Category Archives: Investor Psychology

I’LL BE BACK; Meanwhile Keep Learning


John Chew asked me to post while he goes through his stem cell transplant.  He says, “I’ll be back.” He thanks the many readers for their kind words of encouragement. 

His hospital roommate. John may opt for a radical new therapy.

Unfortunately, John challenged the status quo so he may have to be hospitalized longer.  Sign up to Farnam Street Blog

Novagold Annual Report 2015 This annual report’s shareholder letter including the links provides an excellent example of how several investors view the capital cycle for an asset.  History does provides a guide. Worth a look

Sign up: to receive reading links like:

    1.   Overcoming Their Fears 
    3.   3 Critical Things An Investor Needs – Capital Exploits
    5.   Unique Behind The Scenes Look Into Buffett’s Process – Vintage Value (must read)
    6.   Andy Groove And The Iphone SE – Ben Thompson
    7.   How Maritime Insurance Built Ancient Rome – Priceonomics
    9.   How Buffett And Munger Differ In The Way They Think – Outlook Business
    10. Podcasts: Conversation with Bethany McLean A fantastic interview for aspiring analysts. Her book on Fannie and Freddie seems like a must read!
Ackman: PSH-Annual-Report-12.31.151 See the section on Valeant.
A short summary of the tug of war over Valeant. Setting aside the noise about fraud, greed, and accounting issues, The Valeant Casino, this is a company that financed fast asset growth with cheap debt (at the time) while taking advantage of the flawed quasi-socialized medical system in the US.   Valuation depends on a normalization of true long-term cash flows–VRX_Update_StillOverpriced_2016-03-15 and EV_EBITDA_Misses_the_Point (View video on valuation and ROIC below for more context). The beneficiary of medical care does not DIRECTLY pay ALL of the costs. Who would be willing to accept a $1,000 tube of anti-fungal cream for their itchy feet if a third-party didn’t pay? See Dying with dignity.

Meanwhile……be wise not smart and stay-thirsty-my-friends-3

Price vs. Value–a Disagreement

Clearly people can have violently different views on price vs. value.

More on the Capital Cycle

FMQ for blog

We last left off here: follow-the-capital-cycle-as-a-contrarian

Gold and the capital cycle_2 Edward Chancellor discusses the fall-off in supply in precious metals which bodes well for FUTURE profits for miners.

The future turn in oil prices:

Over or mal-investment in the commodity cycle: Commodity Crash due to Monetary Supernova_Stockman

Buy disappointment and sell popularity  Don’t do this reflexively but place into context.

Peabody from hero to zero_case_resolution_fictconsulting

FCX_AR_2014 Note the increase in the rapid increase in assets before the stock price collapse. Note the research on how rapid asset growth usually precedes declines in future profitability  Robin Greenwood Investment and Ship Prices and asset_growth

Follow the Capital Cycle as a Contrarian


Ed Chancellor on the capital cycle…

From his introduction to Capital Returns: Investing Through the Capital Cycle: A Money Manager’s Reports 2002-15, which was released in hardcover today (Dec. 2015):
Typically, capital is attracted into high-return businesses and leaves when returns fall below the cost of capital. This process is not static, but cyclical – there is constant flux. The inflow of capital leads to new investment, which over time increases capacity in the sector and eventually pushes down returns. Conversely, when returns are low, capital exits and capacity is reduced; over time, then, profitability recovers. From the perspective of the wider economy, this cycle resembles Schumpeter’s process of “creative destruction” – as the function of the bust, which follows the boom, is to clear away the misallocation of capital that has occurred during the upswing.

The key to the “capital cycle” approach – the term Marathon uses to describe its investment analysis – is to understand how changes in the amount of capital employed within an industry are likely to impact upon future returns. Or put another way, capital cycle analysis looks at how the competitive position of a company is affected by changes in the industry’s supply side. In his book, Competitive Advantage, Professor Michael Porter of the Harvard Business School writes that the “essence of formulating competitive strategy is relating a company to its environment.” Porter famously described the “five forces” which impact on a firm’s competitive advantage: the bargaining power of suppliers and of buyers, the threat of substitution, the degree of rivalry among existing firms and the threat of new entrants. Capital cycle analysis is really about how competitive advantage changes over time, viewed from an investor’s perspective.

  1. Follow the capital cycle as a contrarian (well worth STUDYING!)
  2. Gold miners in the capital cycle (part 2) (Read several articles on the capital cycle in investing).

Watch for errors  (Interview of the gentleman pictured above)


So you’re Michael Burry who gets his hair cut at Supercuts and doesn’t wear shoes and you know more than Alan Greenspan?

Michael Burry: Yes.

I Saw the Crisis Coming (Michael Burry vs. Alan Greenspan)

A Review:

A lesson on the MBS crisis

Peter Schiff howling about the coming housing bust:

and see the results: aerial-photos

Lake Las Vegas/Macdonald Ranch 05.2012

The movie provides a case study in belief in authority and incentive-based bias.   See how many more biases you can pick out:

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?

More on Burry

BURRY_2000 Annual Letter






Mike Burry Lettersw


I remember being in the president’s office at Merrill Lynch in 1999 to see about selling 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! 


Contrarian Investing (Part II)


“Bull markets are born on pessimism,” he declared, they“grow on skepticism, mature on optimism, and die on euphoria.” –John Templeton

John Templeton paid attention to the emotion of the stock market. The first half of his philosophy was “The time of maximum pessimism is the best time to buy.” When everyone else was selling, he bought low during the Depression and in 1939 at the onset of World War II . . . and he made millions.

The second half of his philosophy was “the time of maximum optimism is the best time to sell.” He sold high during the boom when everyone else was still buying. Founded in the 1950s, his Templeton Growth Fund averaged 13.8% annual returns between 1954 and 2004, consistently beating the S&P 500.

I think there are a few ways to make many times (10x to 100x +) your money over a long period of time.   The first would be to own emerging growth companies that have owner-operators who are both excellent operators and capital allocators who grow the company profitably at a high rate over decades.   The business generates high returns on capital while being able to deploy capital into further growth. Think of owning Wal-Mart in the early 1970s or Amazon after its IPO or 2001.   There will be a post on 100 to 1 baggers soon. I prefer this approach.

Wal-Mart 50 Year Chart_SRC

The second way would be to buy distressed assets and then improve those assets or create efficiencies by creating economies of scale. Carlos Slim, Mexican Billionaire, would be an example of this type of investor. Think activist investing. Note that Carlos Slim has operated at times as a monopolist in a government protected market.  Most of us do not have his options.

The third way would be to buy deeply-distressed, out of favor, cyclical assets and then resell upon the top of the next cycle. Gold mining is a difficult, boom/bust business, for example–see Barrons Gold Mining Index below. All businesses are somewhat cyclical, but commodity producers are hugely cyclical with long multi-year cycles due to the nature of mining-it takes years and high expense to reopen a mine and even if I gave you $2 billion and several years, you and your expert team may not be able to find an economic deposit. Note the five-to-ten year cycles below.

gold mining bgmi

We are focusing on the third way, but in no way do I suggest that this is for you. You need to be your own judge.  There is a big catch in this approach, you need to choose quality assets and/or companies with managements that do not over-leverage their firms during good times or overpay for acquisitions during the booms (or you could choose leveraged firms but be aware of the added risk and size accordingly becasue when a turn occurs, the leveraged firms rise the most). You also need to seek out a period of MAXIMUM pessimism which is difficult to do. How do you know that the market has FULLY discounted the bad news?  Finally, YOU must be prepared to invest with a five-to-ten year horizon while expecting declines of over 50%. That concept alone will make you unique.   Probably most will turn away from such requirements.

We pick up from  Before we delve into the technical aspects of valuing cyclical companies, think about what it FEELS like to have the CONVICTION.  Here is an example:

We last studied Dave Iben, a global contrarian investor, in this post:   You should read, Its Still Rock and Roll To Me at and listen to the last few conference calls at the right side of the web-page.   Note Mr. Iben’s philosophy, approach, and Holdings. His portfolio is vastly different than most money managers or indexers. But being an contrarian takes fortitude and patience. Kopernik Global performance since inception:

koper spy

Next preview the readings below.

First you need to understand Austrian Business Cycle Theory to grasp how massive mal-investment occurs. Why does China have newly built ghost cities? Distortion of interest rates causes mal-investment (the boom) then the inevitable correction because the boom was not financed out of real savings.

Why is the bust so severe for mining/commodity producers?   Read Skousen’s book on the structure of production.  Think of a swing fifty feet off the ground and 200 feet long.   If you are sitting near the center of the swing’s fulcrum (nearest the consumer), then the ups and downs are much less than being on the end of the swing furthest from the consumer (the miners and commodity producers).

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Read Ch. 19 Security Analysis.pdf
Boom/Bust Austrian business cycle theory.pdf
Damodaran Valuing Cyclical Commodity Companies.pdf
Must Read Structure-production.pdf

Sorry: here is the Hooke book (chapter 19 on resource companies)

File Icon Business Valuation Methods – Jeffrey C. Hooke.pdf Download
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Even if you are an expert in valuation, investing in a cyclical company can be lethal: Vale: Go Where it is darkest (Damodaran)

ValeBig Vale

Then Throwing in the towel on Vale. I am not picking on Prof. Damordaran because we all make mistakes, and he graciously has provided a case study for us.  Study the posts and the comments.

Can you think of several research errors he made (BEFORE) he invested?

Remember in the prior post, the long-term chart of the CRB index showing commodities at 41-year lows since the CRB Index is below 175 or back to 1975 prices?  Then why, if gold is a commodity,  doesn’t gold trade at $200 or at least down to $500 to $700 as the gold chart from that time shows?monthly_dollar

Why, if gold is money, doesn’t gold trade in US Dollars at $15,000 or the estimated price to back US Dollars by 100% in gold?  You can change the amount to $10,000 or $20,000, but you get the monetary base


Gold during the boom of 1980 rel. to Financial Assets in 1980 the price of gold at $800 per ounce allowed for the US gold holdings to back each US dollar then outstanding.

Try thinking through those questions.  Can we use what we learned from gold to value oil?

I will continue with Part III once readers have had several days to digest the readings and at least three readers try to answer at least one question.  Until then……………………….be a contrarian not contrary.

Update on 21/Dec. 2015

Contrarian Dream or Nightmare?


You can see the parabolic move to extremes. Extremes can become more extreme, but what can’t continue will end.  Commodities are at forty-year extremes. Prices will go low enough to shut down the high cost producers until the price settles near the lower part of the cost curve.  Supply is shutting down in zinc and uranium, for example.   Financial assets will not be bid up to infinity despite the price charts for AMZN or IBB.


For further perspective:

CRB 2 centuries

The CRB index is printing 174 or not since 1975 have we seen such prices. Consider that Nixon severed the dollar’s link to gold in 1973 which caused nominal prices to rise.  The current bust is the flip-side of the massive mal-investment caused by ZIRP and easy credit over the past several years. the bust is the cleansing of the boom.

What will happen now? 

There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.” Ludvig V. Mises.

Mises is saying that if the government abandons its credit inflation, then there will be a total credit collapse (probably causing deflation or debt destruction). Or the government can increase and persist in its credit inflation leading to a crack-up boom/currency collapse.

The Fed is presently heading down the inflation path, but it doesn’t have to stay on this path. A change of direction is still possible.

Now for the other Mises quote:

This first stage of the inflationary process may last for many years. While it lasts, the prices of many goods and services are not yet adjusted to the altered money relation. There are still people in the country who have not yet become aware of the fact that they are confronted with a price revolution which will finally result in a considerable rise of all prices, although the extent of this rise will not be the same in the various commodities and services. These people still believe that prices one day will drop. Waiting for this day, they restrict their purchases and concomitantly increase their cash holdings. As long as such ideas are still held by public opinion, it is not yet too late for the government to abandon its inflationary policy.

But then, finally, the masses wake up. They become suddenly aware of the fact that inflation is a deliberate policy and will go on endlessly. A breakdown occurs. The crack-up boom appears. Everybody is anxious to swap his money against ‘real’ goods, no matter whether he needs them or not, no matter how much money he has to pay for them. Within a very short time, within a few weeks or even days, the things which were used as money are no longer used as media of exchange. They become scrap paper. Nobody wants to give away anything against them.”  –Mises

The gist is that if the inflation policy continues for long enough then a psychological tipping point will eventually be reached. At this tipping point the value of money will collapse as people rush to exchange whatever money they have for ‘real’ goods. Mises refers to this monetary collapse as the “crack-up boom”. Prior to this point being reached it will not be too late to abandon the inflation policy.

Today, the US is still immersed in the first stage of the inflationary process. If it continues along its current path then a “crack-up boom” will eventually occur, but there is no way of knowing — and “Austrian” economic theory makes no attempt to predict — when such an event will occur. If the current policy course is maintained then the breakdown could occur within 2-5 years (it almost certainly won’t happen within the next 2 years), but it could also be decades away. Importantly, there is still hope that policy-makers will wake up and change course before the masses wake up and trash the currency.

In conclusion, “Austrian” economic theory helps us understand the damage that is caused by monetary inflation and where the relentless implementation of inflation policy will eventually lead. That is, it helps us understand the direct and indirect effects of monetary-policy choices. It doesn’t, however, make specific predictions about whether the next few years will be characterised by inflation or deflation, because whether there is more inflation or a shift into deflation will depend on the future actions of governments and central banks. It will also depend on the performances of financial markets, because, for example, a large stock-market decline could prompt a sufficient increase in the demand for cash to temporarily offset the effects of a higher money supply on the purchasing power of money.

The upshot is that regardless of how the terms are defined, at this stage neither inflation nor deflation is inevitable.

…Back to being a contrarian.  As a contrarian you don’t reflexively buy plunging prices, but you do look for ugly, distressed and cheap where there is a high level of fear and dislocation because you are more likely to find mis-pricings. –Prof. Greenwald.

Are coal stocks a buy?  They are likely to finish 2015 down a whopping 5 years in a row, along with another hated sector, gold stocks.  Both are down over 80% from their peak.

I’ve written a lot about reversion strategies on this blog (Meb Farberand my books.   It is always hard to try and decide when an investment has declined and is a true value, or when it has simply declined with more to go?  There are lots of famous investing quotes to use here that may or may not be funny depending on your current holdings.

“Buy when there is blood in the streets”

“What do you call a market down 90%?  It is a market that was down 80%, and then got cut in half from there.”

“Investing is the only business that when things go on sale, everyone runs out of the store”

“You want to be greedy when others are fearful. You want to be fearful when others are greedy.”

Ironically, the only industry to ever print 6 down years in a row?

Coal stocks. (ending 1933)


You can see the chart here and how it set the stage for great future returns…but it wasn’t until the early 1940s before they really started their bull run…

The next post will describe investing in cyclical stocks.

Ringing a bell for commodities producers


Anglo Suspends Dividend (Ringing a bell)  We are watching collective capitulation by shareholders and management (a sign of the beginning of the end of the bear trend).

Anglo Restructuring

Remember the panic of bankers back in ’09?


A repeat for global miners in 2015/16?

Global Mining Indices

At lows, commodity price narrative is pure supply and demand with LIMITLESS SUPPLY (oil) and anemic demand (China slowdown) while at highs the narrative for commodities is driven by financial speculation (China boom/Commodity Super Cycle).   Buy low and sell high.

Avoiding the Death Zone–the Four Horsemen and the Nifty-Fifty


Climbers say that when you are over 24,000 feet, you enter the “Death Zone. Mistakes become lethal.

The death zone is the name used by mountain climbers for high altitude where there is not enough oxygen for humans to breathe. This is usually above 8,000 metres (26,247 feet).[1] Most of the 200+ climbers who have died on Mount Everest have died in the death zone.[1] Due to the inverse relationship of air pressure to altitude, at the top of Mount Everest the average person takes in about 30% of the oxygen in the air that he or she would take in at sea level; a human used to breathing air at sea level could only be there for a few minutes before they became unconscious.[1] Most climbers have to carry oxygen bottles to be able to reach the top. Visitors become weak and have inability to think straight and struggle making decisions, especially under stress. WIKI

So what does this have to do with investing?  When you pay too much for growth or quality, you may never recover. VALUATIONS MATTER ALWAYS!

First review the Nifty-Fifty Era when fifty stocks were “must own” for institutions in the 1970s due to their growth and quality.  Money managers herded into them similar to this: Money Managers Herding Video.

valuing-growth-stocks-revisiting-the-nifty-fifty  (Note page 22, you as an investor would have eventually broke even, but almost no one would have been able to seat through the 1980’s UNDER-PERFORMING a declining stock market!

Nifty Fifty   Ignore the second half of these notes.

Now think about how the pattern repeated in the Internet years of 1996 to 2000 when MSFT and INTC were the must own stocks of their era.

MSFT Monthly

INTC monthly

Congratulations! If you bought back in 1999/2000 when the press was lauding these “must own” stock for the future, you are now in the black.

Even if you pay too much for stable, high quality companies, you can lose even as the companies grow sales, cash flows and earnings year after year after year. Note: KO_VL_Jan 2013 (See P/E ratio as a proxy for investor enthusiasm and compare to financial metrics).   What is not to like?  So why did the price go sideways for almost a decade after 1998?   Investors adjusted their expectations.

Sun MicroSystems Case Study

One thing to never forget is that the market is mostly efficient but not ALWAYS efficient or correct. 2 plus 2 equals 4 not 10.   The last Internet frenzy gives a perfect case study in Sun Microsystems (SUN).

Sun Microsystems has always intrigued me. For a number of years, it seemed as if the company could do no wrong. During the early 1990′s, Sun occupied the top position in high performance computer workstations, a category of computing that has since virtually disappeared thanks to advances in PC hardware. Despite desperate attempts to unseat it from its leadership position by worthy competitors like HP, DEC, and IBM, Sun was able to prevail.

If you had purchased Sun stock in May of 1994, you’d have seen it skyrocket to nearly 100 times its value by August of 2000, just 6 years later. Had you kept it at the historical high price of $253/share, you’d have seen your investment lose more than 98% of its value when it came back down to just $3.17 a share by October 2008.

SUNW/JAVA stock price meteoric 100x rise and fall


It is easy to pull out a historical chart and say, “Look at the bubble popping.”  But note what the CEO had to say about the price of his company’s stock in 2002:

Q: Sun’s stock hit a high of $64 or adjusted in the chart above of $250. Did you think what tech stocks were doing two years ago was too good to be true?   (Date of the interview was March 2002).

A: No, she trained me well, and the stock made a nice move since we got married. But two years ago (2000) we were selling at 10 times revenues when we were at $64. At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What were you thinking?

Now, the same music is playing but the players have changed. 
New Four Horsemen1

New Four Horsemen

Are now driving the performance of the general stock indexes:

Fab Five

The Fab Five are “NEED TO OWN” stocks for money managers who wish to NOT underperform in the short-term.

  1. AMZN VL
  2. Goog_VL
  3. FB_VL
  4. MSFT VL
  5. GE_VL   certainly the the financial metrics, growth, and rising stocks prices make these easy “one-decision” stocks.

Let’s take AMZN because this company has a dominant position in retail that seems to be growing.

Amazon Key Stats

  • Trailing PE: 950.63
  • Forward PE:  117.65
  • Market Cap: $311.04 billion
  • Book Value: $26.50 per share
  • Share Price: $663.54
  • Price/Book: 24.27

Read more at How Amazons Long Game Yielded a Retail Juggernaut. Can’t you see many Americans becoming addicted to Amazon’s Prime service? Poor Wal-Mart and other retailers. However, IF AMZN doubles in market cap over the next 10yrs or a 7% annual return, and ends up trading at 21.9x earnings (current SPX p/e) in 2025, it needs to grow net income 55%/yr! Since 1973, 0.28% of companies have grown earnings at 55% for 10 years (Source: O’Shaughnessy). Do you like those odds?  Or are you so smart that you can tell that AMZN will win the lottery?

While valuation augur for CAUTION for stocks IN GENERAL:

GMO 7-Year 2015-11

The Bubble Right in Front of Our Faces

The True Contrarian

A MUST-READ ARTICLE:  The Nifty Fifty Becomes the Feb Five

Because when you enter the death zone you need to remember:


Have a great weekend and Thanksgiving for those in the USA!   How is your analysis of Valeant progressing? I hear crickets.

Update: The top 10 stocks in the S&P 500 are +13.9%. The other 490 are -5.8%. Largest spread since the late 1990s. Can you hear the bells ringing?

The Valeant Saga, Part III; Master Class in Deep Value Investing by Icahn


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.

You can start here with company documents:

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.

If anyone has other information to share please post in the comment section.

Also follow the links to the prior posts on Valeant to read the comment sections.

In a week, we will go through this exercise.   Now YOU have the chance to do the work.

Good luck and have a great weekend!

Excellent Video of Carl Icahn below.