Delphi, GM & Rogue Events

by Jim Willie CB
Jim Willie CB is the editor of the "HAT TRICK LETTER"
Oct 14, 2005

The Oracle of Delphi was once a venerable shrine, supposedly foretelling the future in ancient Greek times. The car parts maker Delphi might today foretell of not only a General Motors bankruptcy, but tectonic shifts beneath the foundations of our financial system. Full leverage puts the entire bond market at risk. It is no coincidence to me that on a single day, Delphi filed for bankruptcy, the Bank of America upped their estimated likelihood of eventual General Motors bankruptcy to 30%, and Standard & Poor's downgraded GM debt one level deeper in junk status. The next day GOLD TOUCHED 480 ON THE DECEMBER FUTURES CONTRACT. My viewpoint has it that gold is being purchased not so much as a price inflation hedge but for a HEDGE AGAINST SYSTEMIC RISK. The bond bubble is under siege.

Chart courtesy of ino.com

The USFed is harping about price inflation, in a pathetic orchestrated public relations ploy, which is without a doubt intended to offer them political cover for hiking interest rates. Their hope is to prevent a run on the USDollar, and to continue to encourage foreigners to pay our bills. We have no discipline, no desire to halt waste, no concern even about fraud. Federal budgets are out of control. Monetary inflation unfettered is a valid risk, but systemic risk is a larger risk. Diversion is a key tactic from the Greenspan Fed.

The June episode for GM bond and credit default derivatives was unpleasant and highly disruptive. Gold then began its big rise, decoupled from the USDollar at that time also. Toss in the European Union votes against centralized power. Toss in the advent of euro and yen based carry trades to purchase gold. A witch's brew stirs gold in favorable turns within the cauldron. Tectonic shifts are taking place in the bond market at the foundation sub-basement level. The Delphi bankruptcy will have far-reaching effects to the corporate bond market, and to credit derivative swaps, where risk is offloaded to third parties. What will third parties sell when they take it in the shorts? The treacherous part about derivative risk is that, like an earthquake, it sneaks up on you. The foundation beneath your feet loses its structural integrity and strength. The additional debt downgrade is sure to deliver yet another lethal blow to the convertible debt arbitrage. GM will not go away quietly.

DELPHI BANKRUPTCY
The Delphi bankruptcy pulls General Motors back to the slaughterhouse. The rogue event has a clear loser, makers of inefficient obsolete SUV's. When was the last time you saw an SUV pull a boat? CNN pointed out that 50% of state governors drive an SUV. Our leaders are morons. Shock has reverberated to the bond market and surely to their credit derivatives, with damage unclear to date. Car sales are down big, but limited to General Motors and Ford, as Chrysler has been spared. The first economic domino is with car sales, in the movement from inefficient cars, trucks, and sport utility vehicles, toward smaller more efficient cars. The principal source of "better" cars is Asia. A hidden advantage of Asian cars is the lower cost from reduced overhead due to worker benefits. We are witnessing the death of a large segment of the US car industry before our eyes, the tragic consequence of global trade with unfettered lack of controls. National economic policy fails to recognize the threat to our entire manufacturing base.

September car sales were miserable, except for Chrysler. Sport Utility Vehicle sales plummeted 50%, no big surprise there. The ripple effects from gasoline cost shock extend beyond General Motors to its parts suppliers, notably Delphi, but also to some extent Dana. The Delphi insolvency has caused financial stress above with GM and below with its own suppliers, as the United Auto Worker union has become a principal player. Bank of America has raised its estimate from 10% to 30% for the likelihood of a GM bankruptcy. My number is 99% in an easy call. At the least comes a restructuring Ch 13 BK to rid themselves of their obligations for pensions and retiree health care costs, and to enable a debt writedown. The new bankruptcy laws screw individuals, but not corporations. Wage deflation continues to cut a deep swath. The GM stock price has descended below the Kerkorian rescue price of 31 per share. The GM pension system is badly under-funded, despite claims by officials. Market assumptions are the key to the deception, probably aided by bogus 10% annual gains built into formulas.

General Motors owns $11 billion in pension liabilities from Delphi, a major car parts supplier with 24k employees, which itself has 2000 parts suppliers and $1.9 billion in bills pending. They must be nervous. Delphi has filed for bankruptcy. It has shut some US plants, cut pay up to 60%, and abandoned pension obligation to workers. It has an estimated $10.8 billion in under-funded pension obligations. Any downstream supplier with over 20% dependence is at risk, as a dozen such suppliers have also filed for bankruptcy. Delphi has $750 million in 1H2005 losses. Delphi sees in its future the termination of health benefits for its retirees, however adorned by golden parachutes for its executive staff.

In 1999, GM guaranteed the Delphi pension obligations, as part of the GM subsidiary spinoff, in what has proved to be yet another albatross around the GM neck financially. GM derives $2500 in contents per vehicle from Delphi parts. The United Auto Workers are involved, which makes a certainty the long slow certain death, just like with General Motors. Delphi executives have complained that workers earn over $60 per our, 2 to 3x the norm for competitors. Don't get me wrong. My heart is with unions for improving worker conditions and finances. However, refusal to make deep concessions, along with foot dragging on plant closures, guarantees a continued burden of surplus workers and more importantly surplus car output. The end result is not only added overhead costs, but poor pricing power for the end product. More losses are assured. We have already seen a rash of profitless car sales. Furthermore, a $65/hr wage scale seems off by a factor of two, and 90% locked pay for furloughed workers seems overly generous. Delphi seems more like a socialist corporate entity, just like GM and Ford. A second GM parts supplier is also in trouble, namely Dana, which has accounting problems. They have postponed 3Q2005 earnings, and restated 2004 and 2205 earnings. Ford Motors has a similar parts supplier problem with Visteon.

THE RISK FROM DERIVATIVES
The chain which locks excessive worker pay scales has become the leash leading the companies to ruin. Many are the dominos in Detroit from car makers, their debt burdens, their union obligations, their aging work force, their profitless operations, their heavy unwise reliance upon SUV sales, and the lethal linkage in limbo to credit market "financial sewage," as Warren Buffett calls derivatives.

We have not heard the last of the GM death throes. If the UAW is cooperative, GM might emerge from a restructuring sometime in the next year. If not, GM will endure the death of a thousand cuts, whittled to nothing in the end. The rogue event of twin hurricanes has numerous victims. Each contributes to the process of destabilizing the entire US financial system. Behind the scenes, credit derivatives will continue to fall like underground dominoes. Its underpinning is so dangerous fashioned, that nobody even can properly assess the risk, let alone monitor the status in real time. Heck, an army of 1500 accountants is required to accurately measure their status, another crippled financial giant. Let me save time, and guess that Fanny Mae's capital core is worth well south of $500 billion. The final number cannot be properly assessed until the housing bubble dissipates and resolves itself. The end tally might be somewhere between negative $1800 billion and negative $2500 billion. That figure is a raw estimate, a return of 35% of the $7 trillion in artificially lifted housing value nationally. A bubble giveth, a bubble taketh away.

What one should fear and prepare for is the unexpected. Earthquakes strike with little immediate warning, but often with some imprecise distinctive signals. The LongTerm Capital Management fiasco struck suddenly in autumn 1998, part of the ripple effects from the Asian Meltdown and the Russian debt default. Denials abound for assigning minimal systemic risk from the hurricane damage. Its reconstruction response is audaciously labeled as positive for the US Economy. How about the financial sector fallout? Is that positive also? Is everything positive? Wall Street might prefer a GM and Delphi restructuring over a drawn-out downfall. Last in line, share holders would lose their shirts and shoes. Controlling the strings, their executives might celebrate hefty bonuses and options with newly formed corporate formed entities. Creditors are first in line, while equity share holders pick up whatever does not vanish. Axed workers are not in line at all.

THE EXTINCTION OF US LEGACY FIRMS
In conversations with people about the legacy Detroit car makers, strange irrational comments and perspectives are offered. An older family member has bought Chevy and Buick brand cars all his life. He secretly bristles at my disdain for US cars based years ago on poor quality and low reliability. My stream of purchases include Audi sedan, Ford pickup (lemon, never again), Toyota pickup, Nissan pickup, BMW sedan. Few believe that the Toyota, the Nissan, and the BMW have never had a major repair from a component failure. He is considering another Buick, even with low miles on his current 4-yr-old sedan. In response to my concern about whether GM will be around in a couple years, he says "I hope so" without concern. Another friend has no idea of the burden from retirees, nor their exorbitant pensions. Another buys Ford as an act of patriotism, with a decal to support the troops. A few are happy customers indeed. But one in particular complains chronically about steady repairs required for his GM sedan, with little indication of breaking ranks in an act of disloyalty. He hates Japanese cars, even though they might be more reliable. It is utterly amazing how many younger women prefer small Japanese sedans. By the way, the #1 stolen car in the USA in recent years has always been a Honda. An old roommate owned a sorry GMC truck, which did not survive 70k miles. A Philly friend owns an old Ford truck, pushing 200k miles, described as "indestructible" but a gas hog.

My viewpoint is that legacy US manufacturing firms are at great risk, since Asian competitors have much lower costs owing to absent fringe benefits like pensions, life insurance, workmen compensation, and short-term disability. Japan offers some benefits, but not China. The gain from half the total mfg hours to produce a Toyota sedan enables that cost advantage. Not a single person who has crossed my path and offered an exchange of views has been aware that China plans next year to export the Cheri, a fully loaded sedan in the $15,000 price range. It will be built with state of the art mfg equipment from Japan. That is the death blow for Detroit, the coup de grace. USGovt officials probably might in their myopia regard the Cheri importation as yet another benefit to our economy, another low-cost solution. Macro economic policy is abysmal in the United States. Not so much abysmal, as non-existent or extinct. US mfg is in line for an unnatural extinction.

HEDGE ALL BY YOURSELF, LIKE NEWMONT
It is imperative to protect yourselves and your families. A balance of mining stocks and energy stocks will ensure your personal financial protection, if not prosperity. Equity shares offer more leverage, but physical holdings ensure reduced risk in times of extreme liquidity downdrafts. Newmont Mining, under the aegis of CEO Pierre Lassonde, protected the bellwether gold mining corporation by acquiring a minority interest in an energy firm for $200 million. Three years later, the brilliance of his move has become vividly clear. Newmont endured higher energy costs, but their stake in the energy firm tripled in market cap value. The challenge to Lassonde is to transfer the capital gain into an offset of higher energy costs. Perhaps a dividend from piecemeal share sales would do the trick. Every mining firm should hedge in similar fashion. In his words, Pierre had this to say in a special interview by Bob Bishop. The full interview can be found here.

"A year and a half ago we took the view that oil prices would go well past $60 and that they were going to stay there for ten years, and we asked ourselves how we can insulate Newmont from these high prices. In all of our operations we burn three million barrels a year, which represents about 20% of our production costs. The way we elected to hedge was to purchase 7% of a Canadian oil trust, Canadian Oil Sands, which owns 35% of Syncrude. At the time we made the purchase the reserves in the ground were being valued at $26/barrel. We did that in the summer of '04 and today the stock is $125. Our $200 million investment is worth about $635 million. At $50/barrel oil next year, we anticipate that the dividend would be about $10/share; at $65/barrel, we think it would pay about $14/share. We expect that the dividends on this investment will essentially cover all of the increase in the oil price that we've seen, providing us with a hedge for the next 50 years, because this reserve will last without having to drill another hole. To make a long story short, we've taken very aggressive action to hedge our long-term operations against the adverse cost impacts of rising oil prices."

EVERY HOUSEHOLD SHOULD HEDGE WITH MINING & ENERGY STOCKS. INVESTING IN CANADIAN STOCKS HEDGES AGAINST THE CRIPPLED USDOLLAR. THE HAT TRICK LETTER COMBINES MACRO ANALYSIS WITH INVESTMENTS.

Oct 12, 2005
Jim Willie CB

Jim Willie CB is the editor of the "HAT TRICK LETTER"
email: jimwilliecb@aol.com
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