Category Archives: YOU

Capitulation in Gold (Continued….)

Continuing from where we left off in the capitulation series, a case study, http://csinvesting.org/?p=11351

Gold-COT (1)

Silver-COT (1)

Precious-Metal-Short-Interest

The above charts show the massive swing in sentiment as speculators moved from long to short expecting gold to fall INEVITABLY to $1,000 or so the pundits say:

What's uglier than gold

Demand for gold bullion remains stronger than the supply offered through the futures market–the co-basis is rising:

letter-aug-9-gold

Meanwhile, could divergences be developing in miners vs. gold? Note prior bottoms in 1986 (bear market rally) and 2000, the beginning of a major rally.

bear divergence

HUI_2000_070815

HUI_gold_110815

Mining stocks shunned

Aug8.2015goldstocksvsspx1

This post is not a recommendation but compiling the case study of capitulation in gold and associated miners. Remember Why Gold Mining is a Tough Business_Pollitt (a MUST read!) and Why-is-gold-mining-such-a-crappy-business Summary and…

ray-dalio (2)

Templeton

http://thefelderreport.com/2015/07/21/its-time-to-get-greedy-in-the-gold-market/  John Chew: Don’t ever just concentrate in one gold stock since the company and operational risks can be high.  SDGJ by Sprott offers diversification and sensible companies. Sprott Junior ETF Mining. Why even consider investing in such a bad industry? Because of price and the counter-cyclical nature of these stocks. You buy when the industry is losing money and hated and sell when the pundits recommend it and the trend is forever extrapolated higher.  There is no law that miners won’t go lower; miners are extremely volatile moving up and down 10% in one day.

What Happens When You Buy Assets Down 80%? farber

We’ve done a lot of articles on value and drawdowns on the blog before (search the archives).  I was curious what happens when you bought the US equity sectors back when they were really hammered (French Fama to 1920s).

Average 3 year nominal returns when buying a sector down since 1920s:

60% = 57%

70% = 87%

80% = 172%

90% = 240%  The average of 80% to 90% down is a triple.

 

Average 3 year nominal returns when buying an industry down since 1920s:

60% = 71%

70% = 96%

80% = 136%

90% = 115%

 

Average 3 year nominal returns when buying a country down since 1970s:

60% = 107%

70% = 116%

80% = 118%

90% = 156%

Boom Bust in Coal (Alpha Natural Case Study)

Alpha Stock Bubble

Pop Goes ANRZ

This post and article captures the investing world we live in.

By David Stockman (Please read: http://davidstockmanscontracorner.com)

If you want a cogent metaphor for the central bank enabled crack-up boom now underway on a global basis, look no further than today’s scheduled chapter 11 filling of met coal supplier Alpha Natural Resources (ANRZ). After becoming a public company in 2005, its market cap soared from practically nothing to $11 billion exactly four years ago. Now it’s back at the zero bound.

This article by David Stockman perfectly illustrates that capital DESTRUCTION or mal-investment occurs DURING the boom phase.  The bust which is what Alpha and the entire coal industry are going through creates the healing process as assets are redeployed to their higher uses and supply is re-balanced to meet changed demand. 

From 2006 to today during the greatest coal boom in history, Alpha has lost almost $5 billion for its shareholders.   At the peak of its earnings, the market cap (not including debt) traded at 25 times and during the insanity at over 50 times.  Investors were destroying their capital and the company was mis-allocating its shareholder’s capital DURING the boom phase.   Now is the cleansing process. Ditto for many coal companies.   So ask yourself why do reasonably intelligent management teams and Board of Directors make such a CLUSTER of errors and why do investors pay stupid multiples on peak earnings? A combination of central bank distortion and psychology and momentum chasing?

Alpha Case Study See spread sheet xls.

Yes, bankruptcies happen, and this is most surely a case of horrendous mismanagement. But the mismanagement at issue is that of the world’s central bank cartel.

The latter have insured that there will be thousands of such filings in the years ahead because since the mid-1990s the central banks has engulfed the global economy in an unsustainable credit based spending boom, while utterly disabling and falsifying the financial system that is supposed to price assets honestly, allocate capital efficiently and keep risk and greed in check.

Accordingly, the ANRZ stock bubble depicted above does not merely show that the boys, girls and robo-traders in the casino got way too rambunctious chasing the “BRICs will grow to the sky” tommyrot fed to them by Goldman Sachs. What was actually happening is that the central banks were feeding the world economy with so much phony liquidity and dirt cheap capital that for a time the physical economy seemed to be doing a veritable jack-and-the-beanstalk number.

In fact, the central banks generated a double-pumped boom——first in the form of a credit-fueled consumption spree in the DM economies that energized the great export machine of China and its satellite suppliers; and then after the DM consumption boom crashed in 2008-2009 and threatened to bring the export-mercantilism of China’s red capitalism crashing down on Beijing’s rulers, the PBOC unleashed an even more fantastic investment and infrastructure boom in China and the rest of the EM.

During the interval between 1992 and 1994 the world’s monetary system—–which had grown increasingly unstable since the destruction of Bretton Woods in 1971——took a decided turn for the worst. This was fueled by the bailout of the Wall Street banks during the Mexican peso crisis; Mr. Deng’s ignition of export mercantilism in China and his discovery that communist party power could better by maintained from the end of the central bank’s printing presses, rather than Mao’s proverbial gun;  and Alan Greenspan’s 1994 panic when the bond vigilante’s dumped over-valued government bonds after the Fed finally let money market rates rise from the ridiculously low level where Greenspan had pegged them in the interest of re-electing George Bush Sr. in 1992.

From that inflection point onward, the global central banks were off to the races and what can only be described as a credit supernova exploded throughout the warp and woof of the world’s economy. To wit, there was about $40 trillion of debt outstanding in the worldwide economy during 1994, but this figure reached $85 trillion by the year 2000, and then erupted to $200 trillion by 2014. That is, in hardly two decades the world debt increased by 5X.

To be sure, in the interim a lot of phony GDP was created in the world economy. This came first in the credit-bloated housing and commercial real estate sectors of the DM economies through 2008; and then in the explosion of infrastructure and industrial asset investment in the EM world in the aftermath of the financial crisis and Great Recession. But even then, the growth of unsustainable debt fueled GDP was no match for the tsunami of debt itself.

At the 1994 inflection point, world GDP was about $25 trillion and its nominal value today is in the range of $70 trillion—-including the last gasp of credit fueled spending (fixed asset investment) that continues to deliver iron ore mines, container ships, earth-movers, utility power plants, deep sea drilling platforms and Chinese airports, highways and high rises which have negligible economic value. Still, even counting all the capital assets which were artificially delivered to the spending (GDP) accounts, and which will eventually be written-down or liquidated on balance sheets, GDP grew by only $45 trillion in the last two decades or by just 28% of the $160 trillion debt supernova.

Here is what sound money men have known for decades, if not centuries. Namely, that this kind of runaway credit growth feeds on itself by creating bloated, artificial demand for materials and industrial commodities that, in turn, generate shortages of capital assets like mines, ships, smelters, factories, ports and warehouses that require even more materials to construct. In a word, massive artificial credit sets the world digging, building, constructing, investing and gambling like there is no tomorrow.

In the case of Alpha Natural Resources, for example, the bloated demand for material took the form of met coal. And the price trend shown below is not at all surprising in light of what happened to steel capacity in China alone. At the 1994 inflection point met coal sold for about $35/ton, but at that point the Chinese steel industry amounted to only 100 million tons. By the time of the met coal peak in 2011, the Chinese industry was 11X larger and met coal prices had soared ten-fold to $340 per ton.

coal prices bbg_0

And here is where the self-feeding dynamic comes in. That is, how we get monumental waste and malinvestment from a credit boom. In a word, the initial explosion of demand for commodities generates capacity shortages and therefore soaring windfall profits on in-place capacity and resource reserves in the ground.

These false profits, in turn, lead speculators to believe that what are actually destructive and temporary economic rents represents permanent value streams that can be capitalized by equity owners.

Jeremy Grantham points out the unusual increase in China’s coal demand:

After every historical major rally in commodity prices, there has been the predictable reaction whereby capacity is increased. Given the uncertainties of guessing other firms’ expansion plans, the usual result is a period of excess capacity and weaker prices as everyone expands simultaneously. The 2000 to 2008 price rally was the biggest in history, above even World War II. It was therefore not surprising that the reflex this time was the mother of all expansions and excess capacity. This was further exaggerated by a sustained slowdown in demand from China, which is still playing through. The most dramatic example of this was in China’s use of coal, which had grown from 4% of world use in 1970 to 8% in 1988 and to 50% in 2013, the world’s most remarkable expansion in the use of anything since time began. And yet this remarkable surge was followed in 2014 by a reduction in China’s use of coal! And that in a year in which China was still growing at over 6%. See:price-insensitive-sellers-and-ten-quick-topics-to-ruin-your-summer

Continued…..But as shown below, eventually the credit bubble stops growing, materials demand flattens-out and begins to rollover, thereby causing windfall prices and profits to disappear. This happens slowly at first and then with a rush toward the drain.

ANRZ is thus rushing toward the drain because it got capitalized as if the insanely uneconomic met coal prices of 2011 would be permanent.

Needless to say, an honest equity market would never have mistaken the peak met coal price of $340/ton in early 2011 as indicative of the true economics of coking coal. After all, freshman engineering students know that the planet is blessed (cursed?) with virtually endless coal reserves including grades suitable for coking.

Yet in markets completely broken and falsified by central bank manipulation and repression, the fast money traders know nothing accept the short-run “price action” and chart points. In the case of ANZR, this led its peak free cash flow of $380 million in early 2011 to be valued at 29X.

FREE CF

ANRZ Free Cash Flow (TTM) data by YCharts

Self-evidently, a company that had averaged $50 to $75 million of free cash flow in the already booming met coal market of 2005-2008 was hardly worth $1 billion. The subsequent surge of free cash flow was nothing more than windfall rents on ANZR’s existing reserves, and, accordingly, merited no increase in its market capitalization or trading multiple at all.

In fact, even superficial knowledge of the met coal supply curve and production economics at the time would have established that even prices of $100 per ton would be hard  to sustain after the long-term capacity expansion than underway came to fruition.

This means that ANRZ’s sustainable free cash flow never exceeded about $80 million, and that at its peak 2011 capitalization of $11 billion it was being traded at 140X. In a word, that’s how falsified markets go completely haywire in a central bank driven credit boom.

As it happened, the full ANZR story is far worse. During the last 10 years it generated $3.2 billion in cash flow from operations——including the peak cycle profit windfalls embedded in its reported results.   Yet it spent $5 billion on CapEx and acquisitions during the same period, while spending nearly another $750 million that it didn’t have on stock buybacks and dividends.

Yes, it was the magic elixir of debt that made ends appear to meet in its financial statements. Needless to say, the climb of its debt from $635 million in 2005 to $3.3 billion presently was reported in plain sight and made no sense whatsoever for a company dependent upon the volatile margins and cash flows inherent in the global met coal trade.

So when we insist that markets are broken and the equities have been consigned to the gambling casinos, look no farther than today’s filing by Alpha Natural Resources.

Markets which were this wrong on a prominent name like ANRZ at the center of the global credit boom did not make a one-time mistake; they are the mistake.

As it now happens, the global credit boom is over; DM consumers are stranded at peak debt; and the China/EM investment frenzy is winding down rapidly.

Now comes the tidal wave of global deflation. The $11 billion of bottled air that disappeared from the Wall Street casino this morning is just the poster boy—–the foreshock of the thundering collapse of inflated asset values the lies ahead.   See: Pop Goes the Alpha Bubble.

So I have bought coal companies like FELP, CLD, HNRG, BTU because IF there exists a coal industry, the best reserves, lowest costs, and well-capitalized companies should thrive on the other side of this HEALTHY bust.  Yes, BTU does have a heavy balance sheet but it does have world-class reserves, operations and low-cost structure.  However, Austrian economics teaches that the bigger the boom, the greater the bust.  The TIME and DEPTH of the depression in coal will probably be underestimated by all, including me.  One has to keep your positions diversified and small enough to sleep at night.   I don’t see a turn before the next 18 to 24 months at least. Cyclical stock require a five to seven year horizon, perhaps longer. But NO ONE really knows until well after the bust when it is over. We must live with uncertainty.

Where is the next BUST. Capital is BEING DESTROYED TODAY:

biotech destruction

The same phenomenon that is driving Biotech to unsustainable valuations (ON THE WHOLE) is what has caused coal stocks to collapse:

biotech coal

Stay careful my friends.

http://ceo.ca/2015/08/04/find-companies-with-great-assets-and-mediocre-management-carl-icahn/

HIGHER RETURNS WITH LESS RISK? http://www.universa.net/video.html

Analysts’ Predictions on Gold; Readings

forecast

forecasts-forecasts-everywhere  (A good post on psychology)

So the gold price drops, so the gold forecasts drop. Some recent calls in order of bearishness:


Towards the end of 2010 I (Bron Suchecki)  started recording forecasts in a spreadsheet, as I noticed many analysts revised their forecasts frequently in response to moves in the gold price. By 2012 I had given up as it was a lot of work to make one point – that in general analysts were just following or projecting the trend.

The chart below shows the forecasts I accumulated from late 2010 to early 2012 (the clustering around July are yearly average forecasts) and I’ve added in the recent ones above.

Continued….on recent gold “smash”

When the gold price has a big move the news agencies ring up traders for a comment. When I read these articles I’m looking for two things: why do traders think it happened and what do they think about gold going forward. Understanding these consensus narratives around gold is useful as they control large amounts of money and their views influence others.
Before I go on to discuss the comments, please note that narratives (see Ben Hunt) are not about truth, they are about what everyone thinks is the truth. For many finance professionals, the truth is less important (if at all) than being in the herd – most are not interested in the career risk of taking a position contra to the consensus view.
In terms of the why, here are some of the more sensible comments:
  • Ross Norman: They choose the optimal moment in the early morning and when Japan was closed for a holiday to get the biggest bang for the buck. It was clearly ‘short’ traders using leverage to trigger (technical) stops” he said. The price later regained some of its ground, allegedly as the profiteers cashed in jackpot gains on options that they also had. “It was a trade within a trade”. (link)
  • Marex Spectron: no coincidence that this happened in the quietest, thinnest period of the week … they deliberately want to move it in a big way (link)
  • “Traders”: Gold also fell in the Chinese derivatives market, which, traders said, added to the impression of an orchestrated attempt to push the price down, triggering others to sell their positions. (link)
  • Martin Armstrong: many rumors floating around from China off-loading because wrong storage figures were released, to a large spec investor who sold 6 tonnes and has taken a huge loss on a leveraged trade! (link)
  • “Traders and Analysts”: attributed the massive move to high-frequency trading algorithms as well as stop-loss selling. (link)
  • Societe Generale: It was just a bit of a bear raid and there was nobody on the other side to mop up the selling (link)
  • Chuck Butler: maybe the gold sale on the SGE was “margin influenced,” which would mean that large investors use gold as collateral on stock trades, and as the Chinese stock market has dropped the margin calls have come in (link)
  • “Market Participant”: The fact that it was done in Asian hours and in a loud, messy manner suggests it may be done by people not directly under European and US regulation (link)
The general view seems to be that it was a deliberate tactical move to push the price down, trigger stops, and try to get gold down to the technically important level of $1080, but with the real objective of making money on another derivative position.
On to the narratives around gold after this price smash. Here are a selection:
  • Singapore-based trader: “We do see a lot of people in China selling gold to get fast cash to go back into the equity market” (link)
  • Phillip Securities: “It looks like the end of an era for gold, China has been grappling with oversupply after importing a record volume in 2013.” (link)
  • Societe Generale: “We have breached significant support levels, we know U.S. rate hikes are coming, there is no inflation and there is no catalyst to hold gold when other markets are doing better” (link)
  • Momentum Holdings Ltd: “With low global inflation and an improving U.S. economy, I doubt we’ll see big economic shocks, which is not good for gold” (link)
  • KBC Asset Management: “Gold is a hedge against everything that can go wrong. But at the moment it appears that not a lot is going wrong. We have an Iran deal, a Greece deal and we have good news from European and U.S. economies. There is no real reason for us to invest in gold and gold companies.” (link)
  • Deutsche Bank: “the “fair value” for gold is around $750. … “All the ducks are now aligned for a gold slide: real interest rates are rising, the dollar is getting stronger and the risk premium on equities is going down” (link)
So no change in the “improving US economy” and “Fed raise rates” story, indeed I feel that market participants see this price smash as confirmation of this narrative. That is not good for gold as it will give them confidence to test gold again. I’m not as confident as they are that everything is looking rosy and all the problems have been solved so I find myself agreeing with Adrian Ash that just like in 1999, this is a case of “peak hubris of policy-makers thinking they had abolished the boom-bust cycle” and that “gold continues to do what it does, rising when you need it and slipping when the financial world thinks it’s just a useless commodity”.

Former Gold Bug Turns Bearish: Http://www.armstrongeconomics.com/archives/35556

No Matter What Book You Read Do Not Buy Gold

Current Sentiment (note small specs INCREASING their shorts as price moves sideways this past week).

vOUmCk-300x67

COT positions

2106-300x153

gold spy

commod to stks

country hubris

Grave Dancing on Goldbugs

From Bloomberg (Bloomberg belongs to a limousine socialist, and is well-known for its pro-central banking/ pro-money printing and anti-gold editorial line. Some of the most ludicrous articles about gold ever published have appeared on Bloomberg):

Gold Slump Not Over as Speculators Go Net-Short for First Time – apparently Bloomberg’s authors have yet to hear about contrarian signals.

Gold Is Only Going to Get Worse (“Our survey shows a majority of traders and investors aren’t optimistic”) – indeed, Bloomberg seems to be blissfully unaware of contrarian sentiment analysis.

Gold Could Fall to the $1,000 Mark (video)

Good Luck Bargain Hunting for Gold Miners – naturally, gold miners are even more doomed than gold itself…

From the Wall Street Journal:

Let’s Get Real About Gold: It’s a Pet Rock – actually, as we have previously pointed out, it’s a door stop, not a pet rock. We should perhaps mention here what Jason Zweig, the author of this WSJ article, wrote in 2011 right at gold’s peak. From Mr. Zweig’s WSJ Article of September 17, 2011:

“Growing numbers of investing experts have been declaring that gold is a bubble: an insanely overvalued asset whose price is bound to burst. There is no basis for that opinion.”

With respect to gold miners (which since then are down by more than 80%) he opined:

“But there is one aspect of gold investing where it is possible to make rational estimates of value: the stocks of gold-mining companies. And, by historical standards, they seem cheap—based not on subjective forecasts of continuing fiscal apocalypse, but on objective measures of stock-market valuation.”

This is really a textbook example of how market sentiment works.

From Marketwatch:

The carnage isn’t over in gold, other metals-mining stocks

Study predicts gold could plunge to $350 an ounce (i.e., here come the extreme predictions, the inverse of the vast bullish consensus and the extreme bullish predictions that were made at the peak by gold bulls)

And all of this was finally crowned with the following pronouncement in the Washington Post:

Gold is doomed

Interestingly the author of this article, Matt O’Brian, actually gets one thing right, although his conclusion remains utterly wrong – he writes:

“When you think about it, a bet on gold is really a bet that the people in charge don’t know what they’re doing.”

That’s exactly what it is Mr. O’Brian. The wrong conclusion he comes to is this one:

”But economists do, for the most part, know what they’re doing.”

Yes, in some parallel universe perhaps. That people can profess such beliefs after the twin debacles of the tech and housing bust and after yet another giant asset bubble has been blown by these “economists who know what they are doing” is truly stunning. How blind and naïve can one possibly be? This article is a good example of statist propaganda. Our wise leaders know what they are doing! How can anyone doubt it!

Meanwhile, the mirror image of bearishness, we see:

Meb Faber ‏@MebFaber  Jul 29

2015 has seen the largest amount ever raised in a biotech IPO, as well as the largest valuation for bio IPO with no drugs. via @IPOtweet.  Can anyone guess how those investments will do over the next five years?

Additional Reading

A reader contributes: http://www.buffettfaq.com/ The blog has questions and answers of Buffett and Munger categorized by different parts of investing.

Common_Stocks_and_Uucommon_profits_and_other_writings.pdf

Also, worth a look: This Blog Analyzes Money Managers

Perpetual Capitulation

macrocosm-600x294

An ode to the end of a con

How long can deception go on?

When prices are set By banks printing debt

All trust in the “markets” is gone!

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!

See 6_30_13-HOW-GOLD-LOST-ITS-LUSTER-THE-ALL-WEATHER-FUND-GOT-WET-AND-OTHER-JUST-SO-STORIES  and   A Negative Narrative on Gold

gold IR

Negative News Tends to Cluster at MAJOR bottoms:

  1. Gold Could Go To $350
  2. Gold Sends a Message
  3. Gold Could Plunge to $800

My Jaw Dropped: Long gold, short US stocks, Short US Dollar

3-Gold-Optix-1024x641
low gold

Zeal073115A

commodities and emerging market equities

Commodities

Will the US Dollar Continue its Rampage Higher? 272660136-Raoul-Pal-GMI-July2015-MonthlyRate hikes and goldRate hikes are “bad” for gold?

rising rates bad for gold
Zweig Calls HighStocktoCommodityAtAllTimeHighInvestors above flee tangible assets for financial assets. Taken to an extreme, input costs for companies will go to zero and profit margins to infinity. Reality?

Biotech Fantasy2Biotech Fantasy

Capitulation Part II

Gold-Miners-vs-200-MA

Gold-Miners-Compound-Return (1)

An Epic Bear Market in miners

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)

dust gdxj

There is NO REASON to own gold! (NOW, they tell us!)

No hope for gold holders

Global dollar stress might be causes gold price crashes.

The “price action” for gold is bad!  The price of gold went down.

dollar mg

Why not be happy and say that the dollar buys you more gold because of this:

Chart-2-basis-and-cobasis

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.

Video: Sellers in action:SELL ‘EM!

BAML commodities

20150718_yield_0

2015jul21xau1

Does Gold represent good “value?”

Gold to S&P 500


Ratio gold to sp

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.

See Value Investors Hate Gold

For those technical wizards out there, note that silver did not “confirm” the price decline in gold yesterday.

Capitulation

Just remember (thanks www.monetray-metals.com)

Batman-knows-best

Capitulation Selling-A Real-Time Case Study

T-XAU-SP

The chart above shows an index of gold and silver miners relative to the S&P 500, breaking now to a new extreme.  Will the world need to produce and find more minerals and metals or will the world just need health care and bio-tech?

letter-jul-19-gold

The read line is the co-basis that is rising as the dollar rises relative to gold. This indicates rising demand for physical and more futures selling. Bullish.

So who is selling?

The Fed’s decision to restock the rate toolkit has got the gold market very nervous,” George Zivic, a New York-based portfolio manager at OppenheimerFunds Inc., which oversees $235 billion, said by phone. “We have already seen that gold did not perform as a safe-haven investment. There is not a single motivating reason to own gold.”

CKT5wyiUYAAopBy

Who knows, perhaps money managers are funding their long equity positions with short gold positions.

“It looks like the end of an era for gold,” said Howie Lee, analyst at Phillip Securities in Singapore, adding that China had been grappling with oversupply after importing a record volume in 2013.

wmc150720b

Money managers (a few of them) finally see gold as undervalued.

Gold_Valuation1

Gold_CoT_Chart1

Gold_Specs

GLD_Sentiment

I am posting this so as to have a record of certain market events.  I seek out where the most marginal or urgent seller is operating AFTER a long decline (four years).

NUGT_Sentiment

The Secret to Good Returns

What I learned

Gold Going to $1,000

5-CEF-NAV-premium

7-Gold-Optix-1024x650

4-Rydex-assets-1024x638

1-Gold-CoTs-1024x636

I just thought it would be fun to join the herd, band-wagon, chorus, and media for a change.

Checklists

670px-Pre-Flight-an-Aircraft-Step-1

2015-06 ABBA Part I   Investing Checklist (Helpful)

2015-06 ABBA Part II – Bird in hand

2015-06 ABBA Part III – Brick House

2015-06 ABBA Part IV – Alignment of Interests

Actual pre-flight checklists http://freechecklists.net/

Have a Great 4th of July Weekend!

I Passed on Berkshire at $97 per share

Thanks to David Hui Lai. Excellent!

In 1982, working as a 26-year-old money manager, I passed on Berkshire Hathaway, which was trading at $97, because I thought it was too expensive. The price represented a 50 percent price to earnings and price to book premium to the broad market. Had I made a different decision – at the time I was sitting on a large cash position from a successful real estate investment – I would now be smoking $10 cigars and hanging out with swell chicks. I’ll wait, I thought, until it hits $60. I’m still waiting. On Friday BRK.A closed at $217,000.

Although I was familiar with Warren Buffett’s investment record – he was widely regarded as one of the best investors of his generation, and I carefully read the Berkshire Hathaway annual report each year – he had not attained the prominence he now has. I mentioned this to Ian, and he suggested I might write about what I learned from passing on Berkshire Hathaway, and the years I worked as an investment analyst on Wall Street.

By way of background, I did not finish high school. I left home at the age of fifteen and hitchhiked up into Canada’s subarctic and worked fighting forest fires and then as a forest tower lookout. The loneliness was too much for me, so at the age of eighteen I became a real estate salesman. In my early twenties I sold hotels and nursing homes, and then met with some success as a real estate investor. I became fascinated by the stock market, and a full time investor in my mid-twenties. Within a couple of years I was managing money, specializing in mismanaged, undervalued companies. They ran the gamut from companies whose stock had declined significantly, had new management, heavy insider buying, to the bonds of bankrupt or distressed companies, to companies with substantial real estate holdings, low insider ownership and minimal or no profitability. I was fairly successful at this in Toronto, acquired some major clients in New York City and in my late twenties moved to the US and started an investment research firm serving institutional money managers and corporate acquirers. I did that for five years, made some money and retired to the Adirondack woods.

Overall, I was successful but my performance was extremely volatile including two years in a row down over 40 percent. Most of my investments lost money or broke even; the few winners were up so much that overall my portfolio averaged a thirty percent return. Among my clients were some of the most successful corporate acquirers of the day – Sam Zell, Richard Rainwater, Leucadia, Jay Jordan, and some of the most successful money managers of the day, Chuck Royce, Leon Levy, Michael Price, Seth Klarman, Fidelity’s Alan Leifer, Ernie Kiehne of Legg Mason (Bill Miller was Ernie’s assistant at the time), George Soros — about 100 money mangers paid my firm $20,000 a year in soft dollars for my “contrarian research.” They followed my work because I studied, in an in-depth way, companies not otherwise followed by analysts.

Much of what I learned I learned from watching extremely successful investors make and lose money. And from losing my own money.

What did I learn?

Lesson 1: The role of financial markets is to take money away from mediocre and underperforming companies and put it in stable, growing, high return on capital companies. Money has an almost metaphysical attraction to places where it is put to careful, good use. You can fight that trend, and invest in companies, for instance that are deeply undervalued and mismanaged – and some people are successful investing in the dregs – but very few over the long term. To use a whitewater kayaking analogy, freshwater seeks salt water, and you can fight that if you want, but paddling upstream eventually is likely to become highly problematic.

The approach that’s worked best in my experience is investing in high return on capital, low debt, growing companies that have the ability to reinvest earnings in the business and generate high returns on those reinvested earnings. The power of compound interest is so profound (mind-boggling really) that over time, returns in investments in those companies are enormous. The trick is finding companies that are compound interest machines. I remember Leon Levy, founder of Odyssey Partners, once telling me that John Paul Getty became the wealthiest man in the world by achieving a 17%percent compound rate of return, on average, over his career.

As in the case of Berkshire Hathaway, trying to invest in those companies based on an analysis of value is more likely to result in opportunities missed than it is make money. An approach that is much more likely to be successful – investing in high quality companies after a market decline of thirty percent, and retaining the liquidity to build positions in those companies after a fifty percent decline in the broad market averages. That takes extraordinary patience, which is a matter of personality.

Lesson 2: I’ve worked for two extremely successful investors who were experts in cyclical, commodity-dependent, capital intensive industries – real estate and mining – and learned that almost all of the real money made in those areas is made only by extremely patient investors who invest once every ten or twenty years, liquidate their holdings once a decade and spend long, long periods of time in cash.

One of those investors, Pat Sheridan, an owner of mines all over the world, once said to me that the classic business mistake was to be fully invested at the top of the market. The objective, he said, was to be liquid at the bottom because business cycles are primarily caused by the creation and destruction of debt. Those are functions of greed and fear, in other words of emotions. He built inventory (by buying mines) during times of low demand, and sold them during times of high demand, including one for $10 million in 2011. Managing cash is crucial to his strategy, he told me.

When oil or real estate prices increase, money flows in to take advantage of what appears to be above-average returns. Overcapacity results, prices decline, debt can’t be serviced and gets converted into equity or otherwise written off, capacity declines and within a few years commodity prices begin to recover. Then the whole cycle starts over again. The swings are unpredictable in terms of duration, but successful investors in those areas look for opportunities after a major (20 percent or more) capacity reduction in an industry, when the debt of the bottom thirty percent of companies in terms of quality of management and assets no longer exists and the debt of mediocre companies (the next ten or twenty percent of companies) trades at pennies on the dollar.

Three approaches, I’ve observed, work best over time: investing in the low cost producer with a durable cost advantage, investing in premium assets such as well-located real estate, and buying debt at pennies on the dollar after an industry wide collapse. All three strategies are most successful after a severe market decline when emotionally it is difficult to do.

The approach that almost always results in disaster – investing in cyclical stocks based on P/E ratios. Cyclical stocks are cheapest when, industry-wide, companies are losing money or have very low earnings, and most risky when they have low P/E and high price-to-book ratios.

Lesson 3: Most successful investors share some common personality characteristics.

They have superior analytical skills in at least one important area of investing. This results from an obsession with investing. They are students of the art. Ian, your commentary on this subject has helped me really focus on what I think I do better than most other investors. In your case Ian, I think that you have an important long term advantage in being willing to, and knowing how to, build relationships with management based on mutual trust and respect. In my case it is an ability to identify superior companies based on financial statement trends. I think. I hope. Only time will tell.

My skill evolved out of the realization that I could have avoided 90 percent of my disasters by spending a couple of hours with a company’s quarterly balance sheets and income statements. Instead, I would routinely fly thousands of miles, interview management, interview former executives and directors, especially those bearing grudges, visit company real estate and local appraisers, interview competitors, suppliers, and customers. I even, on occasion, would sit in a bar outside company factories and have a beer (or two) with workers coming off shifts. I studied accounting at night, read Ben Graham’s classic Security Analysis (twice) and spent twenty years running a business with customers, distributors, suppliers, employees and, as part of that, prepared financial statements once a month. I learned what fluctuations in twenty criteria including inventory, accounts payable and receivables and gross profit margin indicate about a company’s competitive position and prospects. That makes me uniquely qualified, I think, to analyze companies based on their financial statements. We’ll see.

Investing can be looked at as an emotional competition – your emotions and ability to control them versus the emotions of those you buy or sell securities from and to. A primary function of investment strategy is to counteract emotional impulses and thus survive (and take advantage of) adverse market developments. Investment performance is mostly determined by patience, risk management, a willingness to study, and what you do when things go differently than you anticipated. Those factors are personality driven.

In addition to having a clear concept of what their competitive advantage is over others, successful investors, I’ve learned, incorporate into their investment strategy clear concepts of acceptable risk, what constitutes an acceptable level of inactivity and length of holding period after funds are committed. And successful investors stick to their strategy. That strategy – for instance sitting on cash, sitting on losing positions, sitting on winning positions — must be based on self-knowledge. If the strategy is out of sync with the personality, it won’t work, no matter how well it has worked for others.

There are successful short and long term investors, but rarely are there successful investors who do both. A long-term investor must be a patient person. A short term trader who thrives on, perhaps needs, constant activity is likely to be an impatient person.

Regardless of short or long term investor/trader, risk management is crucial to survival and success. Once again, this is a personality issue. A successful investor’s strategy will anticipate adverse market developments – will assume that sooner or later they will be wrong and will lose money. Cash position versus invested capital is perhaps the single most important area of risk management, although acceptable debt levels (both in one’s own financial structure, and the companies in one’s portfolio) is also important. Does an investor have a cash management plan that fits with the other key elements of his or her investment strategy? Successful investors, in my experience, think their cash position through very, very carefully and they pursue a strategy that mitigates risk in what is otherwise a very risky field of endeavor – investing. Depending on the stage of the market cycle, very high or very low cash positions have a major impact on portfolio returns. And on investment survival.

Does and investor buy on strength or buy on weakness? Fluctuations in security prices are often determined by factors other than the underlying fundamentals of the companies involved. A stock can decline due to a major investor needing to raise cash, emotion, faulty analysis, and macro economic factors that do not affect the particular company in question. Is an investor a victim of those factors or a beneficiary? Does an investor know more about a particular company than the market? If yes, buying on weakness augments an investor’s returns. If not, returns are diminished by buying on weakness. Does an investor have the ability to admit when he or she is wrong and take action? Does an investor have the courage to buy during irrational price declines, when economic collapse is widely anticipated and discussed in the news media? Those factors impact long term returns, and they too are personality driven.

Ian, I find your belief that quality companies with market caps of under $30 million are more or less immune to general market declines because they have low institutional ownership very intriguing. Regardless, I strongly suspect that investing in quality companies that used to have market caps of over $100 million, and high institutional ownership, but now have market caps of under $30 million and no institutional ownership because the market is down 50%percent, is a lower risk variant on your strategy.

Whatever one’s position on that subject, an investment strategy needs to anticipate significant market declines, as well as declines in the securities in one’s portfolio, since declines have been a part of markets ever since markets were first created. Humans are emotional, therefore markets are emotional, debt results, markets collapse, and humans become more emotional. And master investors invest.

Or something like that.

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