Deflation. I have heard numerous comments about the current "loose money" policies of the Federal Reserve. Most say, we are going to have to face the consequences and the most likely result is hyper inflation. I know that money creation is always linked to inflation; however, it seems unlikely in view of some of the obvious deflationary pressures we are seeing. The most obvious to the casual observer is energy prices. Since July, crude oil has dropped 60%, unleaded gasoline has dropped 62%, and natural gas is down 52%. These are huge drops and it could be expected that these drops would filter down to other commodities. In just three weeks, steel, a basic building block of industry, is down 20 % with China and other countries exporting mega tons of the stuff into the US at cut rate prices. Aluminum is down by 29% and plants are closing in places like Booneville, Indiana where 770 jobs have been lost. Copper prices are no exception, having dropped by 31% in the past three months. Finally consider molybdenum, a hardening agent for steel. Prices are down by 60% since mid-October. That huge drop caused a the loss of several hundred jobs in the Colorado mountains as the long-anticipated re-opening of the Climax mine was put on hold indefinitely.
Since I have been following markets, I don't remember anything like this. Deflation is dangerous since it can cause massive job loses and lowering of wages as the newly unemployed workers tend to work for less than those currently employed. From what I have read about the great depression, this is what happened then. Hopefully, the central bank can manage monetary policy in such a way as to prevent it from happening again. To the extent that we can change our over- consumption habits to eliminate the excess consumption of the past, an adjustment could be healthy.
De-Leveraging. Acquiring leverage is fun. You can buy stuff without using your own money. Using leverage to buy income producing assets is often highly profitable while using it to buy consumption assets is almost always unprofitable. People who loan you money are very unreasonable. They want it back. They also want interest. When they are in trouble, they want it back faster. In the past, they were willing to roll it over when it became due. Now they are much less willing to do so. Most everyone (except the federal government) is in the process of de-leveraging. Real estate investment trusts, mortgage lenders, mutual funds, and hedge funds, are selling assets into a market where there is little demand, in order to repay loans that are being called due. Even prior to the due date, some loan documents give the lender the right to call the loan due if certain conditions are not met. There are also government regulations that keep some types of businesses, such as business development companies, from having too much leverage. When the value of assets fall, these rules can come into play. As much fun as acquiring leverage can be, the pain of de-leveraging is even greater. Companies previously considered as healthy can be forced into bankruptcy in extreme circumstances. Unfortunately, the market is concerned about some of the companies in our portfolio. An example is Prologis, a company I talked about in my last post. Even though the value of real estate in the portfolio is worth $30 per share, the share price is close to $6.00. When I bought shares of this for my own portfolio, I made a bet that they would be able to manage these assets during this period of deflation and de-leveraging, and emerge in a much healthier position. Hopefully, they can. As with anything you buy in today's market the risk that they can't is almost always there.
Back To Colorado In December. I will be available from December 5 to 14. Be glad to talk to any of you then. Please call Susan at 720-449-0200 and let her know you want me to call to schedule a meeting.
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