Friday, September 18, 2009

New Dollar Weakness: And the Hunt for Water Rights

Agora Financial
Agora Financial's Capital & Crisis

Capital & Crisis Hotline -- New Dollar Weakness: And the Hunt for Water Rights
September 18, 2009

Margaret Wente: Are you saying the U.S. shouldn't have done all those bailouts? What was the alternative?
Taleb: Blood , sweat and tears. A lot of the growth of the past few years was fake growth from debt. So swallow the losses, be dignified and move on. Suck it up.
-- Globe and Mail interview with The Black Swan author Nassim Nicholas Taleb

Dear Capital & Crisis Reader,

The great Raymond Chandler once wrote that "Hollywood is easy to hate, easy to sneer at, easy to lampoon." The same applies to Wall Street and Washington. In fact, there are a lot of similarities between the three.

All have a craving for stories. They all have customers who want another story. And so Hollywood -- or Wall Street or Washington -- must dig up a narrative somehow. They must have a story to tell (and sell).

The story trotted out these days in Washington and Wall Street is pretty much the same. The recession is over. The recovery is for real. The bailouts worked. All praise Fed Chairman Bernanke.

Yet big problems remain. There is still too much leverage in the system. And while the big banks seem to have patched up a lot of holes, the midtier and smaller banks are still failing at alarming rates. The fiscal position of the United States is atrocious with total liabilities -- including the entitlements of Social Security, Medicare and federal pensions -- topping $118 trillion! As QB Partners writes in its latest shareholder letter: "Using corporate valuation metrics, the U.S. government's debt-to-sales ratio is over 8-to-1 and its debt to income ratio is running about 47-to-1. It is quite a levered entity."

The powers that be in Washington want you to believe another story -- of recovery and progress. Amazingly, judging by the stock market's action, investors are eating it up. The whole thing reminds me of the Jedi mind trick of Star Wars fame, with the Feds playing Obi-Wan and investors playing the part of the stormtrooper with probing questions:
Stormtrooper: Let me see your identification.
Obi-Wan Kenobi: [with a small wave of his hand] You don't need to see his identification.
Stormtrooper: We don't need to see his identification.
Obi-Wan: These aren't the droids you're looking for.
Stormtrooper: These aren't the droids we're looking for.
Obi-Wan: He can go about his business.
Stormtrooper: You can go about your business.
Obi-Wan: Move along.
Stormtrooper: Move along... move along.
But some things you can't hide. The dollar is on a slide. It hit seven-month lows against the Japanese yen and sits at a yearly low versus the euro. It's done even worse against other currencies. On a trade-weighted basis, the dollar is at its lowest levels in a year.

Now there is new pressure on the dollar. It's becoming the top carry trade currency.

A carry trade is when you sell a low-yielding currency and buy a higher-yielding one, profiting from the difference. The yen was the currency of choice, but it looks like the dollar is the new yen. With short-term U.S. interest rates near zero, it has become profitable to sell the dollar and buy a currency that pays a higher interest rate. This selling pressure on the dollar explains its weakness -- or so goes the theory.

The popular explanation for dollar weakness is that investors have a fresh appetite for risk. But maybe there is more to it than that. As one analyst said, if the dollar is the new yen, "The greenback is in real danger." That's because foreigners hold a lot of dollar assets, and selling them to swap into higher-yielding currencies could continue to keep fresh pressure on the dollar.

This loss of purchasing power is like a subtle tax and eats away at your wealth. That's why I'm bullish on gold and oil and other real assets. As the dollar weakens, these assets ought to reprice and hold their own.

No surprise, then, that gold is over $1,000 an ounce. I think it will move higher. Our gold stocks have done very well in a short amount of time. We've got a double in IAMGOLD (IAG:nyse), and we're up 40% on New Gold (NGD:amex) since July. The latter is still a buy. If you don't already own it, today looks like a good day to pick some up. The GDX, an index of gold stocks, is off nearly 5% as I write, as many gold stocks are off today. But the longer-term thesis for gold going higher is solidly in place.

*** The Hunt for Water Rights

Another company we own that has real assets and ought to do well is PICO Holdings (PICO:nasdaq). Its best assets are its water rights. PICO owns water rights mainly in Nevada, Arizona and Idaho. As you are probably aware, water is a big issue out west. It's a dry and arid place. The population growth has been strong. So you have keen competition for water.

A money manager friend of mine, whose fund owns a good slug of PICO, sent me a story the other day about the Mojave Water Agency in California. Apparently, the MWA plans to spend $73.5 million on buying water rights.

What was most interesting about the story was the view of MWA's general manager, Kirby Brill. According to the (Victorville, Calif.) Daily Press, "Brill said it was a 'huge' challenge to find rights to that much water… 'I didn't think we would be successful, to be honest with you.'"

MWA did find 14,000 acre-feet of water (an acre-foot is the standard industry measure; it is the amount of water it takes to flood a plain of one acre to a depth of one foot. A family of four consumes an acre-foot of water per year). But the story was telling, nonetheless.

PICO's portfolio of water rights is a valuable and scarce commodity. The stock has doubled off its lows, but remains quite cheap, in my view. My own conservative net asset value estimate for PICO comes to at least $50 per share.

I look forward to PICO's next report too, as the company recently raised some cash to invest in more water and land assets.

Enjoy your weekend, and I'll write to you again soon.


Chris Mayer

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