the SEC says issuers of private securities, like hedge funds, can now advertise their wares

SEC disclosure 

The SEC has very specific rules that limit what a company can say, either about itself or about the securities it’s selling, when it’s in the process of issuing stocks or bonds.

The securities of some companies aren’t subject to general SEC oversight,  either because the firms are tiny or the securities are being sold only to a small group of supposedly savvy buyers.  In such cases, the SEC rules have been, basically, that the firm can say nothing publicly.  In particular, the issuing company can’t solicit interest from the general public or advertise its offerings in ways the general public might see–like in newspapers or on the internet.

a rule change

That changed last year when Congress passed the JOBS (Jumpstart Our Business Startups) Act.  This legislation requires the SEC to take back the regulations that bar solicitation and advertising by issuers of non-regulated securities.  Mary Shapiro, former head of the SEC, decided this was a bad idea and didn’t comply.  The current chairman, Mary Jo White, has followed the Congressional directive and removed them.

Yes, Ms. White had no legal choice…

…but is this a good idea?

At first blush, it would seem that it isn’t.  After all, the consensus is that the JOBS Act, by eliminating the requirement for many issuers to offer audited financial statements to potential buyers, is an open invitation to fraud.

Washington is the same crew that repealed the Glass-Steagall Act in the late 1990s, allowing commercial banks to reenter businesses they helped cause the Great Depression with–and which they promptly used to help cause the Great Recession that we’re still digging ourselves out of.

In this case, the glaring issue is that there’s lots of evidence that significant numbers of hedge funds misstate in their marketing materials their investment performance, their professional qualifications and the size of their assets under management.  It doesn’t take a genius to guess what side of the ledger the misstatements fall on.  (Search PSI for my posts on hedge funds.  If you read one, maybe it should be about an NYU study.)

Why would hedge funds change their stripes when selling to a much wider group of individual investors.

accredited investors

Yes, issuers are supposed to sell the bulk of their offerings to “accredited” investors.  But that only means that buyers are supposed to have either:

–net worth of at least $1 million, excluding the value of a primary residence, or

–income of $200,000 in each of the past two years, with prospects of the same in the current year ($300,000 for couples).

That doesn’t mean they know anything about finance.

maybe it is

But there may be a method to the apparent madness.

Ms. White seems to be drawing a sharp distinction between the character of the buyer of a private offering (supposedly sophisticated parties, who are outside SEC purview) and the disclosure materials relating to it.

Because the offering documents have so far been disseminated only to qualified buyers, the SEC had no say over their accuracy. That was up to the buyer to judge.  Now, thanks to the JOBS Act, these materials can be disseminated to everybody, whether “accredited” or not.  The issuer subsequently screens potential buyers to ensure they meet the accreditation criteria before he allows them to purchase.

The SEC is asserting that the wider dissemination gives the agency jurisdiction over the accuracy of the materials.  It is preparing rules it intends to have issuers of private securities follow.

It may turn out that the JOBS Act has accidentally given the SEC another weapon in addition to prosecution for illegal insider trading in its fight to clean up the hedge fund industry.

June 2013 Macau gambling statistics–no sign of slowdown

Last week the Macau Gaming Inspection and Coordination Bureau (DICJ) posted on its website the total that casinos in the SAR won from gamblers during June 2013.  The figures, in millions of Macau patacas, are:

Monthly Gross Revenue from Games of Fortune in 2013 and 2012
Monthly Gross Revenue Accumulated Gross Revenue
2013 2012 Variance 2013 2012 Variance
Jan 26,864 25,040 +7.3% 26,864 25,040 +7.3%
Feb 27,084 24,286 +11.5% 53,948 49,325 +9.4%
Mar 31,336 24,989 +25.4% 85,284 74,314 +14.8%
Apr 28,305 25,003 +13.2% 113,589 99,317 +14.4%
May 29,589 26,078 +13.5% 143,178 125,395 +14.2%
Jun 28,269 23,334 +21.1% 171,447 148,729 +15.3%

Source: Macau DICJ

Of course, we have to be careful not to read too much into one month.  The situation is also complicated because the gambling market in the SAR is new enough that it’s difficult to know what the seasonal patterns in visitation may be–that is, whether June is usually a big month for gamblers or a weak one.  That factor is being covered up by the overall mad rush by increasing numbers of Chinese citizens to the baccarat tables.

In addition, we should note that the apparent acceleration in year-on-year revenue comparisons that we see in June is due to the effects of last year’s economic slowdown in the 2012 numbers–in advance of the November leadership change in the Communist Party–rather than a surge in revenue last month.

Still, the past four months have been the biggest in the Macau gaming market’s history.  June appears every bit as strong as the months that preceded it.  Reports I’ve read suggest that so far July is stronger than June.

This is good news.

That hasn’t helped the Macau gambling stocks, which have sold off in sympathy with the Shanghai Composite over the past six weeks or so.  Chinese stocks are falling on fears about the credit crunch I described yesterday.

The most attractive Macau gambling stocks right now, in my view, are Galaxy Entertainment and Sands China (I own Galaxy and LVS, Sands China’s US parent).  But I’m not in any rush to add to either position until I see more data on how the credit situation will unfold.  (There’s also the issue of a potential crackdown by Beijing on money laundering in Macau.  But I think this is a problem with the pre-SAR casinos and will have little effect on the companies invited into the market by the current Macau government.  In any event, in my view, stricter regulation would be another long-term plus for Macau’s development into an Asian Las Vegas.)

the developing Chinese credit squeeze

a new broom

The new administration in Beijing has begun to crack down on a series of abuses in the domestic Chinese financial system that pose a long-term threat to the stability of the economy.

I think this is a very positive development for China, and one that’s crucial to the central government’s efforts to channel resources toward domestic consumer-oriented industries and away from low value-added export-oriented manufacturing.

I don’t know the details of Beijing’s plans the way I might if the domestic market were open to foreign private investors like you and me–and, for the same reason, I’m not particularly interested in finding out.  But I think it’s safe to say that sectors like real estate and finance won’t be happy places over the next six months or so, nor will highly leveraged, labor-intensive export-oriented manufacturing.

where it’s sweeping

As I see it, there are three avenues to the government’s attack on out-of-control credit growth.  Much of this follows very familiar patterns:

1.  non-bank financials.  Regulators tell banks to stop speculative lending, usually in real estate.  The banks counter by forming non-bank subsidiaries–out of the regulators’ purview–and continue imprudent lending.  Political “contributions”  to powerful legislators keep the regulators at bay.

The “Keating Five” in the US during the savings and loan crisis are a good example of the last.  The Five, all Senators–including former astronaut John Glenn and Vietnam war hero John McCain, become famous for intimidating regulators into not acting on a massive financial fraud perpetrated by Charles Keating, who preyed on lower-income workers and the elderly at the Lincoln S&L in California.

2.  loans to “zombie” companies.  During the 1990s, Tokyo forced Japanese banks to continue to lend to highly inefficient, loss-making companies–apparently in order to avoid layoffs.  One consequence was that these “zombies” destroyed the businesses of healthy, well-run firms that were not receiving continuing large infusions of cash.

The Chinese analogue is state-owned enterprises in mature industries.  Also think:  almost any state-controlled business in the EU or the auto industry in the US.

3.  lending to state and local government projects.  This is a particularly Chinese problem.  Mayors and governors are officials in the Communist Party, as are the heads of local banks.  The former get promoted by keeping the local workforce employed and GDP growing.  An easy way to do this is to sponsor (dubious) construction projects and armtwist bankers into providing the finance.  As the adage goes, “The mountains are high and the emperor is far away.”

my thoughts

Long-term, the crackdown is a very positive development.

The extent of crazy lending, and attendant political corruption, is invariably much larger than anyone realizes.

This may be a years-long project for Beijing, in which it applies pressure to uneconomic lending until GDP begins to wilt and then backs off for a short while.  That’s how the central government has been reducing the size of the state-owned sector since the days of Deng.

Although I don’t expect any significant negative effects for world economies or stock markets, this is another (big, I think) piece of bad news for suppliers (like natural resources and basic materials companies) to construction and low-end manufacturing companies in China.

We’re already seeing spillover into Hong Kong of downward pressure on Chinese stocks.  At some point, this will create a big buying opportunity.  Maybe not right now, though.

where’s the bottom for the gold price?

falling gold

The gold price has fallen steadily from a high of just under $1800 an ounce last October to the current spot price of $1231 this morning.

How low can the gold price go from here?


In the simplest terms, prices fall when producers supply more to the market than buyers want at a given price.  The price drops to the point where buyers are willing to absorb the excess supply.  Typically, producers read the market signal and begin to cut back on the amount they put on the market.  When cutbacks are large enough, the price stabilizes.

For most things, adjustment happens quickly.  For gold   …not so much.

…for gold

Gold is mined in remote, inhospitable places by hardy workers who operate expensive and highly specialized machinery that needs considerable maintenance.  Once a mine shuts down, chances are it won’t reopen.  It’s hard to reassemble the needed mining crews…and it’s expensive to bring the plant and equipment back up to snuff.  So mining companies try to avoid shutdown at all costs.

Part their planning tends to make over/undersupply worse rather than better.

As the gold price rises, mines continue to process the same amount of ore, but switch to lower-grade areas.  This means they produce less gold, increasing the supply squeeze.  Conversely, when prices being to fall–the situation we’re in now–mines routinely shift to processing higher-grade deposits.  The idea is to keep their revenue steady–and therefore the mining crew together and the mine profitable.  But putting more gold on the market tends to depress prices further.

waiting for the weak to falter

Experienced mining firms also know how any market downturn will play out, even if no one voluntarily withdraws supply from the market.  At some point, the gold price will drop below the cash outlays of the highest-cost mines.  When red ink causes enough of these to cease production, supply will shrink, restoring equilibrium.


…the gold price bottom question boils down to what cash costs for gold miners are and at what price do high-cost gold mines begin to die.

the Thompson-Reuters report

On April 4th, Thompson Reuters issued its 2013 Gold Survey.

TR says current average cash costs for the gold mining industry are $738 an ounce.

Average cash costs in 2009 were well under $500 an ounce, suggesting that that price level is highly defensible.   The addition of high-cost South African supply (averaging over $1,000 an ounce) and cost increases in Australia (much of it currency-induced, I think) are responsible for most of the rise since.

my take

Relative to nine months ago, gold looks cheap.  But supply probably isn’t going to be withdrawn from the market until the gold price falls below $1,000.  And rock-bottom (sorry) is probably $600 or so.

That’s a long way down.

To my mind, no one other than dyed-in-the-wool gold bugs will be interested in gold today.

the June 2013 Employment Situation report–a blockbuster

the Employment Situation report

As usual, the Bureau of Labor Statistics of the Labor Department released its monthly Employment Situation report at 8:30 am eastern time this morning.

The numbers were really good.

S&P futures are up by 21 points as I;m writing this, in what is doubtless relatively thin holiday trading.

the June figures

The June numbers from the Establishment Survey are:  +195,000 new jobs, comprised of +195,000 in the private sector and a loss of -7,000 in government.  The result compares favorably with economists’ guesses of +165,000.

The strong figure also comes at a time of widespread unease that the government sequester would begin to depress job growth.  Maybe it has.  But the ES figures nevertheless continue to show a US economy that’s steadily strengthening–if somewhat more slowly than we’d like.

check the revisions

They’re also good news.

The April ES survey initially reported a gain of +165,000 jobs during that month.  In the May survey, the April figure was reduced to +149,000.  The June report, which contains the final numbers for April, pencils in +199,000 for that month.

The May ES survey gave the government’s first estimate of job gains for that month as +175,000 new positions.  The June survey ups that to +195,000.

So not only are the June job gains +30,000 better than Wall Street had thought, but there are +70,000 more new people put to work during the prior two months than we’d thought.

flies in the ointment?

There is one.  The situation of the chronically unemployed, about which Fed Chairman Bernanke has become increasingly outspoken, doesn’t seem to have improved at all over the past year.  That’s bad because the longer a person stays without work, the less likely it becomes that he will ever find meaningful employment again.  Other than getting upset, there’s little Mr. Bernanke can do about the situation.  It’s a task for fiscal policy, shaped by Congress and the administration, neither of which shows any inclination to help.

value investing and rapid technological change

value investing

The best of the many value investors I’ve worked with in my career used to explain what he did by saying, “There are no bad businesses.  There are only bad managements.”  He defined “business” as any endeavor that produces revenue.

In other words, the tools needed to make money–plants with machinery in them, sales forces, distribution centers, brand names, consumer goodwill…–are all there inside a company for management to set in motion.  Whether on not the firm makes a profit depends on how skillfully management uses this toolkit.

the value opportunity

Take two companies in the same industry and with identical assets.  Both have $100 million in annual revenue.  Company A makes $10 million in profit; Company B makes $3 million.

Value investors buy company B.  They either wait for or instigate change that will toss out incompetent management and put in new guys who will use the toolkit better.  (By the way, I wrote a lot about growth vs. value a few years ago.  Try my style test.)

what has to work

Two basic assumptions value investors make are that:

–change is possible.  Not a problem in the US.  Japan, where Western black ships are now toothpicks along the shore, is the obvious counterexample.

–the assets endure and can prosper in better hands.  Therefore metrics like price/book value or price/cash flow are reliable measures of a company’s worth.

the pace of change…

Look at the computer industry.  The mainframes of the 1960s gave way to the minicomputers of the 1970s.  The latter, in turn, lost out to the PC, whose dominance is now being undercut by mobile devices.  That’s 60+ years of history in two sentences   …that’s plenty of time for a nimble value investor to operate successfully.  But it’s also pre-Internet.

…is accelerating

Take Ouya.  It’s a $100, Android-based videogame console.   The idea is to play casual games on your TV, at a fraction of the price of a Nintendo, Sony or Microsoft console.

You can also play prior-generation games of all sorts on Ouya.  You can use old XBox 360 controllers, too.  Try games for free before buying.  (Developer tools come in the Ouya box, too,just  in case.  Revenues get split 70/30 in developers’ favor.)  There’s also the possibility of apps like Netflix, Hulu…

Maybe Ouya will be successful, maybe not.

What I think is more important is that Ouya has overcome the barriers to entry that supposedly ensure the permanence of the “toolkits” of incumbent firms:

–Financing:   Ouya set out to raise $950,000 through Kickstarter to get going.  It took in $8.6 million.

–Advertising:  social media  (In the UK, Ouya sold out in seconds;  in the US, it sold out on Amazon in eight hours.)

–Factories:  outsourced

–Game content:  all third-party.

Ouya’s biggest problem, as I see it?  It’s not XBox One, PS4 or Wii U.  Ouya’s low cost is likely to put downward price pressure on the price of all these traditional machines.  Ouya’s biggest worry is that its greatest competitive edge is its first mover advantage.  Low-cost competitors Gamestick, Game Pop and Project MOJO are are speeding down the same Internet-enabled trail Ouya has blazed.

What’s a value investor to do in this new world?