Paul Wilmott & The Need for Nerd Therapy/Valero/Bernanke Testimony/

1.  Valero:   Valero priced its stock offering of 40 million shares at $18 a share, with a option to include another 6 million.  I am monitoring the share price on a daily basis now, though I have no intention of buying at a price higher than $17 (item #6:  Evening Notes 6 2 2009/Dollar Index and International Bond ETFs/Microsoft and Windows 7 Release/PST-What Am I doing With 30 shares?/Valero) This is a link to a recent Bloomberg article on crack spreads, gasoline inventories and demand. Bloom  Recent quotes on the crack spread: Forbes Charts on recent refining margins and crack spreads: Hard 

Valero put on hold a 1.7 billion dollar hydrocracker project at its Port Arthur refinery, and a similar project at its Lake Charles refinery in Louisiana that would have cost 1.25 billion. Instead, it would buy a 45% share in a refinery in the Netherlands operated by Total from Dow Chemical that already includes a hydrocracker for 600 million. Houst

BMO Capital downgraded VLO to market underperform yesterday. A Deutsche Bank analyst cut his earnings target for 2009 to  94 cents versus $2.22 a share before VLO's warning for the 2nd quarter. 

Zachs had downgraded VLO to a sell on May 26th. Valero 

Oil inventories continue to build which is consistent with tepid demand for refined products. 

Part of the problem is the narrowing difference in the cost of sour and sweet crude. Valero has the capacity to refine the lower cost sour crude, and stands to benefit when there is a large difference in its prices of sweet and sour crude. The spread between West Texas Intermediate sweet crude and sour crude fell to less than $4 recently from around $21 in the year ago quarter according the Zachs and other sources. This appears to me the be the critical factor for Valero.  It is possibly related to the overall demand for refined products being down during the recession. As demand for gasoline picks up, I would generally expect the discount for sour crude to widen and this would improve Valero's refining margins particularly where the price of the refined product was also rising due to a revival of demand.  This is when Valero would shine, as the spread between its input cost and the price of the refined product expands. That is sum total of my limited understanding on this subject.   

Based on some estimates that I have seen recently, the current price is about 1/2 of projected 2010 book value. 

2.  Bernanke Tells Congress to Cut Entitlement Programs/Entitlements Estimated to Soar to 2 Trillion in 2009:  I thought that it was interesting to read two story lines in USA Today.  In the business section, there was a story about Bernanke telling Congress to pare spending on entitlement programs in an effort to control massive budget deficits that threaten fiscal stability. USATODAY.com Then, on the front page, there was a story about entitlement spending soaring to an estimated 2 trillion dollars in 2009 or about $17,000 for each household. USATODAY.com Maybe I have missed something, but those who receive entitlement benefits also vote. 

3.  The World's Nerd-In-Chief, Paul Wilmott, Can Not Value the CDOs Created by the Masters of Disaster: For those interested in how nerds with models facilitated the near brush with another Great Depression, the article in Newsweek about Paul Wilmott is worth a read. Newsweek.com

On page 3, a brief history of Collateralized Debt Obligations, one of the primary sources of our woes, is made focusing on the activity of one quaint David X. Li who created in 2000 what is called a Gaussian copola function. Disaster I do not profess to understand that concept, being a simpleton, but  I would call it just another Nerd Abstraction divorced from reality, a mathematical model which attempted to predict default of mortgage pools based on statistical correlations rather than what was actually happening in the real world. If someone came to me and told me about that back in 2000, I would just reply: "are you serious, is that a joke". I am sure that it was just brilliant-on paper. The Nerd Abstraction fueled the explosion in the CDO market to 520 billion in 2006 from 157 million in 2004, according to Newsweek. Wilmott is now conducting NERD therapy sessions financed by the large investment banks to help connect the quaints to the real world. And Wilmott, reputed to me the NERD-IN-CHIEF was quoted as saying that we still do not have the tools needed to price the CDOs. Wow, this is just amazing to a simpleton from the financial hinterland. Remember what Buffett said: "Beware of geeks bearing formulas" NYT 

Li's formula is explained in greater detail in this article from Wired: Disaster

4.  More on First Industrial: The main issue for First Industrial now is whether the economy will start to improve in 2010, at least to the point where the REIT can keep tenants at favorable rates as leases expire, or to attract new ones. The quarterly report that I referenced in my earlier report does show a lot of debt maturing in 2011 or 2012. EVENING NOTES 6 3 2009/FIRST INDUSTRIAL/HOW MUCH MONEY WILL THE FED HAVE TO PRINT TO FILL THE DEFICIT HOLE I have read some dire forecasts about FR's prospects that focus on those debt maturities. If one assumes that 2010 will be the same or worse as 2009 for the industrial REITs, then there may be a sound basis for serious concern. I am not in an habit, however, of scaring myself by projecting the economic conditions of a serious recession indefinitely into the future. If one wants to scare investors and predict what will happen by a continuation of the current conditions for two more years, then such a prediction, unreasonable as it may be, would be extremely problematic for FR and a host of other companies, particularly if it is coupled by a continuation of a credit crunch for owners of commercial properties.  

Based on yesterday's news, the FR common was rallying almost 20% by 9 A.M. with the cumulative preferred issues up around 12 to 15%. 

5. Retail Sales-Target & Costco:  Both of these retailers had disappointing same store sales for May.  Costco reported a 7% decline in same store sales and Target had a 6.1% fall. I still do not have a position in a retailer.  If I had to buy one today, which I am not going to do, I would buy WMT. 

6. KeyCorp:  KeyCorp was upgraded by RBC Capital Markets to Top Pick from Sector Perform. I do remember the period in 1990-1991, when many banks suffered a near death experience primarily due to improvident real estate lending. Stock prices were smashed for many banking institutions. In fact, the recent lows this year reached by a large number of financial institutions matched the lows from the 1990 to 1991 period. That earlier period was the low point for almost two decades. Subsequently, banks recovered gradually, and their stock prices increased by several hundred per cent. I do believe that the current debacle is worse than the one from 1990-1991, and the recovery process now is likely to be far slower. Still, RB, always optimistic and never focused on any detail, has been buying several bank stocks as lottery tickets. LB barely condones this excursion, even after taking into account the inconsequential use of Headknocker's capital, and asserts that 1 or 2 at most will prove worthwhile 5 to 10 baggers, provided the holding period is at least 5 years.