Month: August 2014

Book review: “Camillo Castiglioni or the metaphysics of sharks”

BookCoverCastiglioni

I have just finished Prof. Dieter Stiefel’s book about Camillo Castiglioni. Written by A University of Vienna Professor, it is one of the rare exhaustive information sources about one of the most controversial figures of Europe’s interwar period. Unfortunately, for english speaking readers, the book is only available in German.

Camillo Castiglioni was one of the most notorious interwar speculators on the European continent. He was the owner significant industrial shares and a pioneer of Austrian Aviation at the beginning of the century. After his flight over Vienna’s St. Stephen’s cathedral, which stunned the Viennese at that time, he was personally congratulated by Emperor Franz Joseph II. As a chairman he played an important role in the early history of BMW – a company, of which he was a majority owner for some time. One Ferdinand Porsche worked as a chief engineer in one of his major holdings before quitting after a serious dispute with Castiglioni who wanted Porsche to focus on cheap, mass-market cars rather than on cutting edge sports vehicles. Besides, he was much into art and sponsored the Salzburg festival founded by his friend Max Reinhardt, today one of the worlds most remarkable festivals of music and drama. His luck turned somewhen around 1924, when he, like so many speculators large and small on the Continent, lost a significant amount of money in the famous speculation against the french franc from which he never fully recovered.

So, how did he do it?

As you can imagine I read the book with the intention to find out what  principles guided the man in his speculations. Unfortunately, the book focuses too much on details regarding corruption and scandals (Castiglioni more than once got sweet deals at the expense of taxpayers) and less on the economics behind his actions. The book also lacks a coherent structure. It seems Prof. Stiefel hastily assembled it from pieces of his archive. Nevertheless I still could take away a few principles:

1.) In a heavily regulated market (FX controls, Import/Export controls a.s.o) it matters whom you know and who you are.

The book sometimes hints at price discrepancies between different market places, i.e. Vienna and Zürich that can only be exploited if you can work around the rules impeding the free flow of capital. Knowing officials was also necessary for Austrian and German industry which found itself cut-off from its major raw material suppliers as a result of newly erected borders. Interestingly, in the interwar period it mattered whether you where a citizen of a defeated (Austria, Germany) country or not. Castiglioni, born in Trieste, main port of the Austro-Hungarian Empire, shrewdly opted to become an italian citizen after the war (despite the fact that he had supplied the Austrian army during the war) which brought him considerable advantages. For instance, the book mentions one episode where the Czech government was pondering about nationalizing assets of a Vienna-listed company. Fearing expropriation the shares were trading at depressed levels. Castiglioni, having the advantage of his Italian citizenship, organized a loan from a friendly italian bank and bought the depressed shares, knowing that the Czech government would not dare to nationalize a company belonging to a citizen of a friendly government.

2.) When trying to profit from an hyperinflation environment, you need a bank.

In order to truly profit from a fall in the currency you need to be able to get loans in that currency, preferably loans you are able to roll and repay at some later date. Castiglioni seems to have been among the first to recognize the steady fall of the Austrian Crown as a result of which he could trick some creditors by agreeing to pay the purchase price at a later settlement date thereby lowering the real cost of his investment. The book is not explicit of what made him suspect the crown to fall more than expected, but I got the impression that watching prices of shares in different currencies and gold was a key to understanding of what was going on. It took the rest of the population some time before they realized that the notes had been seriously debased. The author mentions that Castiglioni, after inflation had subdued in Vienna, turned to Berlin where the printing presses were running mad and had a competitive advantage because he was used to calculating in gold.

Nevertheless, once the inflationary mentality is well entrenched, there is only one way to procure a loan in a debasing currency: you had to own a bank-which is exactly what Castiglioni did. The book is not precise, but it seems that more than half the share capital of his bank was lent out to himself, something which also seems to have happened in Greece, more recently.

3.) Castiglioni seems to have had no true economic insight, he just repeated his strategy to buy hard assets with depreciating currency which was successful at first but devastating in the end.

After his first successes in Austria, he went to Berlin where the inflation lasted longer (as an aside: Ludwig von Mises seems to have had played a major role in the stabilization of the Austrian Crown, which is one reason the inflation if Austria was not as devastating as in Weimar Germany, for more information see his memoris). After both currencies had fallen substantially, his attention turned to the french franc, reasoning, like many others as this was a crowded trade, that the same fate that had befallen the Austrian Crown and the German Mark would come over the French Franc. He overlooked that France at the time was ruled by hard money men and had huge gold reserves (difficult to believe, I know). Further as a victor country it could always procure USD from the (friendly) US. Ultimately the news that JP Morgan had provided a credit line to the Banque de France lead the speculators to capitulate inflicting heavy losses on Castiglioni.

Conclusion

The author, being an economic historian, could have provided more hard economic data (balance sheets, interest rates a.s.o.) – then the book would be a gem to the investor community. Unfortunately, the author exessively focuses on questions of morality (highly subjective), which should not necessarily feature in economic history.  I dare to say: properly researched and presented the topic would have the potential to become a classic.  Furthermore, although the world cannot be compared to the crazy interwar period, you can bet that China’s closed capital account is a source of riches for the entrenched elite, just as it was back then for Castiglioni and friends.  The story once more stresses the importance of process over outcome as the only way to asses the sustainability of an investment strategy.

Great Jim Chanos interview

Great audio interview with Jim Chanos by Barry Ritholtz.

Jim Chanos is one of my favorite managers because of the logical consistency of his arguments – a rarity even among successful managers. In the interview he critically reviews the current buyback craze, among other topics. He basically argues that corporate america, on average, has a return on assets (ROA) in the mid teens, whereas buying back stock gives you, again on average, an expected return of high single digits at best. He concludes that either the historic ROA way overstates current investment opportunities, or that management allocates capital poorly, neither of which is overly bullish for the stocks.

I happen to think that both conclusions are true: I have written about how distorted management incentives are the main culprit for poor capital allocation decisions, be it in M&A and buying back stock. I also think that managements are faced with poor outlook for organic growth, which is a result of the fact that a true liquidation of malinvestment of the past cycle has not happened due to accommodative monetary policy – a fact Marty Fridson pointed out at the Grant’s conference.

As Austrians always stress: it is not the absolute, but the relative price level that matters for companies’ investment decisions. Trying to avoid the liquidation of unviable businesses unnecessarily keeps the price level up by withdrawing scarce resources from the market. This, in turn, makes it more difficult for new entrepreneurs to earn a decent margin for their investments. To sum it up: there can be no profit if losses are not allowed…

On the overvaluation of the Australian Dollar

I have been short the Australian Dollar (AUD) since 2012. Initially, I have made some money, but in the past few months it has been painful as the cost of carry is high (4%). You will not be surprised to hear that the reason for my bearishness is the Chinese bubble: it is well-known that no other country has profited from the China boom as much as Australia whose exports to China are up from 5 percent of gdp in 2000 to more than 35 percent in 2013!

As the chart below shows (via ft-alphaville) iron ore has been the biggest contributor to Australian export growth, followed by energy – all things China needs.

Aussie-exports-by-type-590x560

Iron ore demand has virtually exploded post 2009 as a result of China’s investment binge. Note that the increase in volume has more than made up the fall in iron ore prices, which is probably why neither Australian miners, nor the economy have yet felt the pinch from falling prices and the Chinese “slowdown” – simply, nothing has happened yet. By the way, despite the heavy fall, prices are still way above the long-term average.

IronOrePrices

According to Austrian Business Cycle Theory (ABCT), those sectors that are most removed from ultimate consumption benefit the most during a credit boom. Due to the long-term nature of these projects interest cost is a relevant cost component, which gets lowered during the boom and hence ignites heavy activity. Needles to say: these sectors also disproportionally fall during the slump.

Now, there are few things further removed from consumption than mining. The credit boom in this case is China’s lending binge and the most remote sector impacted by the binge is the mining industry, which provides the main input for all that steel that goes into the empty skyscrapers. And in Australia’s case the whole economy is a derivative of the mining boom. China is the main reason why there has not been a recession in Oz for the past 20 years – not some superior central bank management or “growth model”.

Due to the steady demand for Australia’s raw materials, the demand for the currency has been high and manufacturing plants are closing, which is why I think Australia has caught what economists call a “dutch disease,” at least that’s what the following chart measuring the competitiveness of various developed economies suggests. Australia is even more expensive than Norway!

I Aus-competitiveness-JPM

Once the Chinese start building less skyscrapers and infrastructure Australia will be hit very, very hard!

Disclosure: short AUD

Watch that space: High Yield Bond funds show significant outflows

Zerohedge has an interesting article bout high yield bond outflows: recent weeks have seen the longest streak in daily outflows from high yield bond funds. As one would assume, this has led to an increase in spreads albeit less than one would expect given the size of the outflows.

Regular readers will know that I believe there is a link between frothy credit markets and the stock market via buybacks (most recent links: here and here). Consistent with this view, the recent sell off in credit has led the ( very small) correction in equities, as can be seen in the chart below:

CreditSpreadsleading

So far nothing has happened yet, the moves depicted have been small and investors have not suffered major pain. If the outflows continue at this pace, however, this could mark the beginning of the next great unravelling…