Latticework Investor

May 11, 2009

I have started a new blog Latticework Investor.

From now on any new blog posts will be found there.


Gold as an Inflation Hedge

January 26, 2009

Few more articles about investors using gold as a potential inflation hedge.

Greenlight Capital

Our current chairman of the Federal Reserve, Ben Bernanke, is an “inflationist.” When times were good, he supported an easy money policy. Even when the Fed raised rates, Bernanke took great pains to give the markets many warnings to insure that the higher rates wouldn’t break up the credit party, i.e. bubble formation. Now that the cycle has turned, the Fed has promised to resort to “all means necessary” to head off the effects of the collapsed bubble. Rates have effectively been lowered to zero. The Fed is making loans collateralized by toxic waste and has now begun a policy called “quantitative easing” — a fancy term for “printing money.” The size of the Fed’s balance sheet is exploding and the currency is being debased. Combined with an aggressive fiscal policy, it is clear that the authorities are going “all-in” to try to mitigate the near-term effects of the economic collapse. Our guess is that if the chairman of the Fed is determined to debase the currency, he will succeed. Our instinct is that gold will do well either way: deflation will lead to further steps to debase the currency, while inflation speaks for itself. We have bought gold, calls on gold, an index of gold mining stocks (GDX) and calls on higher long-term U.S. interest rates. We have also moved some of our cash into foreign currencies, particularly the Japanese Yen.

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Pabrai Funds

Pabrai Funds is primarily a stock picking outfit. We know very little about bonds or fixed income. Thus we should be the last ones to pontificate on bonds and US Treasuries. The reason I have ventured out and commented is because the situation is so extreme today. On one hand, yields on US Treasuries are the lowest in decades. On the other hand, yields on every other kind of debt are at their highest levels (relative to treasuries) in decades.

Municipal bonds are among the safest investment class out there – especially when bought as a basket. With their tax-free nature, they typically yield less than treasuries (which are taxable). Today 30-year munis have yields that are 161 percent higher than 30-year T-Bills. It is unprecedented.

Typically the yield delta between 10-year treasuries and Baa rated corporate bond has vacillated between 10 and 400 basis points (0.1% to 4%) for over 45 years – with the average being around 200 basis points (2%). It got over 300 basis points in just 6 of the last 45 years – and quickly fell back to the 2% level. In December, 2008, this delta hit 616 basis points – 6.2%! While 10-year treasuries yielded 2%, the Baa corporate bonds yielded over 8% – the widest spread in over half a century.

I believe these spreads between US Treasuries and various types of bonds will get back to historical ranges in the not too distant future. They may even overshoot (very tight spreads).

How can I setup Pabrai Funds to protect and profit from the above? Well, the best assets to own in an inflationary world are businesses whose products are inflation indexed – where prices can be raised at or above the rate of inflation. In addition if a business has done large amounts of capex using old dollars and does not have much need for capex at new dollars, yet can sell products at inflated prices, it is likely a home run. Such a business has a minimal need to take on additional debt. It is a beneficiary of both high interest rates and high inflation.

View this document on Scribd


November 28, 2008

A few recent articles have caught my eye about the potential for inflation to spike up in the next few years, as a result of the financial bailouts.

This quote from Seth Karlman from Street Capitalist, with the orginal post here.

We think inflation could become out of control in 3 to 5 years. Yet, we might not wait for that position. Hence, perhaps early, we have a large inflation hedge. We don’t own gold as a commodity. We won’t disclose our inflation hedge, yet with enough work, you can find true inflation hedges.

And this comment from International Value Advisers’ Charles de Vaulx in the latest issue of Value Investors Insight

Do you still have an affinity for gold?

CDV: Yes. As governments throw significant amounts of money at the economic crisis, that will eventually push inflation higher. We want to have some gold in our portfolio – it’s now a 4.5% position, virtually all in bullion – as that happens. There’s a saying that you should not confuse a clear vision with a short distance. We’re willing to own gold even though it may not act as a hedge in the near future, because we have a fairly clear vision about what will happen to inflation three, four or five years out, and it’s not a pretty sight.

Pershing Square Letter to Investors

November 18, 2008

Scribd has a copy of Bill Ackerman’s letter to investors. It is a good read with details about specific investments, their attitude to investing and how they operate their fund.

Here are a few excerpts:

Current market

We are currently witnessing the greatest deleveraging event in history.

These actions have led to forced and indiscriminate selling in security markets around the world, which in turn has caused other investors to panic or simply to sell, to get out of the way of other forced sellers.

As such, it may be reasonable to conclude that the forced liquidation that is now taking place may not be a prolonged process.


Our strategy is to seek to identify businesses and occasionally collections of assets which trade in the public markets for which we can predict with a high degree of confidence their future cash flows – not precisely, but within a reasonable band of outcomes. We seek to identify companies which offer a high degree of predictability in their businesses and are relatively immune to extrinsic factors like fluctuations in commodity prices, interest rates, and the economic cycle. Often, we are not capable of predicting a business’ earnings power over an extended period of time. These investments typically end up in the “Don’t Know” pile.

Risk management

Our simple approach to investing also allows us to avoid complicated approaches to risk management. Our investment strategy does not require us to open offices all over the globe. As such, we don’t need traders working around the clock. We can go to sleep at night and sleep. Our weekends are largely our own (Ok. I admit it. I am writing this letter in the office on Sunday.) Our risk management approach is to: (1) put our eggs in a few very sturdy baskets, (2) store those baskets in very safe places where they cannot be taken away from us and sold at precisely the wrong time due to margin calls, and (3) to know and track those baskets and their contents very carefully. We call this approach the sleep-at-night approach to risk management. If I can’t, we won’t.

Porsche Stub Stock

October 13, 2008

One last post about Greenlight Capital’s letter to investors. Below is a excert about Porsche AG, who holds a 35% interest in Volkswagen, an investment that is larger than Porsche’s current market cap.

The PAH3 stub (symbol formerly POR) fell sharply during the quarter, as PAH3 increased its stake in Volkswagen from ~30% to ~35% and the state of Lower Saxony postured that it would consider increasing its stake from ~20% to ~25% in order to keep its veto rights if the European Union deemed that this was necessary. We believe that these actions are providing an artificial bid for Volkswagen shares in the market place. We also suspect the stub value suffered due to liquidations by other funds including a certain failed investment bank that market participants believe held the stub. On a fundamental basis, we believe that Volkswagen is highly overvalued at 21 times estimated 2009 EPS, more than twice the multiple of its peer group.

PAH3’s market cap is €13.3 billion and it has €4.2 billion of net debt. At current market prices, the company’s 35% interest in Volkswagen is worth €28.9 billion.

Punch Taverns

October 7, 2008

Excerpt from Greenlight Capital’s recent letter to investors which talks about Punch Taverns (PUB).

PUB is an operator and lessor of over 8,000 pubs in the United Kingdom. Approximately 875 are owned and operated, and 7,500 are leased to live-in long term lessors. PUB charges “dry rent” equal to 50% of the estimated 5-year average of pre-rent profits and “wet rent” of markup In beer. Lessors are required to buy all their beer from PUB, which PUB sells at a markup, acting as a distributor from the brewers. U.K. pubs are suffering from the initiation of the U.K. wide smoking ban, supermarkets’ aggressive beer discounting, and the U.K. consumer crunch. We believe the franchise model creates high margin revenues with low volatility. In addition, it appears the stock is under pressure because the market misunderstands PUBs debt structure. PUB has three debt securitizations, each structured to pay down incrementally between now and 2036 without needing to be refinanced. In addition, PUB has £283 million of convertible debt at the parent company due December 2010. During the quarter, the market began pricing in a high risk of default or cash trapping within the securitizations. In addition, PUB announced its intention not to pay a final dividend for fiscal year 2008 to conserve cash at the parent company. The market took PUB’s conservatism as a sign of potential cash flow problems regarding the debt and began pricing in an equity issuance to pay down the convertibles. Based on conversations with the company and analysis of the debt documents, Greenlight believes PUB has the flexibility to manage its securitizations without a liquidity crunch, even in a difficult period for pubs. PUB is likely to use the cash savings from the cancelled dividend to pay down some of its debt early. We do not think the chances of an equity issuance are high. Greenlight initiated the position at £2.83 or less than 4x estimated 2008 profits. PUB shares ended the quarter at £1.32 (you do the multiple).

Valuecruncher seems to agree putting a valuation of £5.25 / share on the PUB

Dr Pepper Spinoff

October 7, 2008

Excerpt from Greenlight Capital’s recent letter to investors which talks about the Dr Pepper (DPS) spinoff.

DPS was spun off from U.K. based Cadbury PLC in May 2008. The Partnerships established their position at an average price of $23.84, which represents 12x estimated 2008 earnings. DPS exhibited many of the characteristics we have seen in successful spinoff investments, including favorable management incentives (which were struck while market participants were still wondering how bad the company’s initial outlook might be in the difficult industry environment), systematic selling by U.K. shareholders more interested in the global confectionary business and less so in the U.S. beverage business, and a conservative management posture. DPS is the third largest liquid refreshment beverage company in the Americas, with a portfolio of 50 brands including Dr. Pepper, Canada Dry, 7-Up and Snapple. The company is a combination of a high-margin concentrate business (like Coke and Pepsi, which trade at 17x earnings) and lower-margin and more capital-intensive bottling and distribution operations (like Coca Cola Enterprises and Pepsi Bottling Group, which trade at 12x earnings). While the market seems to apply a discount for its bottling ownership, we believe that an integrated model affords DPS the opportunity to expand distribution of its underrepresented and newly-launched brands. Over time, DPS has the potential to generate meaningful earnings growth through new product extensions, increased use of its distribution capacity, further cost reduction, and increased exposure to single serve channels, where it is currently underrepresented. DPS shares ended the quarter at $26.48.

Other bloggers have posted on the DPS spinoff previously:

Gurufocus (which tracks investments by funds) points out that Greenlight have invested 6% of their fund in DPS.