Market Beer Goggles: Part II, Ethanol Stocks

(For Part 1: Click Here)

Market Beer Goggles: Part II, Ethanol Stocks

Three of the bigger players in Ethanol were VeraSun Energy Corp (VSUNQ), Aventine Renewable Energy Holdings (AVRNQ), and Pacific Ethanol (PEIX).

It is difficult to locate good charts of VeraSun and Aventine because both have declared Chapter 11 bankruptcy. Pacific Ethanol is technically solvent, but had its four operating subsidiaries file Chapter 11 petitions. Excellent summaries of what happened can be found here and here.

Let's take a look at a chart of PEIX. You will notice that in the week of May 9th, 2005, PEIX was at $10.60/share. In one short year, during the Beer Goggles Stage of acute intoxication and amorousness, it shot up to $42/share in the week of May 8th, 2006 (more than a 300% return). By the following year (May 7th, 2007), Pacific Ethanol was down to $15.39/share. A look at the volume (at the bottom of the chart) shows that the heaviest buying was on the way to the peak while PEIX was in the 30s. The comparative lack of volume on the way back down to 15 tells you that... a lot of poor people got stuck holding PEIX. And if that $15 price seemed to be "too low to sell". Consider this; by March of 2009 your $15 would be worth 23 cents.

What happened? Why did people break out the beer goggles and leer at VeraSun, Aventine, and Pacific Ethanol? What were they drinking? (My bet is tequila). In fact, several social/emotional factors were in play, danger signs for those who stayed sober enough to recognize them.

It Was the Next Big Thing: Investors are always looking for the "next big thing". The prospect of discovering the next Apple Computer while it's still being run out of a garage is one of the most enduring investing fantasies. Part of it is rooted in the almost universal desire to A) Get rich, and B) Not have to work for it. (This is the entire basis for the massive Lottery business). A new fuel that can support our energy needs and be grown in your back yard is indeed a compelling story, one that captures the imagination. It almost seemed too good to be true.

It Made People Feel Good: In addition to being a great story, the thought of ethanol appeals to our moral/patriotic sides. Regardless of what you think of the state of Anthropogenic Global Warming research, we all want a greener Earth. Only Bond Villains (and possibly a subset of hard core Raider fans) are evil enough want to choke the life out of the planet. To support a plausible, if perhaps specious case, against carbon-unfriendly fuels is only natural. Plus energy independence (or at the very least independence from people who hate us e.g., Hugo Chavez, Mahmoud Ahmadinejad, Saudi Wahhabists) are things most of us are actively looking to support.

Non-Investors Loved It: Ethanol was one of those rare investments that had people talking who knew nothing about investing. At, George Keeley, (my local) when I would tell people what I do, their eyes would light up - men and women alike; "Ooh! Tell me, what do you think of Ethanol stocks! Are they a good buy?" and "Do you have any stock tips? What do you think of ethanol?" As Bernard Baruch famously, if apochrophally, said before the Great Crash of 1929, "When the shoe shine boy starts giving you stock tips, it's time to get out of the market." In fact, non-investors chatting up stocks is one of the most tangible and reliable indicators that hype has eclipsed reality.

In the midst of all these danger signs came the greatest catalyst of all; the stocks took off. The cycle of hype > price gain > hype > price gain was a self-perpetuating motion machine.

People were as figuratively "drunk on ethanol" as if they were literally drunk on ethanol. That's why when we find ourselves "hooked on a feelin'" and "high on believin'", we need to order a cup of coffee, talk to that buzz-kill friend (or financial professional) to give us an alternative opinion and bring us back to reality.

There were/are points in favor of investing in Ethanol stocks. And our point here is not to put down companies or industries. There were; however, some powerful arguments against it:

• The Brazil "success story" is an apple and we're an orange. Ethanol works better in Brazil because they make it from sugarcane, a much more efficient source. Also, Brazil has more available farmland and cheaper labor costs than we do. The US does not have these advantages.


• It's corrosive. Ethanol can't be transported via traditional pipelines, as can oil or gas. It has to be shipped in trucks and trains with specially lined containers. Some claim this can be rectified in the US. At this point; however, it hasn't.


• In the case of Pacific Ethanol, as noted in this article, California is "too far from the corn". In order to keep costs down, you want the corn supply close to the ethanol plant, 50 miles at most. The Golden State is a long way from the Hawkeye State.

Did people hear these arguments, (and many others) against these stocks before they stampeded in? Did they give full weight to the risk of investing in ethanol or merely the rewards?

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Some people point to Bill Gates's investing in PEIX as evidence that it was a sound bet. But did those people bother to factor in the opinion of Warren Buffet (an actual investing professional), when he said this below:

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"Charlie Munger and I do not know enough about the business to evaluate it. It depends on government policies and a lot of other variables we're not good at predicting. It's also a very hot area for investors right now, and we don't like looking at things that are hot and easy to raise money for. Generally speaking, agricultural processing businesses have not earned high returns on tangible capital. Ethanol could prove an exception, but I'm not sure how you gain a competitive advantage with any particular ethanol plant."

No. Probably not. When you're dancing with the lampshade on your head, the world - and all the people in it - look beautiful and bright. You don't want someone harshing your gig. That's why it is so utterly important that we invite some wet blanket, Johnny No-Fun to do just that.

Which brings us to MarketPsych Maxim that we drive home to our clients; Never commit money to a stock until you have heard (and digested) the best arguments against it.

To be fair to ethanol stocks (who are still in business), they have rebounded since their lows. PEIX has gone from under a quarter a share up to as high as $2.75/share ($1.38/share as of this post). Here's an article that makes a case for the comeback. But that is cold comfort to the beer goggling investors who, when the hangover set in and their bleary eyes fluttered open, found that their investment that looked so hot the night before looked anything but in the clear light of day.

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Beware the Market Beer Goggles. Know the warning signs. Hear the best case against your case. And when you're feeling really, really excited about a stock, for goodness sake, order a club soda.

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Happy Investing.

-Dr. Frank

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MarketPsych is the original Investing Psychology Consulting Firm. We have been doing talks, keynotes, trainings, workshops, coaching and consulting in the field since 2002. Our clients include institutions and individuals in all areas of the financial community. Contact us at info@MarketPsych.com for more information on how we can help you.

MarketPsych Presents: Market Beer Goggles, Part I

College, 1992: A Flashback

It happened late at night. It always happens late at night. The keg was kicked and the host was reduced to breaking out a bottle of Peach Schnapps that had been in the back of the liquor cabinet since the Nixon Administration. What. A. Party. You danced a little. Drank a lot. And you spent the last hour on the couch canoodling with this really hot girl (or guy as the case may be). You asked your model-esque romantic interest if he/she wanted to find some place a little more private...

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Yep. It was a pretty cool night. That was until you got the party photos back. Looking at them now, you see that something is strangely, terribly amiss.

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"That's definitely me on the couch", you think, "I have the matching Guinness stain on my Polo shirt to prove it. But who in the name of Extreme Makeovers is that decidely un-hot person sitting next to me?!" And, follow up question, "What did I do? (gulp) Please tell me it's not what I think it is!"

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Beer Goggles: noun, A metaphorical set of "eye-glasses" worn after excessive alcohol consumption that makes otherwise unattractive individuals extremely desirable.

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Back in college, it was known as Beer Goggling. And for most of us college is where it stayed. We all get older, and generally that means wiser. We learn to make better choices, to channel our impulses. As we mature our lifestyles change, we settle down. But while we don't break out "The Goggles" at parties anymore, we sometimes break them out in "The Market".

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How does it happen? What is this intoxicating mixture that distorts our judgment, lowers our standards, and causes us to hook up a dreadful, "oh-my-gosh-I-did-what" stock. It's a pretty simple recipe:

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Market Love Potion #9

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Mix:

2 Parts Media Hype

2 Parts Greed

2 Parts Impulse Control

1 Part Peer Pressure

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Shake well. Serve over crushed ice. Garnish with lemon peel.

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Welcome to MarketPsych's new semi-regular feature, Beer Goggle Stocks! Where we use hindsight, and the harsh, wince-inducing light of day to illuminate those times we became intoxicated by a stock or sector and made a regrettable choice that could have been avoided if only we were thinking clearly.

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We will highlight a number of these investments. Analysis will include a "before" and "after" picture, a break down of the emotional/cognitive/social factors that led to misjudgment and an outline for how to avoid such mistakes in the future.

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Like the old T-shirt, "Friends Don't Let Friends Beer Goggle".

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And at MarketPsych we like to think of ourself as your investing friend. The responsible one who takes your car keys, orders you a cup of black coffee and walks you around the block when you're not thinking straight. So if you've ever hooked up with a hot stock only to later to see it was a dog... stayed tuned for part II.
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Coming Soon: Market Beer Goggle Part II - Ethanol, I Promise I'll Love You in the Morning.

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In the meantime, happy investing.

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-Dr. Frank Murtha

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MarketPsych is the premier Investing Psychology Consulting Firm. We have been doing talks, keynotes, workshops, training, coaching, consulting in Investing Psychology since 2002. Our clients include individuals and institutions in all areas of the financial community. Contact us at info@marketpsych.com for more information on how we can help you.

Do You Like Scary Movies?

You're watching a movie - a thriller actually. You just don't think of it that way.

You laugh at the happy parts. Lose interest a bit during the slow parts. And occasionally, when there's a plot twist... it scares the living hell out of you. The funny thing is you actually know how it's going to turn out in the end. But that doesn't stop you from "getting into" it.

The movie is, "The Market" and it show times are M-F, 9:30 AM through 4 PM (EST).

Okay. It's not technically a movie. Nobody's selling $8 popcorn and it doesn't have Ben Affleck in it or anything (thank God), but a movie is a good way to think about your investments from a psychological perspective.

Take James Bond movies, for example. When we watch a Bond flick, we know what we're getting into. He's going to use some cool gadgets, drink a martini, save the world, "get the girl", etc.

But at certain times during the film, there are moments in which 007 is in mortal peril (inordinately involving buzz saws, lasers, and exotic predatory animals). If we've been following along, if we're "into it", we experience an unavoidable emotional reaction - anxiety, or as the movie business euphemistically dubs it, "suspense".

We can't help it. We experience this supense because we follow the story not just with our eyes, but with out brains, and that means we follow it on an intellectual and an emotional level.

In fact, it's almost as if our emotional brain and our intellectual brain watch the movie on a couch together and during the suspenseful parts, wrestle for control of our head.

Sometimes the conversation looks like this. (Watch the following classic clip from Goldfinger to really provide the context.)

Emotional Brain (EB): HOLY CRAP! THE LASER IS GONNA SAW HIM IN HALF! THERE'S NO WAY HE CAN ESCAPE!!

(Note: The Emotional Brain not only speaks in exclamations, it uses all "caps".)

Intellectual Brain (IB): I say, get a grip, lad! It's a half an hour into a 3 hour movie. He'll be fine. Stiff upper lip and all that.

(Note: The Intellectual Brain is not only the voice of reason, it has a 19th century British accent.)

EB: BUT, BUT! HE CAN'T REACH HIS MAGNETIC PEN KNIFE!!! HE'S SCREWED!! AAAUUUGH! I'M HYPER.. VENTILATING...!!

IB: Yes, yes. Dire straits, indeed. But we know full well that Daniel Craig signed a 3 movie deal. Can't just dispatch him in the first one, now can we? Wouldn't be cricket!

EB: ARE YOU NUTS?? ARE YOU BLIND?? THE LASER IS ALMOST UP TO HIS - OH, MY GOD, I CAN'T EVEN SAY IT! MAY DAY! MAY DAY! MAY

IB: - All right, all right, lad! I suppose a bifurcated John Thomas is more than you can bear. No talking you out of it, this time. I'm going to send a neuro signal to the hands to cover your eyes... now. And hand me those pretzels, old boy. You're getting crumbs all over the floor and I just had it cleaned yesterday, don't you know.

EB: SORRY!!

Now, it should be said, we have enough data on James Bond and on the major market indexes to know what happens in the long run. But when we're watching the movie, we're not in the long run. We get drawn into the emotions of the moment and we struggle, sometimes in vain, to restore a big picture perspective.

The above conversation is essentially what our psychological defense mechanisms look like when we watch a movie or when we watch The Market. The tactics are certainly the same. Get us out of the "moment" (short term) and refocus on the big picture (long term). Supplant emotion with reason, fear with facts.

And sometimes when we can't reframe from a short-term to a long-term perspective, we simply cover our eyes (i.e., stop watching). It's an excellent last resort tactic that is underutilized.

So enjoy your thrillers, if that's your thing. And enjoy your Market watching. But remember what it is your watching, and retain that ability to pull yourself up out of that short-term emotional tailspin. Because you will get draw in and it will happen without your awareness (just like in a movie).

And if you insist on watching scarey movies, in the name of Freddy Krueger... do NOT watch them alone.

Happy investing.

-Dr. Frank

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MarketPsych is the premier Investing Psychology Consulting firm. We do talks, keynotes, workshops, training, coaching, consulting with out clients. They are consistently rated as highly educational, professionally valuable, and fun.

MarketPsych on TV

Been a little remiss in my blogging the past month, but I wanted to update folks.

I will be on CNBC Monday morning (supposedly between 10:30 and 11:00 AM) with Erin Burnett and Mark Haines talking about Fear and Market Bottoms.

So tune if you wish.

And congrats to Richard and the MarketPsy Asset Management crew who have been riding high through these turbulent markets. When it comes to secret formulas for deliciousness, there's Coca Cola, Kentucky Fried Chicken... and MarketPsy.