More Banking Confusion: Liquidity Versus Solvency (@EconTalker, #banking, #liquidity)

Here is a choice quote from the recent EconTalk podcast with Anat Admati of Stanford University:

Well, they have fancy ways to talk about banks, and we try to unpack those. They talk about maturity transformation, liquidity transformation. What that means is really that the depositor, the people who lend to the banks, often time want their money quickly, especially demand deposits. But when they invest it, they kind of invest it longer term and in less liquid things. So there is a sort of imbalance between the money that they use to fund and their investment in the sense of the length of time until something has to happen and also the speed with which they have to pay versus get paid. And so that mismatch creates fragility by itself, which also means for example if all of us run to the bank at the same time then the bank may not be able to cover all of that. Even if it technically would be solvent, it has everything, that’s kind of an inefficient run that you could have, in principle. So basically the banks tend to run a little bit more than other people into liquidity problems. You could say that, just, I have the money but I didn’t go to the ATM kind of thing–I can pay you back but we’re going to have to find a liquidity solution, sort of a rolling back my debt. Their funding is kind of fragile almost by definition because of the way it comes and the way people can come back for their money on short notice or any time they want. So that’s part of the funding. And the investments are not as liquid or longer term than that. (emphasis added)

This is an utter confusion. This is not a “liquidity problem”, it’s a solvency problem.

Money-in-an-ATM is not the same economic good as money-in-my-hand. That is, money-five-minutes-from-now is not the same as money-right-now.

They are separate economic goods due to the time value of money. What Admati has done is create an arbitrary distinction between a future money good and a present money good, by projecting her preference/judgment onto an exchange involving two other parties of which she is not one.

If party A demanding “liquidity” from the bank B truly saw no difference between money-right-now and money-a-few-days-from-now, for example, then a bank run would never happen and these items would trade at the same price, which they do not.

This is a fundamental error of economic reasoning. I expect a professor of finance and economics to understand something like this and as a result I find myself disappointed to see that she does not.

Economists and politicians only let banks get away with this. If anyone else were to be so arbitrary and haughty toward contracts they’d be thrown in prison, but for banks insolvency never comes so long as you can contort logic to the point that you convince yourself that all that’s missing is a bit of liquidity.

This is more free lunch thinking.

Four Views On Gold And Gold Miners (#gold, #investing, @atyantcapital, @valresproj)

1.) Atyant Capital, “What is gold saying?”:

Gold stocks lead gold and gold leads currencies and currency moves correlate with stocks and bonds. Gold stocks have been declining for two or so years now. This is in part due to unavailability of capital and credit for gold mining projects, but in our assessment, not the whole story. We believe gold stocks are also correctly forecasting lower gold prices.

Long term readers know my gold pricing model puts fair value at $1100 per ounce (Alpha Magazine Aug 24, 2011). So at $1700-$1800, gold was about 60% overvalued, floating on a sea of credit. Gold declining now tells me the sea of credit is receding here and now. This should translate to a higher US Dollar and pressure on asset prices globally.

2.) Value Restoration Project, “Gold miners – Back in the Abyss – An Update“:

Gold mining stocks remain cheap by almost any objective measure.

One way to look at mining stocks is to compare them to the price of gold itself.

Comparing miners to the price of gold itself, show miners are cheaper today than they have been in decades.

[...]

Today, gold appears undervalued relative to the growth in the monetary base that has occurred up to now, and in light of the monetary expansion the Fed and other central banks are currently undertaking, gold appears more undervalued. The Fed’s current quantitative easing program probably won’t be curtailed until households stop deleveraging and the government can handle the rising interest expense on its expanding debt.

Yet, in the face of all this, many gold mining stocks are now selling at valuations that suggest the market has priced in a decline in the price of gold back to 2007 levels, before the Fed began expanding its balance sheet during the financial crisis. Many gold mining stocks are now selling near or below their book value, which is the market’s way of saying that these businesses won’t be able to add shareholder value in the coming years by mining gold and silver. If the price of gold were to decline below $700 or so, it would certainly be the case that most mining companies wouldn’t be able to profitably sell gold. Yet such a decline in gold is the main implied assumption being priced in by the market today, and this has sent valuations of gold mining stocks to their lowest levels since the current bull market began.

3.) Robert Blumen, “What is the key for the price formation of gold?“:

The gold price is set by investor preferences, which cannot be measured directly. But I think that we understand the main factors in the world that influence investor preferences in relation to gold. These factors are the growth rate of money supply, the volume and quality of debt, political uncertainty, confiscation risk, and the attractiveness (or lack thereof) of other possible assets. As individuals filter these events through their own thoughts they form their preferences. But that’s not something that’s measurable.

I suspect that the reason for the emphasis on quantities is that they that can be measured. Measurement is the basis of all science. And if we want our analysis to be rigorous and objective, so the thinking goes, we had better start with numbers and do a very fine job at measuring those numbers accurately. If you are an analyst you have to write a report for your clients, after all they have paid for it, so they have to come up with things that can be measured and the quantity is the only thing that can be measured so they write about quantities.

And in the end this is the problem for gold price analysts, you’re talking about a market in which it’s difficult to really quantify what’s going on. I think that looking at some broad statistical relationships over a period of history, like gold price to money supply, to debt, things like that, might give some idea about where the price is going. Or maybe not, maybe you run into the problem I mentioned about synchronous correlations that are not predictive.

Part of the problem is that statistics work better the more data you have. But we really don’t have a lot of data about how the gold price behaves in relation to other things. The unbacked global floating exchange rate system has never been tried before our time. How many complete bull and bear cycles has the gold/fiat market gone through? My guess is that when we look back we will see that we are now still within the first cycle. Our sample size is one.

[...]

I do think we will have a bubble in gold, although it may take the form of a collapse of the monetary and a return to some form of gold as money in which case, the bubble will not end, it would simply transition over to the new system in which gold would go from being a non-money asset to money.

I have been following this market since the late 90s. I remember reading that gold was in a bubble at every price above 320 dollars. I very much like the writings of William Fleckenstein, an American investment writer. He has pointed out how often you read in the financial media that gold is already in a bubble, a point he quite rightly disputes. Fleckenstein has pointed out that the people who say this did not identify the equity bubble, did not believe that we had a housing bubble, nor have they identified the current genuine bubble, which in the bond market. But now these same people are so good at spotting bubbles that they can tell you that gold is in one.

Most of them did not identify gold as something which was worth buying at the bottom, have never owned a single ounce of gold, have missed the entire move up over the last dozen years, and now that they’re completely out of the market, they smugly tell us for our own good that gold is in a bubble and we should sell.

So, I don’t know that we need to listen to those people and take them very seriously.

4.) valueprax:

I don’t know what the intrinsic value of gold is. I don’t think gold mines are good businesses (on the whole) because they combine rapidly depleting assets with high capital intensitivity and they are constantly acquiring other businesses (mines) sold by liars and dreamers and schemers. And I don’t think this will end well, whatever the case may be. So, I am happy to own a little gold and wait and see what happens.

I wonder what the short interest is on gold miners?

 

Brilliant Economist Proposes Bold Solution To Education Crisis From Comfort Of Keyboard (@noahpinion)

I saw this on the Atlantic Monthly’s website, written by an economist (/physicist? /finance professor? /midget wrestler?) named Noah Smith. He came up with a plan for solving the nation’s college education crisis. I am so out of touch, I didn’t even know the nation was having a college education crisis! There are too many crises today, it’s hard to keep up with them all so I hope you’ll forgive me.

Anyway, I read through it and my take-away was that economists like Noah Smith have given up on the whole “voluntary social cooperation” style of getting shit done and have decided it’s more effective to just crack a few whips and get people on board with their objectives that way:

So here’s my idea for increasing the supply of college: A system of federal universities. Currently, we have no such system, but it is not unconstitutional. After all, the federal government runs the United States Military Academy at West Point. My idea is simple: The federal government provides start-up funding for a large number of new universities, offering attractive salaries to professors.

I just realized something. Racism isn’t unconstitutional, but if we don’t amend the Constitution, pronto, someone might decide that the fact that racism isn’t unconstitutional is reason enough to be racist.

Why federal universities instead of state universities? State spending is likely to focus on the existing state university systems. But that will have a limited impact on total college availability, for two reasons. First, increased state funding for existing universities may simply displace alumni funding or tuition funding. That could lower the net price of college, but would have a limited impact on enrollment. Second, there are many geographic areas that don’t yet have elite universities, or only have a few (Ohio comes to mind, as well as much of the Southwest and the Pacific Northwest). Federal universities could fill these gaps. Finally, it’s very difficult to coordinate policy between states, and if we want to create new universities on a large scale, only federal government can do it. [bold emphasis added]

Damn straight! We don’t want any of these puny, fancy-pants small scale universities. If we’re gonna get serious about this crisis, we gotta put our big boy pants on and hire the big guns, FedGov-style!

My take? Dragooning national labor and capital into massive social development projects at the federal level is a great idea, Noah. And I agree, public goods, like education and pyramids, can’t be built any other way.

It’s like I’ve always said– if it’s good enough for the Pharaohs, it’s good enough for our education system!

If you enjoyed this article, you might also enjoy Noah Smith’s glowing praise of a man who is “an important and positive figure in America today,” Michael Moore. I love being helpful.

*UPDATE* (11/19/12)

I stand corrected! A reader is also a writer and e-mails in a correction:

It is unconstitutional for the government to be racially biased–See the Equal Protection Act of the 14th Amendment. It’s why affirmative action is getting to the court so much these days.

I think I might still have a technical case in saying that the Average Joe isn’t prevented from being racist by the Constitution itself, but this is close enough that I might as well retract that little bit of wit.

Inside The Minds Of Wall St Analysts & Earnings Reports: Spotlight Nintendo ($NTDOY)

This post is about Nintendo, specifically, and about the logic of the earnings season and Wall St analysts, generally. Let’s start in reverse order.

The following is from Michael Pachter, a securities analyst with Wedbush Securities (WallStCheatSheet.com):

We expect a Q2 miss. Nintendo is likely to report Q2 results below our estimates for revenue of ¥100 billion and EPS of ¥(127), compared to consensus of ¥108 billion and ¥(84) and implied guidance of ¥145 billion and ¥(22).

I don’t really care what the forecast or expectations are, here. What Nintendo does or does not report tomorrow is immaterial to the point I want to make. Look at who is responsible here.

According to Wall St logic, a company is responsible for missing Wall St’s targets. It is not Wall St that is responsible for accurately modeling and anticipating a company’s results. In this sense, there is something holy and sacred and inviolable about such forecasts– they represent a hurdle for a company like Nintendo to cross over, if it’s good enough. If it’s not good enough, the company will “disappoint” everyone in the financial community by not overcoming these (somewhat arbitrarily chosen) performance targets.

It seems entirely backwards. The company is going to perform as it’s going to perform, regardless of Wall St expectations. If anyone creates disappointment, it should be the Wall St analysts who are held responsible. What should be disappointing is that with their salaries, schooling and deep focus on these companies, they still can’t manage to accurately forecast their earnings from quarter to quarter.

If you think about it, it’s ridiculous for a company to ever “miss” its Wall St earnings forecast because these can be adjusted on the fly, all the time. In fact, this entire exercise of writing a report like this saying you “expect a miss” is an absurdity. If you expect a miss, then recalibrate your forecast to what you think is actually going to happen. It’s preposterous to act surprised with a “miss” tomorrow, when you said ahead of time that you were expecting it.

This seems to be part of the Wall St priesthood tradition. Analysts can’t accurately forecast earnings just like investors can’t– the future is uncertain. This is one of the tenets of value investing. But somehow, despite Wall St analysts trying and failing to do the impossible, the ill result is not their fault.

The last bit of commentary is specific to Nintendo:

We think that Wii U’s price points are appropriate given likely demand from Nintendo’s core fan base, but believe that pricing will be too high to sustain long-term demand. Demand for the Wii U will likely wane once Nintendo’s core fan base has purchased the first 6-7 million units, especially given the number of cheaper, comparable alternatives. For example, the prices of the Xbox 360 Kinect bundles have been reduced by $50 at Amazon, GameStop, and Wal-Mart.

DS and 3DS unit guidance is likely unrealistic. Nintendo guided to growth for combined DS/3DS hardware and software units for FY:13. In our view, handheld hardware sales will continue to decline due to migration of casual gamers to mobile devices. We do not expect handheld hardware to see a rebound in sales without price cuts. Similarly, we think that overall handheld software growth is unlikely.

Maintaining our NEUTRAL rating and our 12-month price target of ¥10,000, a slight premium to Nintendo’s ¥9,000/share in cash, giving it credit for brand equity. We cannot assign a P/E, given the company’s low potential to generate significant profits in light of declining product demand and unfavorable F/X.

I don’t know how to put this… this is just stupid. And it demonstrates zero creativity and zero ability to think beyond the end of one’s nose.

First, the analyst is confusing things. Perhaps casual gamers were partly responsible for the booming success of the Nintendo Wii, but few have ever made the argument that “casual gamers” are a big market demographic for the company’s handheld systems, like the Nintendo DS. Surely, wouldn’t someone who is so in love with gaming that they must have a portable system to carry with them everywhere they go be the opposite of a “casual gamer”?

Second, the analyst is being pseudo-precise. The Nintendo Wii sold almost 100M units worldwide since release. But the analyst calculates that the “core audience” is only 6-7M customers? So approximately 90M, or about 90%, of all sales were to casual, non-core gamers? How precise can an estimate like this be?

Third, the analyst confuses apples and oranges. The emphasis on price cuts to make Nintendo’s products competitive from here on out implies that the experience Nintendo sells is identical to the one offered for free or cheaply on mobile phones and other devices which are now deemed to be “competitors” to Nintendo’s product. By this logic, Nintendo is vastly overcharging for its wares. It’s hard to spell this out in simple terms but, is there an analog experience to that of an epic puzzle adventure game such as the Legend of Zelda series on smartphone app games? How would one play something as complex as Pikmin with the ability only to tap on the screen to control the gameplay experience? Or even something as simple as Mario Kart? These are not comparable experiences so the argument that Nintendo must cut prices to be competitive doesn’t hold water– it’s like arguing that Mercedes-Benz needs to cut the price of the S-Class or else they’ll lose all their customers to the Nissan Sentra.

Fourth, the analyst is being inconsistent. To give the company brand equity credit, and any non-zero valuation at all when one argues that Nintendo must cut their prices when they can’t and won’t do this is idiotic. Because Nintendo won’t do this, by the previous logic they’re doomed to fail, but if they’re doomed to fail the brand has no equity and it certainly shouldn’t get a premium to the cash value of shares. If anything, it should get a discount to the cash value as it’ll probably burn through more.

Fifth, the analyst is being disproportional and lacks perspective. Negative charges due to forex translation have been more than de minimis but are still a small, small fraction of revenues and total earnings. To cite ongoing forex issues as an earnings problem for the company shows a lack of respect for the true magnitude of this issue.

Sixth, and finally, this is another demonstration of Wall St’s short-term focus and inability to think of the big, long-term picture. The analyst doesn’t see ANY WAY that Nintendo can generate meaningful earnings in the next 12 months, even though it’s rolling out a brand new system without any competition from Sony or Microsoft doing the same, and even though it’s gaining sales momentum with the new 3DS system. The analyst sees NO optionality in any initiatives or efforts by this company, whatsoever. And, even though the stock market is supposed to be discounting all future cash flows of a company, therefore qualifying it as a “forward-looking” market, this analyst only cares about the next year.

Will Nintendo even be around 13 months from now? This analyst doesn’t know and doesn’t care, and seems to think that either way, the company represents such a frightening risk with 90% of his share price target in cash and no debt, that he is only willing to assign it a small premium value over that cash.

If Nintendo just scrapes by, the market should lift off once it realizes it’s not dead in the water like this analyst believes it is. And if Nintendo has another hit on its hands, with the Wii U or otherwise, it’s really going to catch everyone with their pants down.

Which is quite an embarrassing position to be in.

Oh, and one other thing– the smartphone gaming ecosystem seems to be in the process of cannibalizing itself. I don’t think they’ll present much of a threat for ol’ Nintendo.

DreamWorks Animation CEO Katzenberg On The Studio’s Future Opportunity ($DWA)

Am I reading this correctly? Is he saying films like Madagascar 3 generate $1.5B in revenue over their lifetime, and that in the future these films will generate $3.75B in revenue?

From a USA Today interview:

Take a movie like Madagascar 3. About 150 million people pay us about $10 from beginning to end on the movie. Some people go to the movie theater, some buy a DVD, some get it from HBO, some from Netflix, some from Redbox. But you sort of take it through the whole course, whole life of the movie, (it) is about 150 million people, and it’s about $10, on an average.

Ten years from now, two and a half billion people are going to pay us, on average, $1.50. Literally hundreds and hundreds and hundreds of millions of people for 65 cents will watch it on a smartphone in all parts of the world. Then you’ll pay $2 to watch it on your iPad. You’ll pay $5 to watch it on a big high-def flat-screen TV, and you’ll pay $15 to watch it in a premium movie theater, $25 to watch it in IMAX and $10 billion to watch it in Richard Branson’s spaceship somewhere.

The one thing that the movie business has done, which is very different than music, is we have always made our product available to people in different shapes, different forms, different prices. You can own it, you can rent it, you can borrow it. Please don’t steal it. Digital will move us to a mass, mass, mass market, radically different from what we have today. All the stakeholders will change in terms of what their stakes are.