“Wisdom consists of the anticipation of consequences.” Norman Cousins

“Every attempt to pump up asset prices with cheap money has failed, from John Law’s Mississippi fiasco in 1720 to Bernanke’s recent housing bust. But our economists think this time is different. And for now the market seems happy to go along.” Dylan Grice


After Which Magazine Cover Would you Rather Buy?

February 2012


August 1979


The market is unrelenting – we have not had a single 1% down day on the S&P since the middle of December. Albert Edwards said…

“The market is once again in a hope phase, hoping that the US is now in a self-sustaining recovery; hoping that China might be soft-landing; hoping that the Greece bailout and the ECB liquidity polices have settled things down in the eurozone. These bursts of hope are essential in long bear markets. Essential in the sense that hope must be crushed.”

Volatility is so 2011 and the VIX reflects this hovering around 20. The FTSE All Share was up 3.7% for the month and the Hedge Fund index was up 1.4%. Kelpie was up 3.3% held back by the short positions and the sizable cash weighting.


One question I have been grappling with this month is whether the LTRO(s) of around 1 trillion Euros have changed the game? Clearly the bulls have been right in 2012 so far and Crispin Odey’s comments about the authorities having no choice but let banks earn their spread are proving prescient. Governments and the ECB are providing unlimited financing and liquidity to the banks via the LTRO at 1%. The banks are filling their boots with this cheap money, turning around and buying sovereigns, which carry a zero risk weighting in capital terms, which is the primary cause of driving the yields down and increasing the perception that the crisis is receding and the problem has been solved. Peter is paying Paul to buy things from Peter. This is vendor/Ponzi finance and doesn’t cure much – but it certainly makes everyone feel better in the short term and allows the banks to earn a lovely carry.


The crisis was caused by the mispricing of capital, the Fed and the other major central banks kept interest rates too low for too long. It made debt too cheap and leverage too attractive and too accessible to too many people. It seems that we have learned nothing from the crisis because we are pricing capital near zero again with the LTRO and the Fed’s promise to keep rates anchored at zero until 2014. We are doubling down on a strategy which has proven thus far to be unsuccessful but also to cause a great deal of wealth destruction (eventually).


Two quotes have been playing on my mind….

“If the market has a problem, buy the problem and sell the market because the market isn’t going up until the problem is fixed.” Crispin Odey

The sector that leads you into trouble does not lead you out.” David Yarrow

Both of these are quite interesting and could provide impetus to the bulls or bears at this stage. Looking at history and the Japanese bubble, their real estate and equity prices; the Tech bubble and the Nasdaq’s subsequent performance makes me think that I side with Yarrow.

I think the portfolio had a good February, there were some very strong individual performers like Yukon Nevada (38%), Dart Group (17%) and Gravity (48%) which were very gratifying and all 3 were reduced into strength. However for the second month in a row it has been my conservative positioning that has held the portfolio back. Performance is going to be driven primarily by the core equities in the long book tempered or aided by the net exposure from macro or market shorts which are intended to protect the portfolio from the 100 Year Storm, or 7 Standard Deviation event, that we now seem to have with increasing frequency in financial markets.


When it comes to engaging with the market I try to let history be my guide. This would suggest that there shall almost certainly be better times to invest than now. When these opportunities arise they will likely be preceded by an abrupt and unheralded drawdown in speculative gains and risk appetite.

John Hussman was quite explicit in his 20th February note about the stability of the market and it’s susceptibility to a sharp correction. These conditions or syndromes as he calls them are completely distinct from the economic worries we may or may not soon face.

“As one of many ways to define “overvalued, overbought, overbullish, rising yield” conditions, consider the points in history when the S&P 500 was at a “Shiller” multiple of over 19 times 10-year inflation-adjusted earnings, the index was at least 8% over its 89-week moving average, within 2% of a 3-year high, with Investors Intelligence sentiment over 45% bulls, less than 30% bears, or both, and with at least one yield measure above its level of 26-weeks earlier (corporate, Treasury bond, or T-bill). This set of conditions produces a cluster restricted to about 8% of market history, and also self-selects for many of the worst times an investor could have chosen to buy stocks, based on the depth of the market’s decline within the following 18 months.

While the criteria above are loose enough to include several false signals, the periods also include late-1961 (-25%), early-1966 (-20%), late-1968 (-30%), late-1972 (-30%, and a nearly -50% loss extending beyond that 18 month window), mid-1987 (-33%), mid-1998 (-12% over the next 13 weeks), mid-2000 (-35%, and a loss of more than 50% beyond that 18 month window), and mid-2007 (-55%).”


This is sufficient warning to me that we need to remember that optimism can hurt. Robert Rodriguez highlighted what he calls “the investor delay recognition period” where market participants, particularly equity market participants do not yet fully grasp, due to their lack of awareness of historical context, the severity of the danger they are in or the magnitude of the risks they are taking.



Patents & Intellectual Property

“Knowledge is Power.” Sir Francis Bacon (1597)

Intellectual Property and Patents is a theme that permeates amongst several holdings within the portfolio. Alan Greenspan once called technology “the embodiment of ideas” and it is clear that in the modern age capitalism is driven by brains rather than the brawn that drove the industrial age. The course of history has shown us that innovators and inventors who can take “the inventive step” can become the recipients of supernormal profits.  For context, in July 2011, a consortium of technology firms acquired Nortel’s portfolio for $4.5bn, and following the Nortel transaction, Google agreed to acquire Motorola Mobility for $12.5bn with many commentators speculating the bulk of Google’s interest was founded upon Motorola’s patents. There is a global arms race for intellectual property afoot. Aware Inc , Microsoft, Genie Energy and IDT Corp are all stocks where I think substantial upside resides in the value of their IP assets.
The marvellous thing about IP assets is that once you own them you can receive cash flows for no incremental investment and you have a tangible, defendable moat. These cash flows are incredibly high margin and sometimes the assets are so strategic that they are purchased at great expense by larger incumbents.

I view these assets as “free shots on goal” – some will miss but some might score big. Aware Inc’s portfolio of patents has around a 50% classification crossover with Nortel and Motorola’s portfolios focus on digital communication, encryption and digital transmission. To use a sales comparison metric we can see that Motorola received around $450,000 and Nortel received around $750,000 per patent. Aware has 456 patents so assuming that they could receive only $100,000 on average then these assets are worth well in excess of 50% of the current market cap of the company.

IDT owns “Fabrix” which is a video software storage platform which they say has received interest from the Mega Caps as a bolt-on acquisition. IDT also owns “Zedge” which is the most popular mobile content community site in the world visited by more than 40 million unique users every month. Given the Social Networking stocks are all currently trading at egregious multiples this asset is worth something.  IDT Corporation also owns VoIP (Voice over Internet Protocol) patents and has spent millions trying to defend them. This demonstrates the value that management see in the assets and further shows another way that IP owners can defend and monetize their rights.

Genie Energy (a spinoff of IDT) owns a technology which they believe can extract shale oil by heating up the rock in the ground and extracting the oil from the ground in liquid form without serious surface disruption. They believe this method is cheaper and more environmentally friendly. CEO Howard Jonas puts breakeven at $25 per barrel, with oil at over $100 there is a decent margin to be earned. This technology and the economics it would generate on their oil assets make this a very dull business with a strong balance sheet, a 2% yield and a call option on a 20x return.



New Buys

Aware Inc


Aberdeen International


Positions Increased

Genie Energy

JZ Capital Partners


Positions Decreased



Dart Group

Mercer International

Yukon Nevada Gold