Download PDF

Volume I, Issue 4 / December 2007

Welcome Letter

Dear Reader,

Fitz here. I’m sitting on the rooftop terrace at the Hotel Albergo in the Ashrafia district of Beirut. It seems so peaceful at this time of the evening. Children are playing in the neighborhood streets, and in this Christian part of town,Christmas songs are playing in the shops. But me? I’m feeling melancholy, almost depressed – which is odd, since I am normally the cockeyed optimist able to glean the positive/opportunity in almost every situation.As I smoke my shisha, I can’t help but think about how much things have changed, not only in the Middle East but also in the rest of the world – politically, economically, and sadly, philosophically. Less than 36 hours ago, just a couple of miles from here, a devastating car bomb exploded, killing General Francois al-Hajj and at least three others. Lebanon seems unavoidably destined for chaos.

On this very terrace, not that long ago, the local Beirut “Junto” held its twice-monthly gathering, a group of friends with one thing in common: the steadfast belief in freedom, open markets, capitalism and the rights and responsibilities of the individual. And like the original Junto, our philosophical outlook was underscored by a strong desire to stay on top of the local and regional deal flow. The founding members of our group, some of whom you will meet in our Dispatch section, were two Lebanese Shia, one Lebanese Druze, two Lebanese Christians, four Lebanese Sunni, one Armenian Jew, and this non-believing American. The source of my melancholy is that, since the last time our merry bank of capitalists met here, the world has gone bloody nutty, and Beirut seems to me a microcosm of what portends elsewhere.

How so? Well, if during one of our regular meetings I was to have said, “In a few years time, say less than ten years, the following would happen”:

1.  The U.S. will occupy Iraq, causing bloody civil war and fermenting resentment throughout the world.

2.  Mainstream political thought in the U.S. will turn anti-immigrant, and the people will want to construct a concrete wall along its border.

3.  The U.S. Government will not only condone but defend its right to monitor the private communications of its citizens for “their own protection.”

4.  The U.S. dollar will no longer have superior purchasing power.

5.  Some Emerging Market spreads will be less than 60 basis points.

6.  The Russian ruble will be trading over $0.04 and the Brazilian real will be trading over $0.50.

7.  Gold will be trading above $800 per ounce.

8.  Oil will be closing in on $100 per barrel.

9.  Socialism will be on the rise again in Latin America.

10.  The Chinese will be eager to pay over the market for oil in Iran…

 …everyone would have thought me insane.

So I must admit a bit of frustration and perhaps a notable lack of holiday cheer. This is partly because my memories of life in Beirut are some of my fondest, and partly because sometimes I feel as though we are failing you, dear reader.

You see, as we hunt for bargain basement opportunities in out-of-the-way places, we continue to be struck by how expensive things are in both real and relative terms. Even in places where you might expect things to be cheap, they are not. Don’t get me wrong, there are still ways to play the big trends profitably, and we will continue to formulate our attack using oblique angles to protect our capital. This month, for instance, we highlight a company that stands to gain significantly from an imminent reduction in regulation and we update our plans for investing in real estate in Slovakia.

In the Pulse section, we further elaborate on our view of emerging markets and how to position your portfolio to capitalize on the next phase in the cycle. As we mentioned in this very space two months ago, outside of the resource sector, there are bubbles desperately searching for a pin everywhere we look, and we want to prepare you for the massive opportunities just ahead when the masses panic and head for the hills. A monetary, political, military and demographic perfect storm is brewing just over the horizon.

Finally, let me say how much we enjoy corresponding with our subscribers and even more how much we enjoy meeting you in person. Since launching the letter, it has been a real pleasure meeting a number of you in Denver, Uruguay and Panama. We continue to be humbled by the intellect of our readers. Thanks again for subscribing.

The Dispatch

Back to Beirut

Fitz always says, “I may have only Irish blood in me, but I am part Lebanese.” There are two reasons why he says this. First, he wishes that he were Lebanese because they are probably, as a group, the most savvy, entrepreneurial, global, intrepid, relentless and fun group of people he has ever met. And secondly, because every time he goes to Beirut, he gains 20 pounds. Part Lebanese? Yep, half his butt and two of his chins…

Fitz lived in Lebanon – it was his base of operations for the Middle East. Although Dubai has now surpassed Beirut as the international banking and business center in the region, it is a great country. Beirut, Lebanon’s capital, is a strange mixture of tension and carefree living… a schizophrenia that’s intoxicating. Walk through any of the cafés that line the streets in Solidaire, the completely rebuilt city center that was totally destroyed in the civil war, and you’ll think you’re in St. Tropez. If you speak enough languages, you will hear elegant women discuss fashion and politics. However, it is just as likely they are discussing French or American politics as Lebanese politics. The fashion… well, the world is the Lebanese woman’s shopping mall for reasons we will touch on in due course.

If you can understand the men, they will be talking about one of five topics – global politics, global economics, Lebanese politics, deals and more deals. Now the problem is that it’s tough to understand what they are saying; the Lebanese are so well traveled and global in their mindset, that only the poorest of society speak only Arabic. For example, to say hello in Lebanese is “Hi Kifak Sava,” a three-word, three-language greeting most common amongst the educated and cosmopolitan Lebanese. It doesn’t take long to notice that the wealthy Lebanese don’t meet any of the commonly held beliefs about the society.

Tell the average American to envision Beirut and he thinks car bomb… and with good reason. But that is not the Beirut we know and love so much. It is a vibrant, upbeat city where bars, restaurants, and nightclubs inhabit what seems like half of downtown. Elegant men and beautiful women strut the streets in the latest haute couture. Big skyscrapers and expansive hotel complexes overlook the Mediterranean. Yet, it is not at all uncommon to have a 10-million-dollar building next to a bombed-out shell, looking like the war ended last Wednesday. Leave the city center and the poor live in dilapidated buildings with no windows. Juxtaposition is everywhere. Not surprising, given the history of the land and the culture.

The Phoenicians

The history of this rich land exceeds the amount of space available here, but essential is the lineage of the Phoenician trader that looms in the psyche of the Lebanese. The Phoenicians, due to lack of arable land, were forced to find other ways to thrive. They plied the coast of the Mediterranean as traders of goods ranging from spices to slaves. They traded with warring nations simultaneously and set up outposts in faraway lands, later repatriating their wealth to build what is modern-day Lebanon and Syria. Today, the modern Lebanese are empowered internally by the belief that at any time they can leave Lebanon and return later in life with a fortune capable of supporting La Dolce Vita. They do it in great numbers regularly, especially in times of crisis. They may need to do it again soon.

Diaspora

“Throw a Lebanese to the sea and he will come out of it with a fish” states an old Lebanese saying. They are proud of this reputation and rightfully so. You can’t spend time with a man or woman from Lebanon without them dropping one famous name who has a remote tie to Lebanese society. Check out (http://www.youtube.com/watch?v=CWaiJwPgoYE&feature=related). Want to drive a prominent Lebanese businessman mad? Tell him you’ve never heard of Swatch or the Palms casino.

Lebanon has known three important waves of migration. Starting in the late 1800s, the first wave was frantic and often clandestine, because the Ottomans initially prohibited movement. The second wave was more organized and followed the First World War, when there were too many people to support, and the partitioning of the “Middle East” suspended many of the local trading opportunities. Villages actually banded together and chose which residents were best suited for migration. They formed schools that taught languages and customs of the lands where many Lebanese were already located. The final wave came during the ’75 to ’91 civil war. The migrants always maintained close ties to the homeland – most left with an eye on returning someday after they made their fortune.

Many of those who left during the civil war returned during the 1990s, but there was little opportunity in the war-torn city. Many men went abroad again to look for opportunities, while their wives and children tried to rebuild their lives in Lebanon. Unlike many other cultures with a significant Diaspora, the Lebanese rarely get jobs – they start businesses. If they have nothing but their wits, they are still armed with the spirit of the Phoenicians. These hungry entrepreneurs are everywhere in the emerging world. They work hard in arduous conditions, saving and investing so they can return to live prosperously along the Mediterranean. This is still the case today. Let us give you one emblematic case.

No You Worry, Mister Fitz, We Have Lebanese

When Fitz was still working for Uncle Sam, he spent some time in Kinshasa, Congo. It is not a great place. Very few places Warren Zevon writes about are nice places. While Fitz never bumped into any headless Thomson gunners, he met quite a cast of characters. One remains legendary. His name is Khalid. He is a Shia Lebanese, unless that wasn’t good for business, in which case he was a Christian named George – or Jacob, if he thought he could get a better price. He deserves his own chair in entrepreneurship at Harvard.

Anyhow, Fitz desperately needed some refrigerated rail cars. The government said he needed to fill out a requisition form, send it back to Virginia, and then they would send some railcars by cargo ship from Bremerhaven in Germany. He’d have them in three months, if there wasn’t a backlog. That would have been two months and three weeks too late. So, he cabled the States and asked how much he was authorized to spend if he could procure them locally… after all, it was a mission in support of “vital” U.S. interests. He was told he could spend the full requisitioned amount of about 300,000 taxpayer dollars if they could get the local procurement approved. After all, it is patriotic to buy American.

So with a budget of three hundred grand, Fitz went to see the man who really knew the goings on in the Congo. CIA station chief? Nope. MI6? Nope. Tony, the concierge at the Grand Hotel Kinshasa? You betcha. Tony was the man. If it were available to be bought, stolen, smoked, shagged, stripped off and sold for parts, Tony knew the deal. The problem? Tony spoke “not so big Inglessh, Mr. Fitz.” So Fitz, armed with a picture torn from a catalogue, gesticulated wildly, and rubbed his index finger and thumb together indicating he wanted to “make buy.” The smile was immediate and the reply perplexing: “No you worry, Mr. Fitz, we have Lebanese.” Huh? Now shaking his head like a dog with water in his ear, Fitz pointed again and said “make buy” louder than was necessary. Tony only replied, “No problems, Mr. Fitz. Lebanese come tomorrow. Weedsdaaay nite. 630. You be here Weeedsdaay 630 too. Okay?” Perplexed, he agreed. After all, Tony was the man.

At six thirty the next evening, Fitz was sipping what he hoped was tea made with boiled water… and in walked Khalid. What a sight. Five foot eight and a good three hundred pounds, Khalid could not be missed. He was wearing khaki pants, sandals and a short-sleeved, yellow (not daffodil yellow but old newspaper yellow) linen shirt unbuttoned to the navel. Most amazing were the two gold chains so deeply intertwined with Khalid’s chest hair that they ran a gravity-defying circuitous route through his cleavage and hung suspended an inch from his skin, like a scale model of several interlocked freeway interchanges. In his day, Fitz had been caught staring at the third shirt button before, but never on a man. Even worse were Khalid’s teeth, which made Austin Powers look like Donny Osmond. It took a cup of tea to recover from the first impression. Fitz tried to find a spot to look, just above the eyebrows, so as not to openly stare.

In fluent but accented English, Khalid asked what Fitz needed. Fitz told him and handed him the picture. Khalid simply replied, “These are tough to find. It’ll cost you a hundred twenty grand.” Now, Fitz knew that, a) this was less than half the cost to get them the normal U.S.G. route, b) if he agreed to the initial price, he would lose credibility, and c) the refrigerated rail cars in question might belong to the Red Cross. So, trying to muster the best “man of the world” look a twenty-eight-year-old with freckles can, he said “Come on, you can’t be serious.” Khalid shrugged and replied, “That’s the price man. You need ‘em and I got ‘em. They will come with a bill of lading and source documents. If you don’t want ‘em, I have a buyer in Durban who does.” Fitz: “Ah, well I’m not sure I can get that much approved. And when would you be able to get them?” Khalid’s response: “What’s your first language, man? I said I had ‘em. You want me to ask Tony to translate for you? And don’t give me that bullshit about price. You probably already’ve got a quote from U.S. Army Europe HQ, shipped via Bremerhaven for twice my price.”

The best attempts not to look ridiculous and dumbfounded failed. Fitz gaped and agreed. True to Khalid’s word, the brand-new railcars arrived as promised. The money was wired from Virginia to Khalid’s account in Lichtenstein, and all was groovy with global commerce. Over the next several months, Khalid and Fitz became friendly. When Fitz left Africa, he thought he would have a good story for the preppies back home in Northern Virginia. Little did he know that there would be a Khalid chapter 2.

Fast forward to summer 2004, on the rooftop deck of the Hotel Albergo in Beirut. The Junto was meeting and talking about Iraq, and the full-contact sport of Lebanese politics. That week, two members had been jailed for 48 hours while accused of smuggling – trumped-up charges by the government. When released, one of the “political prisoners” asked Fitz why he liked Lebanon and the Lebanese. Fitz said he was interested in the land and the culture ever since he met this crazy guy in the Congo named Khalid. Everyone laughed at the chest hair story. The conversation moved on, but in less than twenty minutes, in walked the new and improved Khalid.

The Khalid of Kinshasa was long gone, and Khalid of Beirut by way of Paris was standing before Fitz. Evidently, one of the Junto members knew exactly who was running Kinshasa in ‘98 and sent a text message to Khalid to drop by and see his old friend. The new Khalid had undergone quite a transformation. Stomach reduction surgery had helped shed nearly two hundred pounds, a cosmetic dentist had sorted the mandibles and Zegna had replaced the old newspaper shirt… no way to judge the chest hair, but short odds say any surviving chains hung flush with the pecs. After making over ten million dollars in seven years in the Congo, Khalid had bought three villas in the south of France that he rented to minor Kuwaiti princes, and had started a chain of clothing stores in the Middle East.

His strategy? Go to Europe at the end of each season and buy one of everything on the high-end boutiques’ sale racks. He and his super-hot French-Algerian girlfriend Carole would then fly to China, where the sales rack surplus was instantly turned into next year’s line in Khalid’s stores. He also had a stake in the Algerian wireless company, which he later sold to Orascom for quite a profit. Instead of traveling by sandals, he now drove a black Porsche 911 Targa. Parking was tough in Beirut, and Khalid was impatient… so he hired two guys to follow him around in an old Toyota. When he arrived at his destination, he would just let the car idle in the street and one of the flunkies jumped in. BYOVP – bring your own valet parking – why not?

There are literally thousands of Khalids out there, and hundreds of thousands more not quite so flamboyant or prosperous but still making an impact. There are at least four million Lebanese citizens in Brazil today, and we’re confident that a good number of them are capitalizing on opportunity in a big way. In almost every viable market in the world, you can find three things: a Chinaman selling food, an Irishman selling booze, and a Lebanese selling everything else.

Race/Religious Relations

There are four main groups in Lebanon: Christians, Shi’ia, Sunni, and the Druze. These are not monolithic groups, as there are plenty of factions and subsets within each one. But these groups, although divided based on religion, are really little more than interest groups engaged in a power struggle. The Sunni have long been considered the controlling elite; the Shi’ia the rural poor and agitated; the Christians a holdover from the power granted them during French colonial rule; and the Druze a small but influential group able to punch above their weight by leveraging their support. By far the fastest-growing group are the Shi’ia. The Druze and the Christians are shrinking for two reasons: like most other prosperous groups, their birth rate is declining, and being educated, they are more likely to vote with their feet as productive members of the Diaspora.

The Government

Lebanese government is even crazier than most governments. By constitutional design, Lebanon is governed by a system called Confessionalism. Just the name alone, knowing nothing else, makes us shake our heads. Confessionalism is a system of government that distributes political and institutional power proportionally among religious communities. Posts in government and seats in the legislature are apportioned amongst different groups according to the relative demographic composition of those groups in a society, which is seen as a way of formally recognizing the communal political rights of indigenous groups. Its intent is to secure the peaceful coexistence of diverse religious and ethnic communities by empowering each according to its relative presence in the region.

However, this system is like democracy, only worse. It only deepens the divide between “groups” and naturally leads to class warfare. Traditionally, the uneducated and poor have greater population growth, ensuring that over time the have-nots control the purse strings.

In Lebanon, the system requires high-ranking offices in government be reserved for members of specific religious groups: the president must be a Maronite Catholic Christian; the prime minister a Sunni Muslim; the deputy prime minister an Orthodox Christian; and the speaker of the Parliament a Shi’ia Muslim. No wonder they are always tossing each other in jail. The system is designed not to work efficiently but to ensure power struggles.

Greater Syria and the Cedar Revolution

Complicating the situation is the influence of Syria, and therefore Iran, in Lebanese internal affairs. Syria believes that Lebanon is part of Syria. Full stop. No questions. Their argument comes down to the simple fact they don’t recognize the lines drawn by imperial powers in the wake of World War II. Greater Syria also includes Israel and parts of Jordan.

On Valentines Day 2005, former Prime Minister Rafik Hariri (and father of our first Heiress of the Month, see Without Borders, September issue) was assassinated in a car bomb explosion in Beirut. Most Lebanese accused Syria of the attack, because of its intrusive military and intelligence presence in Lebanon. Syria naturally denies any involvement. The Hariri assassination marked the beginning of a series of assassination attempts. The result has been the loss of many prominent Lebanese figures, including General Francois al-Hajj just a few days ago. Today, the somewhat legitimate claim of a Greater Syria is merely a cover for the Iranian and Syrian coalition’s desire to destabilize Lebanon. There is an accepted expression in the Levant, “As Lebanon goes, the Middle East follows.” Therefore, all interest groups use it as a battleground. Although formal Syrian involvement ended with the Cedar Revolution of 2005, Syria is a driving force in Lebanese politics if not the driving force in Lebanese politics, except when Hezbollah steps into the forefront

…Hezbollah: The Party of God.

It would be unreasonable not to mention Hezbollah when talking about Beirut. It is also impossible to address it fully within this article, and we have decided to do a full-blown article on Hezbollah in an upcoming issue. Most Americans associate Hezbollah with its 1983 attack on U.S. marine barracks in Beirut that killed 241 servicemen. Hezbollah has engaged in that and other acts of terrorism, such as the hijacking of TWA flight 847 in 1985, and the 1998 kidnapping of Lieutenant Colonel William R. Higgins of the U.S. Marines, an unarmed U.N. observer who was tortured and murdered. While the blame was not undeserved, it is generally easier to trace much of the terrorism of the ’80s and early ’90s to Iran than to Hezbollah.

But it’s important to note that Hezbollah is a driving force in Lebanese society. But not because of its armed stand against Israel, but because of its social programs. Hezbollah won the support of Shi’ite Muslims by providing social services, health care and welfare when the Lebanese government failed. Hezbollah runs hospitals, news services and educational facilities for its followers in Lebanon. It is behind a large number of economic and infrastructure projects in the country. The aforementioned ineffective government created a void filled by Hezbollah.

Please don’t misunderstand. We are not justifying the horrible things Hezbollah has done in “God’s Name.” However, they do not derive their support from religious fanatics who want to kill infidels. Rather, they brainwash their young men and desperate families who have no other source of education, food, clothing or medical care. They take full advantage of the miserable living conditions in the refugee camps to indoctrinate multiple generations that know nothing else to hate. It’s not hard.

We have said it before and will continue to do so: there is no such thing as religious or ethnic conflict. There is only economic conflict. Often the economic conflict is “justified” by charismatic leaders using ethnicity and religion, because by definition blood and faith need not be justified with reason. Hezbollah is no different, and Sheik Hasan Nasrallah is nothing if not charismatic.

Gulf Money and the Building Boom

Q: Why do you invite two Saudis to your party?

A: Because if you invite only one, he will drink all your booze.

That may be an unfair generalization – there are plenty of pious Saudis – but it is certainly not untrue. If you ever fly to Beirut from any of the Gulf nations, be sure and pee before you get on board. Why? Because the minute the seatbelt light goes off, the locals run for the john to shed their robes for the latest in Italian and French fashion. They need to look good before they land and meet the Tunisian chicks joining them there to party.

Gulf Arabs are no longer welcome in Europe and North America. As such, Beirut has become one of their outlets. Lebanon has casino gambling. Lebanon has skimpily clad, buxom beauties. Lebanon has nightclubs that don’t close until after breakfast. Lebanon has a beachfront thirty degrees cooler than the Gulf region in July and August. And what goes on in Beirut stays in Beirut. As a result, the Gulf Arabs are pouring money into real estate developments. Apartments in any place you would want to live start at over half a million U.S. dollars, and are being bid up by locals and Gulf Arabs looking not only for party pads but for a place to turn deflating dollars into brick and mortar. So is there a real estate or public equity play for us? No.

If you think the political instability in Lebanon may have caused some bargains, think again. There is no room for any of us to make a killing in the real estate market. Not now and probably not ever. Even when the city was in ruins and rubble, the bidding wars on property were highly contested by those with emotional ties to the area.

Public Markets

Only recently surpassed by Dubai and Cairo, Lebanon was the former financial capital of the region. It has an active stock market, but none of the listed companies look attractive at this time – valuations are at historical highs, and all would be gutted if violence spreads to Beirut. There are some great Lebanese firms that do business all over the world, but most are private. We’d love the opportunity to play the Khalids in Africa selling to the Chinese through a listed company, but there is thus far no outlet.

One interesting way to play Lebanon, however, is to keep your eyes on Lebanese sovereign bonds. From time to time, these provide a very interesting trading opportunity. Believe it or not, these bonds are sitting in a lot of old ladies’ accounts in France, Italy and Spain. Why? Because when they’re trading at par, they yield close to 10%. And although it’s one of the most indebted nations in the world per capita, Lebanon has never missed a payment. Nonetheless, when Lebanon hits the news in a bad way, many of these bonds are sold off to anyone who will buy them. During the summer of ’06, when Israel invaded, we bought some for about 76. They are now trading at 120. Yields are currently in the 4.5% to 6.5% range, but if they drop sharply you can pick them up on the cheap, with a yield north of 14%. You can either sell them and move on as they recover, or hold them and clip the coupons.

The Future?

As I mentioned in the Welcome Letter this month, we are not optimistic. We want to be. We love the Lebanese. We love Lebanon. But this trip has not been kind to our spirits. Friends who are normally bullish are bearish, and sending their kids out of the country for education and jobs. Perhaps more prescient is the belief of several of our well-educated, globally minded contacts that the country needs another civil war. Yes, they actually make the case for war the way a good Austrian economist argues for a correction. One actually used the term “Creative Destruction” and others talked about their belief that “Lebanon is a Phoenix” and will “rise from the ashes.” Flashy rhetoric aside, a dark cloud now hangs over Beirut, and the smart money thinks it will get worse before it gets better.

A Place to Live

Five years ago, we would have heartily recommended you visit, even consider living in, Lebanon. Today it is expensive and likely to get dangerous; a full-blown civil war is being discussed in circles that would have ruled it out completely two years ago. It is still a delightful place full of delightful people. But there are too many options out there, making it tough to choose Lebanon. If you’re at the stage in your life where you need excitement, and are thinking about going to Africa to find a hot spot, then we think you should look at Beirut – just as much potential for turmoil, and much more fun. If you’re one of the wise folks, looking for your place to go should calamity strike the U.S., we can’t say Beirut is a good choice as safe haven.

Worth a Visit?

Should you still visit? It’s a tough call. We still feel comfortable there, and so far the violence has been targeted towards specific internal political leaders. There has been no random violence. You are probably safer in Beirut than New Orleans after dark; today your greatest danger in Lebanon is a car accident, not a car bomb or kidnapping. We don’t ride in the passenger seat in any car in Lebanon, we sit behind the driver. Why? Because our buddy Mohamed drives his new Mercedes SUV at 70 miles an hour in town and told us red lights are for tourists. No matter how much the driver likes you, the split second before impact, he’ll jerk the wheel in the way that best protects him. Always sit behind the driver in the emerging world.

If you want the chance to be the one at the neighbor’s pool party to drop, “Oh, I was in Beirut just before the civil war started…” then now may be the time to go. For U.S. citizens, you can visit without a visa for up to 30 days. There are daily direct flights from London on British Airways and from Paris on Air France.

Where to Stay?

So if indeed you want to go now, then by far the best place to stay is the Hotel Albergo if you are looking for service, quiet and elegance. Fitz just stayed there, and even after a three-year absence, the management had enough institutional retention to have the mini-bar stocked with extra Scotch and Diet Cokes, and the FT was delivered shortly after check-in – all without asking, they just remembered… impressive service by any standard. Room rates are on a par with the rest of Lebanon’s finer hotels at around US$200 a night.

The catch? Well, if you are going to Lebanon on business with a Muslim Lebanese, it is advisable to stay in either of the two Intercontinental Hotels, or perhaps Hotel Palm Beach. These hotels are Muslim-owned and considered neutral. Unfortunately, the Albergo is in the Christian part of town. So if you don’t know the people you are meeting, they may interpret your choice as a statement in the land of misguided symbolism. To be candid, not until Fitz felt he had fully established his Arabist credentials with his local partners, did he think it acceptable to start staying at the Albergo. If you are a tourist, it is absolutely not an issue, and the Albergo is the best choice unless you need to be directly on the sea. If weather permits, please smoke some shisha on the rooftop deck for us.

Where to Eat?

The Italian restaurant in the Albergo is one of the very best in Beirut. But why eat Italian when in Lebanon? We recommend Abdoul Wahab, in the Monot district, for the best local cuisine. If you like steak and frites with that French Lebanese flair, then L’Entrecôte is for you. There is also DUO, in Solidaire, for more eclectic continental fare with some of the most glamorous of Beirut’s jet setters. For coffee and sandwiches, Paul, located in the pedestrian area of Solidaire, is a great French café. Dining is great in Beirut. You get the best of French élan with Lebanese friendliness and passion.

You simply can’t go to Beirut without sampling the world-famous nightlife. Even if you have partied like a rock star in Cannes and smoked weed with Dylan, you haven’t completed the party circuit until you’ve emerged from a Lebanese disco at seven in the morning. The Lebanese are very status conscious, and nowhere does that trait come out more than in the clubs. We have seen tables battle one another for prestige and “wasta,” each trying to order the greater number of $1,500 bottles of champagne. The waiters carry a silver bowl with twenty sparklers over their heads to make a real show of the delivery… it is quite a spectacle.

For you brave souls willing to try hanging with the locals, we suggest Crystal in Monot and The Sky Bar on the roof of the Palm Beach Hotel. Also, if you enjoy live Arabic pop music, try Taj in Monot, owned by a friend’s brother. Tell the big guy at the door that Abu Pete sent you. Even if your nights of partying till dawn are behind you, have a late dinner on the pedestrian mall in Solidaire and then stroll on the cornice along the Mediterranean. But be careful to stay in central Beirut. Once you leave the downtown areas, it can get dangerous for tourists in the poorer neighborhoods.

Further Reading

If you’re as fascinated by the city and the culture as we are, but not planning to visit anytime soon, we recommend a novel titled Bliss Street, by Kriss Kenway. It’s an easy read that tells a fascinating story and highlights many of the interesting and unique elements of the society, government and the capital city. It is frankly better than most of the scholarly works with their inherent bias, and desperate attempts by the authors to claim insight into an all but incomprehensible situation.

Finally

We really wanted to write an article that went something like, “As always, CNN and SKY miss the picture. Beirut is wonderful and you should consider it a must-see destination and maybe a place to live part of the year…” Unfortunately, we cannot write that article right now. Lebanon is a rich and perplexing place. The people are so damn capitalist, we just want to be with or around them. They party and enjoy life while keeping a firm grasp on the happenings in the world at large. How could we not be ready to jump in? Well, we can’t. It just feels like it’s about to teeter over the edge of the abyss. We do not know if it will be Israel, Syria or internal strife that tips the balance, but we think it will happen. Could it bounce back and avert trouble? Yes. But we think it is unlikely.

Actionable Intelligence

Betting on Reform: Public Utilities in Argentina

Argentina’s new president, Cristina Elisabet Fernández de Kirchner, took office on December 10, accepting the ceremonial sash from her husband and predecessor, Néstor Kirchner. Cristina (using her given name to avoid confusion with the first gentleman of Argentina) won the presidency by a fat margin. While her promises to stamp out poverty won neither the hearts nor the minds of upper-middle-class residents of Buenos Aires, it resonated strongly with the rural poor.

She got the votes, yet the average Argentine (and even the comparatively well informed) seems to know very little about her specific policies, perhaps because her campaign was long on smiles and grandiose promises, short on substance. During her career in the Senate, she became notorious for unpredictable votes and a disdain of the party line – and for being cagey. When her husband came to office in 2003, she already had a stranglehold on the Senate, and from then on could elect to kill a bill or pass it on to her husband for, naturally, his signature.

It’s always fun to win, but the Argentina she inherits has serious problems, many left over from the country’s turn-of-the-millennium economic crisis. Poverty has declined, but inflation is moving in the other direction. The government claims an 8% to 10% inflation rate, but ask an economist or businessman and you’ll hear 15% to 20%. A labyrinth of protectionist measures – including price freezes, export taxes, currency manipulation and exchange controls – befuddle the markets and frustrate growth, in a country that could quickly become one of the world’s most prosperous if only the government would get out of the way. But much of the public accepts the protectionist measures as safeguard against the rapacity of foreign investors, whom the politicians ritually denounce as the root of all economic evil.

But evil influence from that source has gotten scarce. Argentina is once again struggling to meet its debt obligations, and this time foreign investors aren’t coming to the rescue. The worldwide subprime fiasco, and consequent flight to quality paper, has pushed up risk premiums. A recent offering of Argentine government bonds had to promise buyers a yield of 10.5%. We expect rates to go even higher as the government presses to raise the nearly $10 billion it will need next year.

As has happened in many other countries, the need to placate foreign lenders may give Argentina a strong nudge in a healthy direction. Argentina is talking with the Paris Club (www.clubdeparis.org/sections/qui-sommes-nous) about restructuring its outstanding debt, yet it’s unlikely that either the Paris Club or the IMF will give Argentina what it’s looking for without serious reforms. Both groups regret their failure to impose a little sanity on economic policy during the crazy years of 2001 to 2005, when Argentina defaulted, devalued and finally settled on paying bond holders 30 cents on the dollar.

Today, the Argentine government needs capital to avoid another economic crisis; for now, at least, that capital will have to come from the outside. High inflation has fostered a high-consumption mentality, as Argentines are quick to spend disposable income rather than watch it lose purchasing power by saving. Consequently, there’s not much capital formation at home.

Energy

Perhaps the most vigorously self-defeating element of the government’s meddling has been its energy policy. The government puts a lid – a painfully low lid – on the rate utilities can charge for electricity. Argentina’s wholesale price for power is 40% lower than Peru’s and about half of Brazil’s and Chile’s. Argentine prices for residential service are less than 25% of regional comparables. 

That seems convenient for consumers, until you notice those are the prices for electricity when it’s available. Price controls have dampened the reward for adding to capacity, even with growing demand, so now there are energy shortages across the country… it’s Economics 101. The shortages, which are getting worse, threaten to choke off economic growth and consign Argentina to an era of candlelight and stagflation: energy shortages hinder output, which gooses inflation and suffocates employment. The story reads like Atlas Shrugged.

It’s not as though the government lacks a method for setting the price of electricity… it’s the method itself that’s lacking. The Argentine government uses gorilla math. It sets the national price for power with a formula tied to the price of natural gas, which is pure insanity because, 1) the government also sets the price of natural gas, and 2) most electricity in Argentina is generated from hydro, nuclear or sources other than natural gas. The components of the formula yield average prices for electricity low enough to guarantee shortages; the link to natural gas aggravates matters with its antic fluctuation to the perversely low price.

The only way out of this mess is to loosen controls and allow the market to set prices. While we don’t expect clean, market-driven pricing anytime soon, our sources in Buenos Aires say that Cristina will likely allow electricity rates to rise.

When it became clear she would win the election, utility companies began talking with the government about fixing the fixed price scheme. Also, a Senate “Emergency Law” authorizes Cristina to directly negotiate contracts with electricity, phone and water companies, whose rates have been frozen for years. This authority runs through 2008, and it appears she intends to use it. Cristina has already been testing the waters, negotiating with retailers about higher prices for Christmas decorations (yes, we’re serious) to see how the public reacts. The pitch and volume of the screaming should tell us something about the political timing of utility rate hikes.

Ultimately, price increases will be painful for some Argentines, but are needed to prevent the country from going down the economic slip-n’-slide. Cristina understands that energy shortages and price controls will stall the foreign investment required for economic growth.

Overall, we love Argentina and think it a fantastically beautiful and sophisticated country – cost of living is wonderfully low, and real estate looks like a bargain. We’ll provide a more in-depth treatment of the country in future issues, but our intelligence on the ground warrants a discussion of a company that would benefit significantly from a utility rate hike.

Empresa Distribuidora y Comercializadora Norte, SA ADR (EDENOR)

EDENOR is a large electricity distributor, operating primarily in Buenos Aires and the surrounding area. The company’s customer base already exceeds 2.4 million and is growing rapidly. EDENOR has an official concession as the exclusive provider within a 4,637-square-kilometer area with approximately seven million people, and it’s good for another 83 years.

The company’s primary physical asset is its distribution network – 34,000 kilometers of power lines, 67 substations and associated control equipment. Its current distribution capacity is approximately 20,000 gigawatts, and at present growth rates EDENOR will reach full capacity within 2 years. The company recently announced it will invest more than $1 billion in distribution infrastructure over the next 8 years to double its capacity. Infrastructure investment on that scale hasn’t happened in Argentina since before the economic crisis that began in 2001. We believe EDENOR’s expansion plan signals a significant compromise with the government: utilities expand capacity, and Cristina’s administration allows rates to increase. So let’s take a closer look at EDENOR.

Business Fundamentals

EDENOR’s business is 38% residential, 39% industrial, and 23% other commercial. Despite five years of frozen prices, EDENOR has improved its own efficiency. On the labor side, the ratio of customers per employee is increasing by an average of 3% per year. On the technical side it has accomplished even more. When the power sector was privatized in 1992, EDENOR was losing nearly 30% of the power it purchased to waste heat in power lines, operating errors and theft by line tappers. By the end of 2006, the shrinkage rate was down to 10%, which is lower than other big providers in South America.

Over the last three years sales have grown at an average rate of 13.49%, and earnings have grown at 11.63% per year – progress far ahead of Argentina’s economy as a whole. After a rate hike, we expect even higher revenue and profit growth in the industrial market, driven by favorable pricing and EDENOR’s expanded capacity. In the residential market, a rate hike should decrease the total kilowatt-hours sold per customer, but by an amount smaller than the percentage price increase, making an overall positive contribution to profit.

The Books

EDENOR reports according to GAAP standards, so the financial picture is reasonably clear, and what we see looks healthy. The company has US$61 million cash on hand, which represents approximately 19% of its $330 million in long-term debt. This debt was recently restructured at an average cost of capital of 8%, maturing 2019. That rate means lenders are requiring a lower risk premium from EDENOR than they do from the government of Argentina.

Cash flow for 2007 has been strong (36% of sales), and the company has used some of the money to retire 12% of its outstanding debt. Management has committed to pay for the big expansion of its distribution infrastructure without borrowing, another sign they’ve reached an agreement with the government and will finance the expansion out of the increased cash flow a rate hike will bring.

Growth Opportunities

EDENOR has exclusivity in the most populous region in Argentina, an area with the fastest growth in residential and commercial consumption. The customer base is affluent and delinquency rates are low. And the base is concentrated in a small geographic area, which makes for lower delivery costs. Factor in the benefits of additional infrastructure investment and flexible pricing, and we expect EDENOR to achieve today’s regional averages for number of customers and EBITDA by 2011. Using today’s multiple of 4.3 for Enterprise Value to EBITDA, instead of the regional average 6.9, EDENOR would be valued at nearly five times what it is today upon realizing this milestone.

 

 

 

 

 

 

The Stock (NYSE: EDN)

The stock is traded in pesos in Buenos Aires (Buenos Aires: EDN), and an ADS for the stock has recently begun trading, in dollars, on the New York Stock Exchange (one ADS representing 20 shares in Argentina). All other things being the same, a decline in the U.S. dollar against the Argentine peso would increase the dollar price of the ADS. For years, the Argentine government has struggled, but managed, to keep the peso artificially cheap by further indebting itself to purchase U.S. dollars, driving down the price of the peso. By the middle of next year, however, Cristina will have few remaining reserves with which to purchase greenbacks. If she is able to prevent an economic collapse, we expect the Argentine peso to gradually rise against the dollar.

With a forward P/E of 13.84, the stock is undervalued compared to the rest of the Argentine market, which has had a significant run-up recently. Price/Book ratio is an attractive 1.6. The stock currently has no yield, but the terms of the company’s debt restructuring allow it to begin paying dividends in April 2008 if its ratio of debt to equity drops below 0.4. It is currently 0.5.

Shares outstanding are approximately 900 million, of which 51% is owned by Pampa Holding (a power conglomerate), 48.78% is free trading, and 0.02% is held by the Employee Stock Ownership Program.

The ADS trades in New York in the low 20s, with daily volume usually in the 100,000 share range. The stock is currently 15% off its peak near 26 that it reached earlier this year.

Overall

We believe the government is getting strong armed by reality, and that economic conditions will force a rate increase; our sources read the tea leaves the same way. The key risk is a drop in the peso, a risk we assess to be low; Argentina is running an export surplus, and we don’t expect Cristina to embrace anything extravagantly foolish. We will provide a more in-depth treatment of Argentina in future issues, but for now, we would begin slowly accumulating EDENOR in the $20 – $21 range, particularly if it reaches $20 per share in New York.

Updates

BLADEX

Bladex (NYSE: BLX) recently announced the departure of its CFO Carlos Yap, effective February 2008((?)). Mr. Yap was an excellent CFO and has been at the bank for 27 years; his departure does not reflect poorly on his performance, and we have verified this with trusted sources. His replacement, Mr. Jaime Celorio, is an internal candidate with experience at Goldman Sachs and Merrill Lynch. We view this as a positive change, as he will undoubtedly leverage his Rolodex to help educate analysts on Bladex’s business model, i.e., a non-retail, trade-finance bank with zero subprime exposure.

Even so, Bladex has sold off recently. It may be tax-loss selling or it may just be jitters about the banking sector in general. Regardless, this is one stock we are happy the market is allowing us to pick up at a discount. If you bought shares already, we’d be comfortable averaging down and buying on weakness. If you don’t yet own Bladex, it is attractive at these levels. We originally purchased in the mid-17s, and are buying more now; the dividend yield is currently 5.4%.

COPA HOLDINGS (NYSE: CPA)

Copa Holdings (NYSE: CPA). The Street has treated Copa well lately, having bounced back 15% from a low around $32. As frequent Copa travelers, we continue to be impressed by management’s hedging of fuel price increases, as well as overall demand. Flights are generally sold out several days in advance, and we expect this trend to continue once the airline’s alliances with KLM and Aeroflot kick off in the summer.

Slovakia Update

We’ve been back to Slovakia and continue to be impressed with the real estate opportunity there. We found a contractor we really like, and our local insiders are willing to co-invest their capital along side us – always a good sign. Here are the basics:

Location: High Tatras Ski and Golf Resort area near Poprad

Background: The High Tatras are the premier ski and golf resort area in Slovakia. During the days of Communism, being awarded a trip to this resort was a huge feather in your red hat. It still holds strong cachet amongst former Eastern Bloc residents. It is also known for its hot springs with several “Aqua Parks” in the area. The impetus for opportunity is the growing investment from upper-class Slovaks, Poles and Russians. One Russian oil trader we spoke to in Bratislava told us, after a couple of cocktails, “I have a home in Switzerland but people there think we don’t belong. My wife and children don’t feel comfortable there. All the Russian prostitutes there ruined it for the sophisticated people like us. See here, look at this watch, sixty thousand euros at Cartier. You can buy their watch, but they think we are, you know, nouveau riche and loud like you Americans.” Go figure.

Anyhow, he told us he’s building his chalet in the High Tatras, a trend that will continue, especially as the Russians and others look to convert currencies into tangible property. Grand hotels are being refurbished with millions of Austrian, Russian and German money. Infrastructure, including an international airport with multiple direct flights to London, is already in place. In fact, you can be on the slopes less than two and a half hours after taking off from London. For vacationers from the UK or Germany, it is half the distance of comparable resorts in Bulgaria, and half the price of Austria, France or Switzerland. However, apartments are not cheap and demand is rising, creating an opportunity in the very near term. Other savvy people see this opportunity as well, so you’ll have to move fast.

We are doing just that. Our plan is to buy one or two pieces of land in a prime location near the golf course with great views of the High Tatras. This is the area where all Czech and Slovak professional hockey players and TV personalities are building their big vacation homes. There is also a new hot springs spa being built nearby. We will then build an apartment building and sell a select number of properties “off-plan” at a discount to the market, subsequently selling the remaining units at market price. We should have some solid numbers within a week or two, but initially the return looks more than sufficient to cover the risk, and the upside would realistically be a double in 12 to 18 months. We’ll keep you updated on how things progress.

If you’re inclined to check out Slovakia as a place for investment, as a second home or a place to vacation, we have a hotel recommendation for you.

Hotel Marrols is the place to stay in Bratislava. It’s a boutique hotel with perhaps 50 rooms, a comfortable spa, a great restaurant, and the location is perfect. A couple minutes from the city center on foot, but unlike the more prominent hotels, it is tucked away in a quiet side street. The staff is superb: friendly, multi-lingual and attentive without being obsequious. The mini-bar is free. They serve an outstanding full breakfast, included in the double room price. Marrols is pricey by Bratislavan standards, but to a Westerner prices are reasonable – weekend rates run about 130 euros, weekdays slightly more – and provide excellent value for the distinguished traveler. And yes, they have high-speed wireless Internet; in fact, some of this letter was written by their cozy fireplace while sipping the complementary 12-year-old scotch whiskey.

Tip: Call a local travel agency and ask them to book the room and you will likely get a discount between 10 and 20 percent. In that vein, we heartily recommend the folks at www.hotels-in-bratislava.com. Jan and his partner started a company called Slovakia Incoming Travel Services (SITS). They are accommodation brokers and they all speak fluent English. They can provide transport from the airport or train station, and work hard to help with any other need you may have. Perhaps their best offering for a longer stay in Bratislava are the fully equipped apartments. Fitz stayed in one and found it very comfortable and convenient. The apartments are all centrally located in the old city, and within walking distance to cafes, shopping, restaurants as well as tourist attractions and museums. We now use these guys for all our accommodations in Bratislava. It saves us time and money. Neither they nor Hotel Marrols know we are writing this, but we’ll approach them to see if they are willing to offer a discount to Without Borders subscribers. We will keep you posted.

Letters to the Editors

Have a question or a comment? Write us at withoutborders@caseyresearch.com

Enjoy the WB publication… a unique read that comes up with some good ideas.

However, here’s my problem. When I see a good idea I often take action, but so far WB has focused on South America and Eastern Europe… forget Eastern Europe (far too cold in the winter – I know, I lived in Romania for a year!) and South America is just too far from my home base and preferred location – South East Asia.

Do you have any plans to look at opportunities in SE Asia? Particularly property opportunities?

Being based in Hong Kong & Macau, the region is easily accessible and I am familiar with most locations, so any insights you can bring would be of real interest to me.
Anyway, keep up the good work.

Thanks for the note! Our area of operations is the entire world, so we will absolutely be treating Southeast Asia. Examples of upcoming locations: Vietnam, Burma, Thailand, Mongolia, South Korea, Malaysia, New Zealand, Australia, Qatar, UAE, Iraq, Iran, Egypt, Morocco, South Africa, Angola, Namibia, Zimbabwe, etc. You get the idea. Any special requests, feel free to email us… we’ll try to post a travel schedule (if we can plan that far in advance), so if we happen to cross paths with some readers, we can grab a bite or drink.

For Simon & Fitz:
Could you write about the ramifications of living in these other countries for those of us who are firearms enthusiasts? Can we take them with us? If so, how? Or do they need to be left in the U.S.? And, for some locales, are firearms a wise companion?

Not an angle we had considered, but sure, we can certainly check into it. We can tell you from personal experience that Panama is very firearm friendly; most Panamanians own firearms and the licensing/import procedure is straightforward. Obviously the EU is less firearms friendly, but it is possible to own a firearm albeit with a significant amount of red tape. South America in general is firearm friendly, but importing can be difficult. But, frankly, it hasn’t been on our list of issues we look at when we travel, but we will start asking the question.

I’m looking into moving to Panama to enjoy the weather, but also the freedom there. I’m currently living in Sweden and getting, well, tired of the system here. I feel that the laws are limiting my freedom. I was wondering what WB would say about Panama for young people and not only as a retirement place?

Panama has something for everyone, young people and retirees. For the young among you, there is a growing group of people in their 20s and 30s from around the world who make Panama their home because the lifestyle is so exciting and cheap. We have several friends who are Internet-based currency and commodities traders in Panama and can live where they want. There is also a large group of young entrepreneurs who are setting up consulting practices, furniture galleries, medical tourism companies, and even cement factories. In short, these are people that “get it” and have the Wild West mentality.

The Pulse

Bubble, Bubble, Toil and Trouble: Playing the Emerging Markets

You and I know that one day the orchestra will stop playing and the wind will rattle through broken windowpanes. We are all at a wonderful party and by the rules of the game we know that at some point in time the black horsemen will burst through the great terrace doors to cut down the revelers; those who leave early may be saved, but the music and wines are so seductive that we don’t want to leave. But we do ask, “what time is it?” Only none of the clocks have any hands.

Adam Smith, The Money Game, 1967

So much money has been sloshing around the globe in search of an “above average” return that even risky assets have been bid up tremendously. At this stage, however, with new holes in the financial dike showing themselves almost weekly – more holes, we suspect, than officialdom has fingers – the money flows are building toward a reversal. This will hammer the emerging markets the hardest because, historically, in times of crisis, capital packs up its bags and goes home. When that happens, shares of good companies get sold at the falling bid simply because the seller must get liquid, whether to calm his fears or to cover his losses elsewhere. Asset prices become screaming passengers strapped in to a luge ride.

This creates opportunity, of course. Even though the economies of all the most prospective emerging-market countries are strong enough to weather any likely storm, their financial systems aren’t. This is emphatically true in India, China, Brazil and other fast-track economies. Even so, when foreign financial capital has fled, the physical and human capital will remain, it will still be valuable, and good investments will be cheap in the extreme. But the opportunity won’t be available for everyone – just the investors who’ve been patient.

Buying an investment and waiting for harvest time is the easy part of patience. The hard part is waiting to buy. Investors want to invest. It’s in their nature to expect, without considering the alternative possibility, that there should always be something worth buying. Usually there is. The danger, the psychological trap, is in the “always.”

If you follow the financial talk media, you get plenty of reinforcement for the urge to buy. Long-boom myths like “dollar cost averaging” and the media’s third-hand tellings of modern portfolio theory assume that prices always rise. Every dip is a guaranteed buying opportunity. No dip can turn into a plunge, but if it does, it’s the buying opportunity of a lifetime. All setbacks are temporary, a winding of the spring that will power the next big advance, the one that’s coming soon. Long, dark nights don’t happen.

Were you in the business of managing other people’s hard-earned savings and your compensation depended on outperforming another guy with the same mandate, the ever-buy approach could work for you. Quarter by quarter (or at least year by year), turn in a performance that’s above average, and you collect your bonus – no matter how ugly the average might be.

But nobody we know who loses a third of his home value or watches half his 401k disappear will be doing the happy dance just because his neighbor’s house went into foreclosure or his brother-in-law’s employer went bust. When you are investing your own money, the measure of success is how much stuff you can buy (i.e., purchasing power), not whether you outdo the poor sap next door. That so much of Wall Street thinks differently is part of the danger in today’s environment.

According to the drivel on CNBC, the “experts” are still expecting the rise in asset prices to continue, based on “relative prices.” The assets that have lagged in price are going to catch up. They just have to. This is utter insanity in our book, but the thinking is widespread, so we thought it important to tell you how we look at it and, perhaps more importantly, what we are doing with our portfolios as the unprecedented, worldwide asset bubble approaches the spatter point.

Unprecedented? Well, you are right to flinch when anyone says “it’s different this time,” and certainly we don’t pretend to be a definitive source on economic history. However, we are concerned because we know of no other time when:

1. Yields are low on traditionally higher-risk assets: By now everyone is aware of the subprime problems, but that’s only the tip of the iceberg. Sovereign debt issued by countries that have, in the past, failed to meet their obligations is now trading at a premium to par rather than at a discount. With all the liquidity pouring into the system from the Federal Reserve, European Central Bank, Bank of England and Bank of Japan, long-term rates are ridiculously low given the true inflation numbers. Fuel and food prices are more than doubling, but yields are going down? Doesn’t make sense to us. Abnormal. Unsustainable.
2. Capital has become so mobile and fickle: Never before has capital moved so quickly, regardless of origin or destination. With the push of a button, trillions now flow in and out of markets dominated by hedge funds, sovereign wealth funds, banks and even retail investor accounts. While herd mentality has always been a powerful force, today the herd is far bigger, faster and twitchier — especially in emerging markets (ex-China), where the bulk of the capital is controlled by foreign interests that have no problem running for the exit when someone hears a twig snap. Sentiment changes and markets tumble. Black was in Brazil this month and found that, among the Brazilians he spoke with, sentiment was uniform that the local stock market and currency were too high… so they wanted to talk about buying U.S. homebuilders. The Chinese are sending their markets through the roof based on how “lucky” the numbers in the ticker symbol are thought to be. Nutty? We think so.
3. Globalization and protectionism are growing at the same time: We have a strangely schizoid situation. Growth in global trade is what’s keeping the world economy afloat. But now producers are selling to high-debt consumers. As chronicled so eloquently in our sister publication, the International Speculator, foreigners are buying U.S. debt with both hands, or at least they were. Now, as tough times seem destined for our shores, politicians and the man in the street will start looking for a “them” to blame… hey, much of the Republican advertising now appeals to anti-foreign sentiment, and the public seems serious about walling up the southern border. This blame game threatens a return to protectionism, which would spur the rapid decrease in asset values that we expect.
4. A global vacuum exists politically and militarily: The bipolar security regime that lasted for half a century ended in the early 1990s with the fall of the Soviet Union. It was followed by a global power vacuum that persisted for about one minute, maybe two, and then was filled by the U.S. and to a minor extent its allies. The uni-polar world led by the United States lasted until 2003. Now U.S. land forces are stretched beyond capacity; those not already committed are armed with little more than harsh language; and public support for military action anywhere diminishes by the day. International receptiveness for U.S. leadership is nil. At the same time, Russia and China are cooperating to an unprecedented degree as Putin rightfully displays his angst over missiles in Poland. At any other time in history, this would be DEFCON news, but today it goes almost unnoticed. With member states in complete disagreement on the way forward, NATO is no longer a coherent organization. Something as seemingly small as Kosovo independence could cause the delicate situation to fall out of balance.
5. Massive wealth is accumulating in immature markets: Historically, developed markets are the center for global wealth because they have the infrastructure, information systems and scale of capital. That’s changing, and it’s not necessarily a bad thing, but the transition is hazardous. Not since the United States embarked on outdoing Europe’s industrial revolution has there been such a jolting shift in where wealth is created and power is focused. Events of such magnitude are often marked by the unexpected and the uncontrollable.
6. Stocks in most markets have run up and run far, but without the benefit of underlying fundamental strength: For a given market, this is anything but new or surprising. Investment manias show up more often than cicadas and are just as noisy. But seldom do stocks in almost every local market climb to dizzying heights simultaneously. Excess liquidity, fear of inflation and a falling dollar have led big players who are looking for tangible assets to pour money into questionable equities. As mentioned above, however, when trouble strikes at home or the awkward questions get their awkward answers, liquidity will dry up, and the margin casualties in one market will be forced to sell what they can in other markets.
   It’s not a solitary bogeyman that worries us, it’s the legion. In 2000, when the NASDAQ was getting completely silly, markets in Eastern Europe were just starting their run, and Asian, South American and Russian markets were still in the dumps. Today the dumps are depopulated — plenty of markets near their tops and none that we can see are near a bottom. Throw in the high prices on risky assets, the flightiness of capital, the public’s new receptiveness for protectionist measures, the free hand that so many governments now have for geopolitical and military adventure, the surprises waiting to be delivered by the shift of wealth and power from West to East… all that, and a train wreck seems unavoidable, even if we don’t yet know the exact spot on the tracks.

So What to Do?

“But I have to do something now! That’s why I am paying you two dunderheads!”

We know you’re not paying us your hard-won cash simply to hear about problems. We also know that we’re not omniscient, but nonetheless there are some basic ingredients to our method and strategy that may be useful for you.

Although we’re not committed to any portfolio theory, modern or otherwise, here is how we divide up our little bag of pennies. First, we split it into two piles, “investments” and “speculations.” How you divide your net worth between the two depends more on your personality and psychology than anything Nobel laureates Black (no relation) and Scholes could come up with. We are temperamentally inclined toward speculation, but that’s just us. We recommend that you not allocate any more for speculation than you are prepared to lose without losing sleep in the bargain and without compromising your marital bliss or cheerful disposition.

Having made the big split between the investment pile and the speculation pile, here’s how we handle each of the two, given our expectation that the next big opportunity will come from big trouble in the emerging markets.

Investments:

1. Physical gold and silver stored in multiple locations, ideally in multiple countries
2. Gold and silver ETFs or certificates in accounts in multiple jurisdictions
3. Larger, but not the largest, oil, gas and mining companies
4. Emerging market agricultural land and income-producing properties

Speculations:

1. Junior resource exploration stocks
2. Early-stage private companies in emerging markets
3. Emerging market bonds (but not yet!!!)
4. Selected foreign stocks — either shares that can weather a correction or, more likely, those we want to buy after the correction
5. Emerging market real estate developments with compelling demographic fundamentals

 

The Watch List

Essential to our strategy is a Watch List. It notes stocks we like because the companies are solid and can survive or even thrive in a downturn or outright crisis — but that we are only watching, not buying, because right now they’re so pricey. We screen these companies by conducting sensitivity analysis to determine how they would hold up in different scenarios, for instance, high inflation, declining dollar, a global sales slowdown, etc. Currently we have a list about fifty deep, but it’s not static; we’re always open to adding or dropping a company.

For each stock, we develop a target price where we would want to start accumulating and a lower price where we would want to back up the truck. Then we wait. We wait for a panic, when people either overreact or are forced to sell by margin calls, a bank holiday or some other disruption.

Right now, our watch list is heavily populated with stocks in Hong Kong, South Korea, Australia, Vietnam and Brazil. Although these countries have solid economies, we believe the shares will pull back, in some places severely, before they make their big run. So as painful as it may be, sometimes the best thing to do is nothing. We will be your eyes and ears on the lookout for the right time to buy, and we’ll alert you immediately when that time comes.

Sell or Average Down?

So you already own emerging market stocks. Should you sell? Well, since we allow people to believe we’re experts, we’ll tell you… that it depends. We personally aren’t comfortable owning most stocks in emerging markets right now, but we realize that selling could mean missing out on further profits should the mania continue. So if you own a stock you think will outperform a rising market and you are willing to suffer through what could be a 20% to 30% drop over the next several months to a year, we won’t nag if you decide not to sell. But remember, a stock has to go up 100% to bounce back from a 50% correction.

So if you aren’t selling, do you average down? By this we mean buying more as prices fall. For a few stocks, yes. We have been buying Bladex (BLX: NYSE) (see Without Borders, September 26, 2007 edition) on the dips and are comfortable it will weather the storm well and even thrive in a banking crisis. Because we believe in the company and understand the business model and how they make money, we’re not unhappy when “Mr. Market” lets us accumulate more shares at even better prices. (We can’t say that for the larger caps that are already heavily touted by the regulars in lower Manhattan and the City of London.) We don’t know how to call a bottom or a top, but except where we alert you otherwise, we’re not averaging down. We’re waiting for a cliff-edge drop that will deliver the kind of buying opportunity that reminds everyone why cash is good.

Shorting? Lord Keynes and All That

John Maynard Keynes is credited with “The market can stay wrong longer than you can stay solvent.” In all fairness, we’ve also read that he didn’t say it, but we nonetheless agree with it. Shorting is tricky business, like stealing electricity, and especially so in emerging markets. We don’t recommend shorting, at least not for now, because we are dumbfounded that prices keep going up. And we recognize that we may continue being dumbfounded for some time to come.

Market psychology is as unpredictable as dice. What we are seeing now is like the magician’s trick of piercing a balloon with a knitting needle. The needle goes through the balloon and comes out the other side, yet the air stays in. We don’t know how it’s done, but we don’t believe the central bankers and the pinstripe Houdinis have many more tricks up their sleeves. Still, as long as the audience believes they do, prices could keep going higher. Earlier this month, when all the big central banks of the world held hands and dumped a bucket of cash into the system, we were convinced that the sheer magnitude of their efforts would show the markets how grave the situation is. Instead investors were heard shouting, “Have no fear, Central Bank is here.”

ETFs a Bear Can Love

There are a number of relatively new products that allow market participants to profit in a falling market. These exchange traded funds provide a simple mechanism to acquire a short position against an index. Here are a few:

SH: Seeks daily investment results, before fees and expenses, which correspond to the inverse of the daily performance of the S&P 500 index.

QID: Seeks daily investment results, before fees and expenses, which correspond to the inverse of the daily performance of the NASDAQ-100 index.

DOG: Seeks daily investment results, before fees and expenses, which correspond to the inverse of the daily performance of the Dow Jones Industrial Average index.

SDS: Seeks daily investment results, before fees and expenses, which correspond to the inverse of the daily performance of the S&P 500 index.

Each of these ETFs and others like them offer the investor the opportunity to take a short position and only risk the capital used to purchase the ETF. No worries about margin calls. The only problem is you don’t control the mix in the short position. The managers do that for you based on a predetermined algorithm. This doesn’t bother us because these are macro calls and we think the premium for simplicity is worth it. There are also a series of more specific ETFs designed to target a specific sector. They require a bit more individual research because their formula for shorting may be different than you would expect. For more information, go to http://finance.yahoo.com/etf/browser/op?c=etf_bm

But if you crave excitement and need to be short something, we think the S&P, NASDAQ, DOW, FTSE and other markets are good candidates, and you can scoop up short/ultra-short ETFs like QID, SH, SDS, and DOG.

Emerging Market Bonds

The time is coming when select sovereign and corporate debt in the emerging markets will be very attractive to the crisis investor. Such issues always oversell in a correction. Anyone who invested in Russian debt in the late ‘90s, for example, made a spectacular return. Good securities will be trading at discounts of 30% and up. Yields will be more than high enough to compensate for the inflation likely to ensue, and the bonds can be a good source of currency diversification. But not now. The liquidity provided by central bankers turned helicopter pilot has pushed these bonds to a premium and, in our estimation, way above an acceptable level of risk. But just wait a bit. The panics to come will make the bonds lovable.

Overall Assessment

As we pen this in December, we find that many investments are priced out of our comfort zone. Emerging market run-ups are being fueled by the trillions of dollars trying to find a temporary home. When that home starts growing mold, the trillions will pack up and head back to civilization (provided capital controls don’t stop them at the border). We have a long list of solid companies with solid management and sound business models that we are watching while we wait for the right opportunity to buy. If we recommend something along the way, it’s because a particular company or security satisfies our comfort level. But right now so few do that we are buying gold and real estate and husbanding cash for the big opportunity. Remember that the key to real success is to be bold when others are timid and timid when others are bold. Today, as we raise our field glasses to survey the investment and speculative battlefield, our helmets are pulled down low and our knees are trembling. We’re not just timid but downright cowardly. Our only boast is that we have the courage to admit it.

Heiress of the Month: Delphine Arnault Gancia

Delphine Arnault Gancia- Age 32

Once dubbed “the world’s hottest billionaire,” Delphine Arnault Gancia is every bit as savvy as she is lovely… plus she can get you a good deal on luggage.The daughter of luxury goods mogul Bernard Arnault, Delphine could have taken the Paris Hilton way through life – tabloid scandal parties in Monaco and jet setting to Ibiza. Instead, she chose a hardcore education with degrees from both Ecole des Hautes Etudes in Lille, France, as well as the London School of Economics. After graduation, she spent some time consulting with McKinsey & Company (everyone makes mistakes) in Paris, until joining her father’s company, Louis Vuitton Moët Hennessy, at age 25. She filled different positions around the company in HR, brand management and product development. By age 28 she had joined the board of directors, and by 30 became the largest individual stockholder.

Love of business flows in her veins; the Financial Times has quoted her as saying “We were raised talking about business. It was often the topic of conversation around dinner with my father.” Now she is rapidly becoming the face of the company, and has a growing reputation as a humble, detail-oriented workhorse.

It’s amazing that someone born into such incredible opulence is so well grounded… and sophisticated… and attractive. Unfortunately for Simon Black, it’s a bit too late; she recently married Alessandro Vallarino Gancia, heir to an Italian wine empire. We think we’ll buy some stock if we can. Not because we think it is a good value. It is not. But we might catch a glimpse at the annual meeting.

Over The Horizon

Universal Language: Se Habla Americana

We must’ve looked like lost souls, a bunch of pasty gringos wandering around a rodeo and crafts fair in rural Uruguay… we were surrounded by 5-year-old, mini-me gauchos riding horseback through the crowd, completely unfazed by their age and comparable diminution. In the makeshift dirt arena that formed the centerpiece of the fair, wild ponies were flinging around grown men by the double, one of whom suffered a compound, skin-protruding fracture as a result. This is as gaucho as it gets.

Except, of course, for Van Damme.

Doug Casey, David Galland, Fitzroy McLean and I were on our way to a gorgeous estancia for a few days of isolated relaxation and discourse, and we noticed this feria en route. All of us being horse lovers, we couldn’t resist the urge to stop and check it out. So, while the bone-crushing, ball-breaking action was taking place in the makeshift rodeo arena, I was utterly consumed with browsing the inventory in the retail tents.

Sure, there were plenty of boots and knives and other gaucho paraphernalia. But what caught my eye were the masses of bootleg American DVDs for sale, and amazingly enough, Jean-Claude Van Damme movies in particular. I was astounded by the sheer volume of inventory both carried and selling, in a place where I encountered only two non-gringos who spoke English. This “Van Damme Effect,” as I call it, led me to an immediate conclusion: despite the USA’s geopolitical and economic misgivings, Americana is alive and well around the world.

Being a permanent traveler with 40 countries under my belt, I consider myself a man of the world ordinarily predisposed against such a conclusion. I originally hail from Texas, which is now universally associated with George W. Bush. I’ve been amazed in the middle of the Arabian desert talking with Bedouin tribesmen… “Ah, you are from Texas… like Boosh!” Yeah, like Bush. And Ron Paul too, but I guess they haven’t heard of him yet. Now, while there can really be no official poll taken, my gut tells me that George W. Bush is by far the most hated man on the planet. Ironically enough, “Dubya” might just approve of my assessment, considering he relies on his own gut for so many key decisions. Additionally, my experiences on the ground have shown that while the world hates our leadership, detests our government, and is mildly annoyed with our society, they still can’t get enough of our culture – Coca Cola, Clint Eastwood, iPod, Elvis, and apparently, even Jean-Claude Van Damme.

Challenges of the New Global Economy

China is the crown prince of the global economy. Together with the Gulf states, Russia, India, Brazil and Eastern Europe, China leads a diverse community of budding economic titans that has the capability to define geopolitics in the 21^st century. Right off the bat, though, language is a huge challenge. Like it or not, English is presently the world’s true universal language – there are more English speakers in China and India than in the United States and UK.

Fitz and I believe that languages, like natural species, are subject to Darwin’s theories – they are birthed from necessity out of thin air (industry jargon, for example, or the ridiculous Esperanto experiment). They also grow and adapt (old English), and can frequently die off (Ladino, Aramaic). Like weaker natural species, sometimes languages are futilely protected by irrational governmental policies or social nostalgia (Gaelic, Ojibwe).

In a global economy and instantaneous information age, the world needs a common language. Just consider how many systems require intercommunication – the Internet, worldwide aviation and maritime travel, medicine, global finance. But what makes a universal language? In our opinion, four factors:

1. Non-tonal phonology
   Tonal languages – most Indian and East Asian dialects – are based on varying pitches to differentiate words. There are some elements of this in English; for example, the word “progress” takes on two meanings (one is a noun, the other a verb) depending on which syllable is accented. Yet, the majority of our language does not require an accent for comprehension. If you read this sentence in a monotonous, computer-like voice to your spouse s/he will still be able to understand you. Imposing the same electro-larynx monotony to Punjabi would render it incomprehensible.Let’s be honest, tonal languages are far too difficult for most adults to learn. While children are easily capable of mastering sounds and differentiating between pitches in language, this is nearly impossible for most adults; our mouths and tongues lack the ability to form new shapes and create new sounds that appropriately distinguish nearly identical-sounding Mandarin phrases like “You have a lovely home” versus “I would like a colonoscopy.” Have you ever tried learning to roll your R’s like the Spaniards? Now imagine Mandarin Chinese. The entire world is simply not up to the challenge.
2. Latin-based alphabet and Arabic numerals
   Today, the majority of the earth’s geography uses a Latin-based alphabet; refer to the image below (thanks Wikipedia!): the gray area is Latin; blue/teal area Cyrillic; green areas Arabic; and red/orange/yellow areas “logographic,” non-alphabetic, character-based systems.

Logograms (for example, Chinese characters) are completely out of the question for a universal language; they are far too inefficient and not easily scalable, to allow the introduction of new words and jargon. In English, we would simply coin a new term and write it out. And based on the way our letters are assigned to pronunciation, i.e., if I wrote “clafterious,” anyone would be able to figure out how to pronounce it. Sure, it could easily be spelled in other ways, but this is another advantage of non-logogrammatic systems… as Alexander Hamilton once said “It is a damn poor mind indeed that can’t think of at least two ways to spell any word.” In Mandarin and Japanese, you don’t get the option without butchering the content.

Arabic-based alphabets are also handicapped, as they lack vowels and require too much guess work for non-native speakers; this is why, for example, you see bin-Ladin’s name transliteralized as Osama as well as Usama. Further, one of the most intriguing things about some Arabic scripts is that words are read from right to left, but numbers from left to right. So, for example, the sentence “America’s 2008 election is a farce.” would be written “.ecraf a si noitcele 2008 s’aciremA.” It’s inefficient for your eyes to work both ways.

Cyrillic and Latin are the most effective alphabets to achieve full phonemic pronunciation, though Latin is more efficient with only 26 letters and is already utilized across most of the world.

Widely spoken, widely used, widely adopted
Indian and Chinese dialects are spoken by over two billion people, but only within India and China and pockets of global migration. Spanish, on the other hand, covers 25% of the world’s developed countries, and English is used across the majority of the globe’s land mass. We’re continually amazed at the use of English to bridge the international divide – a group of people from China, Europe, and South America will speak English to communicate, without a single Brit or Yank among them.This is the path of least resistance. As long as they must learn English to know what the Spice Girls are saying, or how to download pirated movies, they may as well use it for other more mundane things like global business and diplomacy. There simply is no way, even in 50 years’ time, that a dinner table composed of educated French, Thai, Columbians and Swedes are going to converse in Mandarin or Cantonese. Besides, the Chinese we know don’t want the foreign devils to speak their tongue, no matter how knee-slapping funny it may be.

 

Non-idiomatic
Idioms – phrases whose meanings cannot be understood through literal definitions – are what make many languages complex. Don’t confuse idioms with slang, which is essentially industry jargon for pop culture. Understanding and properly using idioms are important to mastering a language – older languages, like Latin, lacked idiomatic expressions, but they eventually grew culturally from foundational knowledge and experience.English suffers a disadvantage here, as it takes foreigners a great deal of time to learn and appropriately utilize phrases like “a pretty penny” and “larger than life,” and that’s if you’re not being a “sticky wicket.” Brazilian Portuguese is even worse – a simple Brazilian idiomatic phrase like “don’t forget to flush the toilet” is literally translated in English as “don’t forget yourself in hauling the discharge.”

Overall, we find that English and Spanish are the strongest candidates for universal language use, mostly because, 1) they fit the above criteria the best, 2) they are already being fused into a widely adopted “Spanglish,” and, 3) the Van Damme Effect. The world still loves Americana, and despite economic woes and the falling dollar, America’s largest export is its culture. Teenagers from around the world learn and perfect their English from movies and music (though most hip-hop stars are unfortunately not showcasing a particularly elegant iteration of same), and this ensures that future generations will continue utilizing it.

Granted, the BRIC countries might be taking over the world, but it’s a far cry to expect that Arabs are going to learn Chinese, Indians learn Russian, and Koreans learn Portuguese. English will likely form the base of the future universal language, along with Spanish and the “Ainglish” dialect of English that Asians speak (see Louis James’ notes on China). In the meantime, don’t feel the urge to rush out and take Mandarin lessons tomorrow, lest you be left behind the global shift… you may do better refamiliarizing yourself with Universal Soldier, Timecop, and Kickboxer.

End Quote

 

Ron Paul 2008 Slovakia

While in Slovakia this month, Fitz had two prominent Slovak businessmen ask, “What do you think of this guy Ron Paul? Can he win?” It seems that there was a feature on Ron’s campaign in the Slovakian edition of Trend Magazine, which focuses on the business community. They both went on to say that they don’t understand why he is considered “crazy” or “fringe” in the U.S. One, a prominent developer said, “I read this and I thought, isn’t this what Americans are supposed to say? He talks about politics the way we want our politicians to talk, and we always thought this was the ‘American Style.’”

What a shame it isn’t true.

“There’s the country of America, which you have to defend, but there’s also the idea of America. America is more than just a country, it’s an idea. An idea that’s supposed to be contagious.”

Bono (1960 – ), Oprah Winfrey Show, 2002