In response to a positive comment from an investor acquaintance on Berkshire Hathway, Warren Buffett's investment vehicle:
So, you have thrown in the towel and are riding Buffet's coattails? I know that is enticing. I had BRK-B until a few weeks ago when I sold it to raise cash. It was one of my few winning positions. But I thought at that time (near $5000) that it was probably a little overvalued and I had owned it since the low $3000s. People pay a big premium for BRK, more than the sum of the parts. Some of those parts won't be doing well for a while. He owns a lot of homebuilding materials companies, including furniture. His newspapers probably aren't worth too much any more, either.
The best time to buy BRK the past few years was after Katrina, when all the insurers got knocked down. That is when we got in. BRK has to have some very bad news to lose any of its market premium, there are so many people that want to own it. Maybe there will be enough bad news in consumer durables that will cause BRK to lose some premium, at least that has been my thinking. It is too big to grow much on its own, so it has become more of a valuation game to make money on BRK. (Buffett himself has said in the past at times that he would not buy BRK based on its over-valuation).
I think his proposal to reinsure the bond insurers (AMBAC, MBIA, PMI, etc), but only the municipal bond pool, is very interesting. Reinsuring something that doesn't need insurance in the first place is quite the joke. It is a typical Buffett move, intended to give him a lot of money, quickly, at very low risk. He is asking for $12B (1 1/2%) for extending 30 days of protection on a portfolio that is not at risk (the $800B of AAA municipal bonds insured by the group). But his proposal does not address the real problem with the bond insurers, the CDOs, et al.
It seems to me that if the insurers take the deal, they are admitting defeat: they are in such bad shape that only their very best, the municipal bonds, is worth anything at all, the rest is worth nothing. If the insurers tank, it will cause significant additional damage to the financial markets, and to the economy by extension. While I don't blame Buffett for trying to extort the insurers (that is exactly what this is), they should turn him down and work on deals that address their real problems.
They do need a capital infusion (Buffet's proposal does not provide them any more permanent capital, but only temporarily shifts capital coverage requirements) and a return of confidence by the market, but the best way is a gradual unwind of their positions in a rational way rather than a fire sale of their best assets as in a "going out of business" sale. They can always find a buyer for a municipal bond insurance portfolio.
Monday, February 11, 2008
On BRK and Buffett's Proposal to "Assist" the Mortgage Insurers
Monday, February 04, 2008
Short Hedge of the Week and TSO Short Puts
Saturday, February 02, 2008
Short Sale - Long Collar: the Perfect Hedge
Tuesday, January 29, 2008
Market turning?
Thursday, January 24, 2008
VIX: A Market Timing Tool
Jake, Here is a very simple tool for timing the market. I don’t understand the complexity of some other models that are promoted, so I don’t use them. But I could have really used a simple tool to manage this bear market.
Take a look at the attached 5 year chart for VIX. Notice how VIX provides an excellent indicator for major tops and bottoms. When the daily VIX moves below the 100 day moving average and stays there for 10 days, it is a buy signal. A major buy was given by this indicator on March 31, 2003, which if you remember, was about 10 days after the market made its major low (at the start of the Iraq war) and began a five year bull run. When the opposite happens, like on February 25, 2007, it is a sell signal. VIX went back below the MA on April 2, so a buy would have occurred 10 days later on April 12. You could have bought back in for another 2 months without much conviction from the VIX.
It skidded around along the moving average until May 23 when it broke above the line for good creating another sell signal 10 days later on June 6. The July 19 top and selloff (with the Bear Stearns sub-prime hedge fund implosion) resulted in a big spike in volatility, but vol had already moved above the average. But you wouldn’t have given up much in gains by using this timing signal (DOW moved from 13,591 to 14,000 in that time or about 3%). With a 10% selling program, 80% of the portfolio would have benefited from the rise, saving 20% of the portfolio from what was to follow. Better yet, if we require a 5% move below the VIX moving average in order to buy, or 1.0 on the VIX scale, we would have not had a buy signal on April 12 and would have just kept on selling from the start on March 5 when the DOW hit 12,050. We would have had 40% of our portfolio moved out of stocks by July 19 and been 100% out by December.
As of now, we are way above the buy signal which is at about 18 on the VIX. We will need to fall back to that level and stay under it for 10 days. Then the coast should be clear, if past teaches us anything.
You will also notice there would have been a move out and back in the market in mid 2006 when the market tanked in May and June. But if you use a gradual approach in and out of the market, maybe 10% of the portfolio a month, it would not jerk you around much. Using a 10% per month rule, you would have been completely out of the market by November after the February sell signal which triggered in March (after the 10 day waiting period). It would have been hard selling in April to June as the market kept climbing, but this is why a system is so important.
I plan to use this timing signal in the future as I did not have much discipline this last downturn. Despite a correct reading on the potential problems for the market and the magnitude (so far) of the breakdown, I kept putting my funds back into the market too soon after selling and before volatility had fully subsided, causing needless losses along the way.
CBOE VOLATILITY INDEX VIX (VIX: CBOE)
Last Price Today's Change Bid (Size) Ask (Size) Volume Trade
31.01 +3.83 (+14.09%) 0.00 x0 0.00 x0 0
CBOE Real time Quote
Last Trade as of 4:14 PM ET 1/22/08
1 Day | 3 Day | 5 Day | 1 Month | 3 Month | 6 Month | 9 Month | YTD | 1 Year | 2 Year | 3 Year | 4 Year | 5 Year | 10 Year | 20 Year
Exponential Moving Average (100)
Wednesday, January 23, 2008
VIX: Simple Market Timing Tool
Here is a very simple tool for timing the market. I don’t understand the complexity of some other models that are promoted, so I don’t use them. But I could have really used a simple tool to manage this bear market.
Take a look at the attached 5 year chart for VIX. Notice how VIX provides an excellent indicator for major tops and bottoms. When the daily VIX moves below the 100 day moving average and stays there for 10 days, it is a buy signal. A major buy was given by this indicator on March 31, 2003, which if you remember, was about 10 days after the market made its major low (at the start of the Iraq war) and began a five year bull run. When the opposite happens, like on February 25, 2007, it is a sell signal. VIX went back below the MA on April 2, so a buy would have occurred 10 days later on April 12. You could have bought back in for another 2 months without much conviction from the VIX.
It skidded around along the moving average until May 23 when it broke above the line for good creating another sell signal 10 days later on June 6. The July 19 top and selloff (with the Bear Stearns sub-prime hedge fund implosion) resulted in a big spike in volatility, but vol had already moved above the average. But you wouldn’t have given up much in gains by using this timing signal (DOW moved from 13,591 to 14,000 in that time or about 3%). With a 10% selling program, 80% of the portfolio would have benefited from the rise, saving 20% of the portfolio from what was to follow. Better yet, if we require a 5% move below the VIX moving average in order to buy, or 1.0 on the VIX scale, we would have not had a buy signal on April 12 and would have just kept on selling from the start on March 5 when the DOW hit 12,050. We would have had 40% of our portfolio moved out of stocks by July 19 and been 100% out by December.
As of now, we are way above the buy signal which is at about 18 on the VIX. We will need to fall back to that level and stay under it for 10 days. Then the coast should be clear, if past teaches us anything.
You will also notice there would have been a move out and back in the market in mid 2006 when the market tanked in May and June. But if you use a gradual approach in and out of the market, maybe 10% of the portfolio a month, it would not jerk you around much. Using a 10% per month rule, you would have been completely out of the market by November after the February sell signal which triggered in March (after the 10 day waiting period). It would have been hard selling in April to June as the market kept climbing, but this is why a system is so important.
I plan to use this timing signal in the future as I did not have much discipline this last downturn. Despite a correct reading on the potential problems for the market and the magnitude (so far) of the breakdown, I kept putting my funds back into the market too soon after selling and before volatility had fully subsided, causing needless losses along the way.
Gold: An Investment for Decades to Come
Jake, Thanks for the newsletter. I am pretty much in sync with this writer's perspectives.
My thoughts on gold have not changed much in several years. I think it is a store of wealth and will do better in times of inflation and dollar devaluation (which mostly run together). Even if gold stays steady and goes no where against other national currencies, as long as the dollar goes down, gold will go up by the same amount, just as other dollar denominated commodities do, like oil.
Additionally, there is the risk premium put on gold for an uncertain world and, probably most importantly, the future demand that will come from Asia. Gold is favored in Asia throughout history, so that is not likely to change soon. As Asians have more disposable income, they will buy more gold, and will increase global demand. Also, the Asian (and Middle Eastern) economies will grow rapidly over the next 20 years (10% a year on average, perhaps) and will probably need 10% more a year of gold reserves to back their currency, and maybe more as they lose confidence in the dollar and shift their reserves towards gold and sell dollar instruments like US Treasuries.
So, for many reasons, I think gold is good for many years. The only reason it did poorly the past 30 years was that the dollar took the role of global reserve currency and the global central banks, especially the US and Europe, sold off their gold reserves adding supply and dropping demand. I don't think the dollar will get that "Reserve Currency" role back anytime soon after all the losses incurred by governments and dollar investors around the world the past couple years.
As you know, I own gold through VGPMX, GGN and best of all, BEARX. Even though BEARX is a bear market fund, it held its own even in the years when stocks were in bull mode because of its gold holdings. It is half shorts and half a gold / precious metals fund, with lots of junior gold producers that will do very well if gold prices continue higher.
Hope this helps.
Tuesday, January 22, 2008
Asian Market Selloff - Is This the Bottom?
Brian, Any feeling for the bottom? What is interesting is as I talk to business people nationwide; not including selling or buying a house or selling a mortage.
Business is fine. No major layoffs. Are we just having a 20% correction to bring things back to reality?
Jake, I think we are pretty close to the bottom, though Tuesday could be a “limit down” day with a selloff in the Dow of over 500 points. This is what the futures say, and what is happening in Asia right now. We could be in the 11,500 range by tomorrow night, but that may be it.
Here are the indicators I will look for: a big pop in the VIX (which I think we will see tomorrow) to over 35 followed by a gradual reduction in volatility indicating the storm has passed. Looking back, I can see that most bottoms occur about the time the VIX goes below its 20 day moving average for good. You can see that average on a good charting program.
I will also look for the spread between the US Fed Funds rate and the 2 year Treasury to approach 0. Right now, it is almost 2.0, with Fed Funds at 4.25 and the 2 year around 2.50. I bet 2 year approaches 2.0 tomorrow with a panic.
The Fed will have to cut rates before the next meeting and may go 1.0 given the problems with global markets. That would bring the Fed Funds to 3.25. With another cut to 3.0 or even 2.75 in February, the 2 year might strengthen and narrow the gap towards zero. Remember back in 2003 when the bull began, the Fed Funds were at 1.0 and the 2 year was around 2.0 and went on up to 4.0 before the Fed Funds rate followed. A steep yield curve shows a strong economy and likely a bull market.
If the Fed does nothing (hard to imagine), then the bear goes on and 11,000 is not even safe. But for those who have lots of cash (you, but not me), that will just mean better deals. I have about 5% in cash on the sideline and another 10% in the BEARX funds, though that percentage increases every day as my long portfolio shrinks and my bear fund increases. I think this selloff will also show how dangerous Asia and basic materials have become, at least in the short term. Glad I am out of both.
Monday, January 21, 2008
Problems with Mortgage Bond Insurers
Jake asked me about the problems with mortgage / bond insurers. Here is a good article that briefly explains the problems with the mortgage insurers and the implications for our economy. The big dooms-dayers like David Tice (manager of my BEARX fund) and Robert Prechter have actually outlined the scenario that has begun to unfold, on their website: http://www.prudentbear.com/ in a PPT posted there (see: “The Case for a Secular Bear Market”) that I reviewed in 2003 and shared with you in my annual newsletter that year. Those two have long been leaders in campaigning against the dangers of fiat currencies and the prospect for uncontrolled inflation and dollar devaluation in the United States. The scenario began somewhat like is currently unfolding, with the inability of the insurance companies to back up the banks’ lending hedges, precipitating a financial calamity. This is the reason I own quite a bit of BEARX as a hedge. I figure that Tice will construct that fund to benefit from the disaster scenario he foretold, IF IT HAPPENS.
And that is a very big if. Even Tice has always conceded that the government had the ability, by turning up the printing presses and calling on its trading partners, to forestall or stop his worst-case scenario. But he also warned that if the Fed slipped up and miscalculated, the downward spiral could get away from them and become impossible to stop. Is Bernanke, President Bush and Congress up to the task? That is a very important question. So, just in case, I have a hedge. Ultimately, if Tice is right and as he outlines, even the dollar will become worthless (as has happened in other economies which mismanaged themselves into hyperinflation by overprinting currency, like post WW1 Germany and 70s Argentina). If the worst case occurs, the only safe haven is gold, as the historical store of value. But gold miners and ETFs are no good according to Tice as they are transacted in fiat currencies. If events get bad enough, only physical gold is really safe, as the fund companies sponsoring gold bullion ETFs (like XAU or GLD) can go broke on a cash flow basis have the physical gold reserves in bankruptcy court. My youngest brother buys gold coins because he instinctively does not trust the government. Maybe he will turn out to be right.
I am not paranoid or pessimistic enough to think the worse will happen, so my position is more moderate as mentioned. I think the government will backstop the financial system by guaranteeing the loans / insurance as they did during the S&L crisis when the formed the Resolution Trust Corp to do the same with the S&Ls (and this was a less serious problem to our national economy than the current global banking crisis). But I am monitoring the situation, and if it gets bad enough (say, DOW below 10,000), I will probably use my reserve cash to start buying enough gold bullion to survive an ultimate financial meltdown. But I won’t go all the way and build an underground bunker with food for 3 months, like my brother has.
Here is the article:
Bond-insurer woes may trigger more write-downs, turmoil By Alistair Barr Jan 18, 2008 18:08:00 (ET)
SAN FRANCISCO (MarketWatch) -- Just when you thought it was over, trouble in the $2.3 trillion bond-insurance business could trigger another wave of big write-downs from banks and brokerage firms, experts said Friday.
Leading bond insurers Ambac Financial (ABK, Trade ) and MBIA Inc. (MBI, Trade ) look increasingly likely to lose their AAA ratings. While almost unthinkable just six months ago, such concerns are also causing turmoil in the $2.5 trillion municipal-bond market.
Bond insurers agree to pay principal and interest when due in a timely manner in the event of a default -- a $2.3 trillion business that offers a credit-rating boost to municipalities and other issuers that don't have AAA ratings. Without those top ratings, their business models may be imperiled.
A more worrying consideration is that when a bond insurer is downgraded, all the securities it has guaranteed are, in theory, downgraded as well.
If Ambac and MBIA lose their top ratings, billions of dollars of muni bonds will be downgraded, and the guarantees that have been sold on mortgage-related securities such as collateralized debt obligations, or CDOs, will lose value.
Bond insurers guarantee roughly $1.4 trillion worth of muni bonds and more than $600 billion of structured finance securities, such as mortgage-backed securities and CDOs, according to Standard & Poor's. Ambac alone has guaranteed about $67 billion of CDOs.
"The destruction of the bond insurers would likely bring write-downs at major banks and financial institutions that would put current write-downs to shame," Tamara Kravec, an analyst at Banc of America Securities, wrote in a note Friday.
Kravec cut her rating on Ambac and MBIA on Friday because she thinks that ratings downgrades are "highly probable" now.
Indeed, Fitch Ratings cut Ambac's AAA rating to AA on Friday, becoming the first major agency to take that step. Fitch downgraded 137,390 muni bond issues and 114 other securities guaranteed by Ambac soon after.
Merrill Lynch & Co. (MER, Trade ) took a $3.1 billion write-down on Thursday related to the firm's CDO hedges. Merrill had bought CDO guarantees from bond insurers including ACA Capital, a smaller player that's now struggling to survive. Most of the write-downs were related to ACA.
CIBC (CM, Trade ) and French banking giant Credit Agricole unveiled similar write-downs in December, related to guarantees they bought from ACA.
But ACA is much smaller than Ambac and MBIA. If the two larger bond insurers are downgraded, banks and brokers that have bought guarantees from them may have to write-down their exposures further.
Merrill has net CDO exposure of $4.8 billion. But that includes a lot of hedging, mainly through guarantees bought from bond insurers. Excluding those hedges, the brokerage firm still has a "whopping" $30.4 billion of CDOs on its balance sheet, Brad Hintz, an analyst at Bernstein Research, noted on Friday.
"We remain very uncomfortable with Merrill's CDO balance sheet exposure," the analyst wrote in a note to investors. "If the counterparties are downgraded, and they cannot post additional collateral, we would expect that Merrill Lynch would have to take a valuation reserve against that specific exposure."
Citigroup (C, Trade ) set aside $900 million during the fourth quarter to cover heightened credit risks related to counterparties it uses to hedge CDO risks.
The impact on the muni-bond market may be just as big, experts said Friday.
There are $2.5 trillion to $3 trillion of muni bonds. Roughly half of those are insured by bond, or "monoline," insurers like Ambac and MBIA.
So more than $1 trillion of muni bonds are now in danger of being downgraded. That could trigger losses for muni-bond investors.
"Assuming the "monoline" insurers lose their triple-A ratings, underlying insured muni bonds could be susceptible to downgrades and downward repricing, leading to losses for muni-bond mutual funds," Michael Kim, an analyst at Sandler O'Neill, told investors in a note Friday.
Shares of big muni-bond fund managers, including Franklin Resources (BEN, Trade ) and Eaton Vance (EV, Trade ) have already been hit by such concerns, Kim said.
Franklin stock has slumped 22% so far this year; Eaton Vance is off 27%.
Most muni bonds insured by Ambac and MBIA are now trading as if there isn't any insurance, Richard Larkin, a municipal-trading desk analyst at JB Hanauer & Co., commented Friday.
"The market has lost all faith in bond insurance and the ratings agencies," he said. "Prices are being discounted because people wonder whether there is any value to the insurance."
That's a big problem, because there are no official ratings for many of the underlying issuers of muni bonds, such as cities, school districts and utilities, he added.
When municipalities sold debt, they asked agencies like S&P and Moody's to evaluate the securities with bond insurance attached.
If the insurance on this debt becomes less valuable, muni bond investors have few ways of checking the new creditworthiness of the issuer, Larkin said.
That's creating an "information vacuum" because the rating agencies aren't going to re-evaluate muni bond issuers unless the municipalities request and pay for new analysis, he said.
"The lack of public underlying ratings on insured debt is a big problem, and if more bond insurers are downgraded, the rating agencies are not likely to fill the vacuum and publish underlying ratings unless they are paid additional fees to do so," Larkin explained.
"Trades are being made based on people's best guesses of the creditworthiness of issuers," he added. "And if these downgrades happen, that will be the environment going forward. Not a good one."
Saturday, January 19, 2008
Survival of AMBAC and the Mortgage Insurers
This gets so complicated almost on one can figure it out, which is the whole problem. Interestingly, David Tice at Bear fund actually predicted this whole scenario several years ago. But very few people saw it coming, me included. I should have believed him, and Doug Kass. I thought they were overdoing it, but I guess they were always right.
The mortgage insurers are on the hook for the “Credit Swaps” that were written to insure the companies writing the CDOs and RMBS, the securities created by packages of loans. If you were like Lehman, Citi, Merrill or JP Morgan issuing those securities, you could insure them with companies like MBIA, MGIC and Ambac. This would be similar idea to the PMI insurance that is written on individual mortgages (Private Mortgage Insurance) for loans with less than 20% equity, or the insurance on mortgages sold by Fannie Mae or Freddie Mac. In the case of FNM and FRE, the insurance policy is backed by the American government.
The problem for the commercial insurers is they don’t have enough capital to cover the insurance claims. If the government doesn’t back them up, it will be big problems for the financial system. But I think the government HAS to find some way to support them. I don’t know if $250B is the number, or not. But it would help the banks, too, if some one helped with the insurers. The banks would like to collect on their insurance policies. It would help their capital situation and would also help get the market for commercial paper moving. All this is tied together.
As for Buffett, he is creating an insurance company to insure municipal bonds, not mortgages. Most of these commercial paper insurers were doing municipal bonds till they got the mortgage bug. Now there is no healthy company to insure municipal bonds, so Buffett is stepping in.
As scary as all this sounds, it has to get resolved by the government. This is no different than the S&L crisis when the government stepped in with a $500B rescue. In fact, it is more important this time than that time, since now the money center banks are affected, not the less important S&L industry. So, I would think $250B would be a cheap bailout. Put another way, if they don’t fix this problem with the insurers and the money center banks, there won’t be much of an economy to worry about and I am not sure the dollar will be worth anything either.
The day the Feds announce a comprehensive plan to fix the problem (instead of just promises which is all we have had so far), bailout the insurance companies, the market will rebound and probably in a big way for the financials.
Wednesday, January 16, 2008
On Prudent Speculator and Prudent Bear
Of all the newsletter writers I read, the Prudent Speculator comes closest to matching my own personal outlook, so is the easiest one for me to follow in principle. Pru Spec also has a long term record that is very good, one of the top 10 newsletters of the past 25 years, according to reviewer Mark Hulbert. John Buckingham and his staff follow the ideas of famous value investors like David Graham. They use valuation metrics that sometimes recommend a stock too early. Still, there are almost no examples of a correction like this one (over 15% on the Dow and almost 25% on the Russell 2000 small cap), where the stocks were not higher after two years. Only during the Great Depression was this not true.
So, rather than worrying about the market valuation tomorrow, I am thinking about market valuations in 2010. I am sure they will be higher, then. But just in case this market turns out to be a rerun of the Great Depression, I am hanging on to my BEARX mutual fund holdings. If the market declines by 90% like it did in 1929 to 1932 (DOW 1400?), I expect my BEARX to do the opposite and increase by 1000%, almost offsetting all my other losses.
Thursday, November 22, 2007
Comments on Foreign Investment and Steven Leeb
Jake, I read the Leeb letter you sent me. Looks like it was from year end 2006. I will be happy to share my newsletters with you if you can send me this one whenever it comes out. Even though I don't care for the style of his advertising bulletin that you sent me, I like his thinking (most of these newsletters use an over-the-top style to get people's attention). You have sent me other of his newsletters that are written more subtly and I agree with his positions. I would be very interested to receive his alerts.
Leeb does have a good track record and he did make some good observations on the direction of the global economy. The growing power of Asia (China and India) is fairly well known and I have been positioned for that for several years, though have been afraid of the big China runup recently. Looks like a stock market bubble to me. I just have a very little exposure to China with FXI and to India with IFN. Both will probably get hit hard if there is a global correction, which I think has already started. I will move more into those two funds after we go through this bear market. The place of India and China as the top two economies on the planet is just a function of their populations. India has not yet had the will to push its infrastructure along to keep pace with China, but I am sure it will do so in the next few years. Engineering companies like JEC and FLR are a good way to play infrastructure, though overpriced right now.
I see where you may be getting the signals to go all cash. It looks like Leeb has a timing service to recommend that. It will be interesting to see how that turns out. All investment books I have read say that timing doesn't work, but that modifying allocations to a more conservative posture has a good track record.
Investech is a newsletter written by Jim Stack and is more conservative than Prudent Speculator to which I also subscribe. Check out his "Housing Indicator". It is amazingly like the internet stock bubble (well not really amazing since EVERY bubble looks like that which is how it gets that name). I also subscribe to Fred Hickey's High Tech Strategist. He is also VERY bearish, especially on tech and retail stocks, and has been for several years (much too early). He and Doug Kass, another big bear, reference each other's work all the time in their letters.
Jim Stack is making the same calls as Stephen Leeb, although he is still invested in his fund, but defensively. Stack's negative calls are based on more traditional investment indicators including stock fund flows and the new "housing indicator". I have not been as aggressively bearish as Stack, but probably should have (and have changed my thinking). Now I am trying to get my portfolio in line with his allocations, which include a 10% bear fund exposure (I am only at 5% bearish right now). Prudent Bear (BEARX) is how I am doing it, since it outperforms the inverse market index funds like Proshares inverse S&P (SH). BEARX has a lot of precious metal and mineral exposure in addition to shorts on the weaker stocks. As you know, I like the protection of the precison metals, even at the already high prices.
I have more work to do to get my portfolio squared away. I will need to take some big hits on those financial stocks I picked up too early and allocate the proceeds to BEARX. I can probably keep my portfolio positive for the year if I get that done before any more damage. Too bad I didn't take the more aggressive approach along with Stack. I was up 20% for the year on my overall portfolio at the end of June.
I have also attached David Tice's most recent letter to shareholders of BEARX. It was probably written at the end of October, but is dated November 2007. Everything he warned about the financial stocks has come to pass in November (though, it had already started at the end of July). We made a double top in the broad market with the 14,000 peak in July and then again in mid-October. Double tops that break down like this one has (fast), can signal a long term (secular) high in the market. That is why I am thinking 12,000 is likely soon, if not lower. Tice is the most credible bear that I read, though Kass also has been accurate.
I don't really buy into Leeb's total gloom and doom for the American market. The inflation story at 12-15% would be no worse than the 1970s (as he himself referenced). We have had the repeat of "guns and butter" in the past 5 years and have deep financial deficits, both public (government) and private (hedge funds, banks, many underwater homeowners), which is why a period of high inflation may be on our doorstep. People did not go broke in the market during the 70s, though it was tough to break even on a "real return" basis, after inflation was netted out. The way to do well in the market in the 70s was the same as now: stay invested in hard assets. Bonds and financial stocks are deadly. We have been agreeing on this strategy, but we should not bail out on the "hard asset" investments right now.
I am staying in the Canroys because I believe as Leeb does, that oil will get more and more precious, and the US dollar will continue to weaken (it won't crash becaue our trading partners / creditors can't afford it to). The Canroys are one of the best ways to take advantage of those trends. I will take the tax uncertainties in Canada over the political uncertainties over the other big sources of global oil (Mideast, Africa) or the high cost of deep sea oil. When you buy the big oil companies like MRO, CVX, XOM or BP, you don't know how global politics might affect their ability to pump oil. They may have their assets nationalized (like in Venezuela and Russia) or the royalties jacked up (even higher than Alberta). I am staying in gold (through BEARX and other funds) because I think gold is a store of wealth while the currency situation gets sorted out. I don't trust any of the paper currencies. If there is global inflation, as Leeb su ggests, then all world currencies will devalue in relation to gold (or oil for that matter).
I don't know about this end of the American economy story-line in his 2006 letter. Like I wrote a couple days ago, China and other big American creditor nations need us as much as we need them. They can't walk away from buying Treasuries or some other American assets. They want to and need to export their consumer products to us in order to employ their huge urbanizing populations. When they export product, they get back dollars in return. They have to put those dollars to work, so they buy our Treasuries or some other financial instrument (including the CDOs and other junky stuff they now own). The other option, which I think will happen and which will eventually support our stock market, is they can recycle their dollars by buying American companies. The oil sheiks have been quietly doing this for years. The only time we hear about it is when they try to buy something that has some possible national security implications, like Dubai trying to buy our ports and China trying to buy Unocal. Then, our Congress shoots them down (unfotunately, in my opinion).
I like the idea of having every creditor country recycling dollars by buying our companies. It props up the stock market and stabilizes the global economy, and global politics by extension. For example, Germany and Japan were at war with us in the 1940s, but now are our best friends. Why? Because they own a big chunk of America (we helped make them powerhouse exporters in the 50s by rebuilding their economies with the best new manufacturing plants and then let them export their cheap products to us without tariffs or duties). When foeign companies own our companies, they send their citizens to live here and help manage their investment (I now work for a German company and just left a company that was sold to the Japanese, so have first hand experience with this).
America has the chance to be a literal United Nations (much better than the fake figurative one in New York). So, I want the Saudis, Chinese, Russians and Iranians for that matter, to take a big stake in America. That is the future I see, not America as some long-forgotten, has-been nation, as perhaps Leeb sees it.
Wednesday, November 21, 2007
DOW 12000 Looks Like the Target
Today brings an even worse market. But it is really thin (very low volume on all the majore index ETFs like SPY or DIA), so just means all the potential buyers are taking the day off. Market closes at 1pm EST today, I think.
Based on the big sell-off in Asia last night and the weak USA market today, I think this downward direction could continue a while, until someone announces how they plan to stablize the financial markets (the Fed? a consortium of global central banks?) The whole world's financial system is exposed to our credit markets. The European, Asian and oil exporter countries have been big buyers of the credit that is now so junky (CDOs, subprime securities, etc). China has been an especially big player. So, the whole world has a stake in how this turns out and the global markets will move accordingly.
I am thinking that 12,000 target on the DOW is looking like a pretty sure bet now. We will see if the market holds there. In the meantime, I am definitely overweight what I had planned for this occassion (too many financials...it is killing me). So, you can have the right idea, and still have poor execution. I will try to learn from this and figure out where I went wrong (mostly, I got myself exposed to high yield that I thought was safe (like Citi), but wasn't. High yield = financials).
None of this market trouble changes my thinking on the the weak dollar - strong hard asset story (oil, gold, mining, metals). That should be a theme for many years. By extension, the Asian economies and currencies will be strong for many years, since that is where the growth is. This means good things for EWY, EWT, EWH (Hong Kong), FXI (China), IFN (India) and even Japan (EWJ) which saw a big strengthening of the yen the last couple days. Japan is the financier and infrastructure engineer for China. I predict that Japan and China will eventually become very friendly to each other, like the British and Americans (they share culture, language, religion, some foods).
So, I will wait a while, but pull the trigger on these type trades once the dust settles. I will use the funds from some of my money in BEARX, which is a bear market mutual fund (wish there was a tradeable ETF for it, but there isn't). David Tice is the manager. He is a famous goldbug and long term bear. Everything he has written about the dollar and our economy over the past 10 years is coming to pass. You can see his site at: www.prudentbear.com. It can get a little scary. He is a real pessimist on the dollar.
Monday, November 12, 2007
November and the Market is Ugly
Brian, Today was wild! Do you think we test the lows on the S & P? Does someone step up and buy a Canroy? Oil to mid 80's, old to 760?. VIX to 37?, Candian dollar down 2.3%. Any thoughts on the future?
My gut is this is just a correction but all fundementals are in place for lower dollar, higher gold, higher oil and another buyout of a Canroy...
Jake, I agree this is a pretty ugly market and another leg down in what began in July. Amazing how all the gains of 3 months (since the recovery in mid-August) can be wiped out in a week. This is not a very confident market. People are looking for any reason to sell and are sure getting out now. There is a lot of fear about the housing and financial markets taking down the economy.
I think this market action is showing a rotation from real estate to consumer durables to finance to retail and now on to tech and commodities, including oil and gold, as fear of a global recession spreads (though not much evidence of that). The good news for our commodity plays is they are all high yield, which makes this whole process easier to deal with. The finance stocks bounced a little today and were up against this lousy market. The home builders are also kind of washed out, though I think there must be another leg down for them and I wouldn't get close to them until there are some bankruptcies, signalling the end of the collapse (as supply is taken off the market).
I definitely think we will test the lows of August in the Dow and S&P, which aren't that far away now. We could break through and fall back to the March lows. But I don't think the environment is nearly bad enough to fall to the 2002 lows (7500 on the Dow and 800 on S&P). The financials will establish the bottom and lead the market back, maybe within the next 3-4 months. They always lead the market back.
The big question is do we go into recession and if so, how big a recession? If the rest of the world continues to grow and doesn't collapse, it will help pull the US stock market out by continuing to purchase our goods keeping our exports strong and helping the industrial base build employment.
I think the bigger banks will end up consuming the weaker banks once most of the trouble is on the table. But we still don't know how bad the trouble is, so all the banks are getting whacked. I have picked Citibank and Bank of America to survive and eventually thrive. But they are both hurting now and I was early on them, so it has hurt me. But their 6% yields make it a little better.
The good news in all of this is that the market P/E never got that high in this cycle (20) and has come down now to around 16. If we hit 11,500 on the Dow and the earnings just stay flat (no growth), we will be back under 14 for the first time since the early 90s. That was a good time to be investing in the market since the Dow was only about 3000 then (1992) and is now 4x higher.
I don't know where all the commodities could go if we get the R word going. There is a lot of fundamental reasons for gold and oil to go higher in the long term (growth of demand in the BRIC economies and ever more expensive to produce or limited supply). But over a period of a year or two, reasons for price are more technical and speculative in nature. I think 760 is the minimum pullback, but 650 is a lot more likely. If you do a chart on gold for seven years, you see that the bottom of the uptrend channel is about 650 right now.
Same thing with Oil, you can look at the channel (http://www.chartsrus.com/chart1.php?image=http://www.sharelynx.com/chartstemp/free/chartindCRUvoi.php?ticker=FUTCL) and see the lower trend line is about 65. Oil stocks, like drillers, could go down 35-40% (I am cutting my exposure to drillers) and the Canroys could go down 15-20%, though the dividend should keep them from falling too far. I am looking at writing (selling) more puts on PWE if the price gets down to $27, which it might the next couple of days. I would try to get a $1.50 premium on the $25s (maybe on the March contract). That offers me protection down to 23.50. I think the chance of the dividend on PWE getting cut is very small, so that price would be super secure since the annual dividend is over 3.00, putting the yield when the price is at $25 a t over 12%.
When VIX hits 37-40, that is the bottom, as it was last time (in August) and almost every correction before. That shows a lot of volatility that can only happen when there is some "sell-off" panic in the market. VIX was at 31 today, so on its way.
If you really want some excitment and have your options account set up, try buying at-the-money calls on your favorite names, especially if they are high volatility. Citibank (C) and BAC would be two good ideas. Cisco is another one. You can buy the March 08 $35 C call for $3 right now. That means the break even is $38 on March 17. If the stock goes back above $41 between now and then, which it definitely could, it will be a double on your bet (and if it got back to $44, it would be a triple $9 divided by $3). But if it ends up less than $35, you lose the investment.
Monday, September 24, 2007
Why Invest in Gold and Precious Metals?
Brian, Your thoughts on Gold/Precious Metals.
I recently bought some Freeport Gold & Copper FCX and it is up 15% in one week. The price of gold is $745+-. Many analysts are saying that Gold will double in 2 years. Should I buy more? What percentage do you have in Gold/Precious Metals?
Jake, Even though I really like FCX and have owned it in the past (going back to 1999 when it was Freeport-McMoran C&G), it is not a gold pure play. It is as much copper as gold (and other minerals), but it is a very good China play since most of its mines are in Indonesia and an “anti-dollar” which is the key value of gold right now, as the dollar dives. Another good stock very similar to FCX is BHP.
I have been using funds to create a core position in precious metals and then dabbling around the edges with option contracts on the miners. My favorite gold fund is VGPMX, but it may be closed right now. It has done great the past three years I have owned it (41% annualized return over 3 years). I started buying another fund, GGN, early this year when VGPMX was closed. GGN is a “natural resource” fund and so has a lot of energy stocks as well as gold and basic materials. It also has a very good yield at 6%. There are other good precious metals funds that can be found on Morningstar or other websites.
Once I have my core position, I trade around the edges when the stocks are moving up. Precious metals and basic material stocks are very volatile, so they create good trading and option opportunities. I have been playing with AU, GG and AUY. The latter is a small cap and so very volatile. It is also a darling of the day trading crowd, so really moves fast. I just closed out my positions on AU that I have held off and on for four years. I will get back into AU when it approaches $40 again. I will probably sell put options to get in. Same is true for GG which I closed out in June when it was around $27. Now it is over $30, so probably got out too early. I just got back into AUY this week as it is well below its 52 week high. I sold (20) October 12.50 put contracts for 0.65 each on Friday (worth $1300 on Oct. 19 if AUY finishes above $12.50). That price is still good and will be on Monday (with the price of AUY at $13). I am looking for $15 or $16 in the next 6 weeks if gold stays at these levels.
Selling put options, you may end up with the stock if the price drops. That has happened to me with all the gold stocks along the way. If it happens, I just hold the stock knowing that the price is volatile and I will have a chance to get out at a profit. This is what I just did with the AU (Anglogold) and GG and AUY in the past.
Other conservative gold plays include the bullion ETF (GLD). You could also look at the silver ETF (SLV). Large cap miner possibilities are Newmont (NEM) and Barrick (ABX).
I think gold might double in 2-3 years from this level. It depends on the Fed and tax / spending policy. As long as we run fiscal deficits and also cut interest rates / create excess money, we will continue to see a devaluing dollar which encourages the price of gold to rise. If Congress and the Fed decide to protect the dollar, by raising interest rates and taxes and/or cutting Federal spending, then gold will decline in value. But I am not betting on that in the short term (during an election year).
Wednesday, August 22, 2007
The Trouble with Canroys
Brian, I have one question that keeps coming up on all the boards about CANROYS. The comments are that since the CANROYS pay out such a large dividend, and if they are not able to increase their production capabilites that the stocks will reduce in price over time as all the dividends are paid out. (or something close to this). Do they have a point or is this true for all oil and gas companies.
Jake, It is true that Canroys (and REITS and Master limited partnerships or MLPs in the States) are valued based on their dividend payout which is closely related to cash flow. In the States, REITs and MLPs must pay out 95% of income by law. In Canada, it is left to the royalty trust what percent to pay out.
This is an important distinction in my mind. The additional flexibility in Canada allows the Canroys to use a larger percent of income to make acquisitions to replace or expand production. You will see this is happening with the better trusts we invest in when you read the quarterly and annual reports of the trusts. PWE reinvests about 40% of its income in production, either making acquisitions (like the recent C1 Energy acquisition) or investing in additional wells on existing leases or rehabbing old wells. American trusts (MLPs and REITs) do have a problem with reinvesting in production and must issue more shares (diluting current owners) to raise money for acquisitions or expansions.
The metric that is used to measure how likely Canroys are to keep producing is Reserve Life. I look for a reserve life of at least 10 years. This doesn't mean the trust becomes worthless in 10 years, but that is how much "proven reserves" are available to last at current production rates. Each trust also has "probable reserves" which are normally many times the proven reserves. Probables are on leases that have yet to be tested, but are known to have oil and/or gas. So, as long as the trust doesn't run out of oil / gas, it will continue to produce and pay dividends.
The only other thing that can go wrong is a collapse in the price of oil and gas. Most of the trusts have a business model that generates current dividends well below current prices. (PWE's dividend model is around $40 a barrel). If the price of energy goes below that level, then profitability declines and they may start "shutting in" wells to eliminate marginally profitable pumping. But I am betting againsts that happening anytime soon. It would require a lengthy global recession to significantly reduce global energy demand.
So, in short, if we stick with the big trusts like PWE or PGH, I don't think there is much to worry about. If the trusts are acquired by a private company, then we will get a nice one time appreciation, but will lose the long term dividend. So, I am hoping the trusts remain independent and the Canadian gov't backs off on the tax change.
Thursday, July 12, 2007
Update on Canroys and Energy Stocks
A couple of notes:
BP is in a bad position now as most of the favorable lease sites are now taken, even companies such as South Korea Oil Company have taken out leases and plan development.
CNRL is struggling with the leases they bought from BP. They have had a few work site deaths including two workers killed when a tank under construction collapsed during high winds. They also had an incident where they over-pressurized the well field (they extract oil using steam injection) and blew a massive gaping crevasse in the ground which rendered that entire area worthless for any subsequent extraction.
Suncor is massively expanding their steam extraction capabilities. By next year they should be producing over 100,000 barrels a day at their Firebag site.
One thing to keep in mind is that Bitumen (oil) does not sell for $75 a barrell like Saudia crude. Bitumen requires much more processing and there are only a few refineries that can take it, so there is a glut of bitumen on the market. It sells for maybe $40 a barrell. Smart bet would be to build a refinery, buy cheap bitumen, and sell expensive gasoline.
This is from today’s Financial Post (Toronto) newspaper. It shows that BP now estimates the Alberta oilsands to have over 15% of the proven world oil reserves. “Economically challenged” means production cost of around $20-25 per barrel. With oil at $75, it is not “economically challenging”, but is very profitable. Canadian Oilsands (COSWF) is one way to invest. Another is Suncor (SU). Pennwest (PWE) also has a big stake in a new mine at Peace River, AB:
“BP, PLC, the oil giant, one of the few super-majors in the world without a significant oilsands project under development, has long been reluctant to count the number of potential barrels in the unconventional, economically challenged oilsands in its annual Statistical Review Of World Energy.
The London-based company pulled a quiet about-face late last month, however, and its highly regarded publication now lists Canadian oilsands as containing 163.5 billion barrels of undeveloped reserves -- oil that could be produced using today's technologies and in today's economic climate -- among a total of 1.37 trillion barrels worldwide.
Recognition from BP, alone, is a significant change from the past and continues "momentum" that began four years ago when such influential entities as the United States Department of Energy; the Oil & Gas Journal; Cambridge Energy Research Associates and the International Monetary Fund began including Canadian oilsands reserves as mainstream, said Greg Stringham, vice-president of the Canadian Association of Petroleum Producers.
"It's a big step for BP and it's a world-renowned publication," Mr. Stringham said yesterday.
"The earlier steps by others allowed the international community to recognize the movement of the oilsands into mainstream oil and gas production, instead of being off to the side as a frontier development. They created a lot of international interest.
"This keeps that momentum going."
BP has been the lone holdout in recognizing the oilsands despite more than $125-billion worth of planned investment for the sector by many of its chief rivals, including Royal Dutch Shell Plc.
BP sold much of its oilsands position to Canadian Natural Resources Ltd. in the 1990s, but it retained some land in the Athabasca region, where the oil is buried too deep to mine.
The large U.S. refiner said last year it would spend billions redesigning its refinery in Whiting, Ind., to take Canadian heavy oil from Alberta's oilsands.
Mark Finley, the head of energy analysis within BP's economics team, said the company's tune changed as it got consistent data over time from the Alberta Energy and Utilities Board, the Alberta government regulator that estimates the oilsands hold 178.7 billion barrels of recoverable oil.
In a sign of caution, however, BP also separates out the Canadian reserves and lists its final world tally as "proved reserves and oilsands."
In a footnote to the list, BP further breaks out an additional 10.3 billion barrels of Canadian oilsands reserves now under active development.
"We've always said that the statistical review does not report how much oil is there," Mr. Finley said.
"We added [oilsands] as a line item because our expectation has never been if the resource is there, it's always been around the economics of it. "
Wednesday, June 06, 2007
Energy, Gold and BRICs
Here is more fodder for consideration:
Energy, as a percentage of the S&P500, peaked at over 20% in 1980. It then declined to near 6% in 2000. Now it is back at 10%. So, the price of energy stocks could double versus the rest of the market before they were historically overvalued / near a top.
Gold is a similar story. Gold relative to oil also peaked in 1980 at $800 versus oil at $40 per barrel. Normalized for inflation the past 20 years, the comparable price of oil would be $100, which means the comparable price of peak gold would be $2000. If the dollar continues to decline, then dollar inflation relative to 1980 (as a baseline) will increase this equation and $150 oil and $3000 gold at the next peak. If the pattern from the 70s repeats and we are at about 1972 right now (using the Bretton Woods II thesis), then we would see this scenario play out by 2015.
The above scenario is given a fixed world market for oil and gold. But it can be argued that the global supply of both gold and oil is tighter in 2007 and the demand is greater with the development of the BRIC economies (Brazil, Russia, India and China). So, lots of upside.
Bretton Woods 2: Wither American currency?
I had to share this article with you. It is a reminder that relative global interest rates and their effects on currency exchange rates are what really matter in investing. All the rest is just noise.
China and the ROW have been financing America for a long time, at least since 9/11, by buying up our Treasuries in exchange for the dollars they get from exporting to our consumers. This has allowed our interest rates to remain artificially low and has encouraged consumption and spending, including the housing bubble. It has kept our financial markets (and financial stocks like banks and brokers) strong and supported full employment (by financing production of consumer products and services).
So what happens when this trend reverses? Interest rates go up, financial assets including housing prices go down and inflation erupts. Eventually, unemployment increases and we get a recession. Through all of this, the only safe place to be, relatively, is in hard assets like oil and gold. The real value of hard assets remains constant through time, which means they increase in value relative to a declining currency like the dollar. Here is the article by economist Randall Forsyth in today's Barrons:
Bretton Woods II: About to Follow the Original?
IS BRETTON WOODS II heading for the same fate as its predecessor?
Bretton Woods is shorthand for the postwar international monetary system, named for the New Hampshire resort town where its blueprints were laid out by the Allies in the latter days of World War II. The rules called for currencies' exchange rates to be fixed against the dollar, whose value in gold was set at $35 an ounce.
In reality, however, foreign central banks would buy dollars to keep their currencies from rising in violation of the Bretton Woods rules. That would require the central banks to expand the supply of deutschemarks, yen or francs, to purchase the excess dollars, which was inflationary. Finally, when they started demanding gold for their dollars, then-President Richard Nixon closed the gold window on Aug. 15, 1971. About a year and a half later, the dollar would float along with the currencies of the other major industrialized nations.
The improvised, more-or-less floating exchange-rate system has prevailed since 1973, about as long as the designated-hitter rule in baseball, and equally unsatisfactory to purists.
Bretton Woods II arose not from some formal treaty but as an ad hoc response to the Asian financial crisis that began 10 years ago next month. Then, the currencies of most of East Asia were informally pegged to the dollar. The Thai baht came under attack, and the pegs of much of the rest of the region's currencies were threatened in turn.
The domino theory, so feared in the Vietnam era, came to fruition in the financial markets as hot money fled the region even faster than it entered. The culmination came a year later, following the Russian ruble collapse, which triggered the Long-Term Capital Management near-meltdown.
That's prologue to the present situation. In contrast to a decade ago, emerging economies around the globe, from Asia to Latin America to Europe, generally run substantial trade surpluses and are accumulating vast foreign-exchange reserves. The main reason: to forestall a rise in their own currency's exchange rate, which would harm their economies' export competitiveness.
As under the original Bretton Woods system, the signal aspect of Bretton Woods II is the willingness on the part of foreigners to hold U.S. dollars. In the current regime, that's meant recycling their mounting surpluses mainly into U.S. Treasury and agency securities, providing cheap financing for the budget deficit, American homeowners and the capital markets.
But, as in the early 1970s, the rest of the world is balking at continuing to accumulate dollars at the same pace as before. Bridgewater Associates' Bob Prince and Jason Rotenberg write in the money manager's Daily Observations letter that private-sector accumulation of dollars abroad overseas has been essentially nil.
Central banks have been forced to step into the breach, buying the dollars needed to fund the U.S. current-account deficit, which is equal to about 7% of gross domestic product. In other words, America spends $1.07 for every dollar it earns. Foreign central banks lend us the difference, a form of vendor financing for all those goods produced abroad, especially oil.
In the process, China has accumulated $1.2 trillion of foreign-exchange reserves. Rather than keep piling up Treasuries ad infinitum, China will invest $3 billion of that in Blackstone, which sounds like a lot but equals 0.25% of its reserves.
Less well-publicized is that central banks are just saying "No" to piling up greenbacks. Not selling, mind you, as the disaster-movie scenario envisions; just accumulating at a slower rate.
There are signs that's beginning to happen, as the Bridgewater duo detail. In just the latest, this week Syria became the second Middle Eastern nation to abandon its currency's peg to the dollar, which followed a similar move by Kuwait last month. Meanwhile, a parade of countries has directed an increasing portion of their reserves away from dollars and euros. Among them, the United Arab Emirates, Switzerland, plus America's good friends, Venezuela and Russia. And China announced this week said it, too, will increase the euro's share of its currency cache -- not reducing dollars, but not adding to them as much.
Syria? United Arab Emirates? When the dollar was being attacked in the early 'Seventies, the dollar was losing value against the Italian lira, long considered a joke among currencies. Informed of this, Nixon was famously captured on the Watergate tapes as saying, "I don't give a f--- about the lira." Later, the dollar would plunge, sending the price of everything, notably oil, soaring. (Question: which was more traumatic back then, Watergate or gas lines and soaring unemployment?)
Conversely, in recent years, if there's ever been a free lunch, the dollar has come closest for America. Because the rest of the world wants greenbacks for transactions or as a store of wealth, the U.S. can print dollars to cover the gap between what the nation spends and what it earns.
But as foreign central banks have become less ardent accumulators of dollars of late, U.S. Treasury security yields have been marching higher. Sure, the bond market has gotten over the notion that the Federal Reserve will cut rates any time soon. More particularly, as bonds have retreated, the dollar's recent recovery has stalled. Could there be a connection?
Bretton Woods II essentially translates into foreigners' absorbing a nearly infinite supply of dollars, which they recycle into the credit markets, funding everything from subprime mortgages to private-equity LBOs to the budget deficit.
They'll do that as long as it serves their purpose, mainly to keep their currencies in check to keep their exports strong. Once it no longer suits them, they'll withdraw from Bretton Woods II just as they did with the original. And U.S. bonds and stocks won't like it.
Monday, May 21, 2007
Redflex picks up Albany OR contract
Don’t run any red lights in Albany.
You may recall that about 18 months ago I invested in an Australian company called Redflex. This company makes automated traffic control systems, and sends you a ticket in the mail if you get caught running a red light. Sue got caught by one of their systems in Minneapolis about 2 years ago. I was so impressed with the technology, I began researching it and really liked the business model. Redflex splits the fines with the city in return for installing and running the system (so the city pays nothing for enforcement). It was just getting started in America, so I got in early. This business model is the ultimate monopoly since the business is protected by a city contract, and people will continue to break laws, right?
Now, you get the benefits (as long as you don’t run a red light) of this technology. Safer streets and more police time to chase bad guys rather than monitoring intersections (or speeders, when you get the Redflex speed enforcement system down the road).
I see that Salem also just entered a contract with Redflex. Corvallis has not done so yet. California and Washington have many systems, as does Arizona. Redflex USA is based in Scottsdale.
If you want to buy the stock, you can buy on the Australian exchange, ASX, as RDF for about $3.19 per share. In the USA, you can buy OTC as a pink sheet stock: RFLXY for about $20 (there are 8 ASX shares to one OTC share, times the exchange rate difference of 1.30 to 1). The price is now just about where it was when I bought in, so you haven’t missed anything. It is a small / speculative stock, so I wouldn’t buy too much. But it will be fun to see their systems around town as a stock owner.
Here is the announcement and the website.
http://www.redflex.com.au/ASX_announcements/PDF/432390.pdf
Tuesday, May 08, 2007
Market Strategy - May 2007 Checkpoint
I am still sticking with my original forecast for 2007, though the timing has changed a little. I always disclaim any timing calls because there is no way even the most educated, smart people get this right every year. There are just too many variables, especially now that we are in a world economy. But my general thesis is based on history repeating in some ways. Value is value, so that remains constant and is the basis for all other decisions. I had suggested that the first half of the year (through the summer) would see declines, followed by a rally at the end of the year into 2008 leading up to the elections. The year before presidential elections is almost always good for the stock market.
When the market corrected by 6% on Feb. 27, I thought I had this call nailed. But then the market came roaring back to new alltime highs on the Dow 30 the past month. I still think this summer will be weak and the decline could start any day. However there is a big BUT and that is global liquidity (many years of good profits in raw materials) and the China expansion prior to the Beijing Olympics. Our economy is now global and what worked in the past for American markets, is now influenced by global markets. So, maybe the Melt-Up continues. Here are the arguments for both directions, up and down:
1. The market is neither cheap nor expensive at around a P/E of 16 for the Dow and around 20 for the S&P (which has smaller cap companies). This makes direction difficult to choose. It is why my own portfolio is somewhere in the middle with about 67% equity and 33% cash and almost no bonds, since it is possible interest rates will go up from here as the dollar devalues (to attract money back to the dollar, the Fed can raise interest rates). Of the equity portion of the portfolio, most is in "value" or low P/E stocks like Health Care/Pharma (now historically cheap), Energy or Basic Materials. You know I am heavily in the CanRoy oil trusts both for their value and their large dividends. The big dividends provide the income and diversity that bonds would otherwise provide. Dividends provide a cushion against a potential market downturn.
While attractive from a fundamental, world growth, point of view, materials stocks like FCX and BHP have become more expensive on an absolute historical basis. But, their profits are growing almost as fast as their stock price, keeping relative value almost constant. The potential demand from China and Asia for infrastructure development has the potential to dwarf anything the world has ever seen. Materials companies with operations in that part of the world (both FCX and BHP have big operations in Australia and/or Indonesia) will benefit for years to come. That is unless the China economy were suddenly to come to a halt or collapse. This is possible over the next 12 months as the big push for the 2008 Olympics in Beijing comes to a close. There is a lot of risk in the China economy right now as it is growing at historically unsustainable rates (for a national economy) of over 10% a year for the past 5 years. It makes sense that once the artificial, government led push for the Olympics is done, that the Chinese market will cool off, and maybe cool off the entire world economy.
2. Other than the Olympics thesis, it is not possible to know for sure what might change the current global synchronized economic expansion. Various war scenarios are speculative, they may but probably won't happen. There really is no precedence for this global economy. There was a 20 year period before World War 1 that saw global peace and prosperity with lots of free trade. And again in the 1950s, during the reconstruction after World War 2, there was a 20 year period of the same (Korea in the 50s notwithstanding). But during those periods, there was no internet or global communications. It was also before the era of global air freight and the fast movement of goods and people around the world. So, the expansionary period since the last big recession from 1990-1992 is exceptional. The current environment that favors industrial goods and basic materials is also without precedent (the construction of industrial infrastructure in the USA took 100 years and America is only 20% the size of China by population). High demand and short supply for raw goods could continue for another decade or more, until global infrastructure development slows, or materials production facilities dramatically increase supply.
3. We are now officially in a bull market from the lows in 2003. We did not know this for sure until earlier this year when the Dow went past 11,700 surpassing the previous high from 2000 (the S&P500 has not yet confirmed with a new all-time high, but is only about 2% away at 1510). Bull markets tend to have 5 distinct segments: up for several months to a year, then a 10-15% correction; up for another several months, then another 10-15% correction, and then a final up move which can have a big "melt-up" at the end before it collapses from its own prosperity and exuberance. This was the pattern from 1992 into 2000.
It could again be the pattern, with the correction last summer of 10%, now followed by the up leg which may be "melting up" right now. Note that the every day public investor like you or me is typically the last to get into a bull market (even though we all probably have mutual funds investing on our behalf all along the way). People who follow such data professionally say that the public is still on the sideline and never got back into the market after the 2001-2002 collapse. Until that money comes in, the market can't make a true bull market top. By definition, tops in stocks or in stock markets happen when everyone who ever will buy has already bought. Then, there is no one left to buy at a higher price, so all that can be done is to sell, driving the market lower (into a bear market).
The way we can know a major market turn as average people without access to industry data that shows this action conclusively, is to watch major magazines and newspapers. When the media headlines start talking about a New Era and featuring great riches earned (or lost), we know we have either a market top or bottom. You may have noticed a year ago that all the talk was about how EVERYONE was making money flipping real estate. That was the sign that the top had been reached in that market. Same thing was true in 2000 with all the talk of the Internet changing the world and creating a new era and people day-trading tech stocks that had no earnings.
So, if in the next few months, everyone gets in, then that will spell the top of the market. Since that time is hard to see until it has passed, it is probably good to have one foot in and one foot out of the pool. At this stage of the cycle, investments should be defensive (lower P/E and non-cyclical necessities of life) with a lot of dividends to provide a foundation for the stock should there be a correction.
4. The dollar continues to weaken against world currencies. Fewer nations are using the dollar as a benchmark. Japan still does, but says it may not in the future. China is gradually moving away from the dollar as its standard, slow enough not to hurt its export economy. As the world moves to other currency standards (or "baskets of currencies"), and the US goverment continues to run big deficits, the dollar MUST continue to devalue. This will move the price of all world raw goods, especially precious goods like gold and silver, higher in dollar terms, even if the prices stay constant in other currencies. Gold, then, is a good hedge against devaluation, as are energy plays like the Canroys or the other Materials stocks like BHP or FCX. In fact, the first quarter's supposed "earning surprises" to the upside were mostly a result of currency translation by the big multi-national companies issuing those earnings reports. When the dollar goes down against the Euro, then all profits from Europe earned in that currency will appreciate by the amount of the decrease in the dollar. The dollar decreased by about 8% in Q1. That was about the same as the "earnings increase" reported on average. So, on a weighted basis, profits in real dollar terms may have only increased by 2-3%, not the 8% reported. This will eventually catch up as year over year comparisons do not benefit from currency translations in the future (if the dollar stops sinking).
If you are looking for an idea, other than precious metals / gold (VGPMX) or the CanRoys I recommended in January that you bought, I am now buying and recommending BDJ and DHG. BDJ is a twist on "Dogs of the Dow" investing. It buys the highest dividend Dow 30 stocks and does so with borrowed money which leverages the return. It also uses a Covered Call options strategy to further enhance payouts. Covered Calls are a good defensive strategy and easier to execute on large cap Dow stocks when working with big money in a fund like this (options fees are high compared to the available returns on these big name stocks for average investors). The return is currently around 8.3% with a monthly payment. The payment has been steady for a couple years at a little over 10 cents a share per month. Share price is right around $15. If the Dow goes up, so will the price of BDJ, as its portfolio appreciates. But it is a closed-end fund, so underlying value (NAV) and the market price can be and usually are different. Make sure you don't buy at a premium to NAV. It is a small discount right now, so a good time to buy.
Another closed end that I have started buying is DHG with a dividend return around 7.8%. This is more of a commercial paper (short term loans to companies with high interest rates) and a high dividend fund specializing in deep value stocks (including some CanRoys). It is run by Dan Dreman's fund company. Dreman is a renowned value investor. This one is brand new and so has had a pretty spastic market price as a closed-end can, even though the NAV has hardly changed at all.
Both the above benefit from a lot of diversity. It is unlikely either will get hammered in a market selloff on NAV (market price MIGHT get hurt, but would quickly rebound. The payout probably won't change, so the yield would provide some drag on the selloff: as price goes lower, the dividend yield goes higher if payout is constant). As long as high yielding investments are in tax deferred accounts, there is no tax impact from the payments and they will continue to compound if reinvested in the CE funds.
www.etfconnect.com is a good place to research closed end funds and see the history of discount versus premiums
Sunday, February 25, 2007
More defensive stock / naked put ideas
Besides ADM and ALL both defensive names with good financials and dividends, here are two more worth considering that will diversify the portfolio: FTD and KMB.
Both have dividends over 3%. FTD is a demographics play as the boomers get older and wealthier they should be sending more gifts and flowers to each other. Also, florists are a consolidating industry and FTD will be the consolidator. Kimberly-Clark is also in the out of favor paper products industry and is a consumer staples company with global presence, so has good long term prospects.
Tuesday, August 29, 2006
Contrarian View: Housing Slump WILL Affect Spending
Jeff, Just as we discussed today, here is something that showed up on Barrons that makes the point. Economists are almost always wrong, that is one thing I have learned. Notice how they acknowledge they were wrong in the short run, but still don’t concede they will also be wrong in the long run. This is the consensus, so the opposite is more likely to happen:
Housing Slump Won't Mow Down Spending
UBS Investment Research
WE CONTINUE TO EXPECT WEAKENING in housing to lead to a noticeable slowing in overall growth but not an economy-wide recession.
Our "soft landing" forecast counts on 100 basis points easing [of short-term interest rates] by the Federal Reserve in 2007, with the bond market likely to move ahead of the Fed. Ten-year Treasury yields have already dropped below 5%; we expect a 4.4% yield by the end of 2006.
Our forecast also reflects the expectation that the indirect effects of the weakening in housing, through slowing home prices and a decline in home-equity extraction, will be significant but not sizable enough to cause consumer-spending growth to weaken dramatically. The size and speed of such wealth effects are major sources of uncertainty, however.
Housing appears to be weakening even more than we expected and, on Aug. 18, we reduced our forecast for real Gross Domestic Product (GDP) growth in the second half of 2006 to a 2.0% annual rate, down from 2.5% (still no recession). We also trimmed our 2007 growth forecast to 2.4% down from 2.6% on a fourth-quarter-over-quarter basis (and to 2.2% down from 2.5% on a calendar-year average basis).
The auto sector also looks poised to be a near-term drag on GDP growth, although the drag appears to reflect more of a short-term inventory correction, with much less potential for sizable indirect effects, than the weakening in housing. We estimate that auto production will subtract about 0.5 point from annualized GDP growth in the second half of 2006.
We forecast a 100,000 rise in payrolls in the August report, consistent with some slowing in growth but no collapse. We expect the unemployment rate to reverse 0.1 point of last month's 0.2-point rise. In contrast to housing, growth in the manufacturing sector still looks solid; we expect the Institute for Supply Management index slipped to 54.0 from 54.8 in July. Core personal consumption expenditures (PCE) prices probably rose just 0.1% in July, keeping the change from a year ago at 2.4%.
We expect second-quarter real GDP growth to be revised up to a 3.0% pace from 2.5%, with much of the revision concentrated in inventories. The minutes to the Aug. 8 Federal Open Market Committee meeting will be released on Aug. 29.
By itself, that weakening in residential investment would not appear to suggest a significant risk of a broad recession. Historically, however, housing downturns have been associated with economy-wide recessions. Meanwhile, housing's indirect effects on growth appear to have been unusually large in the current cycle when housing was growing, raising the potential for more related weakness as housing contracts.
As with most issues in economics, there are plenty of points and counterpoints, and every cycle is different (This Time is Different, haven’t we heard that before!!??). The business sector looks strong financially, the broad stock market has shown resilience, inventories are reasonably lean, global growth looks healthy, the trend in core inflation is tame, and interest rates are not especially high.
The big question: to what extent will slowing in home prices cause consumer-spending growth to weaken? The sharp slowing in home prices raises the possibility that home-equity extraction (HEE) and the spending that has been financed by HEE will plunge in coming quarters. We estimate home-equity extraction totaled 7% of disposable income in the first quarter of this year.
We expect the slowing in HEE will be more gradual than the slowing in prices. We also believe the impact on household spending, which we define as consumer spending plus residential investment (which includes home-improvement construction) will be smaller than the decline in HEE.
Some of the surge in HEE has been used to pay off more-expensive credit-card debt or for investment in financial assets rather than for financing increased household spending. In round numbers, we expect housing's indirect effects on consumption, much of which is through HEE, to swing from adding about 0.5 percentage point to the rate of growth in spending to subtracting 0.5 point. This issue is a major source of uncertainty, however.
So far, consumer spending has shown no sign of dramatic weakening. Indeed, the latest retail-sales data were strong. Also, in the very near term at least, the drag on spending power from rising energy prices is likely to decline, thanks to the drop in gasoline prices in recent weeks. That said, we expect the weakening in housing to have enough of an impact on employment growth, as well home-equity extraction, to pull consumer-spending growth down to around a 2.5% trend from what was a 3.5%-4% trend until recently.
In gauging whether our forecast is on track, we will be especially focused on consumer- and labor-market data.
-- Maury N. Harris, chief U.S. economist
-- James O'Sullivan, senior U.S. economist
-- Samuel Coffin, U.S. economist
Monday, August 21, 2006
Contrarian View: Housing Slump WILL Affect Spending
Jeff, Just as we discussed today, here is something that showed up on Barrons that makes the point. Economists are almost always wrong, that is one thing I have learned. Notice how they acknowledge they were wrong in the short run, but still don’t concede they will also be wrong in the long run. This is the consensus, so the opposite is more likely to happen:
Housing Slump Won't Mow Down Spending
UBS Investment Research
WE CONTINUE TO EXPECT WEAKENING in housing to lead to a noticeable slowing in overall growth but not an economy-wide recession.
Our "soft landing" forecast counts on 100 basis points easing [of short-term interest rates] by the Federal Reserve in 2007, with the bond market likely to move ahead of the Fed. Ten-year Treasury yields have already dropped below 5%; we expect a 4.4% yield by the end of 2006.
Our forecast also reflects the expectation that the indirect effects of the weakening in housing, through slowing home prices and a decline in home-equity extraction, will be significant but not sizable enough to cause consumer-spending growth to weaken dramatically. The size and speed of such wealth effects are major sources of uncertainty, however.
Housing appears to be weakening even more than we expected and, on Aug. 18, we reduced our forecast for real Gross Domestic Product (GDP) growth in the second half of 2006 to a 2.0% annual rate, down from 2.5% (still no recession). We also trimmed our 2007 growth forecast to 2.4% down from 2.6% on a fourth-quarter-over-quarter basis (and to 2.2% down from 2.5% on a calendar-year average basis).
The auto sector also looks poised to be a near-term drag on GDP growth, although the drag appears to reflect more of a short-term inventory correction, with much less potential for sizable indirect effects, than the weakening in housing. We estimate that auto production will subtract about 0.5 point from annualized GDP growth in the second half of 2006.
We forecast a 100,000 rise in payrolls in the August report, consistent with some slowing in growth but no collapse. We expect the unemployment rate to reverse 0.1 point of last month's 0.2-point rise. In contrast to housing, growth in the manufacturing sector still looks solid; we expect the Institute for Supply Management index slipped to 54.0 from 54.8 in July. Core personal consumption expenditures (PCE) prices probably rose just 0.1% in July, keeping the change from a year ago at 2.4%.
We expect second-quarter real GDP growth to be revised up to a 3.0% pace from 2.5%, with much of the revision concentrated in inventories. The minutes to the Aug. 8 Federal Open Market Committee meeting will be released on Aug. 29.
By itself, that weakening in residential investment would not appear to suggest a significant risk of a broad recession. Historically, however, housing downturns have been associated with economy-wide recessions. Meanwhile, housing's indirect effects on growth appear to have been unusually large in the current cycle when housing was growing, raising the potential for more related weakness as housing contracts.
As with most issues in economics, there are plenty of points and counterpoints, and every cycle is different (This Time is Different, haven’t we heard that before!!??). The business sector looks strong financially, the broad stock market has shown resilience, inventories are reasonably lean, global growth looks healthy, the trend in core inflation is tame, and interest rates are not especially high.
The big question: to what extent will slowing in home prices cause consumer-spending growth to weaken? The sharp slowing in home prices raises the possibility that home-equity extraction (HEE) and the spending that has been financed by HEE will plunge in coming quarters. We estimate home-equity extraction totaled 7% of disposable income in the first quarter of this year.
We expect the slowing in HEE will be more gradual than the slowing in prices. We also believe the impact on household spending, which we define as consumer spending plus residential investment (which includes home-improvement construction) will be smaller than the decline in HEE.
Some of the surge in HEE has been used to pay off more-expensive credit-card debt or for investment in financial assets rather than for financing increased household spending. In round numbers, we expect housing's indirect effects on consumption, much of which is through HEE, to swing from adding about 0.5 percentage point to the rate of growth in spending to subtracting 0.5 point. This issue is a major source of uncertainty, however.
So far, consumer spending has shown no sign of dramatic weakening. Indeed, the latest retail-sales data were strong. Also, in the very near term at least, the drag on spending power from rising energy prices is likely to decline, thanks to the drop in gasoline prices in recent weeks. That said, we expect the weakening in housing to have enough of an impact on employment growth, as well home-equity extraction, to pull consumer-spending growth down to around a 2.5% trend from what was a 3.5%-4% trend until recently.
In gauging whether our forecast is on track, we will be especially focused on consumer- and labor-market data.
-- Maury N. Harris, chief U.S. economist
-- James O'Sullivan, senior U.S. economist
-- Samuel Coffin, U.S. economist
Friday, May 12, 2006
Finer Points on Writing Option Contracts
I am liking the idea of writing calls and puts closer to expiration. The time decay is uneven. The closer to expiration, the faster the decay. When selling, time decay is good, just as it is bad when buying. So, the best annualized returns usually occur on the shortest dated contracts. I haven’t found an exception to this rule. Also, short dated contracts minimize exposure to dividends and their effect on contract prices. Plus, short contracts are more likely to capture short swings in stock price. For example, Apple and Armor Holdings, which I have held for 30 days, are falling apart. One week ago, they were looking good. The longer you hold the underlying stock, the more likely something fundamental is going to change. Oil could break down in the next 90 days as natural gas has (though not likely), but you will be locked up if you write for September, although, if it moves away from you (down if you are writing a call), the cost of closing out gets cheaper. I closed out of my GM options and reloaded at a higher price to capture some more premium to help offset the loss on the underlying. BTW: you saw that Jim Cramer came out with a BUYBUYBUY on GM on Wednesday (AFTER the 30% move)? He is predicting $40 in 12 months. Sounds like a good reason to be short to me.
I would like to be able to capture the most gain from writing in the shortest period possible. Even 0.60 per contract looks good when over just 10 days, on an annualized basis. Do the numbers in my spreadsheet and you will see what I mean.
What about the precious metals? I am thinking of selling half my PCRDX and VGPMX. I will definitely pull that trigger if gold hits $800 and maybe sooner. Precious metals have become very speculative meaning that when they go down, they will go down fast. I would like to capture some gain before then, and buy back in after the correction.
Covering Shorts on GM
Well, I couldn’t stand the pain of being short GM any longer, so I took cover.
This morning, I put in orders to buy calls for GM to protect my hiny from any more abuse.
I bought (8) June 30 call contracts for 0.50 each and (10) September 30 call contracts for 1.10. If the worst happens, and GM goes to 30 in the next 30 days (could happen with as many people want to see GM work out, and also, the US market index funds must buy GM as more people buy into those index funds), I sell the June 30 for maybe 2.00 and the Sept 30 for maybe 3.00. This will give me around $3200 in coverage, which just about offsets my losses on the short positions from today, with GM at 25.80 (30-25.80 = 4.20 x 800 = $3360).
On the other hand, if the market gets its senses back and GM goes back down to $20, I will lose the call contracts that cost me $1500, but also be able to continue writing sell orders on my 800 GM shares at about $1000 per month. So, this won’t work out as well as I originally hoped, but at least I don’t lose my rear (and will be adding to profits after two months).
If GM does get to $30 and I sell out my positions, I will be buying naked put contracts against GM, that is for sure.
Next time I try one of these covered puts, I will buy my long dated call at the same time to stop losses at 15%. I would already be in the money if I had done that with stock at $20 in mid-April (a 50 cent Sept contract at 25 then would now be paying $2). It takes about 5 months to pay back a 15% loss (at 3% gain a month on writing the put), but I can live with that. This also points out the difficulty of any bet on the short side, which you already appreciate. The market is biased to the long side.
Brian
P.S. GM proudly made the big announcement this morning that they are raising prices on new cars because they are losing too much at current prices and having to dump unsold cars on the rental fleets. Good luck! This will shrink their market share even more, creating even more labor problems and closing more production that must be capitalized regardless. If they weren’t selling enough cars at the lower prices, how does raising the price help? They don’t have a variable cost structure so this can’t possibly work. They will sell even fewer and will find themselves with as many excess vehicles but with lower total revenue at fixed expense. STUPID!!
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