The S&A Digest: A Goldman write-down?

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(Top 10 highest-returning open positions across all S&A portfolios)

As of 06/24/2013

A Goldman write-down?... Bond trading battle... Who owns dollars?... The rise of negative equity... The joy of other people's money... Buffett on the move... Ron Paul on the Phony Reserve...

You might recall our skepticism on Goldman Sachs' accounting...

How, we wondered, could one investment bank manage to be on the right side of every trade, year after year? Goldman Sachs isn't Lake Wobegone, and its traders can't all be above average. Given a choice between believing Goldman has found a way to train and retain super-human traders, who are never wrong, and believing that Goldman has the very finest accounting department on Wall Street, we choose to believe in the accountants.

And... we're not the only skeptics anymore. Now, even the Wall Street Journal is asking a few tough questions. For example, Goldman holds $43 billion worth of leveraged loans, which don't have a liquid market anymore. How should these loans be valued? Judging by the publicly traded pools of leveraged loans, you'd have to guess a discount of 15% to 20% to net asset value. And Goldman owns $12 billion in private-equity investments. Judging by the share price of other private-equity firms (like Blackstone) and the prices of private-equity targets (like Harmon), you'd have to guess the real price of these investments is now down between 40% and 60%. That amounts to $4 billion to $8 billion – at least – in losses alone. Sooner or later, Goldman – like all of the other investment banks have already done – will have to take a huge write-down. Until it does, we still think it's a good short.

Speaking of good shorts... We've never understood the popularity of the exchange stocks, like the Chicago Mercantile Exchange. It always seemed to us that businesses that could operate very well for decades as not-for-profit organizations wouldn't do very well in a for-profit structure. And... what do you know... as soon as these exchanges began trying to raise their prices to justify their soaring stock prices, their clients openly rebelled.

Just before Christmas, the biggest bond desks on Wall Street – Bank of America, Citadel Investment Group, Citigroup, Credit Suisse, Deutsche Bank, JPMorgan Chase, and Merrill Lynch – got together and decided to move their trading from the CME to a digital platform, eSpeed. They also called their lobbyists in Washington and seem to be playing hardball with the CME. The Justice Department has launched an antitrust investigation. Of course, this is Washington... so it's not clear how it will all work itself out. But one thing is for sure: The politicians and the lawyers will get paid. CME has already hired former House speaker Denny Hastert and Tim Bitsberger, the former Treasury assistant secretary for financial markets, to mount a defense.

Foreign central banks hold $2.1 trillion in U.S.-backed debt (Treasury bonds, agency bonds). That's three times more than the Federal Reserve holds. And foreigners own 60% of the dollar bills that have ever been printed. Our guess is that our kids and grandkids will wish we hadn't written so many IOUs to foreigners.

Goldman's chief economist estimates U.S. home prices will slide 10% on average, nationwide in 2008. If he's right, 15 million mortgages – roughly 30% of all outstanding mortgages – will be on homes with negative equity. What will happen then? Will Americans fecklessly abandon their properties and the obligations they assumed to their lenders? Let's see what happens in Vegas. Half the homes for sale there are already empty.

Celebrating the best attribute of managing other people's money, notorious hedge-fund manager John Devaney says: "Just because I lost money doesn't mean I will quit, no way..."

Oh, to be a big-time hedge-fund manager. No matter how the coin toss comes out, you win. Heads the clients win, but you win more. Tails the clients lose everything, and you can always start another fund. Devaney, whose fund blew up last year because it was heavily leveraged in subprime mortgages, didn't walk away without a scratch. He did have to sell one of his two yachts and his private jet. Devaney says he's starting a new fund because opportunities in subprime debt are the best he's ever seen. (Packages of subprime mortgages are selling for as little as 10 cents on the dollar.) While I wouldn't give Mr. Devaney a single nickel to manage for me, I suspect he's right about the opportunities in the mortgage market. PIMCO – the Bill Gross-led investment management company – agrees. It has recently been a big buyer of subprime mortgage debt.

Institutional kudos for our bullish position on shares of chocolate maker Hershey (HSY). D.E. Shaw has boosted its investment in the biggest U.S. chocolate maker, our December 2007 PSIA pick, by more than tenfold.

We wrote it, did you short it?

Private-equity powerhouse Blackstone Group is set to go public the week of June 25... Why would a successful business like Blackstone look to sell?... Our thoughts: Chief Executive Stephen Schwarzman and his partner Peter Peterson started this company in 1985 with $400,000. They've worked hard for 22 years. And they're no dummies. They've seen a top in the credit markets before... and this time they're cashing out.

– The S&A Digest, June 13, 2007

Since the IPO, private-equity activity has hit a stand still. Jittery banks have their cash in a vice grip, and debt sales are nonexistent. Blackstone shares are currently trading at $16.65, down from $38 after the IPO.

Buffett on the move... Berkshire Hathaway is now the largest shareholder in Kraft Foods (KFT) with 132.4 million shares, or 8.6% of the company. Berkshire also bought 1.51 million shares of pharmaceutical company GlaxoSmithKline and increased its holding of Wells Fargo by 3.4% to 289.3 million shares. Kraft is the ideal Berkshire company. Shares lost more than 20% this year due to poor management and high food costs, but the company maintains a stable of iconic American brands, including Oreo, Chips Ahoy, Oscar Mayer, Kool Aid, Jello, etc. Kraft already vowed to improve management and plans on selling underperforming brands. And food costs will eventually return to normal. Meanwhile, the world will still want Oreo cookies and Kool Aid.

Our copywriting genius and resident scratch golfer, Mike Palmer, thinks he's found the Hardest Golf Course in America. He writes, "Over the weekend, I visited friends and family in Las Vegas and played the most spectacular American golf course I've ever seen. The guys in the pro shop told me that from the [pro tees], it's also the hardest golf course in the continental U.S., with a slope rating of 154. Wolf Creek Golf Club is essentially a rollercoaster ride up, down, and in between the canyons of the Mesquite desert, about 90 miles from Las Vegas. The tee boxes are often hundreds of feet above the lush fairways... and the golf carts are gas-powered, because there's no way an electric cart would make it up these mountainous slopes. In my experience playing golf around the world, few courses are worth nearly $200 or more per round, but this is one of them. And in a town where overpriced golf is the norm (three Las Vegas courses cost more than $500 per round), Wolf Creek is actually a bargain at $175."

Mike recently took a month's leave from our business in search of the world's best golf vacation. He wrote a book and built a website about his experience – I recommend you check it out if you or someone you know likes the game of golf.

As you know, we're big fans of Ron Paul. While it's hard to like any politician, Paul is the only guy in Washington who isn't afraid to take on the Phony Reserve... I mean the Federal Reserve. Says Ron Paul about the Fed: "If you didn't have an accommodative Federal Reserve, Congress' deficits would cause very high interest rates. Because we run up the deficits, and if we couldn't borrow money and the Fed wasn't there, interest rates would respond by going up until we could find the money we need. The Fed spoils Congress into getting away with deficit spending. But in the long run, it's devastating because that destroys the value of the currency, and that destroys the middle class, destroys investment, creates malinvestment and bubbles."

We tell you how to make money on stuffed Bengal tigers in today's DailyWealth.

New highs: none.

In the mailbag... A bit of praise and a good question. While we long for the days of over-the-top, bile-spewing readers with their threats of lawsuits... we also appreciate that a few good questions from our readers is probably a lot more useful to most people... but not quite as entertaining. Send us your gripes, your suggestions, and your questions. We can't promise to reply directly, but we will post the best of what we receive below. And we promise to read all the mail we're sent. feedback@stansberryresearch.com.

"Okay, I admit it. I am not one of your brighter subscribers. Work with me here, though, please. Consider it a teaching opportunity for all those who won't raise their hands in class. GM has a market cap of <$15B with shares outstanding of >566M yielding a share price of $26 along with cash instruments of +/- $26B. How does a company lose $38B and not be b-r-o-k-e (much less bankrupt), which is what I would be with numbers like that? What can I infer about other companies' financial statements with information like this? Why is it so easy for a business to lose money hand over fist and impossible for an individual?" – Paid-up subscriber Neil Bourjaily

Porter comment: Most of GM's losses last year came from a write-off of tax-related credits. Had GM's turnaround been more successful, it would have been able to use these $36 billion in tax credits, instead of paying taxes. But because it's not a profitable business, it doesn't pay corporate income tax, so these assets couldn't be used. The company's own auditors now believe these credits will expire worthless before GM returns to profitability. Some analysts would tell you these losses aren't real because they're "noncash" charges. That's nonsense. Those tax credits were worth $36 billion, and they could have been used had GM merged with another auto company, as Kirk Kerkorian was trying to orchestrate. Without those tax credits, GM has no hope that anyone will buy it. And that's why, when Wagoner refused Kerkorian's strategy, Kerkorian sold every last share of GM he owned.

"I haven't had sex with any prostitutes or cops, and I'm not drinking (yet) but I did want to say thank you. This is one of those days (and there have been many since joining up) when the Dow, the Nasdaq, the S&P and the Russell are down, but I made money anyway. Thank you Porter, Steve and Dan." – Paid-up subscriber Julia

"POR-TAH – I can't believe how frank the GM chairman is with you. It's a good thing you're a friend of his. After reading his letter I immediately rushed out and invested $100K in GM stock – you can't get more contrarian than that." – Paid-up subscriber Bob

Porter comment: The next time you have an urge to lose money, just send it directly to me.

"Thought you'd be happy to see our congressional committees talking about baseball and other nonissues. It keeps them from meddling in the financial markets and screwing up the works. Never criticize a congressional committee when it's doing nothing – that's usually preferred to something in this day and age." – Paid-up subscriber John Milan

Porter comment: That's a very good point...

Regards,

Porter Stansberry

Baltimore, Maryland

February 15, 2008

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