An example of my short corporate careerQUIZ: You are called in to interview for a six-figure consulting job for a family office. The family wants to establish an investment policy and procedure for investing. You are asked whether you would recommend investing in IPOs or other hedge funds. You reply that before recommending any asset class you would first determine:__________________________? Also, as a “value” (redundant) investor you would seek to buy from _______________ sellers. In case you need a hint, Ben Graham would have given you the answer in The Intelligent Investor.
One of the family members plops two annotated charts: 1 shows a reverse head and shoulders pattern on pork bellies and chart 2 shows blood spatter on the right of the chart. Which one has more predictive value as to where the market is headed?
Please answer in a few words–two or three–but no more than a sentence. GOOD LUCK!
From 1975-2001: ROI for T-Bills was 6.6%, S&P 500 14.1% with a 15% std. dev., Bulk Shipping 7.2 with a 40% std. dev., and Tanker Shipping 4.9% with a 70.4% std. dev! (Source: Maritime Economics, 3rd Edition)
Who in their right mind would invest in the shipping business? Well, if you can buy low, then fortunes can be made. Recently, the Baltic Dry Index (BDI) hit a thirty-year low of 291, BDI Index and note the long-term chart below. Always look at MANY years of past data. The boom of 2007/08 will probably not be seen again for many years.
“Dry bulk is a screaming buy; one of the best entry points in the cycle in the last thirty years. But be prepared to sustain a prolonged period of poor freight market conditions and have plenty of cash reserves and low leverage. In other words, you have to have a longer-term perspective than most investors–three to five years at least.
Isaac sowed seeds into the land during a drought. –Leon Patitasas
“That’s the funny thing about ships. They are actually more attractive to buy at 20xs EBITDA, or even negative cash flow, than they are at 4xs EBITDA,” Coco said.
“So you are telling me that investors should seek out money losing shipping deals?” she asked incredulously.
“Correct. And sell the ones that are making lots of money. Itis like that little Napoleon said….”Buy on the sound of cannons and sell on the soundsof trumpets.” (Source: The Shipping Man by Matthew McCleery).
John Chew: Here is where I wonder if this post helps readers’ understanding of investing because is this investing or speculating? Note as much as what Warren Buffett does NOT do. He doesn’t invest in mining or shipping stocks. He has already had poor results with the airline industry. So why even mention an industry in massive distress with historically sub par returns and huge volatility? I would prefer businesses with great reinvestment opportunities or great capital allocators at the helm like Markel (MKL), but a horrific business going from a distress price to a bad price may give much better returns depending upon the price paid. Also, the worst bear market in freight rates in the past 30 years for dry bulkers means unusual opportunity just as the worst bear market in gold miners in the past 100 years offered bargains galore.
Readers know that I ventured into the miners in mid-to-late 2013, subsequently suffering back-to-back declines of about 25% before seeing the portfolio rally about 100%. So I still do not have a great return (12% after three years), but I bought miners with a five-year-to-seven year outlook and I am only three years into the investment. With Junior miners you can expect to see a 50% decline before they rally five to 10 times (assuming you chose the ones that survive! –Rick Rule). In a land of negative-to-low interest rates, I have to look further for bargains.
Readers can pipe in what they would like to learn in future posts–let me know.
Five years of declines in gold mining stocks and then…..
Are you investing or speculating by dry-bulk shipping stocks? These are stub stocks where the equity is a small fraction of the enterprise values due to the shrunken market cap and the large debt taken on to finance ship purchases. But if you buy a few well-managed and relatively well-financed shipping companies that can survive the trough of the cycle–two to four more years?– you can tolerate a few going to zero if the ones remaining multiply many-fold. Not for the weak-kneed. Scorpio Bulkers (SALT) has ALREADY diluted shareholders and has taken drastic action to survive. Note management buying shares at $3.00 Scorpio Bulkers Inc. Announces Financial Results for the First Quarter of 2016. An ugly past, but we invest for the future in terms of mean reversion. I have not yet invested in any shipping stocks!
Here is what I love about the shipping business. 10 ships and 11 cargoes, then a BOOM. 11 ships and 10 cargoes, then a BUST. You are also on the SAME footing as the most experienced ship owners in the world. NO ONE knows when the cycle will turn. This is like a poker game where the investor that has the ships when others have thrown in the towel takes a lot of the marbles. The worse the freight rates and the outlook, the better IF you can carry the costs until the cycle turns, and it WILL turn due to the laws of supply and demand.
I view this as intelligent speculation. I allocate five tranches of investment into five shipping companies. Say $5 units each. One unit goes to zero (ouch!), the next to $2 (Boo!), the next to $1 (Damn!), the next to $3 and the next to $50 (Homerun!) and it takes three years. There is a 31% compouned return. Though I have no idea if this is realistic because I must study the shipping industry thoroughly. I am just formulating a possible strategy IF I find the right companies at the right prices. But I am drawn to the shipping companies because some companies are trading below depressed net asset values. As Mr. Templeton suggests, look where the outlook is most dire.
The movie can’t cover all the reasons behind the housing/debt crisis, but you will get a sense of what great investors have to go through when they take a massively contrarian position. Note that Michael Burry started becoming worried about housing in 2003. Why? He asked himself the simple question: How come real estate prices are RISING or NOT going down in Silicon Valley during the biggest tech bust in history during 2001/2002?
I remember being in the president’s office at Merrill Lynch in 1999 to see about selling www.art.com and the president pointed out through the glass partition to his trading floor and said see my risk team? They are the best in the business!
Part II on Valeant Let’s pretend you are asked to evaluate the situation for Mr. Ackman. He is in deep #$%^& and has brought in fresh eyes to advise him. Pershing Square has had to install two hotlines–Hotline 1: for investor suicide calls and Hotline 2: for investors who wish to phone-in death threats.
All bad joking aside, you have a huge pile of information to present the critical issues. Do you advise Mr. Ackman to buy more, sell immediately, sell down to a “more reasonable amount,” or hold? Use reason not opinion or emotion to guide you.
Step back and ask what are the important issues? What is Valeant worth? Can you know that? Pretend you are an investigative journalist trying to uncover the story.
What does Valeant do? Does Valeant have assets or a business method that gives the company a higher sustainable return on capital? What roll-ups/acquisition firms have been very successful in the past and how was success achieved?
Then you can read all the rumours and commentary swirling around Valeant, but be quick to focus on what you determine to be important. There are several links in the documents for you to follow further.
There is a joke that illustrates the value of optionality
An investment banker and carpenter are sitting next to each other on a long flight. The investment banker asks the carpenter if she would like to play a fun game. The carpenter is tired and just wants to have a nap, so she politely declines and tries to sleep. The investment banker loudly insists that the game is a lot of fun and says, “I will ask you a question, and if you don’t know the answer you must pay me only $5. Then you ask me one question, and if I don’t know the answer, I will pay you $500.” To keep him quiet, she agrees to play the game.
The investment banker asks the first question: “What’s the distance from the earth to the Saturn?” The carpenter doesn’t say a word, pulls out $5, and hands it to the investment banker.
The carpenter then asks the investment banker, “What goes up a hill with three legs and comes down with four?” She then closes her eyes again to rest.
The investment banker immediately opens his laptop computer, connects to the in-flight Wi-Fi, and searches the Internet for an answer without success. He then sends emails to all of his smart friends, who also have no answer. After two hours of searching, he finally gives up. The investment banker wakes up the carpenter and hands her $500. The carpenter takes the $500 and goes back to sleep. The investment banker is going crazy from not knowing the answer. So he wakes her up and asks, “What does go up a hill with three legs and comes down with four?”
The carpenter hands the investment banker $5 and goes back to sleep.
Go find bets like that!
A Trading Parable
Once upon a time, a man and his assistant arrived in a very small town and spread the word to the townspeople that the man was willing to buy monkeys for $100 each. The people knew there were many monkeys in the nearby forest and immediately started catching them. Thousands of monkeys were bought at a price of $100 and placed in a large cage. Unfortunately for the townspeople, the supply of monkeys quickly diminished to a point where it took many hours to catch even one.
When the new man announced he would now buy monkeys at a price of $200 per monkey, the town’s resident’s redoubled their efforts to catch monkeys. But after a few days the monkeys were so hard to find that the townspeople stopped trying to catch any more. The man responded by announcing that he would buy monkeys at $500 after he returned with additional cash from a trip to the big city.
While the man was gone, his assistant told the villagers one by one: “I will secretly sell you my boss’ monkeys for $350, and when he returns from the city, you can sell them to him for $500 each.”
The villagers bought every single monkey, and they never saw the man or his assistant ever again.
There is no stand-alone Narrative regarding gold today (June 2013), as there was in 1895. Today gold is understood from a Common Knowledge perspective only as a shadow or reflection of a powerful stand-alone Narrative regarding central banks, particularly the Fed … what I will call the Narrative of Central Banker Omnipotence. Like all effective Narratives it’s simple: central bank policy WILL determine market outcomes. There is no political or fundamental economic issue impacting markets that cannot be addressed by central banks. Not only are central banks the ultimate back-stop for market stability (although that is an entirely separate Narrative), but also they are the immediate arbiters of market outcomes. Whether the market goes up or down depends on whether central bank policy is positive or negative for markets. The Narrative of Central Banker Omnipotence does NOT imply that the market will always go up or that central bank policy will always support the market. It connotes that whatever the central bank policy might be, it will drive a market outcome; whatever the market outcome, it was driven by a central bank policy.
The stronger the Narrative of Central Banker Omnipotence, the more likely it is that the price of gold goes down. The weaker the Narrative – the less established the Common Knowledge that central bank policy determines market outcomes – the more likely it is that the price of gold will go up. In other words, it’s not central bank policy per se that makes the price of gold go up or down, it’s Common Knowledge regarding the ability of central banks to control economic outcomes that makes the price of gold go up or down.
Instead, the focus of the mainstream Narrative effort moved almost entirely towards what open-ended QE signaled for the Fed’s ability and resolve to create a self-sustaining economic recovery in the US. And it won’t surprise you to learn that this Narrative effort was overwhelmingly supportive of the notion that the Fed could and would succeed in this effort, that the Fed’s policies had proven their effectiveness at lifting the stock market and would now prove their effectiveness at repairing the labor market. Huzzah for the Fed!
Mining securities are not the thing for widows and orphans or country clergymen, or unworldly people of any kind to own. But for a businessman, who must take risks in order to make money; who will buy nothing without careful, thorough investigation; and who will not risk more than he is able to lose, there is no other investment in the market today as tempting as mining stock.” – Charles H. Dow (1879)
There is NO REASON to own gold! (NOW, they tell us!)
The “price action” for gold is bad! The price of gold went down.
Why not be happy and say that the dollar buys you more gold because of this:
The holders of physical bullion are not selling, but futures traders are–see the red line rising which is the co-basis. If I hold gold in stock, but sell futures to lock in the price, then co-basis represents the difference between the bid price for spot and the offer price for futures. Leveraged futures traders are selling futures but bullion holders are not de-stocking (selling). The selling in gold futures has brought epic extremes in prices of miners relative to gold/silver. EPIC quantitative easing may be a factor.
Only you can answer that question. Don’t confuse gold (money) as an investment. If you couldn’t find a margin of safety in the current stock market, you might own gold because you believe gold relative to dollars is safer, holds purchasing power better, more stable, etc.
When everything is coming your way, you’re in the wrong lane. –S. Wright
Above you can see Seaboard’s stock price vs. Berkshire’s over the past decade.
Below is a good example of research on a cyclical company. Note that the analyst goes back far enough to see how the business performs over several cycles and economic booms and busts. You may not agree with his conclusions (say that the company will continue to grow at 12%) but you can clearly see his assumptions.
If readers in the Deep-Value group (Google Groups) find interesting case studies don’t hesitate to share with the group. You will learn more from each other than from just reading this blog or the blogs listed below.