Saturday, July 30, 2005

Response to Housing Bubble

Primer on my investment outlook

From the article below :-
The reduction in value due to a 25% fall in housing does not take into account the leverage that housing has today. There is 18 trillion worth of home equity, but a fall in housing reduces the spending on construction, and thus jobs. It reduces consumer spending far more than just the reduction in equity. Also, many people have zero equity and have taken interest only loans. When they walk away, it creates a problem for banks.
I could go on, but a fall in housing prices affects MUCH MUCH than simply 25% of 18 trillion. It affects the entire financial sector in terms of defaults, income in terms of mortgage origination, jobs in terms of financial/mortgage/construction sectors, and the related effects in consumer spending when people are no longer able to extract home equity...
Prices dont need to fall but can just stop increasing.. Just look at the recession in Holland over the past few years...

One of the Feds on housing

Whatever the source of the conundrum, clearly low long-term rates have contributed to the continuing boom in the housing market. The share of residential investment in GDP is now at its highest level in decades. The question on everyone’s mind, of course, is whether this source of strength in the economy could reverse course and become instead a source of weakness. Put more bluntly: Is there a housing “bubble” that might collapse, and if so, what would that mean for the economy? To begin to answer this question, we need to know what we mean by the term “bubble.” A bubble does not just mean that prices are rising rapidly—it’s more complicated than that. Instead, a bubble means that the price of an asset—in this case, housing—is significantly higher than its fundamental value.

One common way of thinking about housing’s fundamental value is to consider the ratio of housing prices to rents. The price-to-rent ratio is equivalent to the price-to-dividend ratio for stocks. In the case of housing, rents reflect the flow of benefits obtained from housing assets—either the monetary return from rental property, or the value of living in owner-occupied housing. Historically, the ratio for the nation as a whole has had many ups and downs, but over time it has tended to return to its long-run average. Thus, when the price-to-rent ratio is high, housing prices tend to grow more slowly or fall for a time, and when the ratio is low, prices tend to rise more rapidly. I want to emphasize, though, that this is a loose relationship that can be counted on only for rough guidance rather than a precise reading.

Currently, the ratio for the country is higher than at any time since data became available in 1970—about 25 percent above its long-run average. Of course, the results vary widely from place to place. For Los Angeles and San Francisco, the price-to-rent ratio is about 40 percent higher than the normal level, while for Cleveland the ratio is very near its historical average.

Closer to home, the figure for Seattle is just over 35. For Portland, it turns out that the price-to-rent ratio is a bit anomalous. Unlike the ratio for the nation and many of the cities I’ve mentioned, Portland’s ratio has been trending up, and this pattern has been going on since the late 1980s. This means that there’s not a stable long-run average ratio to use as a comparison for today’s ratio, so the analysis we did for the other cities wouldn’t be that meaningful for Portland. What we do know is that the pace of home price appreciation in Portland has been close to the national pace over the past few years, lagging behind somewhat in 2003 as the state struggled to recover from the 2001 recession, but mostly catching up in 2004 and early 2005 as economic growth picked up noticeably in the state. As of early this year, home prices in the Portland area were up 12 percent over a year earlier, only a bit below the national pace of 12½ percent. More recently, I’ve heard reports that upscale homes in the Portland area are increasingly being sold at above-asking price—a phenomenon we’re all too familiar with in the Bay Area! So it’s clear that Portland’s housing market has been hot, but I’m sure that’s no surprise to you.

In any event, as I said before, the fact that the ratios for the nation and many areas of the country are higher than normal doesn’t necessarily prove that there’s a bubble. House prices could be high for some good reasons that affect their fundamental value. The most obvious reason is the low level of mortgage rates. This stems both from very stimulative monetary policy and from the conundrum I discussed earlier. Conventional mortgage rates have dropped from around 6 percent in early 2004 to around 5 percent recently.

Other factors could also be raising housing’s fundamental value. For example, recent changes in tax laws may be having an effect. In 1998, tax rates on capital gains were lowered and the exemption from capital gains taxation for housing was raised to $500,000. Both of these changes would reduce the potential tax bite from selling one home and buying another. Another development, which may be making housing more like an investment vehicle, is that it’s now easier and cheaper to get at the equity—either through refinancing, which has become a less costly process, or through an equity line of credit. Both of these innovations in mortgage markets make the funds invested in houses more liquid.

So there are good reasons to think that fundamental factors have played a role in the unusually high price-to-rent ratio. But the bottom line here is fuzzy. It’s very hard to say how big a role these factors have played, so we don’t know how much remains unexplained. Frankly, even the best available estimates are imprecise, and they don’t definitively answer the question: Is there a bubble, and if there is, how large is it?

Given this uncertainty, my focus as a monetary policymaker is on trying to understand what kind of risks a drop in house prices would pose for the economy. One of the classic ways to do this is to ask “What if…?”—in other words, to pose a purely hypothetical question. In this case, the “what if” question might be, “What’s the likely effect if national house prices did fall by 25 percent, enough to bring the price-to-rent ratio back to its historical average?” Before going any further, I want to emphasize that I’m not making any predictions about house price movements, but instead, simply discussing how a prudent monetary policymaker could assess the risk.

First, there would be an effect on consumers’ wealth. With housing wealth nearing $18 trillion today, such a drop in house prices would extinguish about $4½ trillion of household wealth—equal to about 38 percent of GDP. Standard estimates suggest that for each dollar of wealth lost, households tend to cut back on spending by around 3½ cents. This amounts to a decrease in consumer spending of about 1¼ percent of GDP. To get some perspective on how big the effect would be, it’s worth comparing it with the stock market decline that began in early 2000. In that episode, the extinction of wealth was much greater—stock market wealth fell by $8½ trillion from March 2000 to the end of 2002. This suggests that if house prices were to drop by 25 percent, the impact on the economy might be about half what it was when the stock market turned down a few years ago.

Moreover, the spending pullback wouldn’t happen all of a sudden. Wealth effects—positive or negative—tend to affect spending with fairly long lags. So, a drop in house prices probably would lead to a gradual cutback in spending, giving the Fed time to respond by lowering short-term interest rates and keeping the economy steady.

Now let’s complicate things. Suppose house prices started falling because bond and mortgage interest rates started rising as the conundrum was resolved, say, because the risk premium in bonds rose due to concerns about federal budget deficits or other factors. Then we’d have the cutback in spending because of the wealth effect, plus there’d likely be further spending cutbacks, as borrowing costs for households rose. Furthermore, a rise in long-term rates would have effects beyond just households—it also would dampen business investment in capital goods through a higher cost of capital.

How manageable would this scenario be? Like the wealth effect, these added interest-rate effects operate with a lag, so, again, there probably would be time for monetary policy to respond by lowering short-term interest rates. This obviously would not be a “slam dunk,” but in many circumstances it would seem manageable.

A matter of more concern is whether this scenario would lead to financial disruptions that could cause spending to slow sharply and quickly. One issue that receives a lot of attention is the increasing use of potentially riskier types of loans, like variable rate and interest-only loans that may make borrowers and lenders vulnerable to a fall in house prices or increase in interest rates. I believe that the odds of widespread financial disruption on this count are fairly slim, although, clearly, some borrowers are vulnerable. First, the shift to these new instruments appears relatively modest overall. Second, the equity cushions available to both borrowers and lenders still seem, on average, to be pretty substantial. This is evident in looking at loan-to-value ratios, which have fallen, on average, as home valuations have risen faster than mortgage debt. In addition, most financial institutions enjoy comfortable capital positions, so they’re better able to weather any problems with their mortgage portfolios. Finally, some of the risk associated with mortgages has been transferred from banks to investors, as banks have sold off securitized bundles of mortgage debt. These investors may be in a better position to handle the associated risk. So, while there undoubtedly would be some fallout from a substantial drop in house prices, the financial system and consumers appear to be in reasonably good shape to handle the situation.

John Mauldin on India

Primer on my investment outlook

From the letter below, Mauldin suggests that India is like Israel in terms of its opposition to the Islamic world. Not true... India was actually against Israel and with the Arab world for most of its history. India also has the largest Muslim population outside of Indonesia. India pissed of Israel by commending Arafat a number of times.
I can understand that the US needs India as an economic counterweight to China, but India has had long relations with Iraq, Iran and a number of Arab countries..
Its incredible how the truth can get twisted to justify an opinion..By working backwards from the conclusion, we sometimes derive the proof..

India - The Next Big Player
U.S.-Indian Relations and the Geopolitical System
Your Own Private CIA Briefing
Ouzilly and on to London

Last week we looked at China, and this week we look at India, the next rising superpower in Asia. I have asked my friend (and fellow Texan) George Friedman of Stratfor to give us his insights on the political implications of what appears to be a closer US-India relationship. Stratfor has been described by folks like Barron's as being a private CIA. I find their daily letters plus his in-depth analysis to be as solid as anything I read. When George writes, I listen. George now thinks we may be seeing opportunities like those in China in 1980. I will be back from Europe next week, but want to thank George for stepping in while I am gone.

By George Friedman

Indian Prime Minister Manmohan Singh was recently in Washington and addressed a joint session of Congress. Most visiting heads of government don't get that privilege, but Singh is no ordinary leader. The Indo-American relationship is emerging as one of the foundations of the global system. For the United States, India -- particularly since 9/11 -- has come to represent a strategic partner in the U.S.-jihadist war: By its very existence as a U.S. ally, it serves to keep the pressure for cooperation very high on rival Pakistan. For India, the United States has come to represent an alternative to its former relationship with the Soviet Union, which helped to guarantee India's regional interests. Thus, Singh's visit, while dealing with a range of the normal minutiae of international relations, represents confirmation that something of fundamental importance has happened.

Unlike many summits, this particular one has had the look, feel and substance of a significant event. Foreign leaders do not usually get to address Congress. The entire tone of the meetings implied a significant turning point. But in this case, the concrete agreements were as important as the symbolism: Significant deals were signed.

The most publicly significant was a deal giving the Indians access to American nuclear technology for civilian uses. India became a nuclear power in 1974, against strong U.S. opposition. The decision to give India nuclear technology -- even for civilian uses -- marks a sea change in American thinking about India's nuclear capability. To be more precise, it marks the culmination of a sea change. Washington used a series of severe, near-nuclear crises between India and Pakistan following the Sept. 11 attacks to leverage Islamabad toward greater cooperation with the United States. It was clear then that the United States was changing its view of India "on the fly." This new agreement represents a public affirmation that Washington regards India's nuclear capabilities as non-threatening to American interests and, indeed, as a potential asset.

In agreeing to increase India's nuclear technology base, albeit only for civilian uses and under international supervision, the United States is affirming that a special relationship exists with India.

At the same time that this public agreement was being reached, official leaks from the Pentagon said that India would begin purchasing up to $5 billion worth of conventional weapons, once Congress approves the deal. This requires an act of Congress because current law on non-proliferation bars the sale of a wide array of military technology to countries that have acquired nuclear weapons -- specifically focusing on any technology that might be useful to a nuclear weapons program. Since the technologies that are potentially useful are amazingly diverse, large swathes of technology are excluded from sale. Should Congress approve the bill, it would place India in a position similar to that of Israel (save that Israel doesn't acknowledge publicly that it has nuclear weapons).

The things being sold to India are also interesting. For example, India will be allowed to purchase Aegis technology, which is designed to protect naval vessels -- and battle groups -- from anti-ship missiles. So far, only Japan has acquired the technology, partly because of its cost. In addition, New Delhi will be able to purchase anti-submarine patrol aircraft. The United States, which until a few years ago regarded the Indian naval build-up -- based on Soviet technology -- as a threat to U.S. control of sea lanes in the Indian Ocean, has now completely reversed its posture. It is selling New Delhi naval technology that will allow the Indians to fulfill one of their key strategic objectives, which is to be able to control regional sea lanes. The United States would not be providing this technology without having achieved a far-reaching strategic agreement with New Delhi.

This, by the way, has the Pakistanis worried. Islamabad clearly understands that its status as Washington's ally in the U.S.-jihadist war will go only so far in terms of duration and dividends for Pakistan. In other words, while India gets a long-term strategic relationship with the United States, Pakistan's relationship is viewed as short-term and tactical.

To understand the major shift taking place between Washington and New Delhi, it is important to understand the geopolitical context that created it. Almost from the beginning, there were tensions between the United States and India. India's formal position was non-alignment between the Soviet Union and the United States. It was one of the founders and leaders of the non-aligned movement. Apart from its formal position, India had fundamental problems with the geopolitical stance of the United States, which during the Cold War was heavily focused on developing Muslim allies.

The primary interest of the United States was the containment of the Soviet Union. This inevitably caused Washington to focus on two predominantly Muslim countries that bordered the Soviet Union: Turkey and Iran. American strategy could not work if either of these nations were not allied with the United States, and Washington did everything it could to assure their alignment, including engineering a coup in Iran in 1953. The focus on Muslim countries extended beyond these two. The Americans did not want their rear and flanks turned by the Soviets; the United States and Britain, therefore, focused on both Syria and Iraq as well as on the Arabian Peninsula. It is important to recall that during the 1950s the United States had rather cool relations with Israel; it was pursuing a pro-Muslim strategy out of geopolitical necessity.

During the 1950s, the Indians were the ones with a Muslim problem. The partition of India into Muslim- and Hindu-majority nations had created Pakistan, which represented India's primary national security concern. In looking at India's geography, it should be noted that in many ways, India is an island. Its northern boundary essentially consists of the Himalayas, impassable for any substantial military force. Its eastern frontier faces tropical jungles. Most of its borders consist of ocean. Only to the west, where Pakistan lies, did there exist a strategic threat. It is true that what is today Bangladesh was part of Pakistan in those years, but it never posed a strategic threat. As the crow flies, the Pakistani border is only a couple of hundred miles from Delhi and Bombay; that was not a trivial concern.

The United States was pursuing the Muslim world. The Indians saw themselves as threatened by the Muslim world. U.S. and Indian interests, already strained by ideology, diverged fundamentally. India needed a counterweight to the United States and found it in the Soviet Union. Though it never became Communist, India became an ally of the Soviets. The Indians built their armed forces on a foundation of Soviet technology, and their highly bureaucratized economy found some commonality with the Soviets.

From a purely strategic point of view, the Indo-Soviet relationship did not mean all that much. Even after the Sino-Soviet split, the direct impact that India or the Soviets could have on each other's strategic situation was severely limited. India was never the military counterweight to China that the Soviets needed -- not because its forces couldn't challenge the Chinese, but because geography prevented the two forces from coming to grips with each other. People speak of Sino-Indian competition -- and there was a war (though not one that could threaten the survival of either nation) between India and China in 1962 in the Himalayas -- but the fact is that the two countries could be ten thousand miles apart for the extent to which geography permits any meaningful interaction. India's isolation limited the significance of its confrontation with the Soviets. The value of the relationship was marginalized by geography.

India therefore became marginal to the international system. Its major point of contact was with Pakistan, with which it had fought a series of wars -- major ones in 1948, 1965 and 1971 -- had serious territorial issues and deep distrust. Pakistan was supported by the United States and China, the two anti-Soviet powers in the 1970s and 1980s. This was partly due to India's relationship with the Soviets and partly due to American interests in the Islamic world.

Marginalization is the key concept for understanding India's position in the world prior to 2001. Geography prevented it from having substantial interaction with the great powers. Its point of contact, Pakistan, was of some importance, but not decisive importance. Prior to becoming a nuclear power, India had only one recourse: naval power. But its economy would not support a full-blooded fleet-building program. Its strength was in its army, but that army could not be projected anywhere.

Its economy was also marginalized. Built on a socialist model that took the worst from Soviet planning and Western markets, the Indian economy isolated itself by laws that severely limited outside investment. Its infrastructure did not develop and, while several key industries -- pharmaceuticals and electronics -- emerged, this never created the fabric of what might be called a national economy. India was a huge, fragmented country, on the margins of the international system. Its friendship with the Soviets and its enmity with the United States were tepid on all sides.

Then came the 9/11 strikes, and the American relationship with the Islamic world was transformed almost overnight. Suddenly, Pakistan became a critical piece of the United States' long-term war plan, and therefore India became an extremely valuable asset. The Indians understood two things. First, that as marginalized as they had been in the Cold War, they had become irrelevant to the international system in the post-Cold War period prior to 9/11. Second, they understood that the U.S.-jihadist war could become India's entry into the broader international system.

U.S.-Indian collaboration began intensely shortly after 9/11. Part of it consisted of a mutual interest in manipulating Pakistan; part of it had broader implications. As the United States began to view the Muslim world as an unreliable and threatening entity, it started to see India in the same light as Israel. It was a potentially powerful ally that, in spite of its hostility to the Islamic world, or perhaps because of it, could be extremely useful. Long, complex negotiations ensued, leading up the present summit. The terms of endearment, so to speak, were defined. A range of issues on which the two sides could collaborate emerged.

A not-so-hidden issue at the summit in Washington was China. Sino-U.S. relations are deteriorating fairly rapidly. There was much speculation about India being an Asian counterweight to China. We have no idea what this means, since geographically China and India occupy two very different Asias. The United States doesn't need a nuclear counterweight to China, and China is very far from becoming a major naval power capable of projecting force outside of its regional waters. By that, we do not mean sailing into these waters, but fighting, winning battles and sailing home. The nuclear technology agreement that Singh obtained in Washington increases the likelihood that China is not going to project force west of Singapore. On the other hand, it was never likely to do so.

There is, however, another dimension to this. For a generation, China has been the place where hot money in search of high returns was destined. It was where the action was. It is no longer that place, except in the minds of the nostalgic and delusional. But India could well be. If one thinks of China in 1980, the notion that its bureaucracy, lack of infrastructure and a culture antithetical to rapid development would yield the economic powerhouse of 2000 would have been unthinkable. It was unthinkable.

India is in China's position of 1980. It has a mind-boggling bureaucracy, poor infrastructure and a culture antithetical to rapid development. At the same time, it has the basic materials that China built on. As the Sino-U.S. relationship deteriorates, India can be a counterweight to China -- not in a military sense, but in an economic sense. If the United States has an economic alternative to China for investment, Washington develops leverage in its talks with Beijing on a host of issues. China, after all, still courts investment -- even as the Chinese buy anything that isn't Chinese.

Another factor underscoring the significance of the shift in Indo-U.S. relations is New Delhi's relationship with Tehran. India's relations with Iran have always been a serious point of contention and concern for the United States. However, due to the situation in Iraq, tensions with New Delhi over this issue are on the decline. The United States and Iran at the moment are developing parallel interests, each with their own reasons to work together to ensure the success of the fledgling Shia-dominated government in Baghdad.

The Indo-American relationship did not develop out of the subjective good will of the leaders. The Sept. 11 attacks created a dynamic that couldn't be resisted, and that created a reality that the Bush-Singh summit confirmed. It doesn't transform the world, but it changes it fundamentally. India will come out of this a very different country, and the United States will look at the Indian Ocean Basin in a very different way.

Reader's Stock Picks

Primer on my investment outlook

> OK... Then what do you think of - NCOG and RYG
> One is a debt collection company. Its trading just a
> little lower than book
> value. Given that IRS will start outsourcing their
> $300B or so in
> uncollected debt that might become a decent source
> of revenue. Also given
> the huge amount of adjustable loans ... any collapse
> will help them. You
> obviously know the debt situation here better.
> Competitors ECPG and AACC
> seem to have much higher valuations.
> RYG is a Canadian company and is also trading below
> its book value. Has been
> for a while now and the stock hasnt done much in
> last 2 years. Last 4-5
> years seems like Canadian Real Estate market and
> especially existing home
> sales has picked up.

Well. The approach is right, but just the first step. Worldcom traded wayyy below book value before its bankruptcy. You also need to check the debt figures, find out the leverage. Also, many items can be on the account books at cost value, and only updated periodically.
You also need to check on the dividend history. At this point in time, with generationally low interest rates, I only bother with stocks that offer income. It is easy to hold onto a stock when it offers 6% dividend yield, when it goes down in price...

Friday, July 29, 2005

Interesting Situation with SHNG Notes

Primer on my investment outlook

From a press release today,

In October 2004, Sherlock Bay Nickel issued 75 million Convertible Notes at a price of $0.20 per Note, earning interest at 12% pa and maturing on 1 September 2007. The Convertible Notes are listed on the ASX and, as at 28 July 2005,were trading (with minimal liquidity) at $0.10.

−There is currently no guarantee that the Project will proceed
−If the Project does proceed, there is uncertainty over the timing of its development and the commencement of project cash flows.
􀂃Given the uncertainty over the Project, the SBNC Board believes that it is prudent to refinance the Convertible Notes now.

On 1 August, cash per note is 9.3c. On 1 October cash per note is expected to be 6.7c per note.

At first glance, it looks like the existing noteholders are screwed. However, note a few things. SBNC does have fixed assets that will fetch a price - especially with this base metals bull market. I have averaged down my notes and now have them at a price of 13.9c per share. Clearly my gains will depend on the conversion terms on the noteholders meeting. I actually think that, if the notes fall to around 6c per share they are a terrific buy with a lot of value in them.
The notes are yielding 24% p.a. at a price of 0.20. They are priced for default, but this company has a substantial amount of cash and fixed assets. Clearly, the last management screwed up. However, I do believe that the company will avoid receivership and while the shares may not be beneficial, the notes will be of value...
At the moment I am holding my notes and waiting to see what happens!

Tuesday, July 26, 2005

Wages and personal income rising ??

Primer on my investment outlook

From this article,
the US Gov counts year end bonuses in its income statistics. Thus its been possible for hourly wages to stagnate and income to grow. On the flip side, when the housing/stock markets slow and bonuses get reduced income falls as well. Its a double sided weapon.

Monday, July 25, 2005

The China Revaluation and the Environment

Primer on my investment outlook

Hussman gives an interesting take on the China revaluation.

While many of us were taught in introductory economics that the 1970's inflation was due to “oil price shocks” and money growth, it's very hard to actually find this in the data. With all apologies to Milton Friedman, inflation is not a monetary phenomenon but a fiscal one – it occurs always and everywhere when fiscal authorities create government liabilities in excess of economic growth.

Never thought of this myself :-)

Also two companies on the ASX
1. Making paper from waste banana bagasse
2. Using Nanotech to duplicate photosynthesis for Solar Energy

I have an eye on these companies and will take a position after monitoring their listing and price progress. Highly Speculative..

Thursday, July 21, 2005

China Severs Its Currency's Link to Dollar

Primer on my investment outlook

UNBELEIVABLE. I did not expect it to happen. Expect a slow sellof of US treasuries and long interest rates to head up. Also, there may be downward pressure on yields on the JPY and EUR bonds...
Malaysia has followed and India, Singapore and the rest of Asia will follow soon, I expect. Over the next few months, Asian currencies may strengthen while the EUR may drop.

Wednesday, July 20, 2005

Current Readings

Friday, July 15, 2005

Brandrill Notes Reach fair value

Primer on my investment outlook

Well! Well! Looks like someone's been reading my blog. The 10% discount to the shares have disappeared as I wrote in a previous report.

Wednesday, July 06, 2005

Irrelevance of reserves

Primer on my investment outlook

Bernstein Energy: Oil "manufacturing" calls into question the world's ability to grow production fast enough - My thanks to Spalding Hall for this very informative report by Neil McMahon, Ben Dell and John Dowd of Bernstein Research. It's posted in the Subscriber's Area but here is a brief section:

Not only are reserves becoming more difficult to find, but the global reserves mix is also changing. As upstream focus across the industry shifts from conventional to unconventional development projects, so too unconventional reserves will becoming an increasingly important part of the global resource base. Critically however, the rate at which conventional and unconventional reserves can be developed and produced are very different, which may lead to over-optimistic estimates of the production growth that can be delivered from the reserve base.

Their differing development rates are a simple reflection of the fact that conventional and unconventional production are very different processes. Production from traditional, large oil field "gushers" is reliant on natural reservoir pressures. Initially these pressures are high and provide a natural force by which production can be ramped-up quickly, and to a high annual depletion rate, constrained only by economic factors (number of wells drilled). As oil is extracted, reservoir pressure decreases, leading to production decline. Conversely, unconventional production (e.g. heavy oil, oil sands, LNG, GTL) is essentially a manufacturing process, with production a function of the number of processing units built (refineries, power generation facilities etc). While this means that production is unbound by natural limiting factors such as reservoir pressures, the economic limiting factors are far greater. Manufacturing oil, costs more and is harder to scale versus traditional field production, not to mention the lower quality per barrel realized. Consequently, the development of unconventional resources takes far longer.

There is a danger then, that global annual reserve additions will become a less meaningful measure of production potential in the future, given the additional time and resources required to develop unconventional reserves. Indeed, reserve figures of the future may lead to a false sense of supply security unless the issues associated with unconventional resource development are fully appreciated.

Monday, July 04, 2005

Current readings

Saturday, July 02, 2005

Current Readings

Friday, July 01, 2005

The Brandrill story

Primer on my investment outlook

Here are more details about Brandrill Conv Notes that I own (BDLG on the ASX) and a brief outlook on the investment.

Convertible Terms and Conditions
The Mandatory Converting Notes have a face value of 5 cents and pay
an 8.5% interest p.a. payable at 30 June and 31 Dec each year. The Notes
may be converted at the Note holders election by completing and submitting a
Note Converison Notice to Brandrill before 30 September 2005, or they will
mandatorily convert on this date. Interest from Jun-Sep 2005 will be paid
at this date.
* The conversion ratio is calculated as the face value of the Notes
divided by the Volume Weighted Average Share Price (VWASP) for the 20
trading days prior to the conversion date (expressed as a decimal eg 5 cents
is expressed as 0.05). The formula is subject to, if the VWASP is less than
10 cents then it is deemed to be 10 cents, and if the VWASP is greater than
$5.00 then it is deemed to be $5.00.
Price action of BDLG

As per the Conversion terms, BDLG should trade at 0.5 times the price of the stock BDL IF BDL trades below 10cents. Recently due to lots of odd lots and illiquidity, BDLG has been trading at a 10% discount to its immediate conversion value. Thus, if BDL traded at 0.066 cents, BDLG traded at 0.030 cents instead of 0.033 cents.
Also, since I bought BDLG in June, I was eligible for the 6 months interest of 4.25% on BDLG + 2.125% 3 months interest if I held to maturity till September 2005. Thus, I receive approx. 0.0032 cents back as interest payment per Note. This brings my breakeven cost per BDLG to 0.030 - 0.0032 = 0.026 - 0.027. I am able to enter BDL at 0.0268 X 2 = 0.054 while the market value is 0.066.
Thus, by buying BDLG in June I opened a position in BDL at a discount of about 16-17% to market value.

Conversion advantage of BDLG

Look carefully at the conversion terms. Realistically, the price of BDLG should act thus :-
If weighted average price of BDL < bdlg =" 0.5"> 10 cents then BDLG = 5 cents

BDLG conversion takes the weighted average price of the last 20 days. I'm going to hold onto BDLG until the last moment for the interest payments due. Its possible that prices spike above 10 cents, and you think that prices will hold there for an extended period. Guess What!! Since Brandrill uses the 20 day weighted average for conversion, you can fax the conversion form to Brandrill and try to get an even lower price for conversion.
It will take a couple of heavy trading days above 10 cents to pull the 20 day weighted average price above 10 cents, giving an investor ample warning before conversion.

Brandrill outlook

Brandrill has had a chequered history. It entered receivorship (bankruptcy) a couple of times in the past two years. A summary can be found here. The Company management thinks that the company is undervalued. This outlook can be found here.
This is my outlook. If you look at new IPOs in the ASX, every day a few new mining companies get listed or raise cash for exploration. Money is pouring into exploration compared to the last few years. There is a shortage of drills and personnel, since everyone around us decided to do MBAs and degrees in Computer Science.
Do you know anyone going to university for a degree in Metallurgy or Geology ??
Brandrill has drills (Duh), people, experience and contracts. They screwed up royally the last few years but they have a tailwind. During the tech boom, I was in Silicon Valley. TONS of companies got money for the next big things in networks. Most of them went bust, BUT THEY ALL SPENT MONEY ON EQUIPMENT. Companies that supplied to these startups made money. With Brandrill, who cares if there is a bump on the upward path of commodities prices. The money being raised now will be spent on exploration. Since Brandrill will supply drills and contractors to these Johny Come Latelys, Brandrill will make money even none of the newbies strike gold. I believe the stock is substantially undervalued, and the Conv Note is giving an entry point at a bigger discount!!!

Current Readings