Category Archives: Risk Management

A Review: The Bre-X Scandal

The Peak
It was touted by media and banks as the “richest gold deposit ever”
In December 1996, Lehman Brothers Inc. strongly recommended a buy on “the gold discovery of the century.”

Bre-X’s salted samples were never checked by a third party, people wanted to believe so they never questioned the rising price of the stock. Do not ignore the warning signs.

Patience is paying off in http://csinvesting.org/2017/05/12/a-tontine/

When is a P/E not a PE: Case Study in Indexing

A tutorial on the dangers of Indexing investing. 

Know what you are doing IF you buy index funds!  You can learn a lot by studying Horizon Kinetics.  The video provides a valuation of the index and how to think about investing or not in indexes.

http://horizonkinetics.com/market-commentary/2nd-quarter-2017-commentary/

Also, more on indexing here:

Q2-2017-Commentary_APPROVED_FINAL

Q1-2017-Commentary_FINAL-1

Q4-2016-Commentary_Final

Q3-2016-KAM-Conference-Call

Hedge Fund Analyst Quiz–NG $3 The New Normal

Your boss runs into your office and slaps this report onto your desk: Don‘t Bet Against Innovation_Sub-$3 Is the New Normal

After reading the report and using your knowledge of how capital cycles work, what would you say to your boss about using the information in that report for investing?  IF you wanted to make an outstanding investment, then how might the report help you?   The video below might give you a hint.  Remember that the JP Morgan report goes to thousands of portfolio managers and analysts, so how can YOU use the information to have an edge? Or can you? Comments needed in order to keep your hedge fnd job.

Good luck!

 

Indexing Madness or An Indexing Bubble

A must see discussion of today’s index investing distortions

http://horizonkinetics.com/market-commentary/4th-quarter-2016-commentary/   What will turn the tide for active investors. Or read commentary : Q4-2016-Commentary_Final

https://vimeo.com/209940152/f2154e4d3d Grant’s Conference Presentation

Kinetics_Market_Opportunities_11.02.2016

Q2 2016 Commentary FINAL (See section on ETFs vs. Individual Stocks)

Articles of interest:

Risk Disclosure in Plain Language; Go LT Fundamental

Written in 1998 during the Internet Riot (from Cove Capital Blog)

Risks of Investing in IPS Millennium Fund
Plain Language Risk Disclosure (Funny)

First of all, stock prices are volatile. Well, duh. If you buy shares in a stock mutual fund, any stock mutual fund, your investment value will change every day. In a recession it will go down, day after day, week after week, month after month, until you are ready to tear your hair out, unless you’ve already gone bald from worry. It will insist on this even if Ghandi, Jefferson, John Lennon, Jesus and the Apostles, Einstein, Merlin and Golda Maier all manage the thing. Stock markets show remarkably little respect for people or their reputations. Furthermore, if the fund has really been successful, you might be buying someone else’s whopping gains when you invest, on which you may have to pay taxes for returns you didn’t earn. Just try and find somewhere you don’t, though. Dismal.

While the long-term bias in stock prices is upward, stocks enter a bear market with amazing regularity, about every 3 – 4 years. It goes with the territory. Expect it. Live with it. If you can’t do that, go bury your money in a jar or put it in the bank and don’t bother us about why your investment goes south sometimes or why water runs downhill. It’s physics, man.

Aside from the mandatory boilerplate terrorizing above, there are risks that are specific to the IPS Millennium Fund you should understand better. Since most people don’t read the Prospectus (this isn’t aimed at you, of course, just all those other investors), we thought we’d try a more innovative way to scare you.

We buy scary stuff. You know, Internet stocks, small companies. These things go up and down like Pogo Sticks on steroids. We aren’t a sector tech fund, we are a growth & income fund, but right now the Internet is where we think most of the value is. While we try to moderate the consequent volatility by buying electric utility companies, Real Estate Investment Trusts, banks and other widows-and-orphans stuff with big dividend yields, it doesn’t always work. Even if we buy a lot of them. Sometimes we get killed anyway when Internet and other tech stocks take a particularly big hit. The “we” is actually a euphemism for you, got it?

We also get killed if interest rates go up, because that affects high dividend companies badly. Since rising interest rates affect everything badly, we could get killed even worse if the Fed raises rates, or the economy in general experiences higher interest rates beyond the control of those in control, or gets out of control. Whatever.

Many of the companies we buy are growing really fast. Like, 50% – 100% per year sales growth. Many of them also don’t make any money, although they may be relatively large companies. That means they have silly valuations by traditional valuation techniques. We don’t know what that means any more than you do, because we have never seen anything like the Internet before. So we might overpay for these companies, thinking we are really smart and can get away with it because they are growing so fast. It doesn’t take a whole lot for these companies to drop 50% or more, because nobody else knows what they are worth either. Received Wisdom can turn on a dime in this business, and when that happens prices fall off a cliff.

Even if we were really smart and stole these companies, if their prices run way up we are still as vulnerable as if we were really dumb and paid that high a price for them to start with. If we sell them, you will get pretty irritated with us come tax time, so we try not to do any more of that than we have to. The pole of that strategy, though, is that if we are really successful, you will have a lot of downside risk in a recession or a bear market. Bummer.

Finally, if you haven’t already grabbed the phone and started yelling at your broker to sell our fund as fast as possible, you should understand the shifting sands of technology. It doesn’t take billions of dollars to start a high tech company, like it did U.S. Steel or Ford Motor. Anybody can do it, and everybody does. Many of our companies are small, even though they dominate their market niche. It’s much easier for a new technology to blow one of our companies out of the water than it was in the old days of canal, mining, railroad and steel companies.

Just so you know. Don’t come crying to us if we lose all your money, and you wind up a Dumpster Dude or a Basket Lady rooting for aluminum cans in your old age.

Please e-mail us if we haven’t scared you enough, and we’ll try something else.
Back to Index Page
Fundamental investing and the long term (Go here)
combine with https://www.cxoadvisory.com/240/big-ideas/triumph-of-the-optimists-chapter-by-chapter-review/ to understand how you can gain an EDGE.
Passive investing bubble
 

 

 

 

 

 

 

 

Note: The Value Vault will be down for a few months for reorganization.   For new readers just use the search box or start at the beginning of the blog and go through the 1,200 posts.   By the end you can run Berkshire of Blackrock.

A Strategy for Resource Stocks; Investing Course

A Strategy for investing in highly volatile, cyclical stocks

Once again, gold, silver and their mining stocks are selling off for whatever reason: risk-on as money floods into the stock market, rising nominal yields, 95% certainty of a (meaningless) 0.25% interest rate hike, momentum–take your excuse. The main point is to know your companies (valuation) and wait for sales like you do at the grocery store.   This week we are having a sale on some miners.

As Sprott’s Rick Rule often says, “If you are not a contrarian in the resource sector, you are a victim.  The above video is provided to show a particular investing strategy when your quality miners are selling off to prices where you estimate a margin of safety.  However, it doesn’t mean you predict THE exact bottom.  If your holding period is three-to-five years, you can occasionally pick up cheaper merchandise. Use prices to your advantage, not disadvantage.  I also wouldn’t be surprised to see the miners sell-off further because of their highly volatile nature–huge operational and asset-based leverage–when gold or silver goes up or down, both the price of their product goes up or down and the value of their reserves.  Never expect exact timing–a fool’s game.  Also, miners are impacted by the cost of their inputs, so a rising gold/oil ratio is a positive, for example.

What about the gold price in my assumptions?   I am assuming gold is money (“All else is credit”–JP Morgan) and thus I can benchmark it against world currencies. Gold has been THE strongest money relative to all other currencies for the past 20 years, 30 years, 40 years, 50 years, 100 years.  Gold is THE only money and store of value that can’t be created out of electronic bits like FIAT MONEY.  The stability of available supple is what makes gold the premier money. Of course, due to LEGAL TENDER LAWS, gold is not a currency in the U.S., except that may be changing in some states like Arizona: http://planetfreewill.com/2017/03/09/Ron-paul-testifies-support-arizona-bill-treat-gold-silver-money-remove-capital-gains-taxes/.

In fact, gold (originally silver) is the only Constitutional money allowed–http://www.heritage.org/constitution/#!/articles/1/essays/42/coinage-clause

You can get a historical overview of gold’s‘ price history below. Notice a trend?


http://www.macrotrends.net/1440/hui-to-gold-ratio Now view the miners in perspective.

P.S. Let me know if anyone wants to see a NPV case study on a miner.

Designing an analyst course

My goal is to organize a comprehensive analyst course using the best investors’ teachings and lectures. For example, Buffett, Munger, Graham, Fisher, Tweedy Browne, Walter Schloss, Klarman, and many others etc.  Why not use original sources of the best practitioners?  This is the course I wish I had twenty years ago.  It will be Buffett and Munger teaching not me.

The course would cover search, valuation, portfolio management, and you (how to improve decision-making).   There would be different modules continuing articles, case studies, videos from Columbia Business School and others. We would go from DEEP VALUE to FRANCHISE INVESTING.   Valuing assets to assessing franchises. Understanding reversion to the mean and slow reversion to the mean.  You need to understand that when a moat is breached-watch out! Note Nokia in cell phones.

I would have to make it a private web-site because of copy-right.   This would be more of like a private study place, library, and discussion area for learning.   There could be a in-person value class in some convenient location depending upon interest once folks have had a chance to go through the modules.

For example, putting ebitda into perspective might be a mini-module on a sub-set of cash-flow: http://csinvesting.org/placing-ev-and-ebitda-into-perspective-case-studies/   Now, if you scroll down to the last link, you can see that it was taken down.   With a private web-site, you would see this: http://csinvesting.org/wp-content/uploads/2012/09/placing-ebitda-into-perspective.pdf

Let me know your thoughts because this would be a huge project to complete.  What focus do YOU want?   How would YOU design and make the course.

Have a great weekend!

A Deep-Value Canadian Grahamite Teaches His Process

Tim McElvaine explains his simple but effective process.

2016-05_conference_transcript_McElvaine Fund An excellent tutorial on Graham-like investing. Note his simple four-pronged approach.   Read more below:

Time to Index? Got Gold?

A portfolio manager who will manage the Dogs of the Dow Portfolio.

Most institutional and individual investors will find the best way to own common stock is through an index fund that charges minimal fees. Those following this path are sure to beat the net results after fees and expenses delivered by the great majority of investment professionals. –Warren Buffett.

A minuscule 4% of funds produce market-beating after-tax results with a scant 0.6% annual margin of gain. The 96% of funds that fail to meet or beat the Vanguard 500 index Fund lose by a wealth-destroying margin of 4% per annum.  “Unless an investor has access to incredibly highly qualified professionals, they should be 100 percent indexed. That includes almost all investors and most institutional investors. –David Swensen, chief investment officer, Yale University.

“In modern markets, most institutions and almost all individuals will experience better results with index funds.” –Benjamin Graham.

Those who have knowledge, don’t predict. Thos who predict, don’t have knowledge. — Lao Tzu, 6th Century B.C.

I am reading, The Index Revolution: Why Investors Should Join It Now by Charles D. Ellis

The author presents a compelling case why most individuals should index:

  1. Indexing outperforms active investing
  2. Low Fees are an important reason to index
  3. Indexing makes it much easier to focus on your most important investment decisions
  4. Your taxes are lower when you index
  5. Indexing saves operational costs.
  6. Indexing makes most investment risks easier to live with
  7. Indexing avoids “Manager Risk”
  8. Indexing helps you avoid costly troubles with Mr. Market
  9. You have much better things to do with your time.
  10. Experts agree most investors should index

Articles proliferate such as: https://www.fool.com/investing/general/2016/04/05/the-numbers-are-in-actively-managed-mutual-funds-a.aspx and research for the past few decades has shown that Index Funds Outperform.

Now lets journey into the real world: https://www.mackenzieinvestments.com/en/prices-performance.  I picked this fund family at random. Look at each of their funds’ long-term performance compared to their comparable benchmarks.   Not ONE outperforms. Not one.   Who in their right mind would invest?    As money managers become desperate to beat the index, they tend to mimic their benchmarks, so their amount of underperformance closes towards the index, but GUARANTEES underperformance due to fees and slippage of commissions and taxes.

Time to pack it in and index?   First, do not underestimate how difficult it is to “outsmart” the market.   I personally believe that the ONLY way–obviously–to do better is to be very different from the indexes.   You will either vastly UNDER-perform or OUTperform.  You have to be different and right.  So how to be right?  You must do things differently like use all available information in the financials (read footnotes and balance sheet), have a longer-term perspective such as five to seven years–at a minimum–three years to give reversion to the mean a chance to work or time for franchises to compound.   You have to pick your spots where you are confident that you are buying from mistaken, uneconomic sellers.   And when you do find a great opportunity (assuming that you can distinguish one) you heavily weight your position.  NOT EASY.

SETH KLARMAN

Here is what Seth Klarman recently said about current conditions (New York Times, Feb. 7th, 2017:

Most hedge funds have found themselves on the losing side of trades over the past several years, a point Mr. Klarman addressed in his letter (2016). Noting that hedge fund returns have underperformed the indexes — he mentioned that hedge funds had returned only 23 percent from 2010 to 2015, compared with 108 percent for the Standard & Poor’s index — he blamed the influx of money into the industry.

“With any asset class, when substantial new money flows in, the returns go down,” Mr. Klarman wrote. “No surprise, then, that as money poured into hedge funds, overall returns have soured.”

He continued, “To many, hedge funds have come to seem like a failed product.”

The lousy performance among hedge funds and the potential for them to go out of business or consolidate, he suggests, may become an opportunity.

Perhaps the most distinctive point he makes — at least that finance geeks will appreciate — is what he says is the irony that investors now “have gotten excited about market-hugging index funds and exchange traded funds (E.T.F.s) that mimic various market or sector indices.”

He says he sees big trouble ahead in this area — or at least the potential for investors in individual stocks to profit.

“One of the perverse effects of increased indexing and E.T.F. activity is that it will tend to ‘lock in’ today’s relative valuations between securities,” Mr. Klarman wrote.

“When money flows into an index fund or index-related E.T.F., the manager generally buys into the securities in an index in proportion to their current market capitalization (often to the capitalization of only their public float, which interestingly adds a layer of distortion, disfavoring companies with large insider, strategic, or state ownership),” he wrote. “Thus today’s high-multiple companies are likely to also be tomorrow’s, regardless of merit, with less capital in the hands of active managers to potentially correct any mispricings.”

To Mr. Klarman, “stocks outside the indices may be cast adrift, no longer attached to the valuation grid but increasingly off of it.”

“This should give long-term value investors a distinct advantage,” he wrote. “The inherent irony of the efficient market theory is that the more people believe in it and correspondingly shun active management, the more inefficient the market is likely to become.”

End.

What do YOU think?

PET ROCKS

Imagine owning a pet that doesn’t need to be trained, walked, fed or groomed — ever. That’s exactly what California ad executive Gary Dahl was after when he came up with pet rocks in 1975. Tired of the hassle and responsibility that came with animate house pets, Dahl developed a toy concept that was 1% product and 99% marketing genius: a garden-variety rock, packaged in a comfy cardboard shipping crate, complete with straw for the rock’s comfort and holes so it could breathe during transport. The Pet Rock Training Manual — a tongue-in-cheek set of guidelines for pet owners, like housebreaking instructions (“Place it on some old newspapers. The rock will never know what the paper is for and will require no further instruction”) — helped turn the scheme from an amusing gag gift into an inexplicable toy craze. By Christmas 1975, Americans were hooked. Although the fad was long gone by the following year, the rocks — which were collected from a beach in Baja, Calif., for pennies each and retailed for $3.95 — made Dahl a multimillionaire in about six months. https://en.wikipedia.org/wiki/Pet_Rock and The-Care-and-Training-of-Your-Pet-Rock-Manual-by-Gary-Dahl

BEFORE I became a value investor, I was addicted to bubbles.  I have over 1,200 Pet Rocks lining my Python cage.  I don’t know what the price chart says, but it doesn’t look good that I will be able to resell at a profit.

Also, I have 20,000 Beanie Babies rotting/mildewing in my basement as well.

but there is hope…..http://dailytoa.st/blogs/if-you-have-any-of-these-11-beanie-babies-you-can-retire-now

An amazing story of mass delusion and the dark side of cute.

How to be a Stoic: http://www.perell.com/podcast/massimo

Lessons from Ed Thorp, a self-taught investor: http://www.gurufocus.com/news/473560/the-strip-and-the-street-a-conversation-with-mathematician-hedge-fund-manager-and-blackjack-player-edward-thorp

Edward Thorp: I came at the securities markets without basically any prior knowledge and I educated myself by sitting down and reading anything I could lay my hands on. I began to get oriented, and then I discovered how to evaluate warrants, at least in an elementary way, and I decided that was a way that I could apply mathematics and logical thinking and maybe get an edge in the market.

Using Charts (NVGS)

So if charts have NO FORECASTING ability or, in my humble opinion, no investor/trader can use chart formations like rising wedges, cup and handles, head and shoulders, etc to PREDICT where the market will go IN THE FUTURE. Charts might work for Hindsight Capital, but I have yet to see any research showing the efficacy of chart reading.  Despite that vicious attack on chartists, I do use charts.   Take for example, Navigator’s Holdings (NVGS).   Let’s zero in a bit more:

Note the time period from August 2016 to December 2016.  As the price accelerated downward on larger than normal volume–note in the second week of August the plunge in price from $9.50 t0 $8.10 in one day or about 15%, OUCH!  The price decline occurred on the anouncement of second quarter earnings:

Navigator Holdings misses by $0.04, misses on revenue Aug. 8, 2016

So you have a plunging/falling knife on an “earnings miss” or worse than “expected” news.  Now look at the opposite of the trade. Since I was fundamentally bullish, who was on the other side selling?  First from the holdings, you can see that 41% of the 53 million shares outstanding is held by a private equity firm, Invesco run by Wilbur Ross–a deep value investor. Invesco bought at $9 a share back in 2012, then sold some shares at $20 a year and a half later.  Over 50% of the shares seem to be held by long-term investors.   The NVGS share price had been declining for over two years from $32 per share while it bought more ships, then LPG freight rates declined sharply and the arbitrage shrunk for some of NVGS’s products.  In short, the sudden high volume rapid decline indicated MOTIVATED sellers who were either distressed or late momentum sellers.  Some of the sellers are selling AFTER a long price decline and bad news being announed.  I consider those emotional/weak sellers. Now there is no guarantee that the news won’t worsen and the price won’t keep declining.

I feel confident saying that because NVGS’ balance sheet was not overburdened with debt. See September-2016-Update for NVGS.

INVESCO PRIVATE CAPITAL, INC. 21,863,874 $ 157,201,000 41.05% 53.08% 1 NaN%
PARAGON ASSOCIATES & PARAGON ASSOCIATES II JOINT VENTURE 1,050,000 $ 7,550,000 8.73% 10.85% 4 86,516 NaN%
EMANCIPATION MANAGEMENT LLC 683,422 $ 4,913,000 7.57% 6.95% 3 187,961 NaN%
HOLLOW BROOK WEALTH MANAGEMENT LLC 855,072 $ 6,148,000 3.63% 2.91% 10 489,875 NaN%

Then prices CONTINUED to decline as negative news and research reports came out reporting the known bad news of declining freight rates, over-supply of ships, economic uncertainty, etc.

Let’s set aside that on a normalized basis, I have a value for NVGS above $20, how do I know the price won’t go to $8 or $5 or $2? I don’t!   But I do have context to see if the price is “OVER” discounting the news/fundamentals.

http://seekingalpha.com/research/839737-j-mintzmyer/4912014-exclusive-research-navigator-holdings-cheap-underfollowed-deservedly is an example of several negative research reports that implied, “Yes, the stock is cheap with solid management and the company is profitable, BUT supply will increase next year.” Stay away.

Then for the next two months, September and October, the price chart showed a change in trend from rapidly down to sideways. Why was the price going sideways with negative reports and negative news constantly coming out each day?  Perhaps the chart was showing that prices had ALREADY discounted the known NEGATIVE news and extrapolating a long period of negative news.   Unless the news became much worse–despite frieght rates at 30 year lows–all you needed was slightly less bad news.

Sure enough, the announcement of earnings Nov. 4th 2016 showed that the company could still generate profits in an extremely negative operating environment. The price rallied confirming the prior discounting.  Now I could really start to add to my position.  The chart had helped me “eliminate” one side of the market–the downside.

The combination of fundamentals, the action of majority shareholders (holding firm), extreme negative news coupled with NON-DECLINING prices, gave me a signal that the market had ALREADY discounted negative news.    This is more of an art or combination of fundamentals, sentiment, and human incentives than just looking at chart patterns.

Hope that helps.

You are Hired! A Trump Playbook For Fixing Americas Economy

If you were against the New Deal and its wholesale buying of pauper votes, then you were against Christian charity.  If you were against the gross injustices and dishonesties of the Wagner Labor Act, then you were against labor.  If you were against packing the Supreme Court, then you were in favor of letting Wall Street do it.  If you are against using Dr. Quack’s cancer salve, then you are in favor of letting Uncle Julius die.  If you are against Holy Church, or Christian Science, then you are against god.  It is an old, old argument. –H.L.Mencken