Inflation actions and arbitrage lessons

By DAVID MOON, Moon Capital Management, LLC
May 25, 2008

Fuel prices have gotten out of hand when the Army is looking at alternative fuels. The Wall Street Journal reported that the U.S. military, the world's largest single oil consumer, recently flew a B-1 stealth bomber at the speed of sound using synthetic jet fuel.

I thought enriched plutonium was the ultimate in alternative fuel, but I'm not sure where to put a nuclear reactor on a Prius.

President Bush announced this week that the government will not be adding to its strategic reserves - 700 million barrels of oil ' enough to run the entire country for about two months.

An angry citizen, interviewed on a network news show, complained that the government should release some of that reserve to ease gas prices. That's what she would do if she were President.

The brilliant reporter neglected to ask Mrs. Angry Gas-guzzler what she would do in 60 days after the reserves were gone.

Maybe she didn't plan on being in office that long.

It's not just gas prices that have skyrocketed; the grocery store is also a painful place to visit these days. This past week, the Bureau of Labor Statistics told us that consumer prices increased at an annual rate of 2.3% in the last three months. Food and energy prices increased 6.3% and 5.6%, respectively.

There are reports of shoppers going to the grocery store to stock up on months' supplies of rice and flour at current prices, prompting some businesses to limit customers' purchases.

But if you think it's bad here, be glad you're not in Zimbabwe. Annualized consumer price inflation there is currently 150,000%. That's a weekly rate of about 15%.

* * *

A couple of weeks ago, I reported on the effort of one of our analysts to corner the market in silver trinkets. His trade is complete.

It was his last.

As a reminder, he bid on 154 eBay auctions, successfully purchasing various silver items in four of them. He sent the items to a smelter, and, after making an allowance for all costs, he expected to turn a profit of 31%, which would be an annualized rate of 75,000%.

Or, stated another way, he would make $150.

Except he wasn't counting on getting gypped on his silver purchases.

It turns out that a small bit of the silver items he sent to be smelted were deemed to be too low grade, and could not be turned into cash. (He referred to this piece as his nondescript 'silver blob.') Removing even only this small blob erased all of his expected profits.

Rather than make $150, he lost about $40, an 8% decline in his investment. There were all sorts of lessons from his experiment, one of the most important being that the trustworthiness of a party in any investment is of paramount importance ' whether you're dealing with stocks, bonds, or silver blobs.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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