Its been reported that a lot of investors in Reliance Power have issued stop-payments on their cheques. Anil Ambani’s networth has also dropped significantly due this correction. Since his companies stock prices are down 25%+, I’d assume that his networth took a $10 Billion hit! The bigger they are, the harder they fall!

This severe correction in the markets has wiped out a lot of investors, mainly the ones that were over-leveraged or those that were speculating in index futures.  A severe correction could happen in the US markets too. Now is a good time to trim back your margin and make sure you’re not over-leveraged.

Following the decline in the US markets and a show of no-confidence in Bush’s Economic Recovery Plan, global markets crashed in unison.

According to Yahoo! Finance:

Britain’s benchmark FTSE-100 slumped 5.5 percent to 5,578.20, France’s CAC-40 Index tumbled 6.8 percent to 4,744.15, and Germany’s blue-chip DAX 30 plunged 7.2 percent to 6,790.19.

In Asia, India’s benchmark stock index tumbled 7.4 percent, while Hong Kong’s blue-chip Hang Seng index plummeted 5.5 percent to 23,818.86, its biggest percentage drop since the Sept. 11, 2001, terror attacks.

Canadian stocks fell as well, with the S&P/TSX composite index on the Toronto Stock Exchange down 4 percent in early afternoon trading. In Brazil, stocks plunged 6.9 percent on the main index of Sao Paulo’s Bovespa exchange.

In Tokyo trading, exporters got hit hard, partly because of the yen’s recent strength against the dollar. Toyota Motor Corp. lost 3.3 percent and Honda Motor Co. sank 3.4 percent.

Shares of Bank of China dropped 6.4 percent in Hong Kong after the South China Morning Post newspaper reported that the bank is expected to announce a “significant write-down” in U.S. subprime mortgage securities, citing unidentified sources. In Shanghai, the bank’s stock declined 4.1 percent.

India’s the benchmark Sensex index fell 1,353 points, or 7.4 percent – its second-biggest percentage drop ever – to 17,605.35 points. At one point, it was down nearly 11 percent.

Since the start of the year, Japan’s Nikkei index has declined 13 percent, while Hong Kong’s blue-chip index is down more than 14 percent. Even China’s Shanghai index — which nearly doubled last year — has fallen 6.6 percent over the same period and nearly 20 percent from its all-time closing high on Oct. 16.

The world is definitely getting smaller and the smart thing to do is invest internationally for global exposure. However, don’t expect these different stock markets to be non-correlated. In the event of an economic downturn, all non-correlated markets converge as selling pressures force the liquidation of all assets.

This was how Long Term Capital Management (LTCM), which was led by Nobel-prize-winning professors, went bankrupt. When the Russian government defaulted on their bonds, all emerging market bonds tanked. Because LTCM was leveraged to the tune of nearly a trillion dollars and couldn’t meet its margin calls, Federal Reserve Chairman, Alan Greenspan, had to step in to prevent a meltdown in the US financial system. For a fascinating and very informative history behind this, check out When Genius Failed: The Rise and Fall of Long Term Capital Management. Its one of my favorite books. Readers of the book would have realized that the fancy-schmancy Residential Mortgage Backed Securities and Collateralized Debt Obligations that hedge funds were leveraging 5-to-1 and 20-to-1 would come crashing down and they did in the form of the subprime meltdown.

The reason all these global markets are correlated is because of excessive leverage employed by financial institutions. When you lose 10% on an investment and you’re leveraged 5 times, you face a 50% loss of principle. In this case you have to liquidate your winners to meet your margin call. Unfortunately, this sometimes precipitates in a global panic to bail on investments as the selling causes further losses, which initiates further selling.

The lesson to learn is that its extremely difficult to beat the market and rather than be over-leveraged, its better to have 20% of your assets in cash (like Warren Buffett) so you can take advantage of over-sold conditions and undervalued investments.

Don’t believe that you can achieve risk-diversification by investing in non-correlated assets.

I’m currently on a short trip to India. For the past 2-3 years, India’s economy has been booming. There is construction everywhere and they’re building new malls and apartment complexes like crazy.

Even though I’ve been living in the US for the past decade, before that I spent 12 years in India. There’s been so much development in my city that I can barely recognize some of the areas. The people have definitely become a lot more prosperous and their standard of living is on the rise too. Up until 10 years ago, there was 1 new car model introduced every 5-10 years. This year, there are 30 new car models slated to be released!

Along with the booming economy and growth in jobs and salaries, there’s also jump in asset prices. Real estate has become insanely expensive, having jumped 10 fold since 2000. The stock market has also increased substantially. The Bombay Stock Exchange Sensitive Index which is a weighted index of 30 stocks has doubled since February 2006. This rapid escalation has created an investing frenzy among average people in India and I think the market may be getting somewhat speculative.

Unlike the US, where non-accredited investors cannot invest in a stock’s Initial Public Offering (and other high-risk investments), in India anyone can invest in an IPO. Right now Anil Ambani, son of legendary industrialist Dhirubhai Ambani and the 6th richest man on earth, is raising $3 Billion via IPO for Reliance Power.

Based on his track record and networth of $45 Bilion, which comes mainly from his 35-50% holdings in his 4 public companies Reliance Communications, Reliance Capital, Reliance Natural Resources and Reliance Energy, that doesn’t really sound like a lot. However, the financial report of Reliance Power for the year ending on March 31st 2007 shows it had revenues of ~$562,000 and net revenue before taxes of ~$135,000. After taxes and carry forward losses, its net income was only $3,900!!!

In order to give it a market cap of over $3 Billion, the market is assuming there will be a tremendous amount of growth in the next few years. Considering that the money is ear-marked for buying the land and building energy plants, thats some serious growth that investors are banking on. I’m no accountant and I haven’t even fully read Benjamin Graham’s The Intelligent Investor, but that seems like a pretty lofty valuation.

You’d think that a company with few assets and little revenue would have a tough time raising the money. However, on the very first day is was over-subscribed by 10 times. The period of allotment for the IPO is about 3-4 days and its presumed that it will eventually be over-subscribed by 100 times!

Somehow, this reminds me of the excitement and speculation surrounding Enron in 1999! While Reliance Power probably wont go bankrupt due to fraudulent accounting, I really think the market is getting a little frothy. This doesn’t mean the stock won’t make initial investors money. It might. And the Indian stock market might go up 50% this year too. In fact, it might go up 20% a year for the next 10 years.

But paying such a high valuation for a stock with no earnings and no assets isn’t really investing, it’s mostly speculation. Speculation isn’t always bad. But you should know the difference and set you expectations (and allocation of risk capital) accordingly. Once of the best books about investment manias is Extraordinary Popular Delusions and the Madness of Crowds which was written over a 100 years ago.

Reliance Power’s valuation puts it in the same league as First Solar (FSLR). FSLR had revenues of $350 million and a net profit of $30 million last year. Yet, based on the hype surrounding solar stocks, its market cap went as high as $23 Billion. On Monday, its market cap was $18 Billion and I shorted it. Since then it’s dropped ~17%. Lets see how they both turn out.