by Elliott R. Morss, Ph.D.

Introduction

The world became pre-occupied with economic recovery, but then we had a coal mining disaster and a massive oil spill, reminders that our energy problems have not gone away. The global recession caused energy use to fall in 2009 for the first time since 1981, but the International Energy Agency (IEA) projects energy demand to grow by 41% between 2007 and 2030[1] unless major policy changes occur.

Table 1. – Energy Projections, Current Policies

Source: IEA

* Million tons of oil equivalent (MTOE), is a standardizing measure for energy;

one million tons of oil equivalent is the energy generated

by burning 1,000,000 metric tons of crude oil.

To meet this growth in demand, fossil fuels (oil, coal, and gas) are expected to grow most rapidly. Coal use is projected to grow by 52%, with its share increasing from 26.5% to 28.8%, unless major policy changes occur. Under this scenario, the number of railroad cars loaded with coal leaving mines every day would increase from 225,687 to 343,044.

IEA Projections: How Realistic?

These projections are disturbing: if nothing changes, forget about efforts to curb global warming. And sadly, there are a couple of reasons to think they are quite realistic.

• Momentum/existing infrastructure: 343,044 coal cars leaving the mines daily – a reminder that the world has invested a tremendous amount in its “energy infrastructure delivery system”, and any major change will be costly.
• Oil companies control oil and gas supplies: and they want to protect their markets for these products; and while they don’t work entirely in consort, they will work to keep prices low enough to keep alternative energies from being profitable in the foreseeable future. 

 Consider now coal and nuclear energy. Both industries are profitable at existing oil prices. What can we expect in these two industries?

 Coal

The World Coal Institute likes to remind us that there is enough coal to last us over 130 years at current rates of production. In contrast, proven oil and gas reserves are equivalent to around 42 and 60 years at current production levels.

But there are problems. Coal travels well in trains, but ocean transport is very expensive. So while Russia and the US are sitting pretty with more than 100 years of coal left at current production rates, coal will never be a leading export.

And then there is the China situation to consider. In my last energy piece, I noted that 72% of China’s energy comes from coal. China is using 2.4% of its proven reserves of coal annually, suggesting it has coal supplies left for 42 years at current use rates. Of course, more reserves will be discovered, but China is growing rapidly, and that growth will increase coal demand.

Suppose coal demand grows at the same rate as GDP. Table 2 indicates what this means: a growth rate of 8% implies that China has only 32 years of coal left. To put this in context, the World Bank estimates that China’s GDP will grow at 9.5%, 8.5%, and 8.2%, in 2010, 2011, and 2012, respectively.

 Table 2. – China Coal Use at

Different GDP Growth Rates

 Of course, China is not sitting on its hands: it is scouring the world for oil and gas contracts. The China government could be thinking of trying to buy control of BP as its stock price falls.

But its actions in the nuclear sector are most interesting.

 Nuclear

As Table 3 indicates, estimated for installed nuclear capacity in future years continue to rise. The second column is the IEA’s estimate for 2030 mentioned above. Column 3 is a second projection done by the IEA is major policy changes to reduce global warming occur. The OECD is now estimating as much as 680 GWe capacity in 2030, and The International Atomic Energy Agency (IAEA) now anticipates at least 73 GWe in net new capacity by 2020, and then 511 to 807 GWe in place in 2030.

 Table 3. – Installed Nuclear Capacity Estimates (GWe)

 Feasibility – Costs

 The World

Is this feasible? What will it cost? A joint study by the Nuclear Energy Agency of the OECD and the International Energy Agency estimated that is would cost $3.974 trillion (in 2008 constant US$) to increase global nuclear capacity from 370GWe in 2007 to 1,200GWe in 2050.That works out to US$4.8 billion per GWe. That figure is consistent with other numbers that range from US$5.0 billion per GWe in the US to US$1.5 billion per GWe in China.

A jump from 328 GWe to 680 GWe installed capacity would cost US$1.7 trillion at US$4.8 billion per GWe. Let’s come at this from another direction.

 Table 4 provides data on how electricity is generated worldwide. Suppose we want to replace half of the electricity generated by coal to nuclear. 1 GWe can generate 8,760 GWh in a year. That means you would need 470 GWe of installed capacity to produce  4,113,975 GWh annually. At US$4.8 billion per GWh, that would require an investment of US$2.3 trillion.

Table 4. – World Electricity, by Fuel, 2007

Source: IEA

Is such an investment feasible? With global GDP of US$60 trillion and investment normally running at 22%, or $13.2 trillion, finding US$2.3 trillion over a couple of decades should not be a problem.

 China

Let’s look at China. The World Nuclear Association (WNA) reports that China, with eleven operating reactors on the mainland, has 22 reactors under construction. China aims at least to quadruple its nuclear capacity from that operating and under construction by 2020. It hopes to have 250 GWe capacity by 2030.

Table 5 provides data on electricity generation in China. Note the extremely heavy dependence on coal.

Table 5. – China Electricity, by Fuel, 2007

Quadrupling its nuclear capacity would mean being able to produce 248,520 GWh per year. That increase, 186,390 GWh, would require increasing its capacity by 21GWe. Using US$2 billion as the GWe cost (some estimates for 1 GWe in China are as low as US$1.5 billion), this will cost only US$42 billion. This should be no problem for China.

But let’s consider something somewhat more ambitious: could China replace half its electricity generated by coal with nuclear? That would mean increasing nuclear production by 1,328,217 GWh annually. That would take an additional 151 GWe of capacity. At US$2 billion per GWe, that would cost US$302 billion. With a GDP of US$5 trillion annually, this investment would also seem feasible over a couple of decades.     

 Feasibility – Technical

There are exciting new technical developments taking place in the nuclear industry:

• Breeder reactors are under development;
• More advanced reactors such as Bill Gates’ Traveling Wave Reactor are in the planning stage;
• Work is on-going to use Thorium in reactors; Thorium is 4 times as abundant as Uranium;
• Efforts to obtain uranium from the sea continue.

 But a word of caution: In our new information age, we tend to assume that all technical problems can be resolved. But things can and will go wrong. The nuclear energy system is complex. And although it is better understood than it was 20 years ago, there will be more unanticipated problems.  

Feasibility – Other

The joint study referenced earlier by the Nuclear Energy Agency of the OECD and the International Energy Agency gave the impression that most of the concerns with nuclear are manageable. But there are extraordinarily complex logistical and regulatory problems that still must be faced. China is in a much better position to deal with these problems than is a democracy.

Investment Opportunities in Nuclear

Who develops and produces nuclear power generating plants? Westinghouse, originally an American company, is now part of Toshiba. Toshiba is too large for any growth in its nuclear business to have a significant impact on its profit. AREVA (CEI.PA) is the major European nuclear group: the French government holds a majority of its stock. General Electric, Toshiba, and Hitachi are also big players in nuclear. But again, their other operations are too large to make them a nuclear pick. The Russian and Canadian governments are also important nuclear players.

 How about uranium as a commodity? Very tricky. The speculators are already in. There are a lot of uranium reserves that can be tapped. The one thing we do know: nuclear power will grow rapidly over the next decade, and the demand for uranium will grow along with it.

I am sure there are some great nuclear investments: every industry has someone making “widgets” that turn out to be very profitable.

by Elliott R. Morss, Ph.D.

Introduction

Several points about equity markets:

•  They are growing globally.
• An increasing number of equity trades are computer driven.
• A primary activity of private equity firms is to take publicly traded companies private.
• In the US, the Sarbanes-Oxley Act passed in 2002 made it more costly and burdensome for public companies to satisfy SEC regulations.

 How these factors affect equity trading, now and in the future, is discussed below.

 Global Equity Markets

 Table 1 provides data on stock market values worldwide.

 Table 1.  – Stock Market Capitalization (% share)

n.a. – not available

Source: World Federation of Exchanges

 Note that the lead markets in all regions (US, Japan, and the UK) are losing their dominance to other markets in their respective regions. Japan’s decline is most pronounced. China’s markets (Shanghai and Shenzhen) are now slightly larger than Japan’s, while India now ranks fourth in Asia, just behind Hong Kong. Although the US exchanges share has fallen, they still dominate all others by a wide margin.

 Table 2 provides global data on the number of listed companies.

 Table 2. – Companies Listed on Stock Exchanges

n.a. – not available

Source: World Federation of Exchanges

It is notable that unlike the dominant countries in the other regions, the number of listed companies in the US has fallen by 36% since 1995. Perhaps some of this decline in recent years is attributable to more burdensome regulatory requirements and the activities of private equity and merger/acquisition companies.

Computer Driven Trades   

A recent Bloomberg Businessweek article “The Machines That Ate the Market” made a number of interesting points about computer-driven trading:

1.   History

• “Historically, the NYSE and Nasdaq were nonprofits seen as utilities that served the public interest…. Beginning in the 1970s, Nasdaq, and, later, additional electronic rivals, gradually eroded the NYSE’s dominance…. Newer profit-making exchanges started explicitly to benefit the firms that ran and patronized them.”
• “Directives from Washington have encouraged the dispersal of trading. Some 50 exchanges and other electronic venues across the country now compete for securities business. The volume of equity traffic controlled by the NYSE fell from 80 percent in 2005 to 50 percent in 2007 and then to less than 25 percent this year…. Wall Street’s extreme makeover has achieved its main goals: greater efficiency and much lower commissions for the pension and mutual funds, insurance companies, and endowment managers that invest in equities.”
• “…the market is now dominated by quick-draw traders who have no intrinsic interest in the fate of companies or industries…. High-frequency traders (HFTs) now account for as much as 60 percent of daily volume….The most prolific HFT outfits, such as Getco in Chicago, Tradebot Systems in Kansas City, Mo., or RGM Advisors in Austin, Tex., can individually generate as much as 5 percent or 10 percent of all the stocks traded in the U.S. on a given day.”
• “HFT shops move enormous quantities of stock in fractions of a second.” They locate their computers near the mainframes of wholly automated trading venues “because the distances that their orders travel, measured in feet, can determine profit or loss.”
•  “On its Web site, Wolverine in Chicago says its servers receive direct data feeds from more than 15 exchanges and execute more than 1.5 million orders a day.”

2.     Today

Amazing! What does it all mean for individual investors?

Analysis

The article documents things have changed dramatically.

The HFTs)…argue that all that extra buying and selling provide the liquidity that makes the market more efficient.

1. There is no question that some of what the HFTs are doing keeps markets worldwide accurately reflecting value – classic arbitrage, e.g., “The quants use a range of strategies. One is simultaneously posting bids and offers for ever-changing amounts of a single stock. Prices tend to vary by minuscule amounts on different electronic exchanges, so a stock can be bought at a lower price on one, then sold instantly at a higher price on another…. They direct their mainframes to sift the information flows for minute discrepancies, such as when futures contracts fall out of sync with related underlying stocks.”
2. But there are other computer programs the HFTs use that do just the opposite. Remember, the HFTs primary aim is to make money “with no intrinsic interest….” Suppose the HFTs are betting lots of money on markets to fall. They have carefully studied every facet of momentum quantitatively, and they know how to generate momentum, i.e., if stock prices start down, they know what sorts of trades will accelerate the downturn. 
3. Perhaps one trader does not have the clout to cause a major market disruption. But it is reasonable to assume that most of the large computer driven traders have their own momentum generating programs. What if they all try to generate momentum downward at the same time? It can be quite disruptive.
4. The quants have also studied how market movements are correlated. They know that bad economic news in the US will cause its markets to fall. They also know a fall in US markets will have a ripple effect globally. They can get into other markets before anyone else and short them, thereby accelerating the ripple effect.  
5. Consider what has happened on global markets in the last year. Asia and Latin America are out of the recession, but their markets move up and down with Western country markets. Why?

Before answering that question, let me document my statement with numbers. The so-called coefficient of determination (R²) measures the extent to which the movement in one variable can explain/predict the movement in another. An R² of 1 would mean the movement in one variable can completely explain the move in another; an R² of 0 means there is no correlation between the two variables. Consider first how stock indices, funds, and ETFs from different regions have performed since 2007. In Table 3, the R²s for these variables is provided against movements in the S&P 500. In other words, how much of the day-to-day fluctuations in these other variables can be explained by movements in the S&P 500?

Table 3. – R² of Markets vs. S&P 500

(1/31/2007 – 6/4/2010)

Source: Yahoo Finance

To me, these figures represent markets where values are being pretty accurately represented. The banking collapse and resulting global recession was the result of problems in the US, Europe, and Japan. Note that the R²s for Asia and Latin America are much lower than for Europe and Japan.

But now look at what happened since worries about the four weak sisters of Europe started affecting the markets. As I have been writing for some time, Europe, Japan and the US are still mired in the recession and debt. In contrast, Asia and Latin America are fundamentally debt-free and emerging from the recession. In light of this, one would expect Asian and Latin American markets to be performing much better than Western markets.

As Table 4 indicates, this is not what has happened. Movements in the FTSE 100 are more highly correlated with market movements in Asia and Latin America than the US or Japan.

Table 4. – R² of Markets vs. FTSE 100

(4/23/2010 – 6/4/2010)

Source: Yahoo Finance

Table 5 provides data on what has happened to stock markets since the European worries started. Asian and Latin American markets have fallen more than Western markets.

 Table 5. – Stock Market Performance

(4/23/2010 – 6/4/2010)

Source: Yahoo Finance

Why is this? Does it have anything to do with the HFTs, or is it just the result of the relatively small markets of Asia and Latin America being more affected by Western liquidations than the underlying strength of their economies?

 Conclusions

 What can we expect? The only thing I can say with certainty: the emergence of HFTs as dominant global players will mean more stock market volatility.

 by Elliott R. Morss, Ph.D.

 Introduction

I recently interviewed George Ball, the Chairman of Burpee Gardening, about the economics of the mail order/nursery plant/seed business (I will post that interview shortly). He said the vegetable seed business is growing rapidly, partly because in tough times, people want to take advantage of the cost savings resulting from growing vegetables from seed.

 That got me thinking: at 10 cents a tomato seed, there is definitely a cost savings if you can just rough up the soil, drop in a seed, and get a healthy tomato plant to grow. But living in New England, it is not quite that simple. In what follows, I will take you through what I do and what it costs.

Seed Costs

 Certainly seed costs are low enough to warrant growing from scratch, if that were all there was to it. The following seed prices are taken from my recent article comparing gardening catalogues.

 Vegetable Seed Prices

If we could only live on lettuce, basil, and beans! 

Starting Seeds Indoors

 Living in New England requires that I start growing seeds indoors if I want vegetables before fall. What do I grow the seeds in? In essence, there are two possibilities: buy an all-in-one seed-growing package, or buy separate pieces and put them together. A good example of the former is the APS system that has been offered by Gardener’s Supply for many years. In essence, you get a water-holding tray, a capillary mat, soil holders and a plastic cover at a cost of $19.95 for one that holds 24 plants. You can get 2 with soil for $49.94. A. M. Leonard’s Gardeners Edge offers essentially the same product. Burpee offers something similar – its “ultimate growing system” has a reservoir, a mat, soil and 72 soil holders (the holders are smaller than the other two) for $19.95. The attraction of these systems? In addition to being all-in-one packages, they are self-watering: you can go away for a few days without losing your seedlings. The systems can be reused but new soil will be needed (more on soil costs below).

 All-In-One Sytems

 I turn now to the separate pieces. “Pot-Makers” allow you to make your own holders. In essence, you wind newspaper around the pot-maker to make a soil holder. Pinetree charges $14.95 for one, Burpee charges $19.95.

 Johnny’s offers “hand-held soil block makers”. You press down using a block maker and you get a block of soil that stands on its own. One that presses out 2 square inch soil blocks 4 at a time costs $29.95.

 And then there are the pellets – held together by a biodegradable netting ( that I do not find all that biodegradable the next spring):

• The Jiffy-7 peat pellets;
• Coir pellets.

So how do all of these products compare? To answer this question, we need comparable soil prices. Most catalogues offer seed growing soil, quoted either in quarts or cubic feet. So I asked, how many 2-inch square blocks (8 cubic inches) of soil can one get from each seller’s soil? You need to know there are 1728 cubic inches in each cubic foot and 67.2 cubic inches in each quart to make the conversion from bags of soil quoted in cubic feet or quarts in the catalogues to square inches. And that, coupled with the catalogue prices, allows me to the price per square two-inch (8 cubic inch) block shown in the following table.

Price per 2- Inch Block of Seed Starting Soil

 According to this Table, Jiffy’s seed starting mix (not pellets) sold by Harris is the lowest priced soil. And Harris’ shipping fees are based on shipping value, not weight. How do these soil prices compare with the price of the Jiffy pellets (a peat growing medium held together by a biodegradable netting)? I use the “extra-depth” Jiffy-7. I pay Harris $56.95 for 500 pellets, or 11 cents per pellet. Park offers 200 coir pellets for $19.95 or 10 cents a disk). Clearly, the Jiffy soil is cheaper than the Jiffy pellets. But pellets don’t need a holder. If you buy the soil, you will need to use a pot-maker, a soil block press, or just buy trays with built-in cells.

 Lighting

 To grow a significant number of seeds indoors, you need lighting. I use a 3-level fluorescent stand with 12 growing trays of 10’ x 21.5” for a total growing area of 2,580 square inches. I have been using the extra-deep Jiffy-7 pellets. I can fit 40 pellets comfortably in each tray, or 480 seeds in all. I don’t transplant.

 This lighting apparatus in available from A.M. Leonard’s “Gardeners Edge” for $600 or from Harris for $720. I believe this lighting system bought from Leonard will be as good or better in price per square inch of growing area than any other lighting system on the market.

 My tomato plants get special treatment. I use a now discontinued Gardener’s Supply APS system where each cell is 4” inches square. When the plants get too large for the fluorescent stand, I stake them and take them to the basement where I have a halide light hanging from a beam. They don’t go outside until the Memorial Day weekend.

Heating mats are simply too expensive for me, and my vegetables grow without them.

 Outdoors

 There is really no limit on what you can spend once it is time to move your plants outdoors.

 I believe the following table constitutes pretty close to the bare minimum of what is needed. You really need a small seed dispenser, but maybe you could do without the soil-testing machine. The catalogues convince us we need fertilizer and fertilizer sprayer. But how about the need for the bean innoculant and tomato blossom set spray? I don’t know, but I get them.

 Every year, I buy a few bags of manure/compost. I don’t buy red mulch any more for my tomatoes. They do fine without it. I do need tomato, bean, and cucumber supports (I use the metal cages. Soil is tough on skin and nails, so gloves are needed. A weeding instrument for gardeners is like a good knife for a chef – they come in many different forms but are essential. Rabbits ate all my green peppers and beans last year and it will not happen again. I will start with sprays (Liquid Fence). If that does not work, I will have to buy fencing.

 There are many different ways to water your garden. But whatever method you use, you will at least need a hose with a nozzle. I use a combination of sprinklers and soaker hoses on a timer. You really don’t need a mechanical tiller, but you do need clippers and to be politically correct, a composter.  

On all of these products, I recommend that you first check with Pinetree and Gardeners Edge on price. Gardeners Edge seems to be mimicking Gardener’s Supply but with lower prices.

But I should say: I will always have an allegiance to Gardener’s Supply – so many original great ideas! What does that mean? I will always buy their new ideas from them – but I will not buy upside down plants from them or anyone.

 I have left out a lot. For example, water and electricity costs. And I have to get my trees trimmed back every other summer at a cost of $1,500 a trim.

 I now want to return to George Ball’s claim that there are great savings in growing vegetables from seed. In the following table, I have two columns for costs: the middle one is for annual costs and the right one is for investment costs. I arbitrarily assume the investments will last six years.

Growing Vegetables from Seed: Summary Cost Table

 This assumption is reflected in line 27 where I take the total investment cost ($1,431) and divide it by 6. In line 28, I get the costs per seed planted. For the annual costs, I divide the total ($199.80) by 300 seeds. For the investment costs, I divide $238.50 by 300. That results in a total cost per seed of $1.46.

 What does it all mean? George Ball was right: at $1.46 for a vegetable plant, you are doing a lot better growing than buying your vegetables in the market.

On May 9, I urged you to bet against the dollar – http://www.morssglobalfinance.com/investment-strategies-iii-specific-suggestions/.

Since then, the dollar has lost 10% against both the EUR and Japanese Yen. On June 11, I said buy commodities – http://www.morssglobalfinance.com/investment-strategies-iv/, and the IMF’s overall commodity price index has increased 5%.

On June 11, I also made the specific suggestions shown in Table 1.

Table 1. – Morss Recommendations June 11, 2009

* ETF =exchange traded fund; M = mutual fund.

Now, I could crow about these results. After all, on an annualized basis, they are double the returns presented in this table. But this was a good period for all stock markets – even the S&P 500 was up 16.2%. And I would be the first to admit I am not a good predictor of stock market performance. After all, I completely missed last year’s global stock market collapse that caused a $36 trillion asset loss! And I, like better known investment gurus, personally found “my own inventive ways to lose money on a colossal scale during these last 15 months.” (Ben Stein, NYT, December 26, 2008). And finally, I am a firm believer in the random walk theory that says all information is immediately reflected in stock market prices so the results of stock market picks are pretty random (see Burton G. Malkiel, “A Random Walk Down Main Street”: W.W. Norton).

However, I remain resolute in trying to apply economic logic to stock markets, so consider the following.

Shouldn’t stock markets in countries growing rapidly increase more than markets in slower growing countries? If a country’s GDP is growing rapidly, the primary components of GDP – Consumption and Investment – also have to be growing rapidly. It should follow that the earnings/profits of companies publicly traded in the rapidly growing countries should also grow faster than companies listed in slower growing countries. And if earnings grow more rapidly, stock market prices should go up more rapidly.

I think there is logic in this line of thinking, so let us explore it further.

Table 2 presents the World Bank GDP growth projections for selected regions and countries. Look at China and India – a global recession in these countries means the growth rate falls from 10%+ to 5%+! And the country of South Africa outperforms Latin America and the Caribbean as a region. Now look at Euro, Japan, and the US – large downturns this year followed by meager growth next year, and that growth might be wishful thinking.

Table 2. – World Bank GDP Growth Projections

These figures alone should raise questions about investing in the US, EURO, and Japan stock markets.
But maybe the stock markets of certain countries are overpriced. The price/earnings ratio (P/E) is often used to gauge whether a stock is overpriced. So let us check on P/E ratios of countries. And if stock prices accurately discount country growth rates, should not the P/E ratios of countries with higher growth rates be higher that those with lower growth rates?

Table 2. – Region/Country Projected Growth Rates and P/E Ratios

Source: Data compiled by Bloomberg

Table 2 lists countries by region by projected 2009 growth rates. And as can be seen, countries project to grow more rapidly (or decline by smaller amounts) do, for the most part, have higher P/E ratios than those with lesser growth prospects.

Peter Lynch is considered one of the greatest investment gurus of all time (for more on gurus and how to invest using their strategies, see John Reese’s Validea.com). Lynch ran Fidelity’s Magellan Fund from 1977 to 1990. Its asset value grew from $20 million when he started was $13 billion when he left. Lynch liked to adjust the P/E ratio for the expected growth rate. His reasoning was that companies expected to grow should have higher P/E ratios. So he divided the P/E ratio by the projected growth rate (P/E/G). Projected growth rates and P/E/Gs are presented in Table 3.

Table 3. – Growth Rates and P/E/G Ratios

for Selected Regions/Countries

I think the P/E/G ratios in Table 3 give a great frame of reference for thinking about country investments. I like India and China. Argentina has great prospects but some governance problems to work out – see http://www.morssglobalfinance.com/argentina-effects-of-global-recession-and-future-prospects/. I like South Korea and South Africa for investments. Peru has had tremendous growth in recent years, but it is small…. Chile is well managed but in essence is a one export country (copper) see http://www.morssglobalfinance.com/chile-effects-of-global-recession-and-future-prospects/. Brazil’s prospects are better than any other Latin American country. And unlike China and India with high population densities and as a consequence are resource poor, Brazil is natural resource rich – http://www.morssglobalfinance.com/brazil-effects-of-global-recession-and-future-prospects/.

Am I worried about the recent run up in stock markets and commodity prices? Yes, and I have written about it – see http://www.morssglobalfinance.com/prices-unemployment-and-the-global-economy/. But you will never get the timing just right. And it is too late in the recession to stay on the sidelines with any investment funds.

Specific Investment Suggestions

How do you “bet on countries” while at the same time bet against the dollar?

1. To “bet on countries” use either ETFs or mutual funds. Do not use mutual funds unless the 3-5 year performance is significantly better than the appropriate ETF index fund. ETF fees are lower and they are easier to buy or sell than mutual funds. For more on ETFs, see Don Dion’s ETF Report – http://www.fidelityadviser.com/readme_etfr.html.

2.   To bet against the dollar, make sure that the ETF or mutual fund you choose does not hedge against currency fluctuations. A few do – for example see Longleaf shorting the Yen (and losing money) – http://www.longleafpartners.com/pdfs/09_q2.pdf. Just check – ask if the mutual fund or ETF hedges against currency fluctuations.

Table 4 provides some specific investments suggestions.

Table 4. – Investment Suggestions

I am not an investment adviser and nothing I say should be taken as a recommendation to buy or sell an asset.

In an earlier article (http://www.morssglobalfinance.com/the-economics-of-the-global-entertainment-industry/), I examined the global entertainment industry, where entertainment was is defined as goods, services, or other activities that people pay for to enjoy in their leisure time. The total sales by entertainment category presented in that article are summarized in Table 1.

Table 1. – Global Entertainment Expenditures

David G. Schwartz, the author of the great history of gambling: “Roll the Bones: The History of Gambling” (Gotham Books: NY, 2006), suggested that that my gambling total was low. That, coupled with the fact that I had already planned to write on global gambling, led to this article.

Gambling Defined

The common definition of gambling/gaming is “playing games of chance for stakes”. That definition would include the recent activities of AIG and large global banks. However, this article will be restricted to the following gambling activities:

• Casinos;
• Gaming Machines;
• Lotteries;
• Charitable Betting (Bingo, etc.);
• Other Betting (including horse racing).

Common statistics used for gambling data are the Global Gambling Yield (GGY) and the Gross Gambling Revenie (GGR). These statistics are defined as gross bets minus winnings payments (GGY and GGR are a gross figures in the sense that they do not include the costs and taxes of the gambling institutions). I use GGY/GGR data in this article (for more on gambling definitions, see the Appendix).

As can be seen in Table 2, Schwarz was right: my gambling total in the earlier article was too low. The global total for 2007 was $337.1 billion which puts gambling just below drinking, drugs, and sex in entertainment outlays.

Global Gambling

The most authoritative data on gambling comes from the Global Betting and Gaming Consultants (GBGC). Their estimated global GGY totals for 2007 are presented in Table 2. Casinos are the primary vehicle for gambling.

Table 2. – Global Gambling Revenues (GGY), by Method

Source: GBGC Analysis

The gaming machine contribution is even larger than indicated because GBGC includes gaming machines in casinos in the casino category. Pari-mutual wagering is included in the betting category.

Table 3 presents data on gambling by region. North America and Europe generate the most gambling revenue with Asia & the Middle East in third place.

Table 3. – Global Gambling Revenues (GGY), by Region

Source: GBGC Analysis

Table 4 disaggregates Table 3 data by listing gambling by the leading countries. The countries listed include 91% of total global gambling revenues. In 2006, Macau revenues were slightly less than those of Las Vegas. Since then, Macau’s revenues have exceeded Las Vegas’ revenues.

Table 4. – Global Gambling Revenues (GGY), by Country

Source: GBGC Analysis

In Table 5, Table 4 figures are divided by each country’s population. This highlights the gambling propensities of each country. It also shows “gambling destination” countries. Clearly, Antigua and Macau are leading destination countries.

Table 5. – Per Capita Gambling Revenues (GGY), Leading Countries

Source: GBGC Analysis and UN Demographic Data

In addition to Macau, Australia, Hong Kong, and Singapore are popular gambling sites for foreigners. South Africa is also an important destination site for foreigners.

US Gambling

Turning now to the United States, Table 6 presents gambling revenues by method. Out of a total $92.3 billion, casinos took in $60.4 billion.

Table 6. – US Gambling Revenues (GGR), by Method, 2007

Source: American Gaming Association

As can be seen from Table 7, almost all states allow Charitable Games. Commercial casinos do not have the political acceptance that Indian Casinos have. Only two states, Hawaii and Utah, allow no gambling.

Table 7. – States Allowing Gambling

Source: American Gaming Association

In Table 8, the areas with the largest casino revenues are presented.

Table 8. – US Casino Revenues (GGY), by Region

Source: American Gaming Association

Economic Analysis

1. Long Term Revenue Growth

According to GBGC data, gambling is a growth industry. Table 9 indicates that globally, gambling revenues grew by 69% in the 1999-2007 period. Extremely rapid growth occurred in gaming machine betting, while informal gaming was the only method to decline.

Table 9. – Global Gambling Revenue Growth, by Method

Source: GBGC Analysis

Table 10 provides data on gambling revenue growth by region. North American revenues continue to grow rapidly. There is little legal gambling allowed in the Middle East, so the bulk of the gambling growth in that regions stems from Asian sites. South African growth is largely the result of expatriates working throughout Africa.

Table 10. – Global Gambling Revenue Growth, by Region

Source: GBGC Analysis

According to the American Gaming Association, US gambling revenues increased 59% over the 1999-2007 period, with commercial casinos lagging the overall average.

Table 11. – US Gambling Revenue Growth

Source: American Gaming Association

Overall, gambling worldwide is growing rapidly and is gaining greater acceptance. This is enhanced by it being integrated into an overall entertainment experience. US mega churches and Disney resorts throughout the world have learned this lesson: whether your initial focus was religion or children, you maximize revenues by broadening out your entertainment offerings. As part of the growing entertainment experience, slots have come a long way from just “pulling the crank”. According to William Pfund of the WMS Company speaking at a conference call hosted by USA Mutuals, slots now incorporate the technology of the digital game machines, and these machines are selling well.

Internet gambling bears watching. According to a new Interactive gambling report from GBGC, the online gambling yield surpassed $20 billion in 2008. H2 Gambling Capital estimated that Internet gambling revenue was estimated to be $5.9 billion in 2008 from players in the United States and $21.0 billion from players worldwide. A recent WTO decision against the United States by Antigua opens the possibility for offshore horse betting groups to compete legally with parimutuel betting groups. Only veteran gamblers are likely to gamble on the Internet, and the convenience of doing it on the Web could reduce their visits to gambling institutions.

b. The Recession

Gambling is often discussed along with drinking and smoking as the “sin” industries. They are lumped together in part because all are seen as addictive and consequently recession resistant. But gambling as an industry does not perform like tobacco or alcohol. In the current recession, tobacco sales have been hardly affected while alcohol sales are off only 2%. Gambling revenues, in contrast, are off 12-15% globally.

There are several reasons for the differences.

First, a large portion of the adult population consumes alcohol, and addiction levels are quite high. One sixth of adults smoke, and nearly all smokers are addicted to nicotine.  The American Gaming Association reports that studies have found the prevalence rate of pathological gambling to be close to 1 percent of the U.S. adult population (American Gaming Association). So one major difference is that a very small portion of the population is addicted to gambling.

Second, gambling is increasingly being promoted as an overall entertainment experience. In fact, a recent study has documented that more than 60% of casino revenues are generated by non-gambling activities. This makes a gambling outlay far more like a discretionary consumption item than a necessary addiction purchase.

Charles Norton, Portfolio Manager of the USA Mutuals Vice Fund reported on a recent USA Mutuals conference call that with the exception of Macau, gaming has not started to recover as yet. There is considerable over-capacity in the industry with a large number of new locations being built.

c. Equity Investments

Dr. K.C. Ma, co-author of Sin Stock Returns has reported on the same conference call that the gambling industry goes down more and later in a recession than the overall market. Dr. Ma reports further that gambling usually recovers more and earlier than overall market. But so far, it is not coming back – in part because of new casino supply coming along, and fear of Internet.

GBGC has developed an index of the 50 largest global gambling companies presented Chart 1 below. It appears that gambling stocks are far more volatile than the overall market. From its peak at the end of October 2007 of approximately 185, the GBGC 50 Index fell to about 55 in early November 2008, or by 70%. Over the same period, the S&P 500 fell 42%. Over this period, gambling stocks lost more than $150 billion in value.

Chart 1. – GBGC 50 Index January 2005 to September 2009

Source: GBGC Research

d. Investment Outlook

In earlier articles, e.g., http://www.morssglobalfinance.com/investment-strategies-v-the-global-recession-and-financial-management/, I made two points to guide stock market investing as the world gradually recovers from the global recession:

• The dollar will weaken as the United States tries to finance its huge deficits;
• The growing middle classes of emerging market countries will lead the world out of the global recession.

Given these guidelines, one should search for value in gambling stocks in Latin America and Asia. Macau is not the only locale to investigate, but it is interesting. There is a tremendous capacity increase coming in Macau, but the gambling demand is already rebounding there. And the China government is using a mechanism that allows it to increase and curtail demand at will: to curb demand, it restricted Macau visas for Chinese residents.

In terms of investment vehicles, one might want to consider The Vice Fund of USA Mutuals (VICEX). One of its investment categories is gambling.

I am not an investment adviser and nothing I say should be taken as a recommendation to buy or sell an asset. I do not hold any shares of VICEX.

APPENDIX

Gambling Definitions

For my global gambling total, I think I want total bets. I say I think because it can be argued that betting totals are unlike other entertainment expenditures: bettors do not expect to lose all they bet. In fact, “rational” gamblers have a pretty good sense of the odds, and they view their losses as the entertainment charge for gambling. Viewed in this way, the GGY/GGR statistics are the proper entertainment expenditure figure for gambling.

For those who believe total betting is the number I should use, I can use GGYs if I have “institutional take” data. In the following two tables, I present Nevada data on slots and games/tables and data on the Massachusetts State Lottery.

Source: Nevada Gaming Commission

Source: Massachusetts State Lottery

Assume that for all other gambling, the “house take” is 15%. Applying GGY multipliers using these assumptions results in the data presented in the following table.

Total global bets in 2007 were $2.6 trillion!