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Harry Newton's In Search of The Perfect Investment Technology Investor. Auction Rate Securities. Auction Rate Preferreds.

Previous Columns
8:30 AM EST, Wednesday, August 13, 2008:

How things have changed -- Part 1:

How things have changed -- Part 2:

Monday, August 11, 2008
Dear Investor,.

ACME Systematic Leveraged Macro Momentum Fund LP
321 Overprice Street
Greenwich, CT 00573

Dear Investor,

This letter is to inform you that the wheels have come off of the proverbial wagon at ACME Systematic Leveraged Macro Momentum Fund LP, and that the same awesome thematic portfolio that made you feel (in the first half-year) as if you'd become very rich in comparison to those sucking wind on their leveraged MBS portfolios or Japanese Small-Cap Value Funds, has, quite literally, spontaneously combusted in our faces.

Our long-oil (PBR, SU, SWN), long coal (MEE, BTU), long fertilizer (POT, MOS), and long iron ore (CLF, RIO) positions have been crushed (no pun intended), and though we remain hopeful going forward as the story remains "in tact", our models have forced us to sell some in response to prevailing price action. Our offsetting shorts in selected financials (MS, BLK, GS, and LM) have not fared as we expected, while our core retail and consumer discretionary shorts in AZO & URBN, DECK have quite literally been lodged deeply and inexplicably in an unmentionable orifice.

If that were all we'd not be too sullen, all things considered, but unfortunately our short US dollar positions (vs. everything), our JPYNZD & CHFAUD carry trades have also not performed to forecasted expectations, and both our our long-only, and zero-exposure long vs. short commodity baskets have imploded with a rapidity that would even frighten Taleb to vows of silence. Oh, and if that weren't enough, our gold and silver longs, too, have gone south as if trying to re-embed themselves in the ground, whilst the short Russell-2000 ETFs we've been using as a hedge have been behaving all-too priapically. These losses of course are not as bad - relatively speaking - as some of our peers (who regretfully are no longer in business) and should of course be viewed in the proper context of our delft avoidance of long exposure in the worst of the RMBS and CMBS sectors, our eschewing of becoming a CDO issuer/manager, and our resolve to avoid anything denominated in Icelandic Kronor. Unfortunately we still have a large (leveraged) position in high-yielding cov-lite loans, US sub-prime credit-card-backed receivables for which we remain unable to obtain sensible bids at levels near to where our auditors and administrators agreed that we should pay our prior year's incentive fees. Only our long Japanese REIT portfolio and our unlisted fund of Spanish Olive Groves have held their ground, though regretfully we refrained from hedging the currency risk, and so these too, are now in the red and eroding rapidly.

We have no explanation, since our trades are systematically based upon doing what others are doing (only, hopefully, faster... though, in this instance, not fast enough). Nor do we offer you apologies. You [presumably] knew the risks, and felt the glory (if only for a while). We do lament the the now-sky-high high-water mark, and the absence of performance fees (this year).

Finally, saving the best for last, we will be suspending redemptions as per the Force Majeureclause 6(c)-2 of the Private Placement Information Memorandum of the Fund. We trust you'll agree that only something supernatural could have torpedoed such a finely constructed portfolio put together by the best and the brightest Wall Street has to offer.

Yours sincerely,

Hugh G. Fallis - Managing Partner
ACME Systematic Leveraged Macro Momentum Fund LP

How things have changed -- Part 3: The Wall Street Journal did a piece how we are cutting, and can still cut, our oil consumption (and hence reduce the price of oil). The piece was called U.S. Retools Economy, Curbing Thirst for Oil. An excerpt:

The oil-price shocks of 1973 and 1979 motivated Japan, in particular, to become more energy-efficient. In 1980, when U.S. consumers were griping about $1.25-a-gallon gas -- $3.30 in today's prices -- their counterparts in Japan were paying roughly twice as much. They started using a lot less. In 1983, Japan consumed about 25% less oil per person than it had in 1973. Last year, Japan used 14 barrels per person, and the countries in the euro zone consumed 17. The U.S. used 25 barrels per person.

Yesterday my oil guru and friend, Jim Kingsdale, who writes the excellent web site, Energy Investment Strategies and has made a fortune investing in energy and is my friend, posted a piece called A Further Retreat from Oil Investments:

I understand that oil’s 20+% retracement from its high is not unprecedented; such a pullback often occurs in a bull market. I also know that currently available values in oil and gas stocks seem excellent and that pullbacks in bull markets are the right time to accumulate bargains.

Nonetheless, instead of buying I’ve been increasingly liquidating oil and oil service stocks. I’ve sold my options on oil futures. I’ve increased the EIS portfolio’s cash position for one reason. This pullback may be over quickly but if it isn’t we could be entering a very unusual period of global contraction that would imply significant additional downside risk, particularly for oil related stocks. That could occur due to the emergence of a combination of some of the following possible new trends:

- a major contraction in China’s growth rate

- a period of maximum new oil and gas production over the next two or three years

- oil exporting countries experiencing a vicious cycle of lower oil prices causing less funding available to finance their growth; slower growth resulting in more oil available for export; contributing to lower oil prices, etc.


Analysts are conflicted about what the likely direction will be for post-Olympic Chinese oil use. Here is a good discussion of the arguments for greater and lesser oil use.

One important factor, however, is that lesser oil use is likely the favored direction of the Chinese government for several reasons. First, the Chinese economy can grow more easily in a low-price oil world, which would be fostered by lower Chinese demand. Second, lower oil prices reduce the troublesome risk of inflation in the Chinese economy. Thirdly, lower oil prices take pressure off the government to restrict energy prices and to subsidize oil which distorts the Chinese economy.

Thus, to the extent the government can control Chinese oil demand, it would clearly be happy if it were lower, not higher. There is evidence that Chinese consumers are buying fuel inefficient cars to show off. A wise Chinese government might well put high taxes on such purchase or take other steps to discourage such profligate oil use at a time of tight oil markets.

More important is the possibility that the Chinese economy will simply hit a growth wall. It has been expanding at an unsustainably high 10+% rate for over 10 years. That means enormous infrastructure projects have gone into the pipeline. If end product demand is lower due to the OECD slowdown, China may face a severe capital spending slowdown. As we know, a reduction in capital spending has a multiplier effect in slowing the general economy, just as the great capital spending boom of the past 10 years has had a multiplier effect on growth.

A much more erudite version of this argument was recently published by Vitaliy Katsenelson who describes the bloated and inefficient Chinese economy with this example: “the biggest mall in the world - the South China mall, with space for fifteen hundred stores, only has a dozen stores open for business - it is empty. Shoppers never materialized. Billions of dollars have been wasted.” I highly recommend his entire essay which explains why China may well be due for a significant slowdown.

The Coming Period of Maximum Oil Production

According to the Wikipedia and other Megaprojects analysis the years 2008 - 2010 will see the most new oil produced from new large fields that has occurred in history and it will be far larger than it will during the five years following 2010. Visibility of production out to 2015 is possible because of the roughly 7-year lead times that new oil projects require from announcement to production of oil.

Here is a graph that summarizes the [5] Wikipedia Megaprojects model:

A detailed discussion of projected oil coming on stream is beyond this essay, but much discussion can be found at the above links. Moreover, one important part of the numbers is the simple fact that Saudi Arabia is bringing on stream two major fields in 2008 and 2009 that together are projected to add 2mb/d (million barrells to day) to global production.

Therefore, if any period of time is likely to see an abundance of oil production in the world, it is the next 2 - 3 years. After 2010, as several respected analysts have pointed out, global new production is looking weaker and it looks especially weak after 2012, four years from now. But the period we are entering now looks to be especially strong for new oil production.

Oil Exporting Countries Growth May Slow

Enormous infrastructure projects are underway in the Middle East and Russia based on cash flow from high oil prices. If oil prices decline, pressure will be felt to slow such projects down. There would be a lag period; a slowdown will not happen quickly. But orders for projects under consideration would be delayed and very new projects may be scuttled. Such actions would depress global capital goods markets.

Particularly impacted would be UAE projects in Dubai that are focused on high end business and leisure travel. The OECD slowdown will put pressure on the these highly leveraged projects from a demand viewpoint and a lower price of oil would pressure them from the ability to continue to finance them.

Moreover, less than projected cash flow to oil exporters caused by lower oil prices would also restrict the ability of oil exports to bolster OECD economies by making investments and providing liquidity. There will be less ability to prop up weak OECD financial institutions or manufacturers.

All in the Context of an OECD Slowdown

All of the above is predicated on a continuing slowdown in OECD economies. If the West were not slowing down, there would be far less pressure on China’s economy. While greater near-term oil production would tend to slow the rise in oil prices or cause a temporary pullback, it would not contribute to a significant and lasting fall in oil prices without the weak demand caused initially by the OECD slowdown. And without lower oil prices, there certainly would be no economic stress to the oil exporting economies.

But if the OECD slowdown continues and becomes more exaggerated, three factors discussed above could exacerbate a global economic slowdown and prolong and aggravate a normal pullback in the price of oil and possibly of North American gas. In fact, these factors would combine with a severe OECD slowdown to create a vicious cycle - a negative feedback loop - that I have tried to flesh out in very brief summary above.

If that were to become the case, oil could slip back to $80 - or even go lower. Natural gas in North America would probably stay above $7.50. But the possibility also exists that very weak global economic performance and a negative feedback loop could cause the financial markets - already weakened by the credit crunch and housing slump - to perform very badly.

Let’s also bear in mind that the U.S. financial position has been severely compromised by two presidential terms of deficit spending and increased national debt of record proportions. The U.S. is still the bell-cow of the global economy. Its weakened financial condition (especially in the context of ever-growing entitlement spending and interest costs) would tend to add to the negative feedback loop described above.

OPEC to the Rescue?

As the price of oil falls, OPEC will eventually try to support oil prices by cutting production. But such a cutback might be more difficult to engineer given the fact that Saudi Arabia is committed to increasing its oil capacity by about 2 mb/d in 2008 and 2009. The Saudis might drag out their construction process and might cap a lot of it. But it is simply harder to reduce production when you are already committed to bringing on important new fields.

Moreover, the Saudis have good political reasons to want to see much lower oil prices in the near term. Specifically, they are locked in a desperate competition with Iran for political influence in the region, both in terms of Lebanon and Iraq. They do not want Iran to proceed to become nuclear, nor do they want Iran to continue financing radical Shiite fighters.

Much lower oil prices would put huge pressure on the Iranian economy and could become a significant bargaining chip for the Saudis to obtain the political concessions they want from Iran. So it is not altogether clear that the Saudis will initially cooperate in an OPEC effort to reduce production and it is unlikely OPEC could succeed without Saudi leadership.

The Alternative

All of the above will probably not come to pass if the OECD and particularly the U.S. economies suddenly turn around and begin to strengthen. The chances for such a turnaround will be enhanced by lower oil prices. If the U.S. economy turns around due to lower oil prices, I will have been wrong to withdraw my investment capital from the market. On the other hand, I will have lost only opportunity, not money. It is a chance I have decided to take.

I am embarrassed that only 45 days ago [8] I wrote that oil is an investment Tsunami and that the challenge to investors is to stay invested in it. But conditions changed over the past 45 days.

If I were not convinced that an economic downturn not seen since the 1930’s is a real possibility and that it comes just as China is due for a downturn and oil supplies are due to increase at the highest rate in history over the next 2 - 3 years, I would not have sold my oil-related investments.

Most of the factors that are inherent in the negative scenario could have been perceived 45 days ago. I make no excuses for not seeing them. But I do listen to markets. I see oil moving down when increased political tensions in oil-intensive areas should cause it to move up. I do not like what I observe.

If I’m proved wrong by moving to the sidelines now, so be it. I will plead guilty to panic. But if panic is justified, it is far better to panic earlier than later. Some will not call this an early time but we will not know that for another year or so.

The brain as major powerhouse: Most tennis players are ecstatic when their serve goes in. The big lift in my tennis game came when I realized I could "will" the ball to land in a corner, down the line in the center, etc. Some opponents have great forehand returns, so you only want to serve to their backhands. Others move around, thinking they can figure where you're serving to and outwit you. The key is to move the ball around and fool them. You can do this by "willing" it and outwitting them. The brain works. P.S. I won yesterday against someone (a pro) I shouldn't have. I'm on Cloud Nine.

The incredible Olympics. Second reminder. The swimming. The gymnastics. If you missed any of it, you can watch it on You'll have to install a plug-in called Microsoft Silverlight. It's harmless.

Get up and move around. One of Michael's classmates at business school just spent five days in hospital because he developed a deep vein thrombosis – a large blood clot in his thigh. This led to a pulmonary embolism – a clot that floated into his lung -- along with a significant amount of fluid into his chest. The condition is typically caused by long periods of sitting still, causing blood to pool and clot. He figured the villain to be a 14.5 hour car ride from Boston to South Carolina.

The kid is under 30. He's lucky to be alive. In short, get up and move around. Do jumping jacks. Do anything. But move.

Please cancel your credit cards before you die.
A lady died this past January, and Citibank billed her in February and March for their annual service charges on her credit card. Citi also added late fees and interest. The balance had been $0.00 and now was around $60.00. A family member called Citibank.

Family Member: 'I am calling to tell you she died in January.'

Citibank: 'The account was never closed and the late fees and charges still apply.'

Family Member: 'Maybe, you should turn it over to collections.'

Citibank: 'Since it is two months past due, it already has been.'

Family Member : So, what will they do when they find out she is dead?'

Citibank: 'Either report her account to frauds division or report her to the credit bureau, maybe both!'

Family Member: 'Do you think God will be mad at her?'

Citibank: 'Excuse me?'

Family Member: 'Did you just get what I was telling you - the part about her being dead?'

Citibank: 'Sir, you'll have to speak to my supervisor.'

Supervisor gets on the phone:

Family Member: 'I'm calling to tell you, she died in January.'

Citibank : 'The account was never closed and late fees and charges still apply.' (This must be a phrase taught by the bank!)

Family Member: 'You mean you want to collect from her estate?'

Citibank: 'Are you her lawyer?'

Family Member: 'No, I'm her great nephew.'

Citibank: 'Could you fax us a certificate of death?'

Family Member: 'Sure.' (Fax number is given )

After they get the fax:

Citibank: 'Our system just isn't set up for death. I don't know what more I can do to help.'

Family Member: 'Well, if you figure it out, great! If not, you could just keep billing her. I don't think she will care.'

Citibank: 'Well, the late fees and charges do still apply.'(What is wrong with these people?)

Family Member: 'Would you like her new billing address?'

Citibank: 'That might help.'

Family Member: 'Odessa Memorial Cemetery, Highway 129, Plot Number 69.'

Citibank: 'Sir, that's a cemetery!'

Family Member: 'What do they do with dead people on your planet?

This column is about my personal search for the perfect investment. I don't give investment advice. For that you have to be registered with regulatory authorities, which I am not. I am a reporter and an investor. I make my daily column -- Monday through Friday -- freely available for three reasons: Writing is good for sorting things out in my brain. Second, the column is research for a book I'm writing called "In Search of the Perfect Investment." Third, I encourage my readers to send me their ideas, concerns and experiences. That way we can all learn together. My email address is . You can't click on my email address. You have to re-type it . This protects me from software scanning the Internet for email addresses to spam. I have no role in choosing the Google ads on this site. Thus I cannot endorse, though some look interesting. If you click on a link, Google may send me money. Please note I'm not suggesting you do. That money, if there is any, may help pay Michael's business school tuition. Read more about Google AdSense, click here and here.

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