The present credit crisis, and some advice to banks

At this stage in the credit crisis in the US and the developed world, even farmers are finding it difficult to find credit. This is a banking system gone completely stupid. Here's some advice to the central bankers and the banks of the world.

The most basic human needs are food and electricity. People spend money first on food and on keeping their houses warm/cold, and a good government should also make sure that the prices of these commodities are low-not by artificially controlling prices, but by increasing their production.

Credit must flow freely to farmers-the worst thing is if they cut down on food production. Chicago grain prices are at levels where it is not making sense for farmers to plant more. These prices are set by ponzi hedge funds who are trend followers-they buy high and sell low, causing increases in volatility. They are going bankrupt now, and selling wheat and soybeans at production costs. These prices will go up soon; however, the longer they stay lower, the more hesitant farmers in the US will become to plant in the next season.

Because central banks and banks are based often in big cities like NYC and Washington DC, they seem to be happy loaning funds around where they are-in big cities. To bail out housing in suburbs of Washington DC by putting capital of banks or tax payers in mortgages, or to help farmers plant more food? The answer is obvious. Even commercial paper of corporations should rank lower than helping finance farmers to plant more food.


Sanjay

Coal stocks

Here's my reasoning for the long position in Coal stocks I got in my portfolio.

Prices of Met coal have tripled, and prices of thermal coal are up 100% in the last year, or in fact, since the beginning of this year. Again, details are not important-the key element is, met coal has approximately tripled to $300 per ton, and thermal coal to $160 per ton.

Imagine a company selling just one product, sells $100 of this product, and it earns $10 in 1 year. With a p/e of 10, the market cap of that company is $100. i.e. you will pay $100 for this company today. The profit margin is 10% (profit/revenue---costs are $90, profit is $10).

If the price of the product it sells goes up 2x, i.e. $200, and if the costs remain the same, then the profit of the company will be $110! If you wanted to give the same price/earning ratio, of $10, you would actually bid up the price of the company to $1100. That is an 11 times increase.

However, that's too good to be true. The risks in this simple model are 1) price falls back down, and 2) costs go up.

So when a commodity like met coal goes 3x in price, and another like thermal coal goes 2x in price, the stocks of the producers of coal react positively, to say the least. But what is a fair price ---it can be anywhere between 1x to 11x, depending on what you feel the cost structure will be in the future, and what the price will be in the future. Note that the price can come down---as long as demand volume goes up with that-u still will make a very good profit-it makes sense to bring up more coal mines. In fact, price is a leading indicator of demand in this case-and stock price will follow the price of coal.

Some US listed coal companies shares have goes up 2-3x in this year, but depending on your outlook for prices-you can make a case that this is going much much higher.

And I for one believe that this is a sea change in the coal market-and demand is here to stay. Look at statements of MEE, ANR and JOYG-and you will get an idea. Earnings expectation keep going up every week on these names.

My favorite one is FDG-it is a Canadian trust which holds 60% of Elk Valley-the biggest producer of Met coal. If Met coal holds anywhere near $300 per ton, you are talking about a price of FDG close to $500! Granted that a lot of coal is advanced sold at lower prices, etc. but you have plenty of margin of error-the stock trades at $90 today.

The ETF KOL is also an okay play--but has too much of Chinese Government owned coal companies. They dont let them raise prices-profit making is still a shameful act for Government owned companies in China and India. Which leaves massive room for the private coal suppliers worldwide to make $$$, because the populations will need the steel and the energy regardless of whether the coal comes from domestic companies or foreign.

The rally in Coal in the next few years will look the rally of the last two years in fertilizer stocks look like defensive plays, IMO. I think Ferts still go higher-but the potential of making very large returns in Coal is great. Following the Kelley criterion-my portfolio is heavy on Coal stocks and has some Fertilizer stocks as well.

Sanjay