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UNIT presents


fully franked D



OUR SPONSORS & AFFILIATES special thanks to our sponsors: Citi Bell Direct Propex KVB Kunlun YoutradeFX Eclipse Trading Intelligent Investor Bloomberg Saxo Capital Markets UBS Finsia and also our affiliates: Australian School of Business University of Sydney Business School Australian Investors Association Australian Shareholders’ Association





the market wrap




with Julia Lee

Helpful tips on utilising resources with Drew Wrigley & Tracey Cui.


MAY 2013







australian resources:

by Anthony Griffin

heaven or hubris

by Adrian Arn & Mark Luo


an Interview + why

the gold bull markEt is just getting started with Jordan Eliseo

Disclaimer: The articles throughout the publication are written and compiled by students. The information contained in the articles is general in nature, and should not be construed as professional financial advice. Statements and opinions expressed in articles are those of the authors and do not represent the opinion of Fully Franked and UNIT. Fully Franked and UNIT will not be held responsible for any liability arising from your actions. Please do your own research and come to your own conclusions, or consult with a licensed professional advisor.


marc Faber’s Bold predictions


the story of Herbalife


an Interview +

with Marc Lerner

with Edward Fang

a day in the life of a trader with David Qian




PRESIDENTS Dear Reader, On the 23rd of April the University Network for Investing and Trading held its inaugural Stock Pitch Challenge final hosted by Citi, Intelligent Investor and Bloomberg. The night saw the closing event for the competition of 100 teams across Macquarie University, University of NSW and University of Sydney. Prior to the finalist’s presentations, students were welcomed to network with a range of UNIT sponsors which included HR Coordinators from Citi to graduate and senior traders. With an inspiring speech by the Citi Australia Chief Country Officer Stephen Roberts, it set the scene for a thrilling night of pitches by the finalist. After highly contested pitches the judges awarded (pg. 37): 1st Place: The Anomalies – University of Sydney 2nd Place: CZR Investments – University of Sydney 3rd Place: Equitals – Macquarie University Non-Commerce Prize: GJRY – University of New South Wales We would also like to take this opportunity to thank the competitions team for the selfless time and effort they put into the development and running of the Stock Pitch Challenge. From our humble beginnings, UNIT has focused on hosting educational events and we have achieved that through our education seminars presented by industry professionals to teach students beyond what they can learn from a university degree. In addition, we realise that our members come from a broad range of financial backgrounds from beginners that have a pure interest in learning more about investing and trading to students that already had years of experience, own a portfolio and want to meet like-minded people. As such, we have introduced educational workshops and roundtable discussions to bridge the gap between the novice and experienced investors. From absorbing feedback from our members, we understand the importance of creating networking opportunities to bridge the gap between university and professional working life. That is why we are been working closely with a number of financial institutions to host a women in finance networking event in semester 2. Furthermore, UNIT will play host to larger-scale social events including Poker nights. A warm thank you to the Publication team for putting together such an intriguing and insightful publication, that we hope will become a regular read for all students interested in investing and trading. Regards,





The University Network for Investing and Trading (UNIT) is a student-run society that involves 3500 members spanning across three universities – UNSW, University of Sydney and Macquarie. This makes us the largest investing and trading related student society in Australia. At UNIT, our mission is simple – to provide free education to students interested in trading and investing from all walks of life. We host seminars and presentations from industry leaders that not only introduce students to the fundamentals of investing and trading, but expose students to practices not taught inside the classroom. Whether it may be for your future career, or just for interest, we aim to equip all students with the skills, knowledge and confidence to start up and manage their own portfolios and invest for life. Regardless of degree, background or level of expertise, there will always be something at UNIT for everyone! 2013 brings a new beginning for UNIT, as we hope you will learn even more about investing and trading from our industry professionals and fellow UNIT members. We held our inaugural Stock Pitch Challenge over mid semester 1, which attracted over 100 competing team across all our member universities. We look forward to bringing you a society that is bigger and better than ever before – more sponsors, seminars, more diversified events. Stay tuned!




Dear reader, Welcome to the third issue of Fully Franked! The first half of this semester has really flown past, and the Publications Teams have been working hard across all three UNIT branches to make each issue better than the last. Building on the basics of previous issues - all of which can now be accessed at!news-and-publications/c17jc - this issue will provide insights into the Australian resources sector and precious metals and the confusion surrounding investing in these areas, observe and analyse the ideas of a few prominent investors, as well as look at some more basic fundamental and technical techniques. With this edition we are roadtesting some brand new ideas, articles and a few brand new faces behind the scenes, and we hope that all these changes will assist Fully Franked in enlarging your brain-boxes and fill them with delicious, crunchy investing knowledge. Enjoy! from Jesse Zhou & Michelle Cai



UNIT Presidents University of Sydney

University of New South Wales

Macquarie University

Jason Wu

Hansaka Pasindu Fernando

Drew Wrigley


Michael Kong

Derek Lau

Wilson Wong

Edward Fang

Michelle Cai

Marc Lerner

Carol Yu

Jesse Zhou

We’d love to hear from you! Email your questions, compliments or complaints to: FULLY FRANKED | ISSUE THREE





After a rise of 15% in 2012, the Australian sharemarket is off to a roaring start in 2013. Why the optimism? In 2012 we were worried about US economy, a hard landing in China, European sovereign debt. Compared to 2012, this year is looking much brighter and we are seeing the equity risk premium rising once again. In the year to date, the Australian sharemarket is up 8%. While that sounds good, we are still underperforming the US which has seen a gain of 13% and Japan which has seen a gain of 30%. The underperformance of the Australian market is due to a number of factors. A key factor being that both the US and Japan have are massive stimulus packages in place which devalue its currencies. A low currency makes goods and services relatively attractive to the rest of the world stimulating earnings and stock prices in those countries. Also with real interest rates negative in those economies, it makes sense to put money into risk assets rather than bonds where deflation eats away at assets. Sector Performance Every sector of the market has seen a gain with the exception of the materials sector. Leading the charge is the consumer discretionary sector with a rise of 18%. The market is forward looking. That means that it prices in expectations around the future. While earnings in the consumer discretionary area have been dismal and falling, stock prices have seen a substantial rise. This is because the market is looking through the current period and looking forward. The market is pricing in a cyclical recovery in the discretionary retailers and the media stocks. The problem is if this does not occur, then we will see the stock gains reverse. The worst sector has been the materials sector. Looking into the future here and the market is expecting iron ore prices to continue to weaken. The problem here is not demand; demand is holding up well and China is still growing at a healthy rate. The problem here is supply. Around 250 million tonnes of new iron ore supply is expected to come online in the next few years. With supply growing at a faster rate than demand, prices are being pushed downwards and with it the miners are also declining. Strategy With cheap money around the globe, things are looking good for global equities. In terms of the Australian sharemarket, investors will need to be a little careful. Valuations now have gotten ahead of earnings and now earnings growth needs to materialise to support the next level of growth in the market. Still in comparison to other asset classes, shares look to outperform once again in 2013. Julia Lee Equities Analyst Bell Direct



INVESTING 101 Get some helpful tips on utilising resources with Drew Wrigley & Tracey Cui.

Work smarter, not harder! Making a trade should be based on logic and reason, and information is critical to accurately identify opportunities to exploit a stock as well as to recognise threats that will lead to losses. But where do financial institutions obtain this information? And more importantly, how will you obtain your information? Gaining access to these resources could provide you with the information you need to make successful trades. Due to Australian regulations, finding information regarding listed businesses can be easy and FREE - all listed businesses make their annual reports available free for download. Annual reports provide you with financial and non-financial information. Businesses will also release any documents or results that are likely to affect its share price via Sometimes identifying and analysing the data from annual reports can be confusing. This is an opportunity to use free trading platforms, which provide basic analysis of businesses such as profiles, financial ratios, charting and any economic or stock market news on Australian and international markets. Bell Direct and other online trading platforms provide these services for free when you have an open trading account with them. Still feeling like you aren’t getting the information you need, nor the way you want it?



Premier resources, such as Bloomberg Terminal, provide you with a powerful platform to research and analyse organisations. These platforms contain real time data, news and in-depth analytics for both the Australian and international markets. For a fee, you will get access to advantageous information, not available to everyone. Using these resources will help you to analyse and understand companieswhilst saving you a significant amount of time. As an investor you could use this information to base decisions on or you could utilise it to help identify market opportunities before undertaking individual analyses. For example, trading platforms provide a means for comparing various results, which could identify opportunities and ratios across industries and businesses. As the results and ratios have already been calculated, you may be able to identify opportunities without the time and hassle of completing the calculations yourself. As an investor you must always be sceptical of the information that is being presented due to possible underlying agendas such as bonuses or end of contracts. These agendas may present inaccurate or misleading information that would be detrimental to your analysis. Getting the most up to date and reliable information is an essential way to help undertake greater investment analysis.

women of tomorrow here

Here is where you have an idea. Which inspires change. Making a difference to economies, businesses and communities all over the world. That's the beauty of here: it's where future thinking happens every day.

your place is here Š 2012 Citibank, N.A. All rights reserved. Citi and Arc Design are registered service marks of Citigroup Inc. used and registered throughout the world. Citi Never Sleeps is a service mark of Citigroup Inc.




A company may have brilliant management. It may have huge growth potential. It may be the current market leader. Does that mean it’s a good investment? There is a big difference between a great company and a cheap company. A company may obviously be “great” with high potential to maintain market leadership in the long term, however it may be overbought, meaning it is more expensive than it should be. For an obvious example, we look to the Facebook IPO, where the price paid for the company initally by investors was way too much for what the company is actually worth. Fundamental investing is about buying “cheap” companies that are trading below its intrinsic value. So how do we know how much a firm should be worth? How do we know whether or not a firm is trading above or below its intrinsic value? Equity analyst Julia Lee from Bell Direct, suggests a selection process involving the following metrics: - P/E ratio of less than 13 - ROE greater than 12% - D/E ratio of less than 50% Let’s take a closer look at what these ratios mean...



Price-Earnings Ratio (P/E ratio) P/E Ratio = Market Value per Share / Earnings per Share The denominator (EPS) can be the average of the last four quarters (giving the trailing P/E), or can be taken from the estimates of the expected earnings of the next four quarters (forward P/E). The P/E ratio is also known as the ‘price multiple’ or ‘earnings multiple’. The numerator represents the value of the firm (per share) valued by the market, whereas the denominator is how much the company has earned (per share) in a year. Intuitively, the P/E ratio is the number of years it will take for the company to earn back its value from its operations. Let’s take Woolworths as an example: The P/E ratio for Woolworths is currently 18.34 (Source: Commsec). This means that if earnings stay constant every year, it will take around 18 years for Woolworths to earn its current market value. A high P/E ratio relative to its competitors means the market is willing to pay more for this company for each dollar of their current earnings. This signals that the company may be overpriced. Investors should aim for companies with low P/E ratios compared to similar companies or the industry average. As a comparison to Woolworths, we consider Wesfarmers (owner of Coles) which has a P/E ratio of around 20.62. This suggests that Wesfarmers is more expensive than Woolworths, however this discrepancy could also mean that investors are expecting higher earnings in the future, and are willing to pay a premium because of this expected increase in earnings.

Return on Equity (ROE) ROE = Net Income /Shareholder’s Equity The ROE reveals how much profit the company generates with money that has been invested in it by the shareholders, and is used to compare its profitability against others in its industry. ROE figures vary across different industries as some industries require minimal assets to generate a profit (resulting in a high ROE) whereas other industries require large infrastructure investments before generating income (resulting in a low ROE). ROE intuitively makes sense. You want a higher return for every dollar you invest, so you would lean towards companies with a higher ROE when deciding which stock to buy. Also note that high growth companies tend to have a higher ROE.

Debt-Equity Ratio (D/E ratio) D/E Ratio = Total liabilities / Shareholder’s Equity The D/E ratio shows the relative proportions of debt and equity that the company has used to fund its assets and operations. Higher leverage indicates the company has used more debt to finance its operations. This could result in volatile earnings because of interest expenses, however also potentially allows the company to generate larger earnings than it could have without this external financing. Having debt may not necessarily be a bad thing (for example, banks thrive on having debt), however, care should be taken when companies have high levels of debt in comparison to its competitors. Companies with high debt to equity ratios may also find it hard to attract additional funding if necessary, so growth may be restricted. These comparative approuches helps you value a stock by comparing how similar companies are currently priced in the market. We should be careful though, when using these ratios, as not all companies are the same. For example, it should be logical to compare the two companies Pepsi and Coke, right? However, if you look carefully into the sources of profits, product-type sales and geographic revenues, you will see that the two companies are quite lacking in similarities. CocaCola has a strong global distribution network and has plans for aggresive international expansion. Pepsi’s only has 50% of their operations in beverages compared to Coca-Colas 100%, but it is a clear leader in the global snack market. These two companies are very different, and hence a ratio comparison would not give us much information on which company is cheaper than the other. Rather than just using ratios in a comparative approach, often professionals combine this with a more rigorous approach in valuing a company known as the Discounted Cash Flow (DCF) method. Theoretically, a fair price of a company is determined by taking the present value of all future cash flows – i.e. future cash flows adjusted by an appropriate discount rate. These expected cash flows need to be forecasted. FULLY FRANKED | ISSUE THREE



In our previous article on technical analysis, we explored basics such as definitions of support and resistance, trend lines, candlesticks and volume. We then went on to demonstrate how two wellknown technical indicators: moving averages and MACD, can be used to identify when to buy and sell securities. If you haven’t read it yet, check it out at In this issue, part of the technical analysis series, I will explore a trading strategy/setup using two other commonly used technical indicators and finish off by looking at the different styles of trading you can engage in, regardless of which instruments you choose to trade.

Stochastic (STO) The Stochastic oscillator is an indicator that shows overbought and oversold levels much like the MACD and is based on the theory that closing prices are closer to the upper end of the price range when prices increase, and closer to the lower end when prices decrease. Below is a daily chart of the gold price in terms of US dollars that will be used as our key example:

Source: Spectrum Live platform



As seen in the gold price chart above, the Stochastic oscillator consists of two lines, the faster %K line (black) and the slower %D line (red). The values of the lines oscillate between 0 and 100 with overbought levels being above 80 and oversold levels being below 20. A buy signal occurs when the %K line crosses above the %D line at oversold levels (marked above at ‘A’) while a sell signal occurs when the %K line crosses below the %D line at overbought levels (marked above at ‘B’). The Stochastic oscillator can also be used to determine find bullish and bearish divergences from the price much like the MACD. A bullish divergence occurs when the %D line forms two consecutive rising bottoms below 20 whilst prices continue moving lower. Conversely, a bearish divergence occurs when the %D line forms two consecutively lower peaks above 80 whilst prices continue to move higher. The significance of this is that when a buy signal i.e. the crossing of the %K line above the %D line is taken in the midst of a bullish divergence, the trade will have a greater probability of moving in its intended direction. It should be noted that oscillators such as the Stochastic work best in sideways trending or range bound markets and may in fact give false buy and sell signals within strongly uptrending or down-trending markets. The most common default settings for the slow STO are %K - 14 periods, %K Slowing - 3 periods and %D - 3 periods. Relative Strength Index (RSI) Another commonly used oscillator is the RSI, a line measuring price momentum determined by dividing the average gain over the average loss over a period of time (typically 14 days for a daily chart). A security is said to be overbought when the RSI is above 70 and oversold when it is below 30. A buy signal occurs when the RSI falls into an oversold condition and subsequently crosses back above the 30 line, indicating that the trend is ticking up. This is marked as ‘A’ in the RSI section of the gold price chart above. Conversely, a sell signal occurs when the RSI crosses down past the 70 line whilst in an overbought condition as marked in ‘C’. Similar to the stochastic oscillator, caution must be taken when using the RSI to predict a reversal in a trend. In strongly trending markets, overbought and oversold signals may occur too early and if followed blindly can lead to

early exits from profitable trends or entries into markets that continue to trend in the opposite direction to your position. In practice, it is a good idea to use the RSI in conjunction with the Stochastic oscillator shown in the gold price chart above. This is due to the fact that the RSI tends to reach overbought/oversold levels less frequently as it is usually less volatile than the STO. The most accurate buy and sell signals occur when both technical indicators are simultaneously within oversold or overbought conditions. As seen in the gold price chart, a strong buy signal is generated at ‘A’ using both the STO and the RSI. If both indicators were used to signal entry and exit points, the appropriate exit point would occur at point ‘C’ where both the STO and RSI cross below their respective overbought lines. The advantage of using both indicators simultaneously can be clearly seen here as the exclusion of the RSI would have triggered a premature exit at point ‘B’. However, it must be noted that exit signals will vary depending on the preferred investment horizon of the trader and that the large uptrend in this example was due to fundamental factors arising from the announcement of the third ‘Quantitative Easing’ program by the US Federal Reserve. Styles of Trading Broadly speaking, there are two types of traders, trend traders and countertrend or swing traders. There are, within these categories, traders with different preferred time horizons i.e. short term or long term. Below is a brief description of each trading style, which will give an insight into your own preferred style of trading. TREND Trading with the trend: Buying during an uptrend and short selling during a downtrend. Ironically, and despite intuition, this is the method with a very low success rate. Markets only trend a third of the time on average meaning the majority of your trades will be losers. There are two distinct ways of trading with the trend: retracement and breakout trend trading. Retracement: Waiting for the market to temporarily pull back during an uptrend or increase (relief rally) during a downtrend before entering a position in the direction of the underlying trend. This has lower risk than breakout trading but has the drawback FULLY FRANKED | ISSUE THREE


Technical Analysis cont’d of potentially missing out on large trends, as retracement opportunities may not always occur, especially in strongly trending markets. Breakout: Buying at higher prices in an uptrend and or selling at lower prices in a downtrend in order to enter a position right after a security has broken a key level of resistance or support. Because breakout trend trading doesn’t require the investor to wait for a retracement, it ensures that opportunities to enter a large trend will not be missed. The downside is that risk is significantly higher as false breakouts often occur. SWING Swing trading relies on the statistical fact that markets usually move in no particular direction and that prices tend to oscillate within a trading range so that prices will often rise, pause and fall before rising again. A swing trader will typically buy at lower or normal prices before selling at higher prices within an identified trading range and vice versa. This style is sometimes referred to as countertrend trading as it often involves picking the bottom and top of markets. Swing trading usually has a higher success rate and a greater number of trading opportunities compared to trend trading but has the disadvantage of only capturing smaller price movements per trade. It should be noted that both trend and swing trading are not mutually exclusive. In fact, some of the most successful traders apply both styles in various markets over different timeframes as a form of diversification. How Do I Apply This In Practice? If you haven’t already done so, open up a live or free demo account with an online broker that provides you with access to technical analysis tools and practise overlaying the technical indicators explored within this article over the price charts of securities that interest you. This will allow you to familiarise yourself with the art of technical analysis while at the same time provide you with a greater understanding of the way in which prices move within financial markets. 16


TRADING Traders are not only competing with other traders in the market but also with themselves. Oftentimes as a trader, you will be your own worst enemy. We, as humans, are naturally emotional. Our egos want to be validated—we want to prove to ourselves that we are in control and capable. We also have a natural instinct to survive. All of these emotions and instincts can combine to trading successes every now and then. Most of the time however, our emotions conquer us and lead us to trading losses…..unless we learn to control them. Many traders believe it would be ideal if you could completely divorce yourself from emotions - a next toimpossible task. Actually, some of your emotions can actually help improve your trading success. A crucial step in trading is to understand your personality and emotional responses as a trader. Identify your strengths and weakness and pick a trading style that fits you. There are four psychological biases that may affect trading results and how to overcome them: Overconfidence Bias Overconfidence bias is an over-inflated belief in your skills as a trader. If you ever find yourself thinking you have everything figured out, you have nothing more to learn and trading profits are always there for the taking, you probably suffer from this condition. Dangers of Overconfidence Overconfident traders tend to get into trouble by transacting too frequently or by placing extremely large trades as they go for the home run. Inevitably, an overconfident trader will end up going in and out of transactions—churning the trader’s account—or risking too much on one trade which goes bad and wipes out most of their capital. Are You Overconfident? If you want to know if you have any overconfidence tendencies, ask yourself, “Have I ever jumped straight back into a trade I had just been stopped out of, not because I saw another entry opportunity but because I couldn’t believe I was wrong?” also ask

PSYCHOLOGY yourself, “Have I ever put more on a trade than I normally would because I was so sure this trade was going to be the one?” If you have, you need to be aware of those tendencies. Overcoming Overconfidence The best way to overcome an overconfidence bias is to establish a strict set of risk-management rules. These rules should cover how many open positions you may have at any time, what portion of your account you are willing to risk on any one trade and how much of your account are you willing to lose before you take a break from the markets and re-evaluate your strategy. By limiting the number of trades you are willing to be in and the amount of risk you are willing to take, you can diversify your risk out evenly over your portfolio. Anchoring Bias Anchoring bias is a propensity to believe the future is going to look extremely similar to the status quo. When you anchor yourself too closely to the present, you fail to see the dramatic changes that are possible, especially in foreign exchange markets where currency pairs fluctuate and the underlying fundamentals shift. Dangers of Anchoring Anchored traders tend to land in trouble by convincing themselves that current trends will never end and a reversal in the economic strength of a particular country is next to impossible. Alas, they become emotionally attached to the previous trend of a currency pair, and they continue to place trades against the new market conditions. With each trade, they lose more and more money by following an outdated set of principles. Are You Anchoring? If you want to know if you have any anchoring tendencies, ask yourself, “Have I ever lost money because I couldn’t accept that the trend had ended?” If yes was the response, understand you may be susceptible to this bias. Overcoming Anchoring The best way to overcome anchoring is to look at multiple time frames on your charts. If you usually trade on the hourly charts, take a look at the daily and weekly views every now and then to see where some of the longer-term levels of support and resistance are and what these trends look like. You should also take a look at the shorterterm charts to see when these trends are reversing. Broadening your perspective will help you avoid anchoring yourself to any one point.

by Anthony Griffin - the CEO of Saxo Capital Markets FULLY FRANKED | ISSUE THREE




trading psychology cont’d

Confirmation Bias Confirmation bias is a propensity to look only for the information that confirms the beliefs that you already have. For instance, if you believe the EUR/ USD is going to go up, you will look for the news, the technical indicators and the fundamental factors that support your belief.

Dangers of Loss Aversion Traders who fear losses are much more likely to hold onto losing positions than traders who are able to accept short-term losses and move onto other, moreprofitable trades. Holding onto losing positions jeopardises the stability of your portfolio by not only incurring losses but also keeping you out of better trades.

Dangers of Seeking Confirmation Traders who over-actively pursue confirmation of their beliefs tend to miss key warning signs that would normally have protected them from unnecessary losses. In an attempt to build a case for their beliefs, traders miss the facts. Ultimately, this leads to them fighting the trend and losing money with each ill-conceived trade.

Do You Fear Losses? If you want to know if you have any loss aversion tendencies, ask yourself, “Have I ever held onto a losing trade past the point where I knew I should have gotten out because I hoped the currency pair would turn around and wipe out my losses?” If you have, you need to be aware of those tendencies.

Do You Seek Confirmation? If you want to know if you have any confirmation bias tendencies, ask yourself, “How often do I look for signs that I may be wrong in my analysis?” If your answer is rarely or never, you may be a confirmation seeker, and you need to be aware of those tendencies. Overcoming Confirmation Bias The best way to overcome confirmation bias is to find one or a group of people to discuss your trading positions. Hopefully the person, or people will not always agree with you. Talking with traders with diverse perspectives and ideas will help you look at your trades from multiple angles. Sometimes you will strengthen your convictions by talking with other traders. Other times, talking with your trading partner will cause you to change your mind. Keeping an open mind will help you catch new moves and avoid holding on too long to past beliefs.

Overcoming Loss Aversion The best way to overcome a loss aversion bias is to trade with physically set stop loss orders. Many traders tell themselves that they will trade with a mental stop loss—a stop loss level that they think about and promise themselves they will act on if the currency pair ever reaches it. All too often, however, traders fail to act on their mental stop losses. Emotions cloud judgement and traders start rationalising decisions to stay in a trade until it turns around. As soon as you enter a trade, you should set your stop loss order. Take your emotions out of the picture. While literature on the above psychological biases is plentiful, having a basic understanding of how emotions and the affects it can have on your personal trading activities will ensure greater success than without these principles. Although simple in concept, they are much harder to detect during trading and like anything in life, takes practice.

Loss Aversion Bias Loss aversion bias is based on the theory that pain caused by losing $1,000 is greater than the joy from gaining $1,000. In other words, fear is a more powerful motivator than greed.





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Australian Resources: Heaven or Hubris? by Adrian Arn & Mark Luo (Market Strategy Team at Investing For Charity) Besides being ranked by Deutsche Bank’s “Cheap Date Index ” as the world’s most expensive country for dating, Australia is a lucky country! We are endowed with an abundance of natural resources, political stability, proximity to the Awakening Asian Tigers , cultural diversity, privileged with lengthy public holidays, and the invention of Vegemite. Or are we? The million dollar question is – has Australia exhausted her good fortunes? Sources for our discomfort includes: 1) Platinum’s June publication, and; 2) Andy Xie’s bear column “Australia facing a hard landing”. We hope Australia does not suffer the “full blown financial crisis” predicted by Andy Xie. However, some compelling evidence from Platinum demonstrates “Australia has some very serious problems… that will almost certainly result in a long period of subdued growth (and) hyperinflation”. In our Quarterly Report, the Market Strategy Team at Investing for Charity, examined whether Australia has slipped on her own hubris and broke its resources export market.



In summary, even though we are experiencing a bear market on the Australian Resource sector, we believe this may be when and where the best opportunities will eventually emerge.

Sources of our concerns… Illusions of Comfort, Platinum Asset Management “… while property might fizzle for decades, the real trigger for the bust – that is, declining commodity prices as a result of a slowdown in China which will cause real wages to increase and force businesses to switch to more capitalintensive, labour-saving means to survive – looks like it could be just around the corner.” This piece delivers a compelling assessment of how vulnerable the Australian financial system truly is. Thanks to the oligopoly grant protecting the Big Four, an exogenous shock from China will cripple our financial system. Perhaps most disturbing is their comparison of Australia to Argentina – “Argentina became very rich despite its extractive (banking) institutions… If you become very rich because of a resource boom, but your (financial) institutions are deeply extractive, the moment the resource boom goes away…” Kaboom! Bubble on Bubble, Andy Xie “Debt has piled up in every corner of the economy, and creative accounting is employed to pump up banks’ balance sheets. One consequence is that Australia has the highest net foreign debt among all developed economies. On the way down people realize

that they cannot spend borrowed money forever, and the assets on banks’ books are not worth as much as they say. What happened to the United States in 2008 could happen to Australia in 2013. Australia may suffer a full-blown financial crisis.” We were reaping the dividends from reforms brought in largely by Mr Keating and unremitting commodity demand from our friends in China. But, what if the basis of Australia’s economic growth and asset price inflation is based on a “bubble built on top of China’s over-investment bubble”?  

The Price we Pay, Our Views The commodity boom cycle should have ended in 2008, but excessive Chinese stimulus resulted in capital misallocation and overinvestment. But, things are changing. Slower growth in China is the new norm. As the Chinese economy rebalances by shifting away from an export driven to a consumption driven economy, so will its demand for Australian commodities. Lastly, the high volume of cheap credit injected into global financial system through quantitative easing is disconcerting. We cannot comment on whether this type of expansionary monetary policy is effective in countering deflation and driving “real growth”. But, we are almost too certain that foreign hot money, as they chase “quality yield”, will continue to artificially boost Australian asset prices. Miraculously, we treat this as real savings – as if somehow, all this net foreign debt (Figure 1) vanished. When the bust comes, foreign “hot money” will scramble for the exit – all at the same time. FIGURE 1: Net foreign debt & equity rising to unsustainable levels



Australia’s Iron Ore Of particular concern for Australia is our most lucrative export – Iron Ore. Within the All Ordinaries, the most exposed companies include: BHP, Rio Tinto, Fortescue, and Atlas Iron. The basis of our concern stems from a combination of growing production capacity from China, combined with slowing Chinese demand. To put the commodity in context, iron ore is primarily used to produce steel. China produces 45% of steel globally, and accounts for 60% of global demand. As such, we will focus our attention on looking at the developments which have unfolded in China.

We also find it interesting to compare demand (Figure 1) against Chinese iron ore supply (Figure 2) which is experiencing year-on-year steady growth, albeit at a slow pace. This in part reflects technological constraints relating to Chinese steel production. Blast furnaces cannot be shut down as easily due to the risk of explosion in the cooling stage; and, it takes time for the blast furnaces to become completely operational-subsequent to its deactivation. FIGURE 3: Chinese domestic iron ore production

Declining demand, but increasing Chinese supply Historically, prices of iron ore have more or less been correlated with Chinese iron ore consumption (Figure 2). Since early 2011, we have seen a slowdown in the demand, driven the following factors: 1. Withdrawal of fiscal stimulus slowing down infrastructure investments; 2. Government policies and restrictions aimed at taming property prices These reflect structural changes to Chinese growth as it shifts from an economy driven previously by investment, to one that is consumption based. FIGURE 2: Correlation between Chinese demand and Iron Ore spot prices



The medium term risk for Australia’s iron ore is as follows: a majority of Chinese iron ore demand will be eventually sourced domestically. However,

in the short term, Chinese domestic iron ore producers face both cost inflation pressures and new project execution risks. Naturally, their reliance on Australian iron ore will exist, but not for too long…  

The sustainability of mining in Australia

Let’s assume that we have somehow managed to mitigate risks on the demand-end (by leveraging our infrastructure and relationships with the Awakening Asian Tigers); how do we fare on the supply-side? As Australia’s mining industry matures and as iron ore prices stabilise, quality grades of ore deposits will fall, and so too will the number of known deposits mined. The sustainability of mining in Australia will depend on the following: • Increase in discovery rates by shifting from Brownfield to Greenfield exploration. Historically, the rate of discoveries in Australia has been quite good until recently. This in part is due to the decline in the overall share of Greenfield expenditures from 35% to 21% in the last decade. • Less offshore exploration by Australian mining companies. Many Australian companies have decided to move offshore largely in part of higher unit costs, falling discovery rates and more accommodative overseas governments. • The ability for junior explorers to raise capital: equity funding is vital for mineral exploration. However, restrictive credit market, Eurozone instability and concerns over Chinese growth have made equity raisings ever more difficult for junior explorers. Even though junior explorers are accounting for an increasing proportion of exploration in Australia, the average capital been raised is at its lowest level for 5 years at $6.8m. As bearish as we may sound, we still believe Australia’s fundamentals are one of the strongest in the world. Production and exploration activities will thrive during commodity boom cycles. The emer-

gence of South East Asia, coupled with continual demand from China’s urbanisation will not hamper the supply-end whatsoever. What we are concerned about is our over bloated banking system which will introduce systematic disruptions to the economy in the short term. Rapid asset devaluations and depressed currency may drive smart money to safer yields. However, these may be when the best investment opportunities will emerge. At the end of the day, money is not king – resource assets is the key to economic throne.

Author Biographies Adrian Arn Adrian Arn is an Analyst with the Market Strategy Team in Investing for Charity. He is a fourth year Commerce (Accounting)/ Law student at UNSW and has had previous internships in accounting and corporate finance. Right now Adrian is studying on exchange in Hong Kong for a semester, a place that has utterly destroyed his definition as to what hour of the day is ‘late’. Mark Luo Mark Luo is co-founder of Investing for Charity, and currently sits on the Investment Committee Executive. Privileged to be working with young professionals and students, he leads Analysts in Market Strategy team in originating & examining new investment opportunities. Right now Mark works in buy side, which has utterly destroyed his confidence of value investing in this QE infinity environment!

Contact Details Mark Luo Co-founder of Investing for Charity Investment Committee Executive Head of Market Strategy Email:



Interview with Jordan Eliseo

(Chief Economist, ABC Bullion and Partner, LJ Financial) Micheal had the chance to sit down with industry professional Jordan Eliseo early last month. Here’s what Jordan had to say.

M: What has your background been in the finance industry? I’ve been in the finance industry for just over 15 years. I started back in 1997 in Adelaide where I grew up with BT Financial Group. I worked there whist I was completing university. I then went and spent 12 months working with a brokage firm which was an incredibly exciting time right at the time of the NASDAQ bubble in the huge boom of technology shares around the world. I saw some very interesting trading and so-called ‘investment activity’, where a lot of people make huge paper profits very quickly only to realize large genuine losses months later so there was a 12 month period that shaped my views of markets quite significantly even though I was still quite young at the time. From there I spent a couple of years working with JP Morgan and then moved to the UK where I spent the better part of 8 years working with companies like Deutsche Bank and Cazenove Capital Management. The last two jobs I had were working as an analyst looking at AMP Capital Diversified product range which a lot of people invest in with their superannuation, and then just recently I was a founding partner of a boutique financial firm called LJ Financial. M: Why should people consider investing in precious metals? The main reason to invest in precious metals today, and it’s been the same reason across many years, is simply preservation of wealth. We are taught and in many ways pre-conditioned towards wanting to invest our capital in the hope of earning returns on that money. But any person who has built and preserved wealth over the long term will tell you that the number one rule to grow wealthy is actually to not lose your capital in the first place. So whilst investing gives you the capacity to make money it also carries huge risk as people investing in the stock market will have known from the GFC. The reason to invest in precious metals is over the long run, the one asset class with the best track record of maintaining wealth are precious metals, especially in the environment like the one we find ourselves today with record low interest rates around the world and money being printed by every major G6 central bank, along with huge uncertainty in the real economy despite what’s seen on the front page of the news. Having a portion of your investments in precious metals gives people the comfort that some of their wealth is stored in history’s safest asset.



M: Just recently in Cyprus, depositors had some of their money stolen, despite having deposit insurance up to 100 000 euros. Do you believe such events could occur in much larger economies and what impact would that have on the price of gold and silver? Without being an alarmist the short answer is yes. There really isn’t anything to stop governments passing legislation which would effectively nationalize a certain percentage of domestic depositors’ assets. The most important thing for people to understand is that the money they have in a bank account is not actually there in a physical sense. So if you have $10 000 in a bank account the bank doesn’t have that money sitting around waiting for you to come and collect it. They have lent it out into the marketplace in the hope of earning a return on the money you’ve lent to them. The problem the Cypriots are facing and indeed large parts of the western world and Japan, is that a lot of the investments those banks have made and the assets they hold on their balance sheet are not worth what they are worth. Hence they’re having problems in maintaining their balance sheet and they need government or central bank support. Ultimately what’s happened in Cyprus is the IMF and other core European nations such as the Germans have said “we are not going to continue providing you with funding unless depositors in your bank take some responsibility for the losses.” In terms of the impact on gold and silver particularly if it moves to larger economies, unquestionably in the medium to long term it will push the price of metals up. Why would you leave your money in the bank earning next to nothing when a) you know your money isn’t really there and b) it could be arbitrarily confiscated with a pen by a politician, when you can hold that money in physical gold and silver which cannot be printed, replicated and is not easily accessible outside of the banking system. M: Despite so much currency printing by the central banks worldwide, the massive growth in sovereign debt and counter-party risk, why have gold and silver prices consolidated for over a year instead of going higher? The first point to make is if you at the performance of gold and the correlation between the gold price and the expansion of central bank balance sheets you should take a 3 or a 5 year view. But you’re absolutely right that since the launch of QE3 we have not seen the gold price go up, we’ve actually seen it consolidate and move lower. But there were a couple of reasons for that. Firstly, By September of 2011 when gold was first trading around the $1900 mark it had clearly run ahead of its fundamentals. There was a little bit of temporary euphoria in the market, people trying to make a quick buck and the $1900 price had clearly moved out of the more normalized trading range. Since then, what we’ve seen is quite a strong performance of the US dollar relative to other major currencies such as the Euro and the Yen. In the last 18 months with the problem in Greece, Spain, Italy and even France, coupled with the problems in Japan (they’ve just had a new prime minister and they’ve pledged to print an unlimited amount of Yen until they considerably weaken the Yen versus the dollar, to try and push the Nikki back up), what we’ve been seeing is not so much gold weakness but US dollar FULLY FRANKED | ISSUE THREE


strength. In US dollars we’ve seen the price consolidate and pulled back maybe 20% from September 2011. We’ve seen that pullback a number of times. That’s a very healthy technical correction in an ongoing bull market. If you were to look at the price of gold in British pounds, it’s only pulled back 5-10% which is hardly noticeable. It recently broke out to an all-time high in yen and it’s been performing very strongly in Euros and well. So a lot of people now are talking about the gold bull market being over, but when the bull market is genuinely over, it will be depreciating in value across all paper currencies. M: Why is so little attention given to precious metals by the mainstream media and investors, despite their fantastic 10 year performance? There are probably two or three major reasons. The first is that considering that physical gold is not a financial product, people involved in the finance industry cannot get paid to sell or recommend it. But ultimately they all want to make money so they only recommend products in which they earn fees for it. The second issue is that gold is a very simple investment, and it’s an investment where people don’t need to be a PHD economist, have a degree in quantitative finance or an exceptionally intelligent person on paper to hold your wealth in bullion. So there’s almost an institutional bias against precious metals investors by the “lords of finance” because gold in some way is an insult to their intelligence. They like to sell to their clients their understanding of complex economic models and fantastic mathematical calculations. They talk about all these sophisticated terms such as ratios, leverage and buyouts. So what their message to the public is ‘you haven’t been to school and you haven’t studied that stuff but trust us. We know what we’re doing, and we can charge you a fee to manage your money.’ You don’t need any of that to understand why you’d need to invest in precious metals and every dollar that goes into precious metals is in effect a dollar you’re saying to those people ‘I do want to give you my money because I don’t trust you to be as intelligent has you claim to be.’ Gold has kind of been an insult to what have been highly successful people. If you look at the incredible run that financial markets had between 1980-2007, a lot of people made a lot of money and the managers of those products made millions of dollars. They were brought into the system and with that in mind it’s not surprising most people aren’t into precious metals as an investment. The final point I’d make is there’s a very famous expression around any kind of new product innovation where people will say ‘I’ve got plenty of people lining up to be my second client but I just need to find my first client.’ Nobody wants to try something new in case it doesn’t work, because they might look like an idiot relative to everybody else. Most of the mainstream investment community measure themselves against their peers more than anything else. If someone were to say they were going to put 20% of their client’s money in precious metals, and it falls for say 3 months while more traditional investments rise, they will be the worst performer amongst their peers and they will potentially lose clients. Managers are afraid to invest in precious metals in case they perform poorly, 26


and while most investors have a very long term view, the people who manage their money want to be paid a bonus this year. They do not have a 30 year view of money. So with that in mind it’s quite natural that no one wants to be the first person to really embrace physical precious metals for fear that they might be wrong even if it’s right over 10 years. M: What effect will global monetary stimulus policies have on the world economy? The continued monetary stimulus will have exactly the same effects as it has over the last 5 years. It will cause nominal increases in asset values, large increases in the value of commodities and scare assets which can’t be printed. That will lead to ever higher prices and costs for the things that we need in life, for example electricity and fuel which will leave people with less money to spend on the things they like, which is why retail sales and the consumer discretionary market is struggling so much because people simply have less free money lying around to spend once they pay for their essentials. It is a hugely counterproductive exercise that will cause real prosperity to fall. As an aggregate, society has been getting poorer over the last 5 years. Thus, money printing will continue to cause deterioration in the real economy despite rising assets prices which make us feel that everything is getting better. You can look at the number of people on food stamps, the increase in the unemployment rate over the last 5 years, the fall in real incomes all reveal a society that is getting poorer not wealthier. Real economic growth, for example the imports and exports going through Long beach and Seattle and the rail network are declining. All of these are signs of real prosperity that is being eradicated by these inflationary policies. So as long as we continue them, it is very good for people to be cautious when it comes to investing and I believe precious metals will undoubtedly be the best performing asset class of the next decade. M: How can students get involved in precious metals today without much capital? Perhaps one of the misconceptions out there for many students is they might see gold at $1600 an ounce and thus conclude they can’t afford that. However you can get started with investing in precious metals with as little as $20 or $30. An ounce of silver will cost you a little over $30. But there is absolutely nothing to stop you from opening an account with ABC Bullion. You can buy gold with as little as $50 to $100 at a time for example once a month. We also have an affiliation with a company called First Gold which is as simple as opening a bank account and setting up a direct debit facility. There is nothing stopping them from opening an account like that and purchasing gold. It’s no different from having a bank account with a traditional bank but instead of saving in paper dollars that are depreciating, you can save in gold and silver which are likely to appreciate.

please turn over for more with Jordan -----------------FULLY FRANKED | ISSUE THREE


Why the Gold Bull Market is just getting started

- with Jorden Eliseo

Goldman Sachs predicts gold to hit $1200 an ounce. “Is this the end of the 12 year bull market in Gold?” asks Bloomberg. “Time to buy stocks” says the SMH Money section on March 13. Any follower of front-page news could be forgiven for thinking the global economy has suddenly healed, that gold prices are set to crash and that boom times are soon to return. This is despite interest rates sitting at their fifty year lows, levels described by the RBA as being necessary due to ‘catastrophic economic conditions’. Before we call the golden bull dead, we should look at what is happening in the real economy around the world: • Governments are running unprecedented deficits • Central banks continue to flood the global monetary system with liquidity • Port and rail activity in the US continues to wane • Nearly 50 million Americans receive food stamps • Gas prices have risen by 35% since 2007 • Family incomes are 10% lower than they were 5 years ago • Debt per taxpayer has risen by $54k in the last 5 years


expensive either. There are a number of metrics used to measure the current gold bull market vs. the bull market of the 1970s. All of them show that gold is nowhere near a bubble at today’s prices, if history is any guide. The table (above) shows what the gold price would need to reach, in today’s dollars, to match the previous gold bull market, which peaked in February 1980.

This is not real economic improvement, and should give us pause before we sell our bullion and load up on more speculative investments. Besides, despite the price rise this past 10 years, is gold really that expensive?

While these prices alone should convince individuals that there is still time to invest in precious metals, with potential returns of +500% from current prices, it must be stressed that ultimately, gold is a monetary asset. It competes with the conventional paper money we use in daily commerce and store in bank accounts. Therefore, intelligent investors don’t ask ‘how high can gold go?’ but rather, ‘how low can paper money go?’

What would a gold bubble look like today? Whilst gold is not the bargain it once was, significant evidence highlights that it isn’t

On this subject, history is unambiguous. Paper currency can and always does go to zero. As unlikely as this seems, consider that we are living in a world where the US Fed is printing $85 billion


paper dollars a month, the Japanese central bank has aggressively expanded its QE program, and the European Central Bank has promised ‘whatever it takes’ to preserve the European Monetary Union. How does one really end a gold-bull market? For this current bull market in precious metals to end, we’d need to see nominal interest rates much higher than the inflation rate, which would create a genuine “opportunity cost” for gold investment. This occurred when gold last peaked back in Feb 1980, when the US Federal Funds Rate was 14.13% (on it’s way to nearly 20%). Compare that to the Federal Funds Rate of 0.25% today and you can see we are living in an entirely different world. And despite mainstream media claiming that the economy will improve and rates will normalize in coming years, we wouldn’t be so sure. Higher interest rates would kill off any ‘housing recovery’ in the US and in other parts of the world (especially Australia), and provide a drag on private sector economic activity. Worse, higher interest rates would cause havoc with US public finances, due to the staggering levels of debt the US Government is forecasted to owe over the course of the next half decade: If interest rates were to rise to just 6.10% (the long term average from 1960 until the GFC), over 40% of US Tax Revenue would be spent merely servicing the national debt. To fund this, the US Government would have to make significant cuts to entitlements including Social Security, Medicare and Medicaid, as well as funding for schools, infrastructure and defence. This will be

nigh on politically impossible with an electorate that has come to expect ever more government largesse. The US, and indeed most developed market sovereign nations are stuck. Either they pare back their gross overspending and cause a recession that will likely be far more significant than the GFC, or keep running unprecedented deficits, knowing full well this can only be done by keeping the monetary spigots open, higher inflation in the future be dammed. Follow the Smart Money One of the ‘golden rules’ for investing (pardon the pun) is to follow the smart money. Legendary long-term investors like Doug Casey, Eric Sprott and Marc Faber have worked out clearly what’s going in the economy, can see the obvious risks, and are protecting the significant levels of wealth they’ve built with precious metals. Even the new ‘rockstars’ of investing, like John Paulson and Kyle Bass, who made billions throughout the GFC, are all serious investors in precious metals and view it as a core holding throughout this period of low interest rates and unprecedented monetary debauchment. Who should people listen to? Investors like the ones mentioned above, who made money through very difficult times? Or politicians, central bankers and mainstream economists, who preGFC assured us there was no need to protect our portfolios with ‘outdated’ investments like precious metals. The latter group not only misinformed their constituencies on the threats and opportunities that this economic environment entails, but continue to support an unsustainable financial system, which can only “function” with ever larger amounts of leverage and printed money. Any impartial observation of history demonstrates that it’s a system with an uninterrupted track record of failure, and prudent allocators of capital will continue to look for ways to preserve their wealth through these difficult times. They could do worse than look to precious metals as their ‘port in a storm’ to see out the incredibly challenging economic times we’ll face in the decade ahead. Price prediction. Pick a number - we’re on our way back to the Gold-Standard! FULLY FRANKED | ISSUE THREE


Marc Faber’s

Bold Predictions

with Marc Lerner

Marc Faber is a Swiss investor well known as a frequent guest on finance programs such as CNBC and a vocal critic of government interventions in the economy, particularly those of central banks such as the Federal Reserve. Furthermore he is the publisher of the newsletter the Gloom, Boom and Doom Report. Although less well known, he is also the author of Tomorrow’s Gold: Asia’s Age of Discovery. Written in 2002, the book focuses on long-range economic predictions and is a great read if you can get your hands on a copy. It begins with a parable of two great islands, Leisure and Diligence: One, called Leisure, became famous for its economic and military achievements. The other, Diligence, was the envy of the globe for its rich cultural heritage and hard-working, frugal inhabitants. Both had at different times achieved great deeds, wealth, and power. In fact, ‘Leisure’ was something of a misnomer. This society had emerged from very humble beginnings to become – through hard work, frugality, freedom and wellthought-out legal, commercial, and financial institutions – the leading economic and military power of the 20th century… Diligence, on the other hand – as a result of exploitation and humiliation by foreign powers in the 19th century – long been plagued by internal strife. This had led to the adoption of some impractical ideologies that were spreading throughout the world in the 20th century under the names of socialism and communism. Faber’s core thesis throughout the book is that if Western societies continue to live largely off debt, consumption and war rather than work and savings, in the long term they will be overtaken by Asia. He stresses however that this is an extreme long term prediction, and he is by no means a ‘China permabull’. Faber compares the emerging markets of China to that of 19th century America; a period of immense but by no means stable growth: However, and this point we emphasize, America’s road from extremely humble beginnings to unprecedented economic dominance and prosperity was not smooth and paved with gold (certainly not for foreign investors). Rather, it was strewn with nasty and frequently, even for skilled drivers, unavoidable potholes. Furthermore, the American route to prosperity was often controlled by all manner of banditry and corrupt officialdom, clever at robbing the naïve and credulous traveler of his purse. True to form, Faber has recently publicised a massive credit bubble he sees ready to burst in China. These long-range predictions, however, are not mere speculations, but based on an understanding of economic history and a number of often conflicting economic theories. He warns perhaps to those dreaming of a 30


job in New York or London, that from ancient Egypt onwards, centres of prosperity have been constantly changing location and will continue to do so. In an attempt to understand the business cycle and gain an idea of when to invest in emerging markets, he recounts various theories of the cycle’s existence, with his most favourable being the Austrian business cycle theory. In support of his longer-term predictions, he also spends some time discussing the rather dubious Kondratieff wave, a theory relating to 50-year economic cycles in capitalist economies. Nevertheless, Faber’s argument detailing the Austrian understanding of the difference between ballooning debt and consumption in the West versus work and savings in the East, is very convincing when considered in the very long term. We then ask, what Faber’s advice is for a young person as a result of all of this? He warns that it is too late to get rich in some places in Asia, and one should not move to Hong Kong like he did in 1973. Rather: There is a new Asia to discover. If I were twenty-six again, I would more likely move to Shanghai, Ho Chi Minh, Yangon or Ulan Bator. I would learn the local language to perfection, live with seven concubines and start a business. A controversial recommendation, no doubt. But as a very successful investor, Faber’s publications and theories are well worth reading and taking note of. FULLY FRANKED | ISSUE THREE


The Story of Herbalife

‘If You Want a Friend, Get a Dog’

In Between A Rock and A Hard Place

“I’m telling you he’s like a crybaby in the schoolyard. I went to a tough school in Queens and they used to beat up the little Jewish boys and he was like one of the little Jewish boys crying that the world is taking advantage of him” said Icahn, the 77-year-old majority owner of Icahn Enterprises, a diversified holding company. He continued, “He’s the quintessential example that on Wall Street, if you want a friend, get a dog”. Ackman fired back “This is not great use of CNBC airtime, what I can tell you is, this is not an honest guy and this is not a guy who keeps his word. This is a guy who takes advantage of little people”.

By Edward Fang

| April 13, 2013

The increasingly public brawl between hedge fund titans Bill Ackman and Carl Icahn over a previously little-known nutritional supplements provider has taken activist investing to new and dangerous heights. In a rare confrontation on CNBC’s Halftime Report in late January, legendary corporate raider Carl Icahn sparred with Bill Ackman, founder of Pershing Square Capital Management, a New York based hedge fund with twelve billion in assets under management. In the space of just twentyseven minutes, two of the most prominent activist investors on Wall Street condensed over a decade’s worth of animosity into an ego-driven, insultladen verbal boxing match. For traders tuned into CNBC on the floor of the New York Stock Exchange, the showdown proved to be humorous theatre. Exchange specialists and traders could be heard interjecting the live broadcast with ‘Ooohs’ and ‘Wooahs’ while market commentators covered the brawl extensively in digital ink. Jim Cramer, the host of CNBC’s Mad Money later referred to the dialogue as “the best business television ever”. 32


The acrimonious history between the two heavyweights has its roots firmly planted in a soured 2003 ownership arrangement over Hallwood Realty, a Texas based commercial real estate entity that resulted in extensive litigation. The court eventually ruled in favour of Ackman in 2011 and ordered Icahn to transfer over $9 million including interest and fees to Ackman’s investors, a trivial figure given Icahn’s estimated net worth of $20 billion. As the verbal smackdown continued and old wounds re-opened, CNBC anchor Scott Wapner, attempted to shift the focus of the dialogue onto the current agenda. At the heart of the most recent string of hostility between the two is Icahn’s agitation with Ackman’s short position on Herbalife Ltd (NYSE:HLF), a Los Angeles based nutritional supplement and weight-loss product company. In a short sale, the investor borrows a stock and sells it on the open market in anticipation of a price drop, providing a capital gain when the trade is eventually closed out. But if the underlying stock rallies, the short seller will be ‘squeezed’ and may incur sizeable losses in a short of space of time.

‘Target Price is Zero’ Central to Ackman’s investment thesis is that Herbalife is a ‘sophisticated pyramid scheme’ which he accuses of utilising illegal activities including price gauging, misleading sales information and a complex incentive and distribution structure to hide its fraudulent business practices. Herbalife’s entire business model operates under what’s known as a multi-level marketing (MLM) strategy whereby a sales force is compensated based on personal sales volumes in addition to the sales volumes generated by other distributors they recruit. Illegal pyramid schemes on the other hand generate revenue purely

by charging fees for the recruitment of distributors that are initially enticed by the illusion of lucrative returns. Multi-level marketing remains largely within the bounds of legality, however, given its striking similarities with conventional pyramid schemes, the merits of the MLM model remain highly questionable. In late 2011, a Belgium Commercial Court ruled that Herbalife did in fact meet the criterion of an illegal pyramid scheme, providing merit to Ackman’s hypothesis. He contends that Herbalife relies substantially on the recruiting of new distributors rather than the actual selling of products to the end user. His findings suggest that 90% of Herbalife’s profits are generated purely from recruitment fees. Speaking at an investment conference in New York in late December last year, Ackman delivered a three hour, 340-page presentation detailing what he believed to be one of the most elaborate and sophisticated frauds, likening the company to Bernie Madoff ’s multi-billion dollar ponzi scheme. There he disclosed very publicly that Pershing Square had amassed a mammoth $1 billion short position equivalent to roughly 20% of all outstanding stock. “Our target price is zero because we think the business will fail” says Ackman, referring to his scepticism over the legitimacy of Herbalife’s business model. Immediately following his comments, shares of HLF plummeted, losing over a third of its value over three trading sessions, closing at a low of $26.06.

Talking Your Book While it is common practice for money managers to have a pessimistic outlook on a stock, it is unusual for a fund to publicise its bearish trading position unless it had the intent of moving the market in its favour - a tactic known as ‘talking your book’. In essence, such an approach involves leveraging the reputation and credibility of a prominent investor to convince other investors to follow their lead. This creates a self-fulfilling prophecy where if enough weight is placed on the short side, a perfectly stable enterprise may be driven to the ground. In recent times, activist investors have become increasingly media-savvy, publicly pronouncing their trading positions in television appearances, conferences, regulatory filings, op-eds and even in the form of customised websites. While ‘talking your book’ remains within the boundaries of securities laws, it raises ethical considerations and blurs the red line that separates activist investing from market manipulation.

In an interview on Bloomberg’s Street Smart prior to his heated confrontation on CNBC, Icahn spoke of his resentment over Ackman’s ‘shouting from the rooftops’ approach. “I think if you’re short, you go short, and, hey, if it goes down, you make money. You don’t go out and get a roomful of people to bad-mouth the company. If you want to be in that business, why don’t you go and join the S.E.C.”, Icahn said, referring to the U.S Securities and Exchange Commission, the federal authority responsible for regulatory oversight of the securities industry. Clash of the Egos... Herbalife Share Price

Source: The New York Times

Stock Rebound After closing at a low of $26.06 on Christmas Eve, four days after Ackman’s presentation, Herbalife’s stock staged a remarkable revival, surging to a high of $46.19 a piece by mid January as other activist investors including Daniel Loeb, founder of Third Point LLC, a New York based hedge fund, began attacking the integrity of Ackman’s assertions. It was revealed in a regulatory filing, that Loeb’s $11.6 billion fund held an 8.2% passive stake in Herbalife, pitting him directly against Ackman. In a letter to investors in early January, Loeb referred to Ackman’s thesis as ‘preposterous’, he went on to say “The pyramid scheme is a serious accusation that we have studied closely with our advisors. We do not believe it has merit”. Perhaps the biggest bombshell came on Valentine’s Day when Icahn disclosed a 13% long position in HLF and his intention to discuss “business and strategic alternatives to enhance shareholder value”, exactly three weeks after his epic brawl on CNBC. Markets reacted immediately, shares of Herbalife jumped 20% in after-hours trading. On face value it may be interpreted as egofuelled rhetoric, however, regulatory fillings imply FULLY FRANKED | ISSUE THREE


the story of herbalife cont’d

that his position was built up largely after his verbal confrontation with Ackman.

Pump and Dump Although Icahn insists that the rationale behind his trade lies solely with the “great potential” he sees in Herbalife, it is reasonable to assume that his personal vendetta against Ackman may have served as a contributing force. As market commentator and former CNBC host Charlie Gasparino observed “Icahn doesn’t have a clue about Herbalife’s products or the strength of management. In fact, Icahn spends most of his time telling investors for the umpteenth time how much he hates Ackman”. Although the continuous trash talk between the two financiers may be analogous with a junior high school feud, the ongoing saga has extensive implications for market transparency and for Herbalife itself including senior executives and the thousands of employees who are uncertain of their fate as they find themselves increasingly wedged between the egos of Wall Street heavyweights. While the personal drama may prove entertaining for observers, it raises real concerns over the ease at which prominent investors can manipulate market outcomes, an issue that gained greater attention after it was revealed that Daniel Loeb’s Third Point LLC had largely closed its position in Herbalife. For Loeb who publicly affirmed Herbalife as a “compelling long-term investment”, his swift exit bares stark semblance to a typical 1980s pump-anddump scheme. Market manipulation of the pumpand-dump kind occurs when an investor ‘talks up their book’, the market moves up on the news, and then the investor sells the position, pocketing the windfall in the process. It is unlikely that regulatory action will be taken given the influence of market expectations and the inherent difficulties in proving wrongdoing.

Under Pressure Icahn is not used to folding. The 77-year-old, who has spent more than half-a-century in the money management business, in many ways exemplifies the typical 1980s ‘Gordon Gekko’ persona popularised in Oliver Stone’s 1987 ‘Wall Street’. It is rumoured 34


that Icahn himself supplied Gekko’s famous line “If you want a friend on Wall Street, get a dog”. Icahn, who built his reputation as a ruthless corporate raider, is known for pursuing aggressive strategies and corporate takeovers to squeeze returns on his investments. In his takeover battle for Trans World Airlines in the mid 1980s, the then Chairman of TWA famously referred to Icahn as “one of the greediest men on Earth”. Ackman built his name during the financial crisis in 2008 where he correctly anticipated the demise of MBIA, a municipal bond insurer, placing him in a small group of fund managers that escaped the crisis largely unscathed. Like Icahn, Ackman’s resolve remains practically impenetrable. In 2002 Ackman had presided over the failure of Gotham Partners, an investment firm that became entrenched in litigation and investigations by the New York state Attorney General. Unfazed by the failure, he founded Pershing Square just two years later, it is now one of the most prominent hedge funds on Wall Street. The future for Herbalife and its 3 million distributors remains uncertain. The Los Angeles based company will likely face continuous scrutiny to sustain earnings growth in the immediate future while ensuring greater transparency in its reporting standards. In a surprising twist to the Herbalife saga, KPMG, the company’s auditors resigned itself in early April after its independence was compromised when a lead partner that presided over Herbalife was charged with insider trading and securities fraud. One thing is likely to remain fairly certain though; neither Ackman nor Icahn looks set to budge. Meanwhile other prominent fund managers are likely to exert their market-moving potential by riding the volatility, moving in and out of the stock on the slightest bit of headline news. According to data compiled by Thomson Reuters, Herbalife’s stock is 80% more volatile than average. While Ackman hopes that federal regulators will bring an end to the ‘sophisticated pyramid scheme’, it is difficult to imagine meaningful action being taken without a lengthy investigation. Until regulators intervene or someone issues a tender offer for the company, the ego-fuelled war over Herbalife, is likely to remain in stalemate.


UNIT brings you an exclusive interview with David Qian, a trader with Optiver, a global proprietary trading firm. David shares his intriguing story. Hi David, can you give us a brief summary of your background, and what got you interested in trading in the first place? My name is David Qian. I am 23 years old and have a Bachelors Degree in Commerce majoring in Finance and Actuarial Studies from the University of New South Wales. Being a trader at Optiver is my first job and have been full time trading for a year and a half now. As for my interest in trading, I guess it was more I ‘fell’ into the trading profession via a lucky accident. That is to say I heard from friends about one of the most sought after grad positions out there had a challenging mental arithmetic ‘barrier test’ and I went to a careers fair to test myself out. I investigated the trading discipline more after I was told I had passed the first test and told come in to do 2 more (I found out a year later that I had achieved the highest aggregate score in these 3 tests companywide). I was hooked on trading as soon as I saw the offices and the 6x30” monitor desk setups though. It looked so high energy and fun especially with a lot of the traders just in T-shirts, jeans and flipflops. Immediately thought to myself that this was a place I wanted to work.

You’ve been in the industry for one and a half years. What would you say is the most difficult part of transitioning from a university student to a full-time trader? What is the most rewarding part? I would say the hardest part of transitioning from uni student to full-time trader is how full on it is right from the get go. The training program was probably the single most difficult and taxing period in my life thus far. The level of intensity in those few months make the 3.5 years I spent in uni (even during my stint as an Honours student) seem like a breeze. What helped me get through this time was the help and support of HR, the other trainees and my designated ‘buddy’! My buddy had just been through the program 6 months before me and was able to help me out whenever I ran into any issues and was in general just a chill guy I could chat with. The level of professional support available is definitely much better than what you’d get at uni as well. It is not easy being a trader and you are under the pump a lot of the time while the markets are open but at the same time it is one of the most satisfying feelings to see the effort you put in translating directly into results in the live markets. FULLY FRANKED | ISSUE THREE


When you put in the hard yards, do the analysis that has to be done, put on a trade that you believe in and pull off mad calculated plays. That is what I find rewarding. The fact that I can say I’m the #1 options trader in the world in 20ish Australian stocks is pretty cool as well. Having said that even though it’s been 1.5 years, I’m still learning new things everyday and it’s exciting to develop new tools to aid and improve the way we trade.

What advice do you have for students who want to position themselves for a graduate job like your own? Brush up on your mental arithmetic because if you don’t make it past the barrier test you cannot apply for a trading position at Optiver ever again (this isn’t to scare you; you should be excited by this prospect as I was). We hire from all disciplines but if you have any options knowledge, we will ask you about it. There are a few websites out there that have some decent information on trading so if you’re genuinely interested they are good to read. Don’t think that you have to either trade your own portfolio or be an expert in shares though in order to be a trader as you are taught all the basics during training.

Finally, where do you see yourself in 5 years? If I’m not still at Optiver as a high level trader/ partner, on a tropical island somewhere relaxing in a hammock reading a book. Travelling the world wouldn’t be too bad either.



A ‘typical-day’ as a trader 6:50 am - Wake up. Shower. If I have large positions, I’ll check what’s happened overseas overnight. I ought to move into the city, takes me 50 mins to commute to the office. 8:30 am - Get into work. It’s reporting season so read through the stock reports. Check emails and run some spreadsheets to prepare for trading. Grab breakfast and coffee from the cafeteria upstairs. 9:30 am - Chat with team leader about the reporting stocks and/or stocks where I have large positions and the gameplan for them. 10:00 am - Aussie markets open. Liaise with Wholesale traders and quote some OTC markets. Start quoting options on the screen. Wednesday is massage day so we get a 15-20 minute in-chair massage sometime during trading. Trading starts now... 12:30ish - Go upstairs to grab lunch from the cafeteria. Bring it back downstairs and eat at my desk. Aussie markets don’t have a lunch break but trading noticeably quietens down around this time. If I have time, it’s good to talk to IT about any issues/bugs I notice in our systems or do some coding practice. Continue trading... 4:00 pm - Stocks go into closing auction. Pull all quotes but still trade options. 4:10pm - Stocks stop trading but options still trade for another 10 minutes. Stocks can go nuts during the close. 4:20 pm - Option Markets close. Time to play some Table Tennis to relax a bit after trading. 5 pm - Run P/Ls and market statistics for the Aussie Equity Options desk. 5:15 pm - Grab a gym pass from reception. Run through some online exercises to help me learn some basic programming and writing scripts. 6 pm - If not Friday, go gym. If with mate, lift. Else, do some treadmill and a spin/ride class. If Friday, go out for a few drinks and dinner with friends. 7:30 pm - Shower back at work and grab dinner upstairs. Head home.

UNIT Stock Pitch Challenge 2013 UNIT’s inaugural Stock Pitch Challenge, proudly sponsored by Citi and Intelligent Investor, attracted over 100 teams to test their financial knowledge and stock pitching skills in an attempt to win $2000 of money and prizes. Starting with workshops run by Citi analysts, attendants had the chance to pick the brains of proffesionals working in industry. Next, contestants were to apply their finanical knowledge through a more hands on approuch in the heats round, where all teams were asked to analyse Harvey Norman over a week and present to a panel of judges. Only 6 teams made it through to the finals round, where each team were to pick a company from the mining industry and present to our panel of esteemed judges in the finals event. The finals event presented good networking opportunities for UNIT members, with the CEO of Citi Australia in attendance. UNIT would like to thank all the participating teams as well as everyone who attended the Finals Event!

The Winners for 2013 are: 1st place: The Anomalies – University of Sydney Edward Hyon Victor Yoon Duncan Lee Conrad Brown 2nd place: CZR Investments – University of Sydney Bravin Ragavan Thomas Chen Jack Zhang 3rd place: Equitals – Macquarie University Arish Dutt David Sneath Non-Commerce Prize: GJRY – University of New South Wales Jimmy Zhou Rick Trinh Gary Yan Yang You Congratulations and enjoy your prizes!



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Fully Franked - Issue 3  

The Mining Edition (Semester 1, 2013)