What We’re Reading (Week Ending 11 February 2024) - 11 Feb 2024
Reading helps us learn about the world and it is a really important aspect of investing. The late Charlie Munger even went so far as to say that “I don’t think you can get to be a really good investor over a broad range without doing a massive amount of reading.” We (the co-founders of Compounder Fund) read widely across a range of topics, including investing, business, technology, and the world in general. We want to regularly share the best articles we’ve come across recently. Here they are (for the week ending 11 February 2024):
1. Sal Mercogliano on What’s Happening in the Suez Canal Right Now – Tracy Alloway, Joe Weisenthal, and Sal Mercogliano
Joe: (02:45)
Let’s just start really big picture with how extraordinary and unusual is the scale of this disruption happening right now?
Sal: (02:55)
You’re looking at about 11% of the world’s trade goes through this vital maritime choke point, the Bab-el-Mandeb. This is the Gate of Tears, this is the very southern end of the Red Sea. This is the connection between Europe and Asia, but it’s much more than that. You’re looking at trade that goes not just between those two areas, but actually kind of like a hub and spoke system kind of radiates out around the planet.
And this attack by the Houthis, which started off very small scale, you saw a helicopter assault onto a ship. The Galaxy Leader back on November 19th has now escalated. And what we’ve seen is not just container ships that have started to divert around, but now liquified natural gas carriers, liquified petroleum gas carriers, tankers, and even bulk vessels are now moving around.
And as you mentioned, this adds 3,500 miles. But the biggest thing is it creates massive delays and disruptions. And for the Houthis, which are a small player, you know, one part in a three-way civil war in Yemen, they have created more disruption of global trade than you — you almost have to go back to the world wars to find something similar to this.
Tracy: (04:06)
So Sal, you mentioned that the Houthis have sort of expanded their repertoire of attacks, I suppose to now include LNG and bulk vessels and things like that. What is their strategy here and how has it evolved over time? Because we have seen an escalation since November, but there were sort of isolated attacks happening [even] before then. So what is changing here?
Sal: (04:30)
Yeah, so initially they were focusing on ships connected to Israel. I mean, the root of this issue is the Houthis’ kind of solidarity with the Palestinians and Hamas in the Gaza Strip. And then again, it goes all the way back to the Israel-Hamas issue.
But we’ve seen the Houthis attack ships prior to this. Go back to 2016, 2017, we saw attacks on UAE vessels. We saw an attack on a Saudi frigate. We even saw an attack on a US Navy destroyer. But this effort recently is focusing on Israeli-owned Israeli flagships.
So we saw ships of ZIM and other Israeli companies immediately divert, but then the Houthis expanded. They started targeting vessels, they said [were] connected to Israel, either through their ownership, so for example, Mediterranean Shipping Company, what [is] the largest container liner in the world. They started targeting their ships because the owner’s wife, of Mediterranean Shipping Compan,y has dual citizenship — Switzerland and Israel.
And then we saw attacks that really had no connection at all to Israel, but they would try to make those attacks. And what these attacks are doing aren’t really so much damaging vessels. We’ve seen ships hit and we had a very dramatic one just the other day with a ship called the Marlin Luanda, which caught fire.
But what they’re doing is raising the cost to sail through this area by escalating war risk insurance. And we saw a very similar thing happen in the Red Sea between Russia and Ukraine. But by escalating war risk insurance, the added insurance you need to sail through an area, you make very expensive ships such as container ships, which have a value of between a quarter to a half a billion dollars, cost-prohibitive to sail through. We saw the war risk, for example, jump from 0.02% the value of the ship up to 1%. And when you start doing the math on value of vessels, the very expensive vessels find it more costing economical to sail around Africa.
Joe: (06:27)
Wait, wait. This is interesting. How is war risk insurance assessed? And when you say, like, 1%, is that per trip? How do those… talk to us a little bit more about these deals and the math there.
Sal: (06:44)
Sure. So shipping insurance is done by a group of companies called clubs. And they get together and literally there’s a committee in London that puts together areas of war risk. They identify the areas that there are confrontations and basically whether or not you need this added insurance, kind of like flood insurance for your house. If you don’t have it and your house is damaged by a flood, your normal insurance wouldn’t cover it.
So they identify the area in and around the Red Sea as a potential war risk, initially down to that 0.02%. But as the Houthis attacked and then increased their level attacks, they have ratcheted up that war risk. We’re seeing right now, for example, up in the Black Sea, that war risk is right around 1.25%. That’s come down from about 3%. And so this committee will assess that. And if you want to sail through these regions and they specify latitude and longitude and the distance, you pay it for that one time voyage.
So let’s assume you have a ship of a hundred million dollars, both the value of the ship and the cargo, then you have to pay a million dollars to go through there. And now, you start weighing that against, well, it’s about a half a million to go through the Suez, but it’s going to cost me over a million dollars in extra fuel to go around. What’s the cost-benefit here for doing it?
And what we saw is on the higher end ships, the container ships, the LNG and LPG carriers, then they were weighing as like ‘Okay, it’s much more economical and safer for me to go around Africa than to take this risk.’…
…Tracy: (19:13)
So we have seen [spot] shipping rates go up recently, but my impression is that a lot of the shipping rates are, you know, the shipping rate is sort of pre-agreed, contractually agreed some time ago. And yet we have seen this increase in costs. You described how the wartime insurance rate goes up, it seems [it does so] fairly quickly. You have captains that are presumably wanting additional compensation for taking on this risk. How quickly and how much could shipping rates actually rise from here?
Sal: (19:46)
So, you know what we saw during the height of the supply chain crisis, you see all those charts, that was the spot [rate], right? That’s the rate you pay if you don’t have a long-term commitment in place. Most shipping, most containers, for example, are on long-term charters. And so those, you know, about 70% of the cargo that’s moved is on long-term.
But ironically, the route between Europe and Asia was up for renegotiation as of January 1st. So right when this was taking place, we saw that happen. But even if you have a long-term shipping route agreement, there are charges that can be imposed on top of that surcharges for extra fuel for port stays.
And so a lot of companies that were shipping goods all of a sudden started getting notices like ‘Well, my container’s going to be a thousand dollars more than I thought it was going to be.’ Well, that’s because the company sat there and said ‘Well, I had to stop in South Africa and buy really expensive fuel. Plus we’re not going to the port initially, we were going to drop your container off in, so we’ve got to drop it off in a sub port and it’s got to be moved over there.’
And so we saw the prices begin to escalate because the shipping companies tend to pass that cost on. And what you’re seeing now is even the long-term rates are seeing readjustments because of that. Plus the shipping companies have to readjust their schedules. You know, if you had a container ship that was going through the Suez and stopping in the Med, that’s not happening now. And now you’re seeing ships stop at other terminals dumping their containers and reshuffling them. So the ports at the entrance to the Med, Tangier and Angier and Algeciras, are getting a lot of business because you have to reshuffle containers.
And so now the, the freight rates are changing. If you look at the freight rate charts right now, they kind of peaked and they’ve kind of dipped down and now they’re starting to stabilize at this point. But we’re also seeing impacts in other ways.
So for example, the US freight rates get negotiated by May 1st, but we’re seeing freight rates increase to the United States. Why? Because a couple of factors, if you are shipping containers from Asia to Europe, I mean to Asia, to North America, for example, well you may be shipping it, you know, I don’t want to go to LA and Long Beach anymore because of the issues with LA and Long Beach that happened a couple of years ago. So I’m going to put my containers on these new Neopanamax ships.
They go through the big lane of the Panama Canal that opened in 2016. But, [it’s not] like we don’t have enough choke point issues. Panama Canal’s at low water levels. We’ve seen a two thirds reduction in the number of ships going through there. So now you’ve got this fully loaded Panama, Neopanamax ship, it arrives on the Pacific side of the Panama Canal and they can’t get through because it draws too much water.
Now I’ve got to take 3,000 boxes off rail them across Panama and meet them on the other side. That’s a cost I didn’t plan on. That ship comes to the United States offloads. But instead of going back the way it came, because it doesn’t want to take a passage through the Panama Canal, it’s now going to head back to Asia through the Mediterranean and the Suez Canal. But wait a minute, the Houthis are there. Now I’ve got to head around Africa. And so what you’re seeing is a lot of surcharges and extra charges and most importantly, delays in the movement of goods that were not planned on…
…Tracy: (37:33)
How long until the slowdown, and I guess the additional complexity that you’ve been talking about, how long until that makes its way to US supply chains? Because so far, you know, most people are talking about this as a Europe or Asia specific problem, but as you point out, it just takes some time to reverberate.
Sal: (37:53)
Well, I mean, you’re seeing that right now in Europe. You’ve had a very kind of high visibility [companies], some manufacturers, Tesla and a few others, had to shut down production because they’re waiting to get parts to them. And you’re seeing the impact of that also in the fact that ‘Well, we’ll just throw them on airplanes and send them over.’ Well, 30%-33% of the world’s aviation fuel goes through the Suez Canal and now it’s being diverted. And so now even aviation has issues associated with it.
It tends to be weeks. And we’re going to see it as right after the beginning of February, because what has happened here is a lot of empty containers — which is the most unsexy topic you can talk about is empty containers — empty containers have not been re-positioned back to Asia in time to be reloaded and put on ships to leave Asia before the Chinese New Year, before the second week in February.
Which means that goods that should have been sailing across this week and next week aren’t going to be there. Which means now you’re going to see them about a month later. So we’re going to see some delays. And again, we’re not going to see shortages, we’re not going to have the great toilet paper run that we had during 2020. But what you will see is a little bit of a spike in inflation in terms of transportation costs. A lot of disruptions.
One of the things that we did learn from 2020 and a lot of freight forwarders and smart people who went with companies that do this professionally did, was diversify how their goods come in. So there was a lot of companies who saw what was happening with the Houthis and sat there and said ‘Hang on, let me get my goods on a container ship and I’ll go into LA and Long Beach right now, because even though I hate it, I’ll go in there because I know they’re going to arrive. And I can get them in there and I’ll pay that rail because rail is looking for cargo right now.’
So a lot of people began to make movements, but some didn’t. And the ones who didn’t see this coming ahead of time, they’re the ones who are going to see it. We’re already seeing backlogs of ships, for example, start to pile up off of Savannah and some of the East Coast ports.
2. The risks to global finance from private equity’s insurance binge – The Economist
Adecade or so ago private equity was a niche corner of finance; today it is a vast enterprise in its own right. Having grabbed business and prestige from banks, private-equity firms manage $12trn of assets globally, are worth more than $500bn on America’s stockmarket and have their pick of Wall Street’s top talent…
… Core private-equity activity is now just one part of the industry’s terrain, which includes infrastructure, property and loans made directly to companies, all under the broad label of “private assets”. Here the empire-building continues. Most recently, as we report this week, the industry is swallowing up life insurers.
All of the three kings of private equity—Apollo, Blackstone and kkr—have bought insurers or taken minority stakes in them in exchange for managing their assets. Smaller firms are following suit. The insurers are not portfolio investments, destined to be sold for a profit. Instead they are prized for their vast balance-sheets, which are a new source of funding…
…Firms like Apollo can instead knowledgeably move their portfolios into the higher-yielding private investments in which they specialise…
…Yet the strategy brings risks—and not just to the firms. Pension promises matter to society. Implicitly or explicitly, the taxpayer backstops insurance to some degree, and regulators enforce minimum capital requirements so that insurers can withstand losses. Yet judging the safety-buffers of a firm stuffed with illiquid private assets is hard, because its losses are not apparent from movements in financial markets. And in a crisis insurance policyholders may sometimes flee as they seek to get out some of their money even if that entails a financial penalty. Last year an Italian insurer suffered just such a bank-run-like meltdown…
…As private assets become more important, that must change. Regulators should co-operate internationally to ensure that the safety-buffers are adequate. High standards of transparency and capital need to be enforced by suitably heavyweight bodies. The goal should not be to crush a new business model, but to make it safer.
3. Mark Zuckerberg’s new goal is creating artificial general intelligence – Alex Heath and Mark Zuckerberg
No one working on AI, including Zuckerberg, seems to have a clear definition for AGI or an idea of when it will arrive.
“I don’t have a one-sentence, pithy definition,” he tells me. “You can quibble about if general intelligence is akin to human level intelligence, or is it like human-plus, or is it some far-future super intelligence. But to me, the important part is actually the breadth of it, which is that intelligence has all these different capabilities where you have to be able to reason and have intuition.”
He sees its eventual arrival as being a gradual process, rather than a single moment. “I’m not actually that sure that some specific threshold will feel that profound.”
As Zuckerberg explains it, Meta’s new, broader focus on AGI was influenced by the release of Llama 2, its latest large language model, last year. The company didn’t think that the ability for it to generate code made sense for how people would use a LLM in Meta’s apps. But it’s still an important skill to develop for building smarter AI, so Meta built it anyway.
“One hypothesis was that coding isn’t that important because it’s not like a lot of people are going to ask coding questions in WhatsApp,” he says. “It turns out that coding is actually really important structurally for having the LLMs be able to understand the rigor and hierarchical structure of knowledge, and just generally have more of an intuitive sense of logic.”…
…The question of who gets to eventually control AGI is a hotly debated one, as the near implosion of OpenAI recently showed the world.
Zuckerberg wields total power at Meta thanks to his voting control over the company’s stock. That puts him in a uniquely powerful position that could be dangerously amplified if AGI is ever achieved. His answer is the playbook that Meta has followed so far for Llama, which can — at least for most use cases — be considered open source.
“I tend to think that one of the bigger challenges here will be that if you build something that’s really valuable, then it ends up getting very concentrated,” Zuckerberg says. “Whereas, if you make it more open, then that addresses a large class of issues that might come about from unequal access to opportunity and value. So that’s a big part of the whole open-source vision.”
Without naming names, he contrasts Meta’s approach to that of OpenAI’s, which began with the intention of open sourcing its models but has becoming increasingly less transparent. “There were all these companies that used to be open, used to publish all their work, and used to talk about how they were going to open source all their work. I think you see the dynamic of people just realizing, ‘Hey, this is going to be a really valuable thing, let’s not share it.’”
While Sam Altman and others espouse the safety benefits of a more closed approach to AI development, Zuckerberg sees a shrewd business play. Meanwhile, the models that have been deployed so far have yet to cause catastrophic damage, he argues.
“The biggest companies that started off with the biggest leads are also, in a lot of cases, the ones calling the most for saying you need to put in place all these guardrails on how everyone else builds AI,” he tells me. “I’m sure some of them are legitimately concerned about safety, but it’s a hell of a thing how much it lines up with the strategy.”
Zuckerberg has his own motivations, of course. The end result of his open vision for AI is still a concentration of power, just in a different shape. Meta already has more users than almost any company on Earth and a wildly profitable social media business. AI features can arguably make his platforms even stickier and more useful. And if Meta can effectively standardize the development of AI by releasing its models openly, its influence over the ecosystem will only grow.
There’s another wrinkle: If AGI is ever achieved at Meta, the call to open source it or not is ultimately Zuckerberg’s. He’s not ready to commit either way.
“For as long as it makes sense and is the safe and responsible thing to do, then I think we will generally want to lean towards open source,” he says. “Obviously, you don’t want to be locked into doing something because you said you would.”
4. Famed Short-Seller Jim Chanos says this is the CHEAPEST thing in the Stock Market (transcript here)- Dan Nathan, Guy Adami, and Jim Chanos
Jim Chanos: I think all things being equal, yeah. But I would actually deflect the question and say one of the things that by 1999 could have told you you were getting in the later innings of the tech bubble in the late 90s, was when you began to see a big drop off in the quality of the earnings of the big tech guys like Lucent and Cisco, whatever. And a number of these companies got into the business of not only doing barter transactions, but also having venture arms invest in companies who then bought their products.
Guy Adami: You’re seeing that around the edges now.
Jim Chanos: I was going to say you’re beginning to see people are beginning to report on – which I think is a good thing – the fact that some of these companies now have reasonably large venture operations under the corporate umbrella and are investing in companies that are turning around and buying their products. I would also point out too, a couple of small companies like Microsoft and Google, who are increasingly capital intensive because of their data centers, who are cutting their depreciable lives, which is a one time thing that will help earnings for a while. But the longer this goes, if we start to see more and more big-cap tech companies begin to use more and more fun and games to make their earnings estimates, then the parallel with ‘99, 2000 is going to be hard to miss…
…Guy Adami: If you’re fine, we’ll play another game, as I mentioned earlier. Over the weekend we heard from a couple United States senators, Lindsey Graham, John Cornyn, both said effectively – I’m paraphrasing – “bomb Tehran” or something of that effect. That was out there. I am shocked that the reaction of the market was as muted as it was. So my question is concerning geopolitical risk, which is seemingly as bad as it’s been, I want to say, in the last 30 or so years, yet no impact whatsoever on the broader market.
Jim Chanos: Middle east strife hasn’t made an impact on markets since ‘73, ‘74. So for people that are looking Middle East issues, most investors just go, “it’s a mess, we’re going to be there, kind of, there’s going to be terrorism.” It doesn’t factor in. I do think that something happening in the Pacific, would be a much bigger thing.
Guy Adami: What is that thing that happens in the Pacific? Our relationship with China is probably the worst it’s been in 50 years. You can debate it. I happen to believe that’s the case. Obviously the saber rattling in terms of Taiwan. When President Xi was in San Francisco in the beginning of December, it came out three weeks later that he said – and again I’m paraphrasing – “We will take Taiwan by whatever means necessary.” That came out in the press I think in mid-December. So that’s out there as well. I mean, nobody seems to be focused on it. Maybe again, they think it’s just rhetoric. What are your thoughts on that?
Jim Chanos: I think that the real risk, and we’ve been saying this for a while, is that he gets more aggressive in foreign adventures to distract people from what’s going on domestically in the economy. And the fact of the matter is they cannot get the domestic economy going, because of all the things that we’ve discussed down through the last 15 years and that the model is a bad model and it’s coming to the end of its useful life and they don’t want to address the realities of changing their economic model, which is based on investment in property. And so I don’t know what he does, but boy, the rhetoric is not good and he has made threats. And the curtain dropping there would be something, I think.
Guy Adami: So I brought this up and actually the people agree, disagree. I’m curious about your thoughts. A lot of people think that because of the weakness in China, it makes them less inclined to do something with Taiwan. My pushback would be it makes them more inclined, I think for the reasons you decided, sort of taking your eye off the ball as to what the problems are and then creating sort of a bit of a divergence for lack of a better word.
Jim Chanos: To Xi Jinping, the deal with the citizenry was, “Don’t get involved in politics, the Communist Party knows best, but we will give you prosperity.” In the last five to arguably 10 years, the prosperity engine has slowed down and sputtered, and now it’s becoming, “Support us nationally, in nationalism and patriotism and the greater China.” And that’s a change. That’s a big change. I think that the economy struggling makes the risks worse, not less.
Dan Nathan: Jim, you’ve been making a fairly bearish case about China…
Jim Chanos: Yeah, you might say so.
Dan Nathan: …for a decade. I’m looking at the Shanghai Composite. It’s really trading where it was a decade ago. And then if you think about US companies and all the excitement over this last decade about access to a Chinese consumer that is growing at a scale that we’ve never seen, but then if you look at really how the Chinese consumer has been exposed to risk assets, it’s been in the very thing that you’ve been warning about for a decade, and that is commercial real estate and residential real estate. So they’ve had much more exposure to real estate, both commercial and residential, than they have to the stock market.
Jim Chanos: Much greater.
Dan Nathan: Okay, so when you see a headline like we saw last week, that the Chinese are going to command the SOEs to repatriate maybe $300 billion and put it into the stock market, the stock market rallied, and then it sold back off. Wouldn’t they have much better use of putting that to kind of stem – we saw the China Evergrande story and stuff like that. Is this finally coming undone right now?
Jim Chanos: I don’t know that it’s coming undone. I think you’re just seeing the flaws in the model, which is the Chinese stock market, when we did our bear call on China, the FXI was $41. I think it’s $22, so it’s almost been cut in half since 2009. But if you actually look at the market cap of the Chinese stock market, it’s up now. So what’s the paradox? The paradox is they’re diluting the hell out of you. There’s so much agency risk in China, it’s not funny. And who’s the patsy? Western investors are the patsy. They’ve provided capital over and over again through the VIE structure, which we’ve talked about till we’re blue in the face, which is a complete fraud. And because China sold them on this growth and you want to be part of our growth and whatever, meanwhile, you’ve done nothing but basically provide capital for them to do other things. Having said all that, the problem, the property market dwarfs everything. After US treasuries, it’s the most important asset class in the world, Chinese property. It doesn’t get the attention it should. And that’s where China has its savings. That’s where the Chinese populace is counting on the price of their flat to provide for their retirement and their kids. And if that doesn’t happen and if that doesn’t pan out, then you’re going to have political issues.
5. A beginner’s guide to accounting fraud (and how to get away with it), Part V – Leo Perry
Back in 2017 I ran a job ad that read:
“In 2016 a police investigation of the collapse of a business closed with a public prosecutor recommending more than a dozen individuals be charged with fraud. One of those named as a suspect is the CEO of a UK PLC with a current market capitalisation of several hundred million. A formal indictment could be handed down any day. Name the company.”
The answer was internet of everything stock Telit Communications. In 2015 Avigdor Kelner, founder and former Chairman, had been sentenced to two years in jail for bribing politicians in Israel. He’d previously been arrested in 2007 in relation to alleged insider trading involving several investments made by Polar Investments, including Telit, although no charges were brought.
But that wasn’t the cat I had in mind in the ad, it was then current CEO Oozi Cats. And the 2016 investigation wasn’t his biggest problem. Italian newspaper Il Fatto Quotidiano reported later in 2017 that he was a fugitive from US justice, having done a runner from the country after being indicted for wire fraud in the 1990s!
Oozi and his wife had allegedly been charged for their part in a land flipping scam. Co-conspirators Wayne Weisler and Susan Taylor pled guilty to operating a scheme designed to defraud mortgage companies by inflating the apparent value of a property through a series of related party transactions, and then borrowing against this artificially high value. The scheme used a Massachusetts entity named Dolphinvest. The company’s Articles of Organization show it was incorporated by Weisler, Taylor and one Uzi Katz.
Now I’m guessing Oozi (or is it Uzi again now?) would probably say he was wrongly charged. That may be so. I’m not casting any aspersions here. I don’t know and I don’t care. What matters for us is that this particular story from his past wasn’t easy to find, even though there were details available online. Partly that was because he had changed how he spelt the anglicized version of his name (from Uzi to Oozi, which was obviously odd to an Israeli friend). But mostly because searching for Uzi Katz on Google brought up dozens of websites about people in Boston. There were sites with titles like “Professor of English Literature from Boston – Uzi Katz”, “Uzi Katz, civil engineer from Boston” and just plain “Uzi Katz of Boston”. My own favourite was “Uzi Katz, Boston Dancer”.
The websites seemed like pretty obvious fakes. As in, they did not appear to be about real people. I mean the blogspot for one linked to a Google+ profile with a photo – which Google Images showed was a picture of Ravi Ramamoorthi, Professor of Computer Science at the University of California.
Maybe, just maybe, these websites were designed to create a smokescreen. The fact that the registered contact for one had the email address reputation@seo-properties.com (seo being short for search engine optimisation) didn’t exactly dispel this impression. Or perhaps it was all just a coincidence and there really are a lot Uzis in Boston. Whatever way it happened, the result was the same. Stories about the Uzi Katz in Boston that got charged with wire fraud were buried way down the search rankings, behind all the dancing professors.
Disclaimer: None of the information or analysis presented is intended to form the basis for any offer or recommendation. We currently have a vested interest in Alphabet (parent of Google), Meta Platforms, and Microsoft. Holdings are subject to change at any time.
