Saturday, February 22, 2014

The Economics Of Sex

Peter Schiff Reviews The Social Media Bubble & The Danger Of Vendor Financing

 Peter Schiff
Friday, February 21, 2014
Two pieces of business news announced this week provide a convenient frame through which to view our dysfunctional and distorted economy. The first (which has attracted tremendous attention), is Facebook's blockbuster $19 billion acquisition of instant messaging provider WhatsApp. The second (which few have noticed) is the horrific earnings report issued by Texas-based retail chain Conn's. While these two developments don't seem to have much in common, together they shed some very unflattering light on where we stand economically.
Given the size and extravagance of the Facebook deal, it may go down as one of those transactions that define an era (think AOL and Time Warner). Facebook paid $19 billion for a company with just 55 employees, little name recognition, negligible revenues, and little prospects to earn much in the future. For the same money the company could have bought American Airlines and Dunkin' Donuts, and still have had $2 billion left over for R&D. Alternatively they could have used the money to lock in more than $1 billion in annual revenue through an acquisition of any one of the numerous large cap oil producing partnerships. Instead they chose a company that is in the business of giving away a valuable service for free. Come again?
Mark Zuckerberg, the owner of Facebook, is not your typical corporate CEO. Through a combination of technological smarts, timing, luck, and questionable business ethics, he became a billionaire before most of us bought our first cars. And in the years since social media became the buzzword of the business world, Wall Street has been falling over backward to funnel money into the hot sector. As a result, it may be that Zuckerberg looks at real money the way the rest of us look at Monopoly money. It also helps that a large portion of the acquisition is made with Facebook stock, which is also of dubious value.
But even given this highly distorted perspective, it's still hard to figure out why Facebook would pay the highest price ever paid for a company per employee - $345 million (more than four  times the old record of $77 million per employee, set last year when Facebook bought Instagram). The popular talking point is that the WhatsApp has gained users (450 million) faster than any other social media site in history, faster even than Facebook itself. Based on its rate of growth, the $42 per user acquisition cost does not seem so outrageous. But WhatsApp gained its users by giving away a service (text messaging) for which cellular carriers charge up to $10 or $20 per month. It's very easy to get customers when you don't charge them, it's much harder to keep them when you do.
Boosters of the deal expect that WhatsApp will be able to charge customers after the initial 12-month free trial period ends (it now charges 99 cents per year after the first year). Based on this model, the firm had revenues of $20 million last year. But what happens if another provider comes in and offers it for free? After all, the technology does not seem to be that hard to replicate. Google has developed a similar application. More importantly, no one seems to be projecting what the cellular carriers may do to protect their texting cash cows.
WhatsApp gives away what AT&T and Verizon offer as an a la carte texting service. As these carriers continue to lose this business we can expect they will simply no longer offer texting as an a la carte option. Instead it will likely be bundled with voice and data at a price that recoups their lost profits. If texting comes free with cell service, a company giving it away will no longer have value. People will still need cellular service to send mobile texts, so unless Facebook acquires its own telecom provider, it can easily be sidelined from any revenue the service may generate.
Some say that texting revenue is unimportant, and that the real value comes from the new user base.  But how many of the 450 million users it just acquired don't already have Facebook accounts? And besides, Facebook itself hasn't really figured out how to fully monetize the users it already has. In other words, it is very difficult to see how this mammoth investment will be profitable.
From my perspective, the transaction reflects the inflated nature of our financial bubble. The Fed has been pumping money into the financial sector through its continuous QE programs. The money has pushed up the value of speculative stocks, even while the real economy has stagnated. With few real investments to fund, the money is plowed right back into the speculative mill. We are simply witnessing a replay of the dot com bubble of the late 1990's. But this time it isn't different.
In another replay of that spectacular crash fourteen years ago, the appliance and furniture retailer Conn's has just showed the limits of a business built on vendor financing. In the late 1990's telecom equipment companies almost went bankrupt after selling gear to dot com start-ups on credit. For a while, these "sales" made growth and profits look great, but when the dot coms went bust, the equipment makers bled. Conn's makes its money by selling TVs and couches on credit to Americans who have difficulty scraping up funds for cash purchases. For a while, this approach can juice sales. Not surprisingly, Conn's stock soared more than 1500% between the beginning of 2011 and the end of 2013. These financing options are part of the reason why Conn's was able to keep up the appearance of health even while rivals like Best Buy faltered in 2013.
But if people stop paying, the losses mount. This is what is happening to Conn's. The low and middle-income American consumers that form the company's customer base just don't have the ability to pay off their debt. The disappointing repayment data in the earnings report sent the stock down 43% in one day.
In essence, Conn's customers are just stand-ins for the country at large. In just about every way imaginable, America has borrowed beyond its ability to repay. Meanwhile our foreign creditors continue to provide vendor financing so that we can buy what we can't really afford.
So thanks for the metaphors Wall Street. Too bad most economists can't read the tea-leaves.
Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital, best-selling author and host of syndicated Peter Schiff Show. 

Wednesday, February 19, 2014

Why U.S. College Prices Will Collapse In The Next Decade

This week the Fed released its most recent Household Debt and Credit Report for the fourth quarter of 2013, which illustrates where and how much Americans are borrowing.

The big winner of the year, which is no surprise to readers here, was student loans. Student loans dwarfed all other borrowing, coming in at $114 billion on the year, with auto loans finishing second.

The graph below shows that autos and student loans made up 108% of the annual debt due to the decline in home equity credit.

11.5% of the entire $1.08 trillion in student loan debt is now 90 days delinquent. Student loans (red line below) recently passed credit cards as the most troubled credit market in the country.

I believe one of the most important trends in the next decade will be the move from campus style classroom education toward online education. As the price for college tuition continues to spiral out of control, while the return on the college investment ranges from disappointing to disaster, both parents and students will seek another opportunity.

This will begin with a small portion of students taking their first two years of core classes online and finishing their second two years of concentrated major courses in the classroom. Just this move alone will crush tuition costs as well as industries that currently rely heavily on the current higher education bubble (student housing). There will be both long and short opportunities in the investing world as this trend takes hold.

Marc Faber: Too Late To Buy U.S. Stocks & Too Soon To Buy Emerging Markets

Jim Rickards On China's Gold Accumulation & Currency Strategy

The following is a piece from an excellent interview at The Epoch Times with Jim Rickards discussing China's gold accumulation strategy and their strategy for the next global currency system.

Mr. Rickards: What is going on in Shanghai is very significant. Suffice to say that China is the coming world gold power. In terms of the world monetary system, Shanghai is becoming the center of world gold trading as opposed to London and putting these two things together, you have to ask yourself why?
Epoch Times: Why?
Mr. Rickards: I think they see something most people don’t. The international monetary system based on paper currencies is fragile and likely to collapse, and when the system needs to be reformed, the people with the largest voice at the table will be the people with the most gold.
Epoch Times: Right, but even including this frantic buying, the Chinese have a lower percentage of their money supply reserved in gold than the United States.
Mr. Rickards: I agree with that, which tells me they will keep buying. I think they have acquired three or four thousand tons secretly, but I don’t think they are done.
Epoch Times: Can China supply the world with a reserve currency?
Mr. Rickards: Not with the yuan. A: They don’t want to open their capital account. B: The yuan can’t possibly be a global reserve currency. It is expanding in use as a trade currency, but most people don’t understand the difference between a trade currency and a reserve currency. The trade currency is just a way of keeping score in the balance of payments mechanism.
If you are Brazil and China, and Brazil agrees to take yuan for Brazilian goods, and China agrees to take reals in exchange for Chinese goods, that’s fine. Then you just keep score and settle up every now and then. That’s a trade currency.
But to be a reserve currency means that countries that have reserves have to invest it in something, so you need a deep liquid pool of investable assets. China does not have that. There is no Chinese bond market. There are a few Dim-Sum bonds and a few other things, but there is no Chinese government bond market to speak of, and it would take 10 to 15 years to develop one.
But it’s not just about issuing debt. China doesn’t have to borrow because they have too many reserves. If they don’t borrow then there are no bonds, and if there are no bonds there can’t be a reserve currency because there is nothing to invest in.
Even if they did, there is no rule of law in China, so why would you trust the Chinese not to steal your money? So putting all that together, they are not even close to being a reserve currency.
Epoch Times: So what are the Chinese up to?
Mr. Rickards: What China wants is the SDR [Special Drawing Right, a type of money for governments], because it’s not the dollar. It’s issued by the IMF [International Monetary Fund], and China is simultaneously lobbying for more votes in the IMF.
China is trying to use its willingness to lend money to the IMF to purchase SDR notes from the IMF to give the IMF money to bail out Europe. It’s trying to use that as a lever to get more votes. If it has more votes, it would be comfortable using the SDR as a reserve currency, because its use would be regulated by the membership and that would make China the second largest member after the United States.
The United States is opposing it, but Christine Lagarde [Head of the IMF], is pushing very hard to increase the Chinese role. It’s a complicated global game.
If you said to me, does China want to get rid of the dollar as the global reserve currency, the answer is yes. But most people think it’s that they want the yuan. They don’t. It’s the SDR.
Epoch Times: What can the United States do about the money owed to China?
Mr. Rickards: All we have to do is inflate our currency and pay them back in cheaper dollars and that reflects a wealth transfer from China to the United States. So China is completely vulnerable to that, which is why they are buying gold to create a hedge.
If we inflate, then gold will go up. So what they lose on the paper, they make on the gold.
More from Jim Rickards on the continued strength of the euro vs. other paper currencies:

Sunday, February 16, 2014

Talking Head Simon Hobbs Embarrasses Himself On CNBC At The Gold Bottom

I want to take a minute to review the video below because I hope it helps illustrate the incredible danger the average investor faces by watching too much CNBC.

A guest on the show said that he recommends clients hold 10% of their portfolio in precious metals related assets. He also recommends that investors rebalance their portfolio to keep that number at 10%.

Let's say that you have a $100,000 portfolio. We'll leave out silver and mining stocks and just use physical gold in this example to make it easier to walk through.

In 2000 the price of gold was at $250. It rose for 12 straight years entering 2013, peaking at $1,900. If you just held your original investment without rebalancing, your $10,000 in gold rose 760% to $76,000 at the peak. However, if you were rebalancing on December 31 every year and taking profits, then your return would be lower than 760%. After 12 years of rebalancing you would have $10,000 in gold and $20,060 in profits.

In 2013 gold gets clobbered. It falls 28% on the year. Your $10,000 in gold is now worth $7,200. If you continue to rebalance entering 2014, you now add $2,800 in gold to your portfolio. This means you now have $10,000 in gold and $17,260 in profits ($20,060 - $2,800 = $17,260).

Your gold investment is up 272% over 13 years after an earth shattering decline in prices.

The video below struck a chord with me because this 10% holding and rebalancing strategy is something I recommend to a lot of people who ask me for investment advice. Since 99.9% of the public holds 0.0% of their portfolio in precious metals, a 10% holding is a major shift. I hold a substantially higher percentage of precious metals in my personal portfolio, and I increase that percentage far more during the major sell-offs which I view as a gift wrapped in a bow.

With this conversation in mind, watch the video below where Simon Hobbs rudely attacks the guest for advising this 10% rebalancing strategy. The interview took place on December 13, the day that gold bottomed in price. The mining shares, which he recommends adding to balance the portfolio, are up 30% to 300% since the low that day.

CNBC should be thought of as poison for the mind and looked at only as a case study on behavioral psychology and herding behavior.

Felix Zulauf Discusses China, Gold & The Turkish Lira

Felix Zulauf anticipates coming stress in the Chinese banking system which could trigger a 1997 decline in stock markets, particularly the United States stock market which he sees as tremendously overpriced.

He thinks gold has been washed out in both sentiment and price, with any panic providing a buying opportunity. China, who purchased the entire gold production last year, will continue to soak up physical gold supply.

He feels that there will be trouble with Hong Kong interest rates (due to their peg to the U.S. dollar) that will impact their markets, and the Turkish lira (their currency) could get "explosive" to the downside in the months ahead.