-->The Buffett Of Bombay

The Daily Reckoning

London, England

Tuesday, 22 June 2004

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*** Qui solvo? Deflation or inflation? Yes!

*** Oil, gold, bonds... the three troublemakers...

*** Mini-Manhattan... Norway... Sweden... Geneva and more!

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Qui solvo?

Thus, at last night's MoneyWeek Roundtable, were the great
issues facing investors and economists in the year 2004
reduced to a single two-word question. Who pays? We put it
into bad Latin to make it seem even more important.
Timeless, even.

One way or another, all debts are settled... reckoned
with... either the debtor pays, or the creditor does. Today,
Americans owe more money to more people than any race ever
did. Mr. Greenspan made credit exceptionally cheap and
easy. This EZ money caused a boom in stocks... then a bubble
in stocks. When the bubble began to lose air, the Fed
chairman pumped even harder... causing new bubbles in
mortgage debt, and housing. So impressed were homeowners
with the 'pseudo-wealth' they had gained in their inflated
houses, they rushed to spend the money - causing yet more
bubbles in imports (record breaking trade deficits)... and
Chinese capital spending (trying to keep up with orders
from Wal-Mart.)

The debts have grown so big that the borrowers will not be
able to pay them back."Orderly deleveraging is now
impossible," writes Kurt Richebächer. Most homebuyers, for
example, have no intention of ever paying off their
mortgages. Nor does the Federal government ever intend to
pay off its debt.

Of course, as long as nothing happens, debtors will be able
to continue servicing their loans forever. Nothing is fine
for the lumpen. But the smart money knows that nothing
won't happen forever. Even failing to borrow more would be
something. Today's consumer spending requires more and more
borrowing. And yet, the more they borrow, the harder it is
for the debtors to keep up with the interest payments.

How, then, will all this debt be settled? Will it be
inflated away? Or deflated by defaults and bankruptcies?

"The whole inflation/deflation discussion," began James
Ferguson,"asks the wrong question. Will we have inflation
or deflation? The answer is yes. We will have both of them.
Because the real balance in an economic system is not
between rising prices and falling ones... it's between
stable prices and unstable ones. When an economic system is
healthy, prices move up and down... but in a state of
balance. When the system becomes unbalanced - which is
especially the case in America now - prices can runaway in
either direction and usually both.

"What you might expect is an interest rate shock - which is
what it looks like we're getting in Britain... rising rates
that pop the real estate bubble. Then, consumers stop
borrowing against the rising value of their property. They
stop spending so much. And all of a sudden, you have not an
inflationary environment, but a Japan-like deflationary
one."

Look out for"savage deflation for the asset markets,"
writes Kurt Richebacher,"but stagflation for the economy.
It is so obvious that no one can see it."

In a stable, healthy economy debtors pay their debts. In an
unstable one, it is the creditor who bears the loss. Either
the debtor pays him back in inflated currency... or he goes
bust and can't pay.

Be not a long-term lender at today's rates, dear reader; it
is likely to be a losing proposition.

But what about Treasuries? There, you have no risk of
default or bankruptcy. The U.S. government will pay you
back. Deflation would make them more valuable, not less.

Your only risk is that the money you get back won't be
worth as much as the money you lent.

"That is still a very large risk," said fund manager Arild
Eide of RAB Capital."The U.S. can not allow millions of
consumers and homeowners to go broke. It is not politically
possible in a social democracy. Besides, [Fed governor Ben]
Bernanke has already outlined for us the steps they will
take to make sure inflation eases Americans' debt load."

Okay, let's get this straight. What to expect, we mean.
Rising inflation brings rising interest rates that pop the
debt bubbles. Then, the economy slumps... with falling
prices for almost everything, especially financial assets.
But the authorities can't stomach the sight of millions of
voters trapped by their own recklessness... so they take
action. What do they do?

"Whatever they need to do," came the answer from the
Roundtable.

We do not doubt the logic. Or the will. What we doubt is
the ability. But we will see. We will see.

Here's Eric with the latest from Wall Street...

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Eric Fry, from the City that never sleeps...

- Fortune smiled on very few investors yesterday, as the
price of almost everything fell - stocks, crude oil and
gold all declined. Only bonds managed to eke out a small
gain, which was small solace to long-suffering bond
investors.

- Crude oil for July delivery fell $1.12 yesterday to
$37.63 a barrel, as Iraq resumed partial exports through
one of the two pipelines shut down after last week's
terrorist attack. The gold price followed oil lower,
slipping $1.20 to $393.65 an ounce. Long-term interest
rates also retreated a bit, as the yield on 10-year
Treasury notes fell to 4.68% from 4.71% Friday.

- But despite this trio of good news for stocks, the Dow
Jones Industrial Average failed to advance. Repeated rally
attempts fell short throughout the day, as the Dow fell 45
points to 10,371 and the Nasdaq slipped 12 to 1,974. Many
investors continue to declare their faith in"stocks for
the long haul," but few are rushing to buy. On the other
hand, the bears don't seem particularly eager to sell... and
so, we dispassionate observers in the media, wait for
something - anything - to happen to shake the market from
its torpor.

- According to the finest minds on Wall Street, crude oil,
gold and interest rates are trespassing - wandering into
locales where they do not belong. Crude oil has no right to
tip-toe past $40 a barrel, say the experts, and gold has no
business whatsoever loitering around $400 an ounce... And
the audacity of interest rates!... to encroach so far into
forbidden territory that the 10-year Treasury note yields
nearly 5%.

- But soon, the experts assure us, the rightful order will
be restored and these three troublemakers will be booted
back to where they came from. Indeed, say the experts, were
it not for the incessant meddling of real-world events,
crude oil would sell for $20 a barrel already, gold would
be lucky to trade for $300 an ounce and the 10-year
Treasury would yield less than 4%.

- Maybe it's true. Maybe oil, gold and interest rates are
trespassing, and maybe their simultaneous ascents are a
complete fluke. On the other hand, maybe the experts are
mistaken. Perhaps crude oil, gold and interest rates are
pursuing a kind of Manifest Destiny, preordained by the
easy-money policies of Alan Greenspan and by the
spendthrift ways of America, both public and private.

- Maybe the stock market is the financial
trespasser... After all, a stock market selling for more
than 30 times earnings would seem to have lost its way,
especially when the prices of crude oil and gold are rising
in harmony with rising interest rates.

- A Google search for the words"terrorism" and"oil"
produces a whopping 2,920,000 results. Refining the search
to"Islamic terrorism" and"oil" still yields 749,000
results. Who doubts that these words will remain linked for
many years to come? When might the sort of normalcy and
tranquility return to the Middle East that produces $25
oil? Never, is one possibility.

- We would not be surprised if the next catalyst for
dramatic action in the stock market comes from the oil
market. We don't know where the price of crude oil is
heading, of course, but we expect the crude oil market to
display more pyrotechnics than Manhattan on the Fourth of
July... or Paris on the 14th.

- Two weeks ago, the Washington Post reported,"Saudi
officials scornfully dismiss the suggestion that terrorism
could block the flow of oil. It's one thing to blow up a
housing compound... but quite another to obliterate a
facility that pumps, transports or loads oil. The latter,
they insist, is virtually impossible. Wrapped in layers of
fencing, barbed wire and hydraulic barriers, watched with
cameras and night-vision goggles, Aramco's oil facilities
are monitored by more than 5,000 guards."

- A few days later, terrorists knocked out two Iraqi
pipelines that"pump, transport [and] load oil." It's true
that Iraq is not Saudi Arabia, but oil is oil. If terrorism
can interfere with supplies anywhere on the globe, and do
so regularly, the oil market will become as volatile and
unpredictable as an ex-wife.

- Curiously, despite the explosive conditions in the oil
market, investors value semiconductor stocks nearly three
times higher than oil stocks. The semis seem to be
levitating on the legacy of rapid earnings growth, while
oil shares seem to be laboring under the opposite legacy.
But times have changed, and therefore, the valuation
disparity between semiconductor shares and oil shares might
be seen as a curious and incongruous juxtaposition.

-"With oil prices just a smidge below $40 a barrel,"
Barron's notes,"and one ugly international incident away
from a new record, you'd think these would be good times to
be invested in the big oil companies. But in truth, the
benefit to the stocks from higher crude prices has been
modest. For the year to date, Exxon Mobile shares have
gained about 6%. BP is up 8%; Chevron Texaco, 5%. Not
terrible performances, but hardly windfalls given the spike
in oil prices. The result is that the big oil shares trade
significantly below the multiple on the S&P 500 - 11 times
projected 2004 earnings for Chevron Texaco, 14 times for
BP, 15 times for Exxon Mobil."

- Barron's also notes that Saudi Arabia produces about 12%
of the world's oil."Any disruption in Saudi production
could make $40 oil look cheap," says Barron's."Put it all
together... and the future for the integrated oils looks
extremely bright."

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Bill Bonner, back in London...

*** Blond-haired, blue-eyed, Arild Eide is from Norway.

"It's a great place to go for a vacation," he said."But
living there... the whole population numbers less than the
city of London..."

"Maybe it's like Geneva," commented a Swiss friend."I can
spend a day or two there, but it's so boring... if I stay
longer than that, I feel like going into the woods and
hanging myself."

***"It was lovely..." Merryn Somerset Webb described last
weekend's trip to Scandinavia."We sailed around the
islands off the coast of Sweden. There are beautiful houses
all along the coast... nestled in the trees on the islands.
The food was great. It was a great vacation."

Are they expensive, we wanted to know.

"When you're from London everything seems cheap," explained
James Ferguson."What we find very difficult to understand
is that our point of reference is so far out of the
ordinary that it is no help at all. I have friends who
bought places in France. They bought one for almost
nothing. And then someone gave them another little house
for nothing. It's hard to imagine that houses could be
worth less than nothing - I mean, the owner just wanted to
get rid of the hassle of owning the place - but they are."

Houses can't go too high - because people have to be able
to afford to live in them. And they can't go too low
either... because people want to live in them. But
sometimes, people stop wanting to live in them... and
property sinks to below zero in value. That has apparently
happened in some areas of France - where little towns have
been abandoned. And it happened in Baltimore. Whole blocks
were boarded up as the city's population fell over the last
40 years.

Will people drive away from America's suburbs one day? Will
house prices fall... maybe sinking to less than zero?

Yes, dear reader... they will.

*** Our man in Bombay is no more. James Boric has just
returned from India. From his sixth-floor vista in the Taj
Mahal Hotel, Boric had a perfect view of the most expensive
real estate in Mumbai.

"Mumbai property is surprisingly expensive," James recalls,
"With all the politicians, Bollywood film stars and cricket
legends in the area, a two-bedroom apartment can sell for
over a million dollars while, at the same time, overlooking
some of the poorest neighborhoods I have ever seen. Dubbed
mini-Manhattan, the Malabar Hill area of Mumbai rivals
London's property prices."

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The Daily Reckoning PRESENTS: There has been a great deal
of hype surrounding India recently - some good, some bad.
But as the saying goes,"Value without growth isn't value."
We sent our small-cap sleuth, James Boric, to Mumbai to get
the real story.


THE BUFFETT OF BOMBAY
by James Boric

Amid the squalor in Mumbai lies a golden gem. And for the
uninitiated small-cap investor stateside, it is - quite
possibly - a buried treasure. I have to say that meeting
Mr. Bharat Shah, CEO and Managing Partner at ASK Raymond
James, here in Bombay, was the highlight of my trip to
India. The"Buffett of Bombay," Mr. Shah makes his living
by scouring the market for true value stocks - companies
with both a margin of safety and a growing business model.
He has a history of being right. From the interior of Mr.
Shah's office, even a brain surgeon could tell that Mr.
Shah was a very successful investor.

Before he became the CEO of ASK Raymond James, Mr. Shah
managed $1.2 billion in assets. And at ASK R.J., he manages
nearly $50 million or - as they say here in India - Rs. 250
crore.

There is no doubt that this man knows what he is doing. And
he knows how to spot value in the market. With that in
mind, my first question was:

"Do you think the Indian market is overvalued, undervalued
or properly priced?"

He told me that, as a whole, he felt the Indian market was
slightly undervalued - not much, mind you. But with stocks
trading for around 11-times earnings, Indian businesses
certainly aren't expensive.

Mr. Shah isn't concerned with the price of a company. He
determines value by looking at how well a company manages
its capital, how well the managers run the business and how
the company is valued based on EBITDA and cash flow.

"Look at technology services, business services, pharma and
specialty manufacturing industries," says Shah,"These are
the areas that will continue to grow as the Indian economy
gets stronger. And as more and more government money is
spent on improving India's infrastructure, investors should
keep an eye on the telecom and construction sectors, as
well as the auto business."

The government is spending money like a drunken sailor -
roads, ports, railways and social infrastructure
(education, health care and drinking water)... you name it,
the government is involved. A one-rupee tax was recently
added onto every liter of gasoline sold at the pump - which
will be used to build new roads. India is remarkably
underdeveloped and every road built here will be a huge
help. Not only will it encourage more business (by
supplying construction jobs and allowing people to travel
further to find work), it will also help transport food to
the poorer regions of the country where food is currently
in short supply.

Despite a spate of privatization, the retail sector remains
one of the last government-run sectors in India. But look
for the new government to open up the sector to both
foreign and domestic competition in the next few years.
When it does, goods will get cheaper. More jobs will be
created (although mom and pop shops will likely suffer) and
consumer spending will skyrocket. Right now, India's
savings rate is north of 20% and there are over $150
billion sitting in domestic bank accounts.

With the opening of the retail sector, that money will be
tapped - sparking a chain reaction in the Indian economy.
But before the retail sector is opened up, something has to
be done about the enormous taxation the government levies
on retail goods. Open any newspaper, and you'll read about
the value-added-tax on goods. The idea is to lower taxes.
This, the thinking goes, should encourage Indian consumers
to be more like American consumers in their buying habits,
but with one huge difference - there doesn't appear to be a
credit bubble here in India because, at the moment, the
only lenders are the banks. Indians, themselves, are net
savers.

There's something in the air, here in Mumbai, and it's not
just the sweet smell of curry. Indians are optimistic.
"They know they sit on the cusp of becoming a developed
nation. They've simply come too far to slip backwards
again," said Mr. Shah.

This was great. But what the Buffett of Bombay said next
brought a smile to your faithful editor's face.

"If you really want to find value in India right now," Mr.
Shah told me,"you shouldn't look to the large blue chip
companies - those trading on the Sensex and Nifty (the
equivalent of the Dow and the S&P in the States). Rather,
the real gems are hiding in the mid and small-cap markets."

There are many smaller Indian companies with cash, growing
businesses and competent managers, which are flying under
the radar screen. These are the companies you should be
looking at.

Eureka! These are the same companies that I have dedicated
my career to.

Mr. Shah had confirmed the very reason I boarded the plane
for Mumbai in the first place... small-cap Indian stocks
provide investors with the best chance to get both value
and growth in this market. And then he made a point that
really resonated with me...

"Value without growth isn't value."

That seems so obvious in retrospect. But it is a lesson
lost on most investors in America. If a company isn't
growing its business, it isn't worth owning. It made me
think...

Had investors followed this kind of logic in the 90s, no
one would have lost a dime in the dot-com blowout.

What a trip.


Regards,

James Boric
for the Daily Reckoning