Fundamentals vs. Technicals, Templeton, Ackman, Analysis of Valeant

Fundamental vs. Technical Analysis

Technical analysis, in all of its forms, uses the past price movements to predict the future price movements. In some cases (e.g. momentum analysis) it calculates an intermediate signal from the price signal (momentum is the first derivative of price). But no matter the style, one analyzes price history to guess the next price move.

This is necessarily probabilistic. There is no way to know that a particular price move will follow the chart pattern you see on the screen. There is no certainty. And when it does work, it is often because of self-fulfilling expectations. Since all traders have access to the same charts, and the same chart-reading theories, they can buy or sell en masse when the chart signals them to do so.

Fundamentals or Arbitrage:

Arbitrage works just like a spring. If the price in the futures market is greater than the price in the spot market, then there is a profit to carry gold—to buy metal in the spot market and sell a futures contract. If the price of spot is higher, then the profit is to be made by decarrying—to sell metal and buy a future.

There are two keys to understanding this. One, when leveraged speculators push up the price of gold futures contracts, then that increases the basis spread. A greater basis is a greater incentive to the arbitrageur to take the trade. Two, when the arbitrageur buys spot and sells a future, the very act of putting on this trade compresses the spread.

If someone were to come along and sell enough futures contracts to push down the price of gold by $50 or $150 or whatever amount is alleged, then this selling would be on futures only. It would push the price of futures below the price of spot, a condition called backwardation.

Backwardation just has not happened at the times when the stories of the big “smash downs” have claimed. Monetary Metals has published intraday basis charts during these events many times.

The above does not describe technical analysis. It describes physics—how the market functions at a mechanical level.

There are other ways to check this. If there was a large naked short position in a contract that was headed into expiry, how would the basis behave? The arbitrage theory predicts the opposite basis move. We will leave the answer out as an exercise for the interested reader, as thinking this through is really good work to understand the dynamics of the gold and silver markets (and you can Google our past articles, where we discuss it).

This check can be observed every month, as either gold or silver has a contract expiring (right now it’s gold, as the April contract is close to First Notice Day).


Ackman and Valeant

Ackman and his disasterous investment in Valeant The are many psychological lessons in this article.  What can you learn?

Ironically, one of the best research on Valeant was done by Allergan: Allergan analysis of Valeant 2014.   Did Ackman’s analysts even read it?   At least you have an example of solid research.

Compare to Ira-Sohn-2015-Presentation on Valeant and Other Platform Companies   Studying the two different presentations provides a FREE course on valuation and presenting a research idea.  But not 1 person in 10,000 would be willing to sweat the details like studying the two documents linked above.

Oh well, opportunity for those who work.

5 responses to “Fundamentals vs. Technicals, Templeton, Ackman, Analysis of Valeant

  1. On psychological lessons:
    Overreliance on abilities and greed. He had previously stated that he had avoided the industry and preferred other types of businesses. Yet, after a successful investment in Allergan he continued investing and he bet very big. He acknowledged that he was somewhat late to the party, indicating a lower margin of safety. It’s very possible that seeing the stock price improve quickly and with his previous success, he didn’t take the risks sufficiently into account.
    The fact that he bet so big even without much experience in the sector implies that overestimated his own abilities. He also disregarded comments by other successful investors. Klarman has said that arrogance is necessary in a way in order to make contrarian bets. However, it’s also necessary to see the risks and know your limitations. If you don’t, diversify more.

    I don’t know very much about Valeant and what the prospects looked like at the time but I know that also other investors bet big, such as the Sequoia Fund. It shows that it is always necessary to do your own work.

  2. It’s a delicate balancing act … have conviction in one’s beliefs while remaining humble.

    Nick de Peyster

  3. I think the human element is vastly underestimated. You need to build in some safeguards against hubris. A checklist pointing out the high debt levels would be one red flag. High turnover in management would be another.

    If Ackman, Sequoia, and Glen Greenberg can fall prey to Sirens (Remember The Odyssey), then we are all vulnerable.

  4. And pride. As some of these investors who are very proud and take great pride in their annual returns, it may be hard to accept that as their assets grow bigger, their opportunities diminish. The only way for them to keep earning abnormal profits may be to take stupid risks.

    Mr. Ackman declined to comment on the mistakes he made in Valeant or the
    lessons he gleaned from the loss.
    In a statement, Pershing Square noted that the firm “has generated billions of
    dollars of profits for its investors and double the stock market returns since the
    inception of the firm inclusive of our large loss on Valeant.”

  5. Overconfidence, extrapolating past success into the future, straying outside circle of competence. Thanks Jon, great post to sum up the story so far.

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