Agora Financial’s Rude Awakening

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Laguna Beach, California

• Markets skyrocket on Geithner’s Public-Private Investment Program,
• “Bad” stocks vs. “good”stocks in bear market rallies,
• Investing in the world’s shipping choke points and plenty more…

Eric Fry, reporting from Laguna Beach, California…

One day a goat; the next day a hero. Such is the recent history of Timothy Geithner’s reputation. Mr. Geithner, the nation’s apprentice Treasury Secretary, sparked a huge rally on Wall Street yesterday by unveiling the latest sure-fire bailout plan for the financial sector.

According to the hazy outline of the plan, the government will team up with private investors to buy “legacy loans” – formerly known as “toxic assets” – from financial institutions. No one seems to know exactly how this “Public-Private Investment Program” will work, but everyone seems to know that it will…work, that is.

The approximate details are as follows: The U.S. Treasury will kick in some money; private investors will kick in a bunch more money (although the private money won’t come from the private investors until after they have borrowed it from the government); then the government and the “private investors” will use their war chest to buy some stuff at some price from some bank somewhere; then the government and the private investors will sell the stuff they bought and everybody will make money…and the credit crisis will go away.

What could possibly go wrong with this plan?

Absolutely nothing, it seems, judging from the euphoric reaction of the investing public. A frenzy of eager buying pushed the Dow Jones Industrial Average up nearly 500 points yesterday – capping the blue chip index’s biggest two-week gain since 1938. No sector illustrates this newfound enthusiasm for stocks better than the financial sector. The S&P Index of Diversified Financial Service Companies has soared a whopping 105% since March 6th –or five times the gain of overall S&P 500 Index!

That’s the funny thing about bear market rallies; “bad stocks” tend to perform much better than “good stocks.” Citigroup’s stock (NYSE: C), for example, has tripled since March 6th, while ExxonMobil’s (NYSE: XOM) has gained only 10% since then. Perspective is everything, of course. Citi’s stock is still down more than 90% from its all-time high, while Exxon’s is down a little more than 20%.

Please don’t misunderstand us. We are delighted to see a few rays of sunshine pierce the gloom that enshrouds Wall Street. And we are especially delighted that, for a while at least, the last may be first. Nevertheless, we would be remiss in failing to mention that bear market rallies tend to lack the stability and stamina of bull market rallies. That’s because the shares of fundamentally flawed companies tend to play a very large role in bear market rallies.

For starters, the shares of fundamentally flawed companies tend to be heavily “shorted” by professional investors. Therefore, if the stock market begins to advance from the depths of a steep selloff, short-sellers will begin locking in their profits (and/or limiting their potential losses) by repurchasing the stocks they have sold short, thus causing heavily shorted stocks to jump in price. As this “short-covering” gains momentum and intensity, the heavily shorted stocks tend to rise even more, which creates even more short-covering, which drives the share prices even higher…And before you know it, you’ve got a 105% rally in just two weeks.

Short-covering doesn’t explain all of the recent rally, just a lot of it. The other force driving share prices higher comes from the group of folks we’d call “True Believers.”

These are the folks who believe that the shares of Citigroup at $2 represent a great long-term value. So when the True Believers see the prices of their favorite bank stocks begin to move higher, they rush in to buy some more.

At some point, of course, the buyers of depressed bank stocks will be glad to have made their purchases. At some point, in other words, these courageous buyers will be right. But that hasn’t happened yet. Instead, the financials slump from one depressed level to another, even more depressed level.

Consider the plight of Citigroup, the financial sector’s poster child. On five separate occasions during the last year, Citi’s stock rallied more than 50%. Each rally failed.

In March of last year, the stock jumped 52% from $17.99…then fell again.

In July, it jumped 58% from $14.01…then fell again.

In September, it jumped 83% from $12.85…then fell again.

In October, it jumped 60% from $12.00…then fell again.

In November, it jumped 195% from $3.05…then fell again…all the way to 97 cents.

The stock has nearly quadrupled since breaking the buck. Perhaps it will fall again, but it is running out of levels to fall to.

Maybe, therefore, Citi’s most recent rally will be the one that finally marks the bottom. Or maybe not. We have no idea…and we have no interest in trying to guess if Citi’s financial wounds are fatal, or merely life-threatening. Instead, we’d rather nibble on the shares of fundamentally sound companies.

Selected tanker stocks spring to mind as worthy examples. The Bloomberg Tanker Stock index is down a whopping 66% since last June.

This severe selloff does not lack for fundamental justification. The slumping price of tanker stocks reflects the slumping price of crude, which reflects – in part –slumping global demand. When demand for crude oil drops, so does demand for oil tankers.

But now that the shares of tanker companies have plummeted to multi-year lows – and now that crude oil has nudged back above $50 –these stocks offer a compelling investment opportunity.

Chris Mayer, editor of Capital & Crisis lays out the bull case in the column below…

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Have the Tanker’s Stopped Tanking?
By Chris Mayer

The stocks of oil tanker companies are cheap…very, very cheap. But before moving into the heart of this investment observation, let’s gain a sliver of insight about the value of shipping itself.

The dividends of the old spice trade, for example, financed much of the architectural splendor of Venice, Italy. If you stroll the Piazza San Marco, a complex pattern of Istrian stone plays out beneath your feet. Nearby, grand palazzos and public squares show off a dazzling array of tall columns, carved marble, impressive domes and spires.

As William Bernstein tells us in his fascinating book, A Splendid Exchange, Venice’s dazzling look was built up “largely on profits from pepper, cinnamon, nutmeg, mace and clove.” Spices then were what oil is today. At its peak, cinnamon oil traded for its weight in gold. Venetian traders made fortunes. “Profits well in excess of 100% were routine,” Bernstein notes. “A typical Venetian galley carried 100-300 tons between Egypt and Italy and earned vast fortunes for the imaginative and the lucky.”

Even then, a salty sailing man could count the most important sea lanes on one weathered hand. All of trade boiled down to just a handful of key passageways. Amazingly, these same passageways are still vital to world trade.

The most valuable commodity shipped today, by far, is oil. Nearly half of the world’s tonnage deals with shipping petroleum in one form or another. And nearly two-thirds of all petroleum produced winds up in the hulls of the world’s maritime fleets. The biggest consumers of oil happen to be far away from the richest oil regions. The U.S., for example, imports about 70% of its oil – compared with 42% in 1990 and only 24% in 1973. In fact, the U.S., Europe and Japan account for about 75% of global crude oil imports.

As oil demand grows – and, with it, dependency on imported oil – pressure will build on a handful of key sea lanes. Two of them loom much larger than the rest, accounting for more than 60% of the total oil shipped. These sea lanes are like the world’s throat, funneling the oil that slakes the world’s thirst. If one of these lanes constricts or closes, the world chokes, so to speak. So it’s likely that future oil shocks could stem from problems in these key transit lanes, or “choke points.”

(The nearby graphic appears in Bernstein’s book. It originally appeared in an excellent paper by Jean-Paul Rodrigue, titled “Straits, Passages and Chokepoints: A Maritime Geo-Strategy of Petroleum Distribution.”)

Most of these choke points have ancient roots. The Bosporus, for example, is a little neck of a strait connecting the Black Sea with (ultimately) the Mediterranean Sea. It has been a prized maritime passage for nearly 3,000 years. At its narrowest point, it is only about 765 yards across. “It is packed around the clock with an unbroken line of tankers, freighters, long-distance ferries and luxury liners,” Bernstein reports. Lined for 18 miles on both sides with expensive homes, it reached its maximum capacity long ago. Collisions and spills are common. Delays are routine, especially when large oil tankers make their way down the strait, forcing the oncoming lane to close in stretches.

The Strait of Hormuz is the world’s most important choke point because of its access to Middle Eastern oil fields. It is also one of the most vulnerable. It lies within easy striking distance of a number of troubled countries, including Iran. It has been a source of trouble in the past, as Rodrigue reports:

“Security within the strait has often been compromised. Between 1984-1987, there was a ‘Tanker War’ between Iran and Iraq, during which each party, in their own belligerence (Iran-Iraq War of 1980-1988), began firing on tankers, even neutrals, bound for their respective ports. Shipping in the Persian Gulf dropped 25%, forcing the intervention of the United States to help secure oil shipping lanes.”

There are few alternatives for Gulf oil if it can’t go through the Strait of Hormuz. The strait’s importance in global oil trade seems hard to overstate.

The Strait of Malacca is critical, too, because the eastbound passageway services Japan and China. Interestingly, the U.S. 7th Fleet patrols the Strait of Malacca. As China’s dependency on imported oil grows, I wonder how it will feel about the U.S. fleet’s presence in such a critical waterway.

These choke points may also mean that shipping oil may yet enjoy a long stretch of prosperity. The strained capacity of these choke points may limit the ability of the industry to add much supply. That means the existing shipping infrastructure – pipelines, terminals, tankers and storage facilities – may command better returns than most expect. Some of these assets, such as oil tankers, for which there are a number of publicly traded companies, are easy to invest in.

Venetian traders of yore minted money carrying spices, then the world’s most precious commodities. So too today’s investors may carry away fortunes wading into the business of moving oil. Check in tomorrow as we examine one of the most interesting tanker stocks to buy right now…

Joel’s Note: For a limited time, you can grab a free copy of Agora Financial’s just-released I.O.U.S.A. DVD when you sign up for Chris Mayer’s Capital & Crisis newsletter. But you’ll want to be quick for, as we all know, freebies don’t tend to last for long. Grab your own Personal Bailout Plan right here, complete with free DVD.

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[Rude Endnote: Markets here in Asia continued to pile on gains after yesterday’s blistering session on Wall Street. Hong Kong’s Hang Seng rose another 3.4% for the day while Japan’s Nikkei 225 also finished up, by 3.3%. Korea’s measure, the Kospi 100, advanced more than 2% and the Taiwan Taiex finished 2.3% higher. China’s CSI 300 index moved higher by half a percent.

In Europe, meanwhile, markets were a little more somber. Some unexpected inflation data released in the U.K. dampened sentiment in London where, last we checked, the FTSE was trading down some 1.25%. Indexes in Germany and France were relatively flat.

In the commodity pits, oil blew off a little steam after yesterday’s rally, but still sits upwards of $53 per barrel. Gold is down about ten bucks overnight and trades for $928 per ounce as we write.

Thanks for joining us again. We’ll be back with more tomorrow.

Until then…

Cheers,

Joel Bowman

The Rude Awakening
aussiejoel@the-rude-awakening.com