Are Pension Funds Fueling High Oil?

If you're wondering why driving to work has gotten so expensive, you might want to peruse your pension fund's investments. That's because speculation by institutional investors pouring money into the commodities market may be largely to blame for spiking oil prices, according to testimony on May 20 before the Senate Committee on Homeland Security & Governmental Affairs. Crude oil, a so-called hard asset, is viewed as a buffer against inflation—a foe of longer-term investment returns. At the hearing, "Financial Speculation in Commodity Markets: Are Institutional Investors and Hedge Funds Contributing to Food and Energy Price Inflation?," senators heard from those defending the role of speculators in oil and commodities markets as well as those who argue that excessive speculation is the root of global price surges.

"[Commodities] are experiencing demand shock from a new category of speculators: institutional investors like corporate and government pension funds, university endowments, and sovereign wealth funds," said Michael Masters, managing member of Masters Capital Management, a Virgin Islands-based hedge fund. "Index speculators are the primary cause of the recent price spikes in commodities."

On May 20, crude oil prices settled at a record $129.07 on the New York Mercantile Exchange (NMX) after touching a new high of $129.60. The national average for a gallon of gasoline hit a record of $3.80 per gallon the same day.

Light CFTC Hand

The explosion in the number of financial players in the energy markets has occurred particularly in the past two years—also a period of soaring energy prices. That's why speculators are now under fire from Congress and the public as potential culprits (BusinessWeek.com, 5/15/08).

But in the hearing, Masters distinguished between traditional speculators and what he calls index speculators, or passive investors who enter the commodities markets as a long-term hedge against inflation. Commodities exchanges limit the number of positions an investor can take in the market, but Masters says the Commodity Futures Trading Commission has allowed unlimited speculation in these markets through a loophole. This so-called swaps loophole exempts investment banks like Goldman Sachs (GS) and Merrill Lynch (MER) from reporting requirements and limits on trading positions that are required of other investors. The loophole allows pension funds to enter into a swap agreement with an investment bank, which can then trade unlimited numbers of the contracts in futures markets.

Some experts fault the CFTC, charged with regulating commodities markets, for allowing such loopholes. "Congress has provided the CFTC the power to control this unlimited [speculation]; the law is very specific about establishing position limits," says Steve Briese, author of The Commitments of Traders Bible and CommitmentsOfTraders.org, a site that focuses on U.S. futures markets. "The problem is they have abdicated this role." The dramatic surge in energy prices has helped to spark inflation across the economy and, as others at the hearing testified, has cut into profits of most in the supply chain. Briese points to Treasury reports that the top five users of swap agreements are investment banks, four of which dominate swap dealing in commodities and commodities futures: Bank of America (BAC), Citigroup (C), JPMorgan Chase (JPM), HSBC North America Holdings (HBC), and Wachovia (WB).

Circuit City: Due for a Change?

Cancer's Cruel Economics

Editor's note: For a CBS Evening News report on the challenges confronting new cancer drug approvals, which was made in collaboration with BusinessWeek, click here.

Dr. Oleg Loran treats kidney cancer, but he doesn't have much to offer his patients. They have a 60% chance of surviving five years if the disease is caught early, but more than a third are diagnosed after the cancer is well advanced, when their chances of reaching the five-year mark drop as low as 11%. So Loran was relieved in April when a radically new treatment for kidney cancer was approved. Oncophage, developed by Manhattan-based startup Antigenics (AGEN), is a vaccine that recruits the patient's immune system to fight off cancer cells. It may keep the cancer from recurring for up to two years. "This is undoubtedly a major victory," says Loran.

Perhaps, but not for Americans. Dr. Loran practices in Moscow, and Russia is the only country that has approved Oncophage. The data was not conclusive enough to convince the U.S. Food & Drug Administration; Antigenics will have to mount another clinical trial before the agency will consider approving it for stateside applications. Such a trial would likely take 8 to 10 years and cost at least $500 million, well beyond the means of Antigenics, which has no other products and a stock trading at just over $2 a share. And that, in a nutshell, illustrates the quandary of cancer drug development.

Death and Disappointment

The U.S. government has doled out more than $75 billion for oncology research since President Nixon declared his War on Cancer in 1971. Outlays by the pharmaceutical industry have been far greater. Yet the death rate from cancer has dropped only about 7% in the past three decades, with most of the progress in the last few years. The disease continues to strike 1 in 3 Americans, and it kills 1 in 4. That averages out to 1,500 deaths every day, at an annual cost to the nation of $210 billion and climbing. Cancer is expected to become the nation's biggest killer within a decade, surpassing heart disease.

There are many plausible reasons for so much disappointment, not least the complexity of the disease. But more and more researchers, companies, and patients lay part of the blame on the FDA. They complain that the agency is using outmoded and overly rigorous methods for evaluating a new generation of cancer treatments, rather than doing everything possible to get better drugs to sick patients.

The Vioxx Effect

Since 2005 the FDA has approved 18 new cancer drugs, many of them breakthrough products. But the pipeline contains hundreds more that will never get to market because corporate developers aren't able, or willing, to come up with the money, time, and patients necessary to establish acceptable data. A Tufts University review found that only 8% of experimental cancer drugs end up receiving FDA approval, compared with 20% of medicines for all other diseases.

The FDA knows there's a problem. In 2004 it announced with much fanfare an effort, dubbed the Critical Path Initiative, to make clinical trials more productive. But the initiative never got much funding and little has been heard since. Outside the agency, academic and industry researchers who come up with creative ideas for evaluating drugs routinely complain that the FDA is too conservative to embrace new methods.

The agency's caution may be prudent. But its critics say regulators are too wary of congressional scrutiny in the wake of the debacle involving Merck's (MRK) painkiller Vioxx. Ever since that drug was pulled off the market in 2004 amid safety concerns, the FDA has come under withering attacks in Washington, and overall drug approvals have plummeted. "It's always far easier to say no to a drug than yes,"says Dr. David Kessler, director of the FDA from 1990-97 and now a professor at University of California at San Francisco. "But there are times when the public interest requires that the agency step out of its role solely as a policeman and put into practice those things that might advance the public health."

Kessler believes the agency should overhaul its methods for reviewing cancer drugs much as it did in the late 1980s and 1990s for AIDS drugs. Protease inhibitors and other breakthrough treatments were rushed through the approval process under a new expedited review process put in place to improve patients' access to potentially life-saving medicine. We ended up with a class of drugs that changed the face of the disease," says Kessler. "Even I was struck by how fast it happened, and I was living it."

Kessler and others want a similar push for new cancer drugs, one that would include major changes in human testing. The clinical trial process now is a three-part, years-long effort that effectively kills off all but a handful of once-promising drugs. Medical journals and conferences regularly report on alternative approaches, such as altering a trial's criteria once the first results are in, using mathematical models to predict safety and efficacy, and setting targets that take months to reach instead of years. Pharmaceutical companies would especially like to be able to break down drug-trial results into subsets of participants, so they can establish which groups responded best.

Where Portals and Social Networks Collide

Oil’s Murky Math

How Japan Helped Ease the Rice Crisis

How Japan Helped Ease the Rice Crisis

With prices now falling, the global rice crisis seems to be subsiding. That's thanks in part to a policy announcement by a Japanese bureaucrat. On May 19, Japan's Deputy Agriculture Minister, Toshiro Shirasu, said that Tokyo would release some of its massive stockpile of rice to the Philippines, selling 50,000 tons "as soon as possible" and releasing another 200,000 tons as food aid. The first shipment could reach the Philippines by late summer. Shirasu also left open the possibility of using more of its reserves to help other countries in need.

To understand Japan's role in deflating the rice market, it helps to visit the warehouses rimming Tokyo Bay. It's here in temperature-controlled buildings that Japan keeps millions of 30-kilogram vinyl bags of rice that it imports every year. Tokyo doesn't need rice from the outside world: The country's heavily subsidized farmers produce more than enough to feed the country's 127 million people. Yet every year since 1995, Tokyo has bought hundreds of thousands of metric tons of rice from the U.S., Thailand, Vietnam, China, and Australia.

A Rice Imbalance

Why does Japan buy rice it doesn't need or want? In order to follow World Trade Organization rules, which date to 1995 and are aimed at opening the country's rice market. The U.S. fought for years to end Japanese rice protectionism, and getting Tokyo to agree to import rice from the U.S. and elsewhere was long a goal of American trade policy. But while the Japanese have been buying rice from farms in China and California for more than a decade, almost no imports ever end up on dinner plates in Japan. Instead the imported rice is sent as food aid to North Korea, added to beer and rice cakes, or mixed with other grains to feed pigs and chickens. Or it just sits in storage for years. As of last October, Japan's warehouses were bulging with 2.6 million tons of surplus rice, including 1.5 million tons of imported rice, 900,000 tons of it American medium-grain rice.

It's one of the cruel ironies of global trade that poor countries have been paying through the nose for rice while Japan has been sitting on reserves (BusinessWeek, 5/1/08). The imbalance is a cause for concern because half the world's population depends on rice as a staple food. Following Shirasu's announcement that Japan is putting its reserves to good use, U.S. trade officials have sent word to Tokyo that they back the move. The two sides will meet in Washington on May 23 to discuss the details.

That's good news for poor nations like Bangladesh and the Philippines that either import rice or get handouts. The Japanese gesture has helped to rein in rice prices. On the Chicago Board of Trade (CBOT), rice futures have fallen almost 20% since reaching an all-time high of $25.07 per 100 lb. on April 24. But they are still nearly three times their levels from a year ago.

WTO Rules Act as a Safety Valve

What started the panicky buying? Worries about a scarcity of rice after major exporters banned or drastically cut back their overseas shipments (BusinessWeek.com, 4/28/08). Since last fall, countries such as India and Vietnam—among the world's top rice-exporting nations—have curbed shipments to keep a lid on domestic inflation caused by soaring food prices. That forced many countries to dip into their own inventories. The U.S. Agriculture Dept. estimates that such stockpiles are now at their lowest levels since the early 1980s. The recent cyclone that devastated Myanmar's rice crop, hoarding by consumers, and speculative buying at the CBOT added to the panic. In Haiti and parts of Africa, food riots erupted.

This time, the WTO rules—formally known as Minimum Market Access—acted as a safety valve for the market. Japan's 1.5 million tons of imported rice reserves amount to roughly 5% of the 28 million tons that are traded globally ever year, which explains why Tokyo's announcement had a sizable and immediate impact.

Home Depot and Lowe’s Get Hammered

Are Pension Funds Fueling High Oil?

Why HP's Deal Is a Head-Scratcher

When Hewlett-Packard (HPQ) announced its $13.9 billion acquisition of tech services giant Electronic Data Systems (EDS) on May 13, pundits heralded it as a bold move by HP CEO Mark Hurd. In one stroke, it seemed, he had put HP on a stronger footing with market leader IBM (IBM) in the fiercely competitive tech services business. Together, HP and EDS will create a services giant with $38 billion in revenues, compared with IBM's $54 billion.

Yet a closer look at the deal raises questions about Hurd's strategy and choice of dance partner. EDS, which was founded by H. Ross Perot in 1962 and pioneered the practice of taking over corporations' computing operations, was slow to respond in the early 2000s to the threat of nimble Indian rivals offering services at sharply lower prices. Revenues stagnated, and EDS racked up huge losses. Eventually, the company increased its overseas hiring, and bought control of an Indian company, MphasiS. But even now MphasiS operates independently, with its own sales force and customer base.

So this deal may not change the game when it comes to one of the most important factors in tech services. The top-tier services companies need large, low-cost, global workforces, and their operations need to be tightly integrated so employees with diverse skills collaborate smoothly. IBM, Accenture (ACN), and Indian companies such as Tata Consultancy Services lead in this effort, while EDS and HP have lagged. "The services sector is going through a shift, and this merger doesn't address the global service-delivery challenges that HP faces," says N. Venkat Venkatraman, chairman of the Information Systems Dept. at Boston University's School of Management.

"THIS MADE SENSE"

During a conference call after the deal was announced, Sanford C. Bernstein (AB) analyst Toni Sacconaghi questioned Hurd's choice of EDS. "You could have bought a smaller, faster-growing company with the offshore characteristics." Later, in an interview, Hurd rejected suggestions that an Indian company such as Cognizant Technology Solutions (CTSH) or Satyam Computer Services (SAY) might have made a better match. "We thought this made sense," he said.

For Hurd, the logic is simple. He prizes EDS' giant outsourcing business because it has a large number of customers producing annuity-style revenues. There isn't much overlap between the companies. And he says there will be considerable cost savings. EDS CEO Ronald Rittenmeyer will run the services subsidiary.

EDS, late to the offshoring trend, had only a smattering of employees in low-cost locations when Rittenmeyer joined in 2005. The company now has 45,000 people working offshore, and plans to hire more. Rittenmeyer says MphasiS will continue to operate independently, but adds, "We'll look at integrating all of these things over time, and we'll do it efficiently and effectively."

Hurd, who excels at cost-cutting, had a choice between buying a big racehorse seemingly past its prime or a young colt with lots of potential. He bought the mature horse. Now we'll see if he can whip EDS back into shape.

Circuit City: Due for a Change?

Microsoft Joins One Laptop per Child

Home Depot and Lowe's Get Hammered

It was already clear that Home Depot (HD) and Lowe's (LOW) would get pummeled by the drop in new-home construction and housing sales. But now even consumers who are resigned to staying in their existing homes are pulling in their horns, as rising oil and food prices team up with credit woes to eat into their disposable income.

The combination has proved deadly for the two giants of home improvement. Investors took one look at their dismal sales and earnings reports on May 19 and 20 and began dumping shares. Home Depot's stock price fell almost 6% over the two days, while Lowe's shares lost more than 4%.

Little matter that analysts think Home Depot and Lowe's are doing a good job managing through the tough environment, cutting costs, and slowing the opening of new stores. Their earnings numbers mostly met low expectations. Home Depot saw net income of 41 per share, excluding a one-time charge, vs. 53 a year ago. Same-store sales fell 6.5%, while total sales fell 3.4%, the company said. One day earlier, Lowe's reported an 8.4% drop in same-store sales as it earned 41 per share, vs. 48 a year ago. Thanks to an increase in store count, total sales for Lowe's rose 1.3%.

Further to Fall?

Both chains are hoping the federal stimulus checks mailed this month can slow the slide in same-store sales this quarter, but the effect is likely to be limited. "There will be some offset there from the stimulus package," said Lowe's Chairman and Chief Executive Robert Niblock, though he still predicts same-store sales will fall another 6% to 8% this quarter.

A far bigger factor: There are no signs the housing and mortgage crisis is lifting. "In fact, conditions worsened in many areas of the country," Home Depot Chairman and Chief Executive Frank Blake said in a prepared statement.

The housing downturn set off a dismal chain reaction for the home-improvement industry. New home purchases often inspire construction of a new patio, wallpapering a bedroom, or other remodeling. The pop of the real estate bubble has called a halt to much of that. But even for those homeowners who are resigned to staying put, falling home values make them feel less enthusiastic about launching home-improvement projects. And even if they're so inclined, the evaporation of home equity and tightening of credit lines makes money harder to come by.

A Pileup of Woes

Lowe's Niblock told analysts that his chain has broader troubles, as well. "We've had ongoing pressures from housing, we've had tight credit markets," he said, "but now all of a sudden you've got a couple of other variables … on top of those." Consumers are spending less because of high food and fuel prices, and because they're worried about the economy and the job market, Niblock said.

There was some good news. Lowe's was widely praised for cutting expenses. "Management buttressed investor confidence in its ability to manage costs and profitability against near gale-force market headwinds," said Budd Bugatch of Raymond James (RJF).

Customers and investors have criticized Home Depot for weak customer service, especially compared with Lowe's. Home Depot says it is making strides reorganizing operations while improving service. Some analysts praised management for cutting back on promotional activity that wasn't working. Home Depot "is taking advantage of the slowdown to reinvest in the business," said Credit Suisse (CS) analyst Gary Balter. He says the chain should be "well-positioned once the housing recovery comes," better than Lowe's.

Downturn Squashes Small Rivals

Both chains say they're gaining market share through the housing downturn, because it puts many smaller, independent competitors out of business. This points to the strength of the Home Depot-Lowe's "duopoly," said Bank of America (BAC) analyst David Strasser. "This industry should only get stronger the longer the downturn lasts, as more independents go out of business," he said.

The key to watch for is a rise in housing turnover—if Americans start buying, selling, and moving again, home-improvement stores will get busy. "Really, it's about [the duration], not depth, of the slowdown at this point," said David Schick of Stifel Nicolaus (SF). So far, there is "no macro evidence of business picking up."

A check from the government might inspire the purchase of a couple more plants or the painting of a room, but it will take a true revival of the housing market before Americans feel confident enough to redo the kitchen or finish the basement. Only then can Home Depot and Lowe's start humming again. "Many consumers remain hesitant to begin big-ticket projects," Niblock said.

Circuit City: Due for a Change?

Why So Long to Call a Recession?

Why HP’s Deal Is a Head-Scratcher

Circuit City: Due for a Change?

There is no question that Philip Schoonover's job, as CEO of electronics store chain Circuit City (CC), is in jeopardy. On Feb. 29, Wattles Capital Management, which recently bought 6.5% of the company's stock, proposed replacing Circuit City's entire 12-member board of directors with at least five of its own nominees. "Phil's actions in the past year show that he doesn't understand retail; he's completely mismanaged the company, and it's time for him to go," says Mark Wattles, principal of the investment firm, in an interview with BusinessWeek.com.

Under Schoonover's leadership in the past couple of years, Circuit City's performance has been dismal. The company, which is the second-largest specialty consumer electronics chain behind Best Buy (BBY), has posted net losses every quarter in the past year. That follows a $12 million net loss in its fiscal year that ended Feb. 28, 2007. Schoonover has told shareholders that management is dissatisfied with the results. Since Schoonover took over the top job in March, 2006, he has talked of a turnover plan to relocate underperforming stores and improve customer service, which seemed to give a lift to the company in the first few months. But two years and many quarterly losses later, Schoonover's plans sound hollow. "Our current focus is to rebuild our selling culture," said Schoonover to analysts on Dec. 21, after reporting third-quarter losses totaling $207.3 million.

That focus might be too little, too late. Especially since almost all analysts who cover the company blame its current woes on Schoonover's decision last March to fire 3,400 of Circuit City's most experienced employees. At the time the company said those workers were making too much money and could be replaced with cheaper workers. Analysts say the move led to a devastating loss of morale and a decline in customer service. "Obviously, if customers prefer to walk into a Best Buy rather than a Circuit City, which carry almost exactly the same things, the only point of difference is customer service," says Bob Bacarella, portfolio manager at the Monetta Funds, based in Wheaton, Ill., and a shareholder of competitor Best Buy.

Circuit City's stock, trading at 4.50, has declined 77% in the past year. Despite annual sales of $12 billion, the company's market capitalization today is a mere $760 million, making it a ripe target for shareholder actions like the one from Wattles Capital Management, as big investors can buy huge chunks of stock on the cheap.

The Wal-Mart Effect

To be fair, not all of Circuit City's problems are self-inflicted. A lot of them can be traced to 2006 holiday sales (BusinessWeek.com, 4/23/07), when a dramatic shift took place in the hottest selling flat-panel TV category. A calculated decision by giant retailer Wal-Mart Stores (WMT) to break the below-$1,000 barrier for 43-in. TVs triggered a financial meltdown among several consumer-electronics retailers. Tweeter Home Entertainment Group (TWTR), the high-end chain, shuttered 49 of its 153 stores before filing for bankruptcy. So did regional retailer Rex Stores (RSC), which boarded up dozens of its outlets.

Circuit City subsequently closed 70 stores in the U.S., put its 800 Canadian stores on the block, and then laid off the 3,400 workers. To many of his critics, that move demonstrated Schoonover's lack of experience in running stores. "Nobody who has worked in the field would have made the kind of firing decision that Phil made last year," says investor Wattles. "Phil didn't realize that you cannot cut costs and save your way out of deterioration. He didn't have a plan, and that crushed the stores."

Home Depot and Lowe’s Get Hammered

Why HP’s Deal Is a Head-Scratcher

Where Portals and Social Networks Collide

At first, Facebook was on board with the experiment. Google (GOOG) was testing a new tool that would let Web sites add a host of new social networking features. Using Google Friend Connect, for example, fans of indie pop musician Ingrid Michaelson could invite their friends, via their Facebook accounts, to join her Web site. Google's tool would let them import their Facebook contacts and then send out the invites to their friends' Facebook feeds. But just days after the trial began on May 12, Facebook "suspended" access for Google Friend Connect, saying it violated privacy terms in its user agreement.

Though Facebook says it has "reached out to Google several times about this issue" to work out a solution, the abrupt about-face underscores some of the growing tensions—and blurring lines—between social networks and traditional Web portals, both of which are angling to capitalize on the presumed advertising riches that will come from social media.

Enabling the Web's Social Butterflies

Indeed, it's been nearly three years since News Corp. (NWS) acquired MySpace, and still no one's answered that $64 gazillion question about who's going to make the real money from the social networking phenomenon. Uncovering the answer will only get harder as sites across the Web add social features, making the definition of social networking ever fuzzier. "In two to three years, the entire Internet is going to be more social," says Brad Garlinghouse, senior vice-president for communications and communities at Yahoo! (YHOO).

MySpace and Facebook have, in fact, taken steps that would have you think they're cool with this widening of social media beyond their network walls. In the coming months, both may be aiding and abetting the likes of Google and Yahoo in allowing users to access their profiles, friend lists, and other data for purposes that would steer their ad-viewing eyeballs elsewhere on the Internet.

The reasoning behind this apparent openness is simple: Just as AOL's and Prodigy's subscribers ultimately stormed beyond those gated online communities, social network users may not care to confine their socializing to one service. "I think the days of owning users are over," says Ning CEO Gina Bianchini, whose Web site enables users to create their own customized social networks. Ning was a charter member of OpenSocial, an initiative led by Google that was launched in late 2007 to help programmers create applications that can work on multiple Web sites.

Flocking to Share Data

But even if social network users want the freedom to spread their wings, they're not as keen about retyping all their personal information and contacts on every site. And so, as TechCrunch blogger Michael Arrington noted in a recent post, it's a tricky balancing act: The social networks "know that to keep users happy, and to stop them from entering in all that friend data into other sites, they need to make their data at least somewhat portable. Not too portable, mind you. That means they'd lose control. But just portable enough."

To facilitate this demand, MySpace and Facebook both introduced partnership programs within days of one another in early May. But while they may be cooperating some with other Internet players, the companies have yet to detail what business arrangements they may require to release their members' data to use on other sites.

The Escalator Pitch

The Escalator Pitch