The Coteau 6/14

The Coteau The View from Bannerstone Capital

by Biff Robillard

Abu Dua, Double Irish and Sea Squirts 

“plus ça change, plus c’est le mame chose” –Jean-Baptiste Alphonse Karr


I don’t speak French and many of you know it. Allow me to destroy my inadvertent inference for the rest of you: “the more it changes, the more it’s the same thing”. I looked it up. Or as we say around here: “the more things change, the more they stay the same”. Wha-du-ya know: more conflict in the Middle East. Shocker. It’s like Medieval Europe except for the drones and Twitter. Disputes seem to be settled, or promulgated, depending on whose side you are on, with one solution: war. How clever.

ISIS is advancing daily, evidently, under the direction of their mysterious leader, nicknamed Abu Dua. ISIS is not to be confused with the ancient Egyptian deity, a benign figure known for nurturing. ISIS is a militarized Sunni political movement, too extreme for the likes of al Queda. Yikes. They march under a black flag. How reassuring. With the $450 million recently looted from the Iraqi central bank in Mosul, they might be angry and winning but at least they are rich, too. They seem to have had enough of the Shi’ites. Here we go again.

History is only truly entertaining in the history books. In real-time, it is closer to disturbing. I am reading Timothy Eagan’s The Big Burn, a surprisingly interesting perspective on the dawn of the U.S. Forest Service amidst Teddy Roosevelt’s battles with the Big Money and their Big Money congressmen of the early twentieth century. Reading history, since you know what eventually happens, is so reassuring. This book is no exception. There really is a whiff of omnipotence as we read history when you think about it. It must be how the gods live: you know how it turns out, so sit back and explore subtleties and nuance. Feel calm and smart. Smug. But in 1910, as today, the outcome for America’s wilderness was uncertain, the path forward dangerous and poorly marked, and the deep concerns of each side plausible.

As history unfolds before us, in real-time, only a fool feels smart. The vague sense of omnipotence is replaced with confusion and apprehension. I don’t feel omnipotent about the prospects for chaotically redrawing the national borders of Iraq or Syria or Ukraine. For investors, disrupted energy markets loom. Israel, Jordan and Turkey will all feel threatened. They have powerful allies. A newly empowered extremist state, carved from the heap of post-war Iraq, brimming with angry, newly enriched zealots, may one day make al Queda, Iran and Saddam’s Iraq look like mere motorcycle gangs. Once again the world confronts the inherent juxtaposition of political freedoms with political control. It makes our Founding Fathers look better every day. Count our blessings.

Any good news? The U.S. may find itself cooperating with Iran to meet the new ISIS challenges. Now that’s pretty weird, but with precedent. “The enemy of my enemy is my friend.” This could usher in a new era on the nettlesome Iranian nuke issues, for example. A flashpoint could disappear. Maybe a good old military alliance will rekindle some old ties. Iran and the United States have a complex history, but like Cuba, the people themselves have many commercial and cultural ties and a long fundamental friendship, despite the animosities on an official level. Maybe it can grow into the Cuban model, a big improvement from the Axis of Evil: Fidel Castro? Bad. Tony Oliva? Good. Jazz? Of course. Baseball? Sure. It sounds so implausible it just might happen. What can go right?

New technologies are making energy supplies abundant again without actually creating a single new hydrocarbon molecule (this is the entire anti-Malthusian history of energy so far, of course; pessimists are always disappointed eventually). As the Middle East global energy hegemony erodes, the West may be less likely to risk blood and treasure for joules. With fewer cops on the beat, I expect more regional unrest. But longer term, I think I see lower prices, more reliable supplies and fewer monarchies.

The Standard and Poor’s 500 is up over 6% year to date if you include dividends. The Dow Industrials are up about 2%. Gold is up on par with the S & P at 9%. Silver is up only about 2%. Twenty year U.S. Treasury zero coupon bonds are up in price something like 18% year to date–clearly the biggest “contrary bet” winner so far. Yellen’s End of QE has meant a bull move in bonds? Why, of course! It’s all science, as you can see. The MSCI Emerging Market Index is up more than 4%. The Russell 2000 is up almost 2%. Annualize most these and it looks like “so far so good”. It hasn’t felt all that good, though better lately. I attribute our current emotional state to the so-called “recency effect”. We remember the recent past the best.  After a great last year (we were happy), the first quarter of 2014 was kind of scary for the bulls (we were not happy). We humans remembered that last thing until the last thing that happened was good: the second quarter. Happier. Are you following this? Note to practitioners: third quarter is occasionally tricky. Not a forecast, just a reminder.

My astute colleague David Hust slid a certain Letter to the Editor in our Star Tribune under my nose this past week. The writer was disgusted by the venal pursuit of profit production rather than the noble pursuit of tax maximization. Do they teach economics anymore? I wonder. This leads me to the so-called Double Irish. Contrary to intuition, for those of you unfamiliar with this term, it is not a reference to a cocktail of any kind. Nor is it consecutive Mulligans on the golf course, my second guess. “Double Irish” is a variation on the Irish Inversion, which Medtronic Inc. just consummated with Irish corporation Covidien PLC. Medtronic left the USA and moved to Ireland thru an Irish acquisition. Irish tax rules now apply. Voila: an Irish Inversion. Should Covidien now move certain corporate functions to Bermuda, profits from activities performed in Ireland may be taxed as low as 2%, at least if you believe what you read in the Financial Times. A guy like me thinks capital creation, as in brand new profits available for society’s use, generally benefits mankind at least as much as capital confiscated by taxation for mostly transfer payments (various social insurance for example). Taxes are necessary, of course. Governments consume capital but produce very little, certainly none net of inputs. You can eat an acorn or plant an acorn. You can’t do both.

I mention the Irish Double because within this contrived tax gerrymandering lays perhaps a giant prospective economic policy opportunity: really big tax reform. I imagine a future world where politicians address today’s uneven, growth-smothering tax scheme. It may start as a populist crusade to collect more taxes, but I suspect it will eventually spawn an important compromise which will, indeed, increase treasury receipts around the world via faster economic growth, not mere confiscation. More growth can mean more tax receipts. I think the secular bull market that may be underway now, in part, is due to a collective (if subconscious) anticipation of such essential tax reform. A similar effect occurred in the early 1980’s as investors apparently began to grasp a peak in interest rates in 1981. By 1982 an inexplicable secular bull began. At its dawn, it’s source was an utter mystery. Prospective tax reform may even explain the reluctance of fixed income to sell off. What if the present value of future interest payments is higher than many realize because tax treatment of the payments eventually improves? Sound farfetched? Honestly, I think so, too. But recall my bother Joe’s genius: “successful investing is having others agree with you later.”

After all, it is a terrible idea to have a tax system which, independent of other economic factors, encumbers corporations with the costs of selecting and relocating to advantageous tax environments. Yet, this is evidently the case for U.S. corporations today. Complicated legacy tax codes, dripping with cronyism and high rates may or may not collect more taxes, but they do make people move. It is clearly disruptive to profits short term: moving costs money. Lots of money.  These business “combinations” must consume first consume shareholder capital: it goes to investment bankers, lawyers and tax advisors. Imagine if these costs were instead invested directly in R & D or actual new production. Forget complaining about uncollected taxes. Eat an acorn or plant an acorn. I say plant.

In 1934, total tax receipts for the U.S. Treasury were about 4.8% of GDP (obtained from U.S. Office of Management and Budget data). It hit about 10% for the first time in 1942 and exceeded 20% for the first time in 1944. It was after all, World War II. It has never exceeded 20% since, and it’s lowest reading since 1944 was 14.1% in 1950 (a recession by the way–another suggestion that growth can drive taxes…growth was negative for part of 1950 and sure enough taxes, even as a percent of GDP,  fell). Tax revenue is currently estimated to be about 19% of GDP. Eyeballing the data, the average since 1944 is clearly in the high teens, perhaps 17 to 18%. Welcome to Hauser’s Law. William Kurt Hauser, an American investment analyst. Hauser proposed in 1993, and I quote, “No matter what the tax rates have been, in postwar America tax revenues have remained at about 19.5% of GDP”.

This was an utterly original insight at the time. My sense is there are many ways to obtain 19.5%, so let’s create a new system which, yes, obtains 19.5%, but promotes the optimal creation of new wealth by the system. Maybe a second Irish Wave of corporate immigration back to the U.S. would result: U.S. Conversion rather than Irish Inversion? Who needs Potato Famines? Fix taxes. Somebody. Please.

Harley Davidson has announced they will unveil prototypes of their new electric motorcycles. Does anyone doubt we be mostly driving electric vehicles inside of ten years? Tesla Motors Inc. is a long position on our Thales strategy and I am delighted with it. Thales, which many of you utilize as investors with Bannerstone, is our no-holds-barred “best ideas” growth portfolio. Tesla seems to make little sense from a conventional valuation standpoint, true, but the Great Ones often don’t when they are in fact most attractive.  If TSLA ever does look like a buy to a staid growth stock investor, the kind of GARP investor who now loves say, Microsoft, we will sell them our TSLA shares. The interesting part will likely be over.

The Tesla Giga Factory (which Tesla says it will build at an unannounced future location) has me looking for what I call satellite opportunities. Recall satellites are objects trapped in captive orbit around a far more massive body. The gravity of the more massive host object is the boss, but a captive satellite can do lots of beneficial things for you none-the-less. It’s not a bad metaphor. What future satellites might eventually orbit Tesla Motors, captured by the host planet? Tesla cars and electric Harleys need powerful rechargeable batteries. Today, the chemistry of such batteries requires the metal lithium, atomic number three for you fellow science geeks, symbol Li. It sits atop sodium (Na) in the first column of the Periodic Table and that tells you something: it’s reactive. It’s a metal. It’s also kind of hard to get, especially in North America. China has most of it. Bolivia has a bunch. Both are far from California.

If future lithium demand indeed correlates with the demand for electric vehicles, maybe Western Lithium USA is a satellite of Tesla. Western Lithium is an obscure little company I recommend you don’t buy, but maybe someday. Canada-listed mining companies with a decimal point handle are just crazy to buy with any serious money, so Western Lithium USA Corp. is off limits in an even moderately risk averse portfolio. The symbol is WLC-T on the Toronto Stock Exchange; symbol WLDCF on the America’s NASDAQ. Will the Giga Factory go to Nevada? This stock’s future price action might hold a hint. Should a Tesla Giga Factory be located very very close to a major lithium deposit? We will all find out.

I am happy to report a recent new name we have added to our Thales strategy. GasLog (GLOG) notched a new all-time high this week. It operates a fleet of fourteen liquefied natural gas carriers: ships.  They have something like nine more on order. The natural gas theme, thanks to shale gas, may be an economic tsunami. Liquefied natgas (so-called “LNG”) isn’t far behind.

Thales also owns Cheniere Energy Inc. (LNG) again, speaking of liquefied natural gas. Cheniere is building the massive state-of-the-art LNG terminal at Sabine Pass, Louisiana. What a difference a day makes. Sabine Pass was originally to be an import terminal to bring gas from the Middle East to the USA.

Energy made abundant by new technology is remaking the geography of energy. I believe investors can benefit from thoughtful capital allocations in the New Energy Era theme, and Thales has found an unobvious gem: Kirby Corp. (KEX).

Kirby is close to my heart. I love boats and I love tugboats. Tugboats are the hunting dogs of the boat world and I find them charismatic. They live to work. They live to do.  Nature may abhor a vacuum but capital loves a monopoly. Kirby, among other businesses, owns and operates a fleet of tugs and barges on the Mississippi River. Let me put that another way. Kirby owns and operates THE fleet of tugs and barges on the Mighty Mississippi. They have been acquiring operators up and down the river for years and they now have pricing power for their services: they are the only show in town. This means profits.  More energy geography: a lot of crude goes down the river from the oil fields up north. The fuel barges are often pulled, pushed and cajoled by the stout barges of the Kirby line. I happened to cross the Missouri and Mississippi on a road trip earlier this month in southern Illinois and Missouri. Below both bridges, on either side, the numerous tugs I saw were all in motion. I practically got misty. Kirby also notched an all-time high this week.

America needs a much better national electric grid, producing and transporting our energy, including renewable energy, to power personal electronics, Teslas and Harleys. A major challenge is the storage of electricity generated in off-peak periods to be consumed later: we can’t do it yet. But sea squirts might help us.

If you follow the Mississippi far enough south, on a Kirby tug perhaps, you wind up in the warm, salty Gulf of Mexico. If you tie up on a dock, or proceed further southwest and tie off on a mangrove root, and you look into the water below the low-tide mark, you will likely see some sedentary rather non-descript creatures clinging structure below the waterline. They might be as large as your pinky but probably not. They can’t. They might be brightly colored but they might be pale and translucent. You might wonder if they can sting you. They look sort of slippery, and you instinctively avoid touching them. These could be sea squirts, common marine tunicates found in warm seas all over the world. You might describe them casually to a friend as a sponge or a soft coral. It turns out they may be yet another piece in the mosaic of New Energy Era energy geography. Maybe they are energy biogeography.

It turns out sea squirts naturally concentrate the metal vanadium (V) from seawater. They use it in their blood. Vanadium is also the mysterious constituent of Damascus steel swords, the bane of the Crusaders. For those of you playing at home, vanadium can be found at atomic number twenty three in the Periodic Table, about one fourth of the way across. The four other metals in this column are equally obscure, by the way. They’re all weird. Vanadium is so unusual it had to be discovered twice. As it turns out, V the secret sauce of the almost-infinitely rechargeable battery. I mean big rechargeable batteries. Batteries than can power neighborhoods, for example. Consider in California, there are now so many solar panels the power companies no longer buy surplus power…because they have nowhere to store it. That may change with better batteries and if it does, it is reasonable to expect the demand for vanadium to increase and the price to do the same thing. Maybe an interest in a vanadium-related enterprise will be one of those things others agree with later.  Perhaps you would like read about American Vanadium Corp. Caveat emptor and we don’t own any. I have always wanted to be a rancher, though. How do you check the herd on a sea squirt ranch? On a seahorse?


This publication does not constitute, in any way, investment advice. The views described may have changed by the time you read this, anyway. Use your head, for crying out loud. Craig Cox is our editor, but he didn’t edit this one. I did. Thank you, Craig. You got a day off. Bannerstone Capital Management, LLC is a registered investment advisor. We are on the web at