25th January 2011: Rare Earths ‘Day Trading’

In mid-2010, Ben Eltham and I discussed various ‘emerging’ threats to traditional military strategy. One of them was rare earths: 11 elements used in defence, automobile applications, consumer electronics, and next generation turbines. We foresaw but didn’t act on the speculative bubble that occurred in rare earths between October and December 2010. There’s a lot driving market sentiment: ‘China’, ‘commodities’, ‘political risk’, ‘first mover advantage’, ‘iPods’, ‘greentech’, ‘next generation automobiles’, and ‘defence’.

Jason Miklian, a researcher at Oslo’s Peace Research Institute did act. Miklian invested in ‘day trade’ stocks of rare earth companies using $US9000 in personal savings. His account is revealing for several reasons. Miklian also foresaw the speculative bubble and continued to do fundamental research on the sector and markets. He timed his market entry. Then, Miklian lost what he had gained through attempting to ‘short’ the market in December 2010.

Miklian blames the market but perhaps the error lies in his ‘day trading’ strategy. Miklian traded a small account. He used options which increased his potential profits yet could quickly engulf his trading account if wrong. He bet on firms like the US-based Molycorp (MCP) which, although their stockprice doubled, are still years away from resolving the production problems with its Mountain Pass facility. Many other firms had questionable earnings and their stocks rose on mainly speculative activity. Others are relying on bullish activity when new production facilities come online in the next 18 months and major deals are signed. What Miklian perhaps needed was a valuation model and assessment of future earnings as well as his sector research. Finally, Miklian mistimed his exit. The volume of trade activity means that despite some market skepticism, trading in major stocks will continue. Technical analysis suggests that stocks of rare earths companies will trade within a range, rather than suddenly collapse.

24th January 2011: Sir James Goldsmith’s Acapulco Strategy

Sources: Geoffrey Wansell’s Tycoon: The Life of James Goldsmith (Grafton, London, 1987) and episodes 3 and 4 of the Adam Curtis documentary series The Mayfair Set (BBC, London, 1999). With thanks to Tara J. Roberts for introducing me to Wansell’s Tycoon and to Goldsmith’s financial strategies.

Wansell’s biography depicts Goldsmith as a private and shy financier, who developed a careful approach to risk playing backgammon and cards (Wansell, 57), and briefly considered joining Melbourne’s fire brigade (Wansell, 60). Curtis focuses on Goldsmith’s time at John Aspinall’s Clermont Club (www.clermontclub.com), the Private Eye lawsuit, and Goldsmith’s status as a 1980s corporate raider financed by ‘junk bond’ market-maker Michael Milken and his firm Drexel Burnham Lambert (Wansell 304-305, 315, 359).

The major themes of Goldsmith’s life were entrepreneurship, meritocracy and individual initiative as a path to prosperity. He adopted a European, Parisian stance in England that differentiated him from other entrepreneurs (Wansell, 139, 371). Wansell suggests Goldsmith was like a clan leader: focussed on preserving his family name through primogeniture, conservative in outlook, and seeking to sustain his father Frank Goldsmith’s legacy, and the Goldschmidt dynasty. “To me marriage is having a child, not signing a piece of paper,” and “marriage is more than a piece of paper, it means supporting your family,” Goldsmith noted (Wansell 73, 262), in defence of a personal life that involved several marriages and mistresses (including Isabel Patino, Ginette Lery, Sally Crichton-Stuart, Lady Annabel Birley, and Laure Boulaye de la Merthe). “When you’re twenty, a year is a long time,” he remarked on his short, poignant marriage to Isabel Patino, who died of a “massive cerebral haemorrhage” (Wansell,76,  66, 77). “I can imagine circumstances when a man who was much in love with a beautiful mistress would rather see her dead than in the arms of someone else,” he also told Italian business negotiators (Wansell, 16, 92).

For Goldsmith, the experience of near bankruptcy in 1957 was a major learning experience which he survived due to a bank strike (Wansell 16-17, 89-94, 318). Goldmith developed expertise in the wholesale of generic pharmaceuticals as a way out of his early financial difficulties (Wansell, 88). He achieved early cashflow through sublicensing the rights for generics in different European countries and regions, and growing royalty streams (Wansell, 101-102). He negotiated to buy a chemist chain (Wansell, 106-110), confectionary firms (Wansell, 129), and consolidated his expertise in the grocery and food retail industries.

This expertise underpinned his later finance career in asset and change management. His aim after 1957 was to gain financial and family security and not remain a “capitalist without capital” (Wansell, 101). The two deals that Goldsmith felt were major career turning points were Bovril (Wansell, 148-153) and Diamond (Wansell, 286, 299-300), which were “double or quits” strategies (Wansell, 170).”The most important thing is the right place at the right time. You have to be able to see the swings in the market,” Goldmith observed (Wansell, 177), about his investment approach dubed the ‘Acapulco Strategy.

In many respects, Goldsmith’s ‘turnaround’ strategies foreshadowed the later emergence of private equity firms like Blackstone and Kohlberg Kravis Roberts, and the 1990s interest in lean management and business process reengineering. He benefited from Great Britain’s macroeconomic management in the late 1950s the Heath Government’s policies, and the growth of conglomerates during the 1960s ‘go go’ period.

Goldsmith targeted established companies which met the following ‘screening’ criteria:

(i) They were mature firms that had brands and yet via diversification had drifted from their core strategy (Wansell, 163);

(ii) They had cashflow problems and ineffective current management (Wansell, 44, 183, 203, 365, 367), that were often bureaucratic and institutional (Wansell, 155, 370);

(iii) He was able to take a majority shareholding (Wansell, 117)

(iv) They had unused and hidden assets that could be valued higher than their public valuation, and that were only briefly disclosed in annual reports;

(v) They had underperforming assets that could be sold to other parties, in order to liquidate debt; and

(vi) The market momentum of their share price and cost of capital meant that free cash flow and equity for further expansion could be financially engineered.

The media cultivated a public image of Goldsmith as a financier with energy, ambition, and deal momentum. This was in part due to his intensive interview preparation for The Money Programme in October 1977 where he defended his management style and investment track record (Wansell, 258-259). This program and others are available in the new family archive online at SirJamesGoldsmith.com. In reality, Goldsmith focussed on other aspects such as how the share price reflected the underlying asset valuation, and how asset divestment would affect the capital gains tax for shareholders. He maintained control of his companies through a network of family controlled and vertically integrated offshore holding companies in England’s Cavenham Foods (Wansell, 120-121) France, the  Hong Kong firm General Oriental, a  Liechtenstein foundation, and the Cayman Islands (Wansell, 145, 306-307, 360, 365). His economic outlook could be countercyclical and contrarian (Wansell, 302-303). He used local content and ethnie nationalism in European deals, to gain the loyalty of local management teams (Wansell, 169).

Goldsmith’s early experiences in Great Britain and France meant that he gained valuable expertise in foreseeing speculative bubbles and currency arbitrage opportunities. He sold off property assets and went when the 1973 recession loomed in Great Britain (Wansell, 179-179). After the Private Eye libel case in the 1980s, Goldsmith took firms private with shares at low price, due to favourable cross-rates between the English pound and the United States dollar. These experiences informed his 1990s views about the Maastricht Treaty, the European Union, and the international political economy.

His career coincided with the growth of investment banks, and commodities and currency markets. For Goldsmith, these banks, and the financial team he built around himself with Gilberte Beaux and others, were the funding source for the high share prices he used to takeover companies; they also provided due diligence expertise for projects. Goldmsith also used his subsidiaries and brokers to buy shares on the open market, and to approach the major shareholders. His goal was to gain control of the board and proxies, through shares which had voting rights.

Goldsmith’s ‘corporate raider’ phase for Drexel Burnham Lambert used similar tactics to Carl Icahn. He noted that good deal-makers had a “disequilibrium in the personality” (Wansell, 362) which propelled them forward. Deal-making also required the ‘strategic foresight’ ability to perceive changes in macroeconomics and the capital markets before others saw them (Wansell, 177). Elsewhere, he noted, “The secret is to create new ambitions all the time” (Wansell, 336). To signal a potential acquisition Goldsmith would use his subsidiaries to buy small amounts of shares. He used ‘greenmail’ on the St. Regis deal (Wansell, 318-322), standstill agreements, and strategic lawsuits with Crown Zellerbach when necessary to gain board representation (Wansell, 327). He would work around a ‘poison pill’ defence by focussing on the percentage of shares that Goldsmith required to prevent parties from countermoves. Goldsmith’s ‘contrarian’ strategies and their payoffs if correct echoes John Paulson’s ‘put’ option on the United States subprime market, as outlined in Gregory Zuckerberg’s memoir The Greatest Trade Ever Made (Crown Business, New York, 2009).

Goldsmith was also interested to influence events and societal ideas (Wansell, 234), such as through vigorous debate about freedom of the press and journalism standards. He had an early interest in ecology, but not of early ‘green’ environmental politics (Wansell, 197-198, 223).

Goldsmith also understood strategic culture. Der Spiegel v. Goldsmith dealt with claims of Soviet disinformation in media and anti-communism (Wansell, 341-347), during which Goldsmith interviewed Soviet defector networks for intelligence author Chapman Pincher (Wansell, 346). Goldsmith observed, “We seem incapable of understanding Moscow’s way of thinking” (Wansell, 344) in a view that echoed RAND’s Jack Snyder at the time. However, it was Goldsmith’s nuanced understanding of English, French and United States strategic cultures, and business and regulatory environment, which were pivotal to his long-term success as an entrepreneurial deal-maker.