Steel Bubble

We are reaching the end of 2012. A few days left in Dec 2012, before the new year sets in. The good news is that most of the stock markets will record a year of gain and hopefully many investors will walk into the New Year with a smile.

Many steel traders may also look forward with hope as major steel companies such as Arcelor Mittal (MT), etc. have witnessed some revival in its share prices recently. MT which touched USD 100/- per share in mid-2008 had crashed to sub-USD 14/- levels along with the collapse in steel prices.

It is an interesting story. Not only had the shareholders of MT faced a bumpy ride, the volatility in steel prices during 2007/08 period made many a steel trader bankrupt in 2008/09/10.

Steel Bubble

Steel prices which stood at $500 level in Dec 2006 touched $700/- record high in Dec 2007. Thereafter it zoomed to $1540 by July 2008, at the peak of commodity bubble, as evident from the chart below.

Source: mesteel.com

The problem was that many a normal ‘steel businessmen’ caught up in this whirlwind of speculation and when the bubble deflated by late 2008 to $480 levels, found themselves bankrupt!

Reasons for Steel Bubble

There were stories of steel becoming scarce due to several reasons – booming construction all over the world (GCC, China, US, Spain, etc.) which itself was credit fuelled.  Many businessmen switched to steel trading enticed by the profits and stories, which included that the entire years production of steel mills being pre-booked, etc.  Moreover those were crazy times of credit fuelled inflation!!

Real life example

There is a reason why I write this now. After a gap of about three years, I met an ex- CFO of a steel trading company, who reminisced about the crazy days off 2007 and first half of 2008. In fact from 2005 onwards, the steel prices were on the uptrend and it is like the gold prices of today. Just one way direction!

Attracted by the uptrend since 2006 many business men diverted their capital (exiting perfume manufacturing, textile retailing, etc.) to the lucrative steel business. Together with the credit facilities, they bought and stocked more steel which became almost like a precious metal.

Regular steel traders panicked and also began to stock more. And a borrowing customer (during my banking days) decided to do exactly that – hold more stock in view of the booming prices, which was supported by the research conducted by experienced purchase managers and industry experts. However, when the market crashed, the CEO, CFO and the Head of Purchase and Sales found it difficult to offload as the demand suddenly vanished. The aftermath of holding substantial inventory with borrowed funds in a crashing market is quite predictable! The proud CEO of this company, who was once chased by Private Equity (PE) firms with attractive offers, was humbled as he agreed to rather humiliating terms set forth by creditors (including banks) to restructure the credit facilities he took to finance his overpriced stock.

It took several years for the company to stand on its feet. He was lucky to survive as many of his competitors had either fled the UAE or faced jail terms for not settling business dues.

Strategic Plan

One of the large companies in the UAE recently faced a problem – whether to expand or not. We got in and conducted strategic study. I had the privilege to take an hour’s presentation to the ultimate decision takers- Board of Directors, who quizzed me with sizzling questions as Board was not so keen with the expansions while the top management was full of enthusiasm as they were more confident due to market awareness and day to day operational challenges.  Our solution which was best suited for the company was accepted by both Board and the top management wholeheartedly.

Is, strategic plan an isolated event which companies undertake once in a while?

Strategic management process is an ongoing process that evaluates and controls the business and the industries in which the company is involved. It includes assessment of its competitors and sets goals and strategies to meet all existing and potential competitors; and then reassesses each strategy annually or quarterly [i.e. regularly] to determine how it has been implemented and whether it has succeeded or needs replacement by a new strategy to meet changed circumstances, new technology, new competitors, a new economic environment., or a new social, financial, or political environment. The Strategic Plan will enable understanding of the key drivers of the market, its growth, market size, demand/supply balance, etc. Ideally, the Plan must have steps to identify areas linked to economic growth - to ensure that the performance of the company is in line with the economy.

Usually, it includes the following steps:

·         Evaluate current performance results

·         Review corporate governance

·         Scan the external environment

·         Analyse strategic factors (SWOT)

·         Generate, evaluate and select the best alternative strategy

·         Implement selected strategies

·         Evaluate implemented strategies

Strategy management may consider several options, depending upon the circumstance. It may include one of the following:

ü  Corporate Strategy-decisions regarding the flow of financial and other resources to and from a company’s product lines and business units.

ü  Directional Strategy-A corporation’s directional strategy is composed of general orientations towards growth

ü  Functional business strategy supports overall business strategy in much the same way that operational managers support upper top management. Marketing, human resources, logistics and production are all examples of functional areas.

Many organisations overlook functional strategy, which is very vital for efficient functioning of the business. It answers questions that impact a company’s competitiveness and efficiency. i.e:

§  Are you consistent with materials cost, labor and delivery?

§  What is the most cost-effective way to transport your materials?

§  Are you using social networking to target new customers?

§  Do you keep inventory flowing or work just-in-time?

§  What are your sources and scope of your competitive advantages?

§  Do you know your market position?

§  Is your brand easily identifiable from the competition?

(i) A courageous girl , (ii) US elections

Malala Yousufzai is just a teenager.... however she showed more courage than men in the northern region of Pakistan. Many parents wants good education for their children in the north Pakistan. Hope Malala's efforts brings a new light to the region, which a few centuries ago were beacon of knowledge and technology.
 
The place in Afganistan now notorious for Taliban - Khandahar - was known as Ghandara around BC2000-1000 and is mentioned in Mahabharata. The Ghandara kingdom played a crucial role in the power politics of Indraprasta (now known as Delhi). The battle of Kurukshetra (now in Indian Punjab) was due to the political moves of a gentle (or evil?) man by name Shakuni from Ghandara kingdom.
 
Then around BC 300-200, Buddism became prevelant and slowly the Hinduism gave away to the teachings of Buddism. The people of north Pakistan region and south Afganisatan became a mix of Hindusism and Buddhists and disseminated teachings and boasted about colleges that were the Cambridge of the world of those days (e.g. Thakshasila ). It seems that the world has forgotten the huge Bamiyan Buddists statues destroyed by Taliban a decade ago. Seleucus and Greeks who came with Alexander loved the beauty of the place and settled down. Remnants of Indo-Greco culture is still evident; although it is fading away.
 
Then around 1200, Islam arrived and the conversion followed; some accuse it was done by sword. Yet Islam was absorbed and of that born Sufism, which embodied the principles of life of the region. But Taliban is against Sufism.

Let us hope people of the region will show at least the courage of Malala and hope nowledge and prosperity return to that region.

.......................

US presidential elections are reaching the final lap. Debates are interesting. Somewhere I have read a comparison between George W Bush and Romney. That both are from rich families, got admission to the prestigious colleges because of connections, etc. Well any comparison with George W Bush, who presided over some of the disastrous period in US history starting with Sep 11 2001 and ending with Sep 15 2008 (Financial Crisis), any remote possibility of Romney repeating the same feat is unthinkable.


On the other hand, self-made Barack Obama, who got one of the worst jobs in 2009 has done reasonably well over the last four years and got Osama. In the month of March/April 2012, Times Magazine carried an article on how Obama decided to send commandos to pick up Osama - it was against all the advice by his generals and staff who preferred less effective course of actions. It was Obama's own decision and he oversaw it implementation. Times Magazine had praised the decision making approach and skill of Obama and the way the secret was kept as a secret. Most of his cabinet never knew about his multiple meetings and trainings by commandos.

 

 

Population Growth Dynamics

Recently, my daughter, studying in Class VI asked me a question- is India overpopulated? She learns that India’s population is around 124 crores or 1240 million. Suddenly, I recollected when I was studying in Class VI about 30 years back in early 1980s, India’s population was just above 60 crores or 600 million.

Doubling of population in 30 years! Wow – what will be India’s population 30 years from now– will it be 240 crores or 2400 million! Whatever the India’s population growth supporters say, that is huge number and the challenges will be enormous. The population dividend come with a huge bill to the government in terms of infrastructure, improving standards of living, education, utilities, etc. Even now about 30% of the population of the country is living without electricity and it is almost impossible to believe that will soon change. (Positive thinking persuades me to state that it means 70% of the population have electricity - which is twice the population of USA). A huge percentage of the population will be destined to be poor with low standards of living. Many may have to survive with just one meal per day. Criminal activity will increase, terrorist organisations will get more recruits and social problems will escalate.

Mumbai may be the best sample of India’s population. The City boasts several billionaires of the world, who find place among the top 50 richest persons in the world. There are millions of upper middle class in the City who swallows up luxury products and criss-cross the world. At the same time there are teeming millions of poor who eke out a day’s life. Criminal activity and underworld is active in the city. This social inequality is hard to change if the population continues to zoom. Often the middle/upper class don’t have more children; it seems that the lower middle/poor class tend to have larger families. A few miles outside the city, you get the best of the nature with lush greenery and scenic beauty. Similarly, India is blessed with natural wonders and thousands of years of history and monuments. But increasing population is a challenge –recently the reports of encounters with men and wildlife (e.g. leopards) are on the increase.Well, only the poor class suffer in this manner– the better off segment of the population is in safer places.

One of the reasons for the growth in population is also traceable to religious factors. Pakistan also faces a more severe problem. The fanatic religious leaders encourage more population for strange reasons (Jihad?) and the country is already suffering. Although there is illegal migration from Bangladesh to India, which adds to the growth in population, India continues to manage and accommodate. Pakistan also has got legal immigrants from Afghanistan and Taliban - who deny music, films and education to girls. India’s Mumbai equivalent city in Pakistan is Karachi which is a den of different relegious/political/underworld factions who kills almost one another every day. Recently, I had interviewed a bright candidate from Karachi who advised the sole reason for coming to UAE is the security reasons. He said his family is financially very rich and well off- but security is lacking in the City.

Coming back to India, the population growth in the country has huge disparities. Whilst the experts warn that Kerala state will face a situation akin to Japan within next 15-20 years with huge proportion of elderly population, most of the northern states continue to have large families contributing to the population explosion. This has led to a flow of migrant labourers into the Kerala state from distant regions such as Bengal, Bihar, Orissa, etc.

Overall, whilst the population growth may have its dividends, it comes with huge social costs as well. All responsible governments must be aware of the population growth has a diminishing marginal utility but increasing social costs. And the governments must take appropriate steps when the diminishing marginal utility (of population growth) curve meets the increasing social cost line.

Anti-India move by Trinamool

Financial thoughts had applauded Manmohan Singh when FDI was announced one year back. http://www.financialviewsonline.com/2011/11/indias-next-it-boom-fdi-in-retail.html . But got disappointed when Trinamool congress & other political quarters pressurized him to pull it back.

Last year when FDI was announced, it was the right time. Rupee was around USD=Rs 47/- Indian GDP around 7%. Drop to 6% was unthinkable. If anyone said then Indian GDP will drop to 5.3%, he would have been laughed at. Oil price in Indian rupee terms was much favourable and petrol, diesel and gas cylinders costed much less – thanks to Indian Rupee at Rs.45-47 range in first three quarters of 2011.

After one year, Indian Rupee touched USD =Rs.57/- Oil companies suffering losses, indian subsidies rising fast, fiscal imbalances increasing, cost of oil imports in rupee terms shooting up hurting the increasing consumers of petrol, diesel and gas cylinders in India. Above all, India's growth rate dropped to 5%, falling behind Saudi Arabia (6.2%), Turkey (8%), Indonesia and Philippines. No wonder FIIs and FDI have touched recent historical lows during the last one year.

Trinamool supremo just needs limelight and goes to any extent even thrwating India’s growth and common man's future. If FDI is rolled back again now, 2013 Oct will witness USD = Rs 70/- india’s growth rate below 4%, imported cost of oil shooting up, petrol, diesel and gas cylinders costing much more than what Govt. of India is offering now   and mark the words by Financial Thoughts – MARKET WILL MAKE INDIAN CONSUMERS PAY MORE WITHIN ONE YEAR. All FDI and FII will have migrated to Indonesia and Turkey which is growing by more than 8%. India is no longer attractive compared to Philippines etc.

FII knows how to make money from India whether it goes up or goes down. If India goes down, they will short Indian Rupee and equities and make money. Entire Indian retail investors are long on equity, who will be losers. Common man will suffer heavily in all fronts.

Hope the efforts of Manmohan Singh and Chidambaram will get the support from Indian politicans who have capacity to think in broader terms. A little suffering now will bring in lot of future benefits. Any attempts for little benefit now, will bring in lot more future worries.

Had FDI decision in Nov 2011 not rolled back at the behest of Trinamool, Indian situation now would have been much better – there would have been no increase in gas cylinder and diesel prices now.

PS: an article on poor distribution in India, which highlights need for modern technology and techniques thru retail FDI
 http://www.ndtv.com/article/india/foodgrain-worth-rs-250-crore-rots-in-maharashtra-godown-state-government-blames-the-centre-253898?fb_action_ids=10152024799815584&fb_action_types=og.recommends&fb_source=aggregation&fb_aggregation_id=246965925417366

THE SECRET FORMULA

Edward Thorp is a successful investor, a contemporary of Warren Buffet. He is of almost the same age of Warren Buffet and has been beating the Dow and S&P over several decades since 1960s through his own hedge fund. The brilliance of Warren Buffet is evident as he scaled up his activities from a hedge fund into a listed company and relied on insurance premiums instead of hedge fund limited partners.

 

Edward Thorp is a mathematician by profession and hence relied on mathematical approach to risk and ran a well sought after hedge fund. When Warren Buffet liquidated his hedge fund in 1968/69, he had recommended Thorp to the limited partners who didn’t opt for the shares of Berkshire.  

Edward Thorp’s contribution to the investment area is great and we can learn a lot from his track record and insights.

 
He is an avid follower of Kelly formula for taking positions in the market. By the way, Charles Munger  (Warren Buffet investment partner) also expressed support to this formula.

What is Kelly formula?
 
Let us go back little bit in history.

John Kelly, who came out with the formula in 1956, was Bell Labs scientist. The formula is a corollary to a Bell Lab  application for information theory’s ideas which were developed to facilitate higher information rate for a given channel capacity (of Bell Lab projects). The genius of Kelly understood that the insight of the application is good to solve uncertainty element of gambling or risk taking.

If you have an edge in a probabilistic outcome, Kelly formula would show the exact amount to invest/ risk in order to maximize your capital over the long term.

When applied to stock market, it means the maximum rate of return comes when you know something the market doesn’t or ignores or you can structure a trade or investment where your gains will be more.

The formula is as follows:

Capital to be committed = Pw- (Pl / edge)

Where Pw     = probability of winning

           Pl          = probability of losing

           Edge  = the win ratio i.e. winning amount/ losing amount

For example, if the investment outcome shows a gain of 2000 vs. a loss of 1000, you have an edge in the ratio of 2:1. You assign a 60: 40 probability. The capital you have to invest is 100,000/- . How much you may invest in this deal? Is it full capital? Let us try Kelly’s formula.

= 0.60 – (0.40/2)

= 0.40 or 40% of the capital can be invested

Suppose, after observing some latest developments on the market, you are less confident and revise the probability to 35:65. How much you should invest?

= 0.35 – (0.65/2)

= 0.0250 or 2.5% of the capital can be invested.

Before trying in real life situation, you have to master the formula and understand its limitations as well. If interested, the original 1956 article, “A New Interpretation of Information Rate” by John Kelly is available. Although there are critics to the above formula-  Edward Thorp is a strong supporter. He has penned an article in support “The Kelly Criterion in Blackjack, Sports Betting, and the Stock market’. Edward Thorp is also the author of two successful books related to investment and risk taking.

If interested to know more on the topic/ articles mentioned above, you may please email me at ciby@financialviewsonline.com

CAG REPORT ON COAL ALLOCATION MAY BE IGNORED

Everyone tries to bring in sensationalism! Indian movies, TV serials, Politicians, Media entertain the public with sensationalism and breaking news!

CAG Reports (of India) seem to be no different. As they investigate each accounts, they bring out with more sensationalised scams. Telecom was the biggest scam so far.

Now the purported Coal scam is even higher! Rs. 1.86 lac crore (or USD 35 billion) That is lot of money!
Are you wondering where all this money has gone? Well this is a notional loss!
Are these numbers true and fair?
Are there willing buyers/ bidders at the price levels CAG Report is assuming?

Assumptions are dangerous stuff - as many financial analysts in banks and FIs can confirm. In my previous life, I was a financial analyst and had headed a team of financial analysts in a MNC bank.

During the boom time of 2008, the assumptions made presumed the continuation of the boom times of 2008 into the future. Then the great crash (global financial crisis) came which made many a fantastic projections, IRR, DSCR, PLCR, etc look like a mirage.

CAG assumes that had the coal blocks allocated between 2004 and 2009 were done at a particular price, then there would have been loss to Govt. 

What if there were no bidders at these levels? Even if there are bidders, what is the probability that they have the capability to execute?

As is well known in tender process, the contract is not awarded to the lowest/highest bidder, but to the one who has the capability to deliver on time.

India's future growth will be driven by private sector, which is incentivized by profit motive. Private sector (and even the public sector) is not motivated by charity.  Efficiency & productivity of resources (incl. capital) in private sector is much better than in public sector. Ignore the concerns of private sector of India at the peril of the economic growth, new job opportunities and prosperity.

Hope these kind of allegations don't pull down India's growth.