-->The Salad Oil Swindle

The Daily Reckoning

Ouzilly, France

Tuesday, 19 August 2003

---------------------

*** Are we wrong? Is the dollar forever? Is the boom
eternal? Will the bubbles never end?

*** $2 of imports for every $1 of exports... how long can
that last?

*** Stocks up... bonds up... dollar up... growth estimates
up... spending up... real estate up... debt up... bankruptcies
up... and one dictator down.

---------------------------

Today, we stand back and ask ourselves:

Are we completely wrong?

We have asked the same question each year for the last 4
years.

For each year, we think we see the End-of-the-World coming.
And each year, about this time of year, we find ourselves
still in the middle of it.

One by one, nearly every conceit of the New Era has been
demolished. The Peace Dividend, the Federal Surplus, the
Magic of Technology, the End of Business Cycle, the
Elimination of Bear Markets and so on.

All that remains is the Productivity Miracle and an
apparently unshakeable faith in American capitalism. In the
minds of most economists and investors, a recovery is
always just ahead... and stocks are always going up. And the
bubbles continue.

Yesterday, the Dow hit a new high for the year. Economists
raised their estimates for GDP growth. And home prices hit
new records. We can almost hear the cheerful chorus of
lumpeninvestoriat: If this is the end of the world, let's
have more of it!

And yet, we grumps have no reason to complain, either. Our
gold is up 40% since April of 2001. And we've lost nothing
in stocks.

Will these sunny days of late summer ever end, dear reader?

If we just look at the day's weather, we might think
nothing else. Even looking at the trend for the last 6
months, we see nothing to contradict it. But we know from
experience that in the complete cycle of the seasons is bad
weather as well as good. Likewise, we know from history -
if not from personal experience - that no bubble lasts
forever... no paper money ever survives... and there is no
boom that is not followed by a bust.

We are not guessing about the end of the Dollar Standard
boom. It has lasted for more than 3 decades. But its end
will come, as sure as death, and bring the End-of-the-World
as we have known it. We are only guessing about when.
Today, it looks as though the Fed has done the trick; it
has succeeded in pumping up yet more bubbles... and keeping
the system alive. Another summer seems to be passing with
no End-of-the-World in sight.

But each year, it gets later in the Dollar Standard season.
Even the major media is beginning to see it:

"We Americans are buying vast amounts of foreign-made pots
and pans, cars, CD and DVD players, bicycles, clocks,
umbrellas, socks and shoes," writes Paul Samuelson in
Newsweek."In 1996, the United States imported $1.31 of
goods for every $1 it exported; now, the import figure is
approaching $2 (it's $1.79 so far in 2003)."

Samuelson goes on to estimate that the U.S. trade deficit
must continue to grow by $50 to $100 billion per year in
order to keep the world trade system in business. This, he
reckons, is unlikely... maybe impossible.

And so, the biggest bubble of all - the Dollar Bubble -
will blow up, too, eventually. We came early enough to get
a front-row seat. For the last 4 years, we have been
munching our popcorn waiting for the climactic scene.

That it will come, we have no doubt. That it will come
soon, we have plenty of doubts. In the meantime, we are
afraid even to get up to go to the bathroom - for fear we
might miss it.

And now, over to Eric...

-------------

Eric Fry in the Big Apple...

- The U.S. stock market is as indomitable as the American
Spirit itself. Sure, it suffers a setback now and again, or
even a major defeat from time to time. But it always
battles back, to the shame and chagrin of naysayers and
doomsdayers.

- Yesterday, our hero soared to fresh one-year highs, as
the Dow climbed 91 points to 9,412 and the Nasdaq surged
2.2% to 1,739. In the currency market, the dollar soared
one percent versus the euro to reach $1.11, a three-month
high for the resurgent greenback.

- Technology stocks led the charge on Wall Street
yesterday, thanks to cheery remarks from research firm
Gartner, predicting stronger information technology
spending in the second half of the year and beyond. The
University of Michigan joined the cavalcade of positive
prognostications by revealing that its annual economic
forecast anticipates"robust growth" in the second half of
2003 and throughout 2004. Specifically, the University
expects GDP to increase 4% in the second half of 2003 and
4.5% next year.

- Adding to the economic"high fives," Lowes and Home Depot
both posted better-than-expected earnings results, in the
process demonstrating that Americans still possess a
Nietzsche-esque Will to Spend. Mortgage refinancings and
job growth be damned! Americans will spend without the help
of these allies. The Home-Depot-shopping American consumers
will not be denied their Weber grills, Whirlpool air
conditioners and Henckels kitchen knives.

- For the moment, Greenspan emerges the heroic economist
once again. The bond market may be smoldering somewhere on
a sacrificial alter, but isn't that a small price to pay
for the salvation of American consumption?

-"It has now reached the point," says the Prudent Bear's
Doug Noland,"where we can recognize the Fed's latest
reliquification as having orchestrated one more fateful
Boom - The Post-Boom Boom... Note the following: record July
sales for Lexus (up 16% y-o-y), the third-best month on
record for Acura, BMW sales up 16% y-o-y, Mercedes up 26%,
Infinity up 38% and Porsche up 9%. Surging luxury auto
sales provide evidence that a large number of individuals
are enjoying Boom-time conditions. Furthermore... we are in
the midst of extraordinary home sales. Existing home sales
are set for new records over the next month or two, with
average prices already having surged to a new record
($224,900)."

- Yessiree, the Post-Boom Boom is well underway. And it is
almost as much fun as the original Boom... except for bond
investors.

- While in San Francisco last week, your New York editor
refrained from putting flowers in his hair (what's left of
it), but he did not hesitate to"share the love" with his
fellow bond bears."What a long, strange trip it's been,"
the bond bears said to one another, recalling the 22-year
bull market in bonds that - perhaps - has ended. But now
it's time for yields to get high... really high, the bond
bears believe.

-"The bull market was born in 1981 when the bond market
was in tatters," the Santa Cruz County Sentinel relates.
"Bond investors, who thought rates of 8 percent looked
attractive in 1978 were sitting on losses of 40 to 50
percent. Although inflation peaked at 13.5 percent in 1980
and had declined to 10.5 percent in 1981, the bond market
remained spooked by predictions of 20 percent interest
rates. Business Week magazine proclaimed the death of
bonds. As a result, the benchmark 30-year Treasury bond
issued in November 1981 sported a record high 14 percent
coupon. Investors brave enough to purchase bonds during
those dark days were handsomely rewarded. The 14 percent
treasuries of 2011 are still outstanding and trade at a 36
percent premium to face value. Before taking compound
returns into effect, this represents a return of 15.4
percent per year in cash and appreciation. This is a
cumulative total return of 1,336 percent."

- We cannot say for certain, of course, but we'd guess that
today's buyers of 30-year bonds - yielding all of 5.35% -
won't be relishing 1,300% returns 22 years from now.

-"Contrast the dark days of 1981 with the situation a few
short weeks ago," the Sentinel continues."Ten-year
Treasury bonds were yielding about 3 percent. Thirty-year
Treasuries were paying just higher than 4 percent... Signs
of a speculative peak were everywhere. Mutual fund
investors, who poured record amounts into stock funds
around the time of the 2000 peak, were shoveling record
amounts into bond funds. The leading mutual fund of the day
was the Pimco Total Return bond fund."

- Prediction: the Pimco Total Return bond fund will not be
the leading mutual fund in 2025.

-------------

Bill Bonner, back in Ouzilly...

*** Insiders are selling heavily, reports the Wall Street
Journal. In July, they sold more than $32 worth of stock
for every dollar's worth they bought. You should sell, too,
dear reader.

*** Half of all manufactured goods sold in the U.S. now
come from overseas.

*** Italy is in recession. Germany is in recession. So is
the Netherlands. The euro is down to $1.11. Buy it.

*** Gold lost $4.80 yesterday. It is below $360. We hope it
falls below $350 - so we can buy more.

*** Personal bankruptcies continue to soar, says an
Associated Press headline. Meanwhile, Chrysler is offering
72-month 0% financing if you want to buy their cars.

*** Record worldwide indebtedness... the trade deficit... the
Japanese bubble... the Asian Crisis... bubbles in mortgage
refinancing, bonds and real estate... in the U.S....the
rapid rise of China as a manufacturing center... all of
these things can be traced to a single event that occurred
in August of 1971. President Richard Nixon set in motion a
series of booms and busts... and the biggest of them is
still ahead...

These are just a few of the things we shall be speaking
about at the New Orleans Investment Conference this coming
November. If you would like to come and cheer us on,
details are below:

The 2003 New Orleans Investment Conference
http://www.oxfordclub.com/conferences/neworleans2003/home.cfm?id=2

*** More vile bodies: It has been a good few days for
obituaries. Several brought a smile to our face. First, the
adorable Diana Mitford Mosley expired in Paris... and now,
from Saudi Arabia comes news that another admirer of Adolf
Hitler has joined him in his morbid redoubt.

The Dark Continent must have twinkled a little on Sunday
when news came of the death of Idi Amin. The man was the
kind of the dictator the world could hate without feeling
unkind. He was mad, of course, in a buffoonish kind of way.
He chased Uganda's Asian residents out of the country, and
then distributed their property to his favorites. And then
the big, black fat man made white residents of Kampala
carry him around on a throne and kneel before him while
photographers captured the scene for the papers.

Unlike Diana Mosley, Amin's hands were caked in blood.
Murder, torture, rape, mutilation, theft - he did it all.
When Amin told his henchmen to"give him the VIP
treatment," it meant that they were supposed to kill the
person."Giving tea," meant the subject was to be whipped
and dismembered.

If there were swifter justice in this life, Amin would have
been given the VIP treatment long ago. But we are optimists
here at the Daily Reckoning. Perhaps now, the big man will
be 'given tea' every day... and roast forever in some
especially hot corner of Hell.

At least, we hope so.

----------------------

The Daily Reckoning PRESENTS: What's a stock investor to do
during the"greatest bear market in a generation"? Do as
Buffett would do, writes Extreme Value's Dan Ferris... and
keep an eye on the"equity risk premium".


THE SALAD OIL SWINDLE
By Dan Ferris

The Salad Oil King finally got caught in November of 1963,
and was led from his two-story red brick home in the Bronx
to face criminal charges in Newark.

Never heard of the Salad Oil King? I don't doubt it.

Still, the fall-out from this relatively obscure episode in
U.S. financial history leads directly to one of the
greatest investing fortunes the world has ever seen. And
the lessons you can pull from it are essential to posting
returns when the most difficult bear market in a generation
resumes.

Here's what happened. Anthony DeAngelis, a former New
Jersey meatpacker, ran a company called Allied Crude
Vegetable Oil Refining. Allied regularly delivered
shipments of vegetable oil to large vats in a warehouse in
Bayonne, New Jersey. For each shipment, warehouse receipts
were issued, indicating the amount of oil that had been
stored.

By November 1963, DeAngelis was holding warehouse receipts
legally verifying the existence of $60 million worth of
salad oil. Allied used the warehouse receipts as collateral
for $175 million in loans. DeAngelis used the loans to
speculate on vegetable oil futures in the commodities
market.

In 1962, when vegetable oil prices plunged, DeAngelis
didn't get at all what he expected. Rather, he got what he
deserved: he lost the money he'd borrowed, and Allied went
bankrupt. His loans reverted to the company that issued the
receipts - American Express - which now found itself the
proud owner of a warehouse full of vegetable oil.

American Express quickly discovered that the oil tanks
contained mostly seawater. It was later found that
DeAngelis had his henchmen follow an auditing team through
the confusing, labyrinthine rows of oil tanks. His men
changed the numbers on the tanks that did contain oil, so
the auditors would count the same oil twice. In other
tanks, DeAngelis put enough oil to float on top of the
seawater. Anyone looking in from the top would be fooled.

In the wake of the scandal, American Express's stock fell
45%, from $60 a share down to $35 a share by early 1964.

At that time, Warren Buffett was running a small investment
partnership he'd started 8 years before with $105,000 he'd
raised from friends and family. As Buffet's mentor, the
original value investor, Benjamin Graham, was watching with
great interest as the Salad Oil Swindle unfolded. Buffett
researched the situation, bought shares, and even testified
on behalf of American Express management, which had
remained honest and forthright throughout the ordeal.

Buffett put 40% of his available capital into American
Express, buying 5% of its stock. Two years later, he was
sitting on a $20 million profit.

Buffett made similar coups buying GEICO, the insurance
company, which had run itself to the brink of insolvency by
insuring any and all drivers. Today, he owns the entire
company. Shortly after October 19, 1987, the single worst
day in stock market history, Buffett bought Coca-Cola. In
the late 1990s, when people talked as though California
real estate was going permanently out of style, Buffett
bought shares in Wells Fargo bank. He also bought American
Express shares again, and still holds all four of these
stocks today.

Buffett has bought businesses on the brink of bankruptcy,
including Berkshire Hathaway, Inc., the beleaguered textile
maker that became the holding company he runs today. He
bought bankrupt Fruit of the Loom in 2001 for $835 million.
By running his company as though it were a value-oriented
mutual fund, and investing in valuable businesses and
assets when no one else wanted to buy them, Warren Buffett
has turned every $10,000 invested in 1965 into $14 million
today.

Unfortunately, it's too late in Buffett's career for us to
expect to ride along with him and make a fortune. Buffett
himself admits that his company is currently overpriced!

But Buffett's strategy - buying beleagured-yet-
fundamentally sound companies at depressed prices - still
holds inveterate lessons for the investor with a would-be
growing net worth.

In a study of price to book value ratios from 1963-1990,
researchers Eugene Fama and Ken French found that the
cheapest 10% of the market garnered the highest return with
the least amount of risk. The safest, cheapest and most
profitable stocks, they found, are one and the same. And
among these, those stocks with a sound business behind them
- the ones Buffett sought after - are the stocks to
concentrate on.

This is all well and good... but what about the economic
environment surrounding stocks? For example, during the
greatest bear market in a generation? How much of a stock's
price reflects the machinations of the company that owns
it... and how is due to the greater market forces that be?
Therein lies the rub.

The academic-turned-$5-billion-hedge-fund-manager Cliff
Asness expressed doubts about current future returns for
most stocks. Both French and Asness watch a number called
the"equity risk premium."

Says French,"If anything exercises a gravitational pull on
stocks, it's the risk premium."

The risk premium is the extra return investors require to
justify an investment in stocks, leaving behind the
(perceived) safety of bonds. The equity risk premium is
roughly equal to the expected total return on stocks minus
the yield on bonds.

Asness calculates about 6.5% expected growth in the S&P
500. Using my own method of simply adding the S&P 500's
earnings yield (4.3%) to its current dividend yield (2.2%),
I get the same number, 6.5%. Technically, that's what you
can expect to make from most stocks over the next several
years.

Subtracting the 10-year Treasury bond yield of 4.3% from
the expected return on the S&P 500, we get: 6.5% - 4.3% =
2.2%. That's the risk premium right now, 2.2%. You can
expect to collect 2.2% more on your stock portfolio than
you would on 10-year Treasury bonds bought today and held.

The risk premium was zero just before the 1929 crash,
meaning there was zero benefit for risking money in
stocks... possibly the greatest understatement of that
entire century.

By contrast, in 1972, the risk premium was 3%. From 1970-
1979, stocks hardly budged, while the dollar lost 28% of
its purchasing power. The risk premium was negative in
early 2000... and we know what followed after.

Following the meticulously researched common sense of
Mssrs. Fama, French and Asness, an intelligent investor
finds him/herself on the horns of a dilemma. The bond
bubble is finally bursting. Stocks are either on their way
to the formation of another bubble, or they're about to
fall.

But the dismal outlook for stocks is not necessarily a time
to despair. Rather, it's an ideal time to be an investor in
search of stocks trading at extreme lows in price. Stocks
are easier to ignore when they're so expensive.

If you follow Buffet's lead and investigate the cheapest
stocks in the market, you can reasonably expect to earn the
safest and highest returns. The superior returns available
from buying cheap stocks exist whether the broad indexes
are overvalued or not.


Regards,

Dan Ferris
For the Daily Reckoning


Editor's Note: Dan Ferris is the Editor of Extreme Value,
an investment advisory service that uncovers the safest,
cheapest stocks in the market. Dan has recently published
an 80-page analysis on his latest discovery - a way to own
some of the most valuable real estate in the world, at a
99% discount, through a handful of companies listed on the
NYSE.