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  • Richard Shaw
  • 201 Comments
  • My Website

  Jan 01 08:45 AM
  Excellent and timely article.

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  • dwot
  • 14 Comments

  Jan 01 12:18 PM
  Very good article, and thank you for the link.
  
  The belief systems given to me by people who were supposedly older and wiser followed that mutual funds were low risk compared to really playing the stock market, and that you really needed people with that kind of expertise to do investing for you.
  
  The truth I learned the hard way is those beliefs are completely hog wash. After I lost a third of my investment I had a closer look at what those experts had done and I was shocked at their decision making.
  
  The other thing about mutual funds, they are managing huge amounts of money. Their decisions affect stock price, either sending it up when they try to establish a position, or sending it down when they decide to get out. My little investments have a negligible affect on stock price. I can get in at and overall lower price, and get out at an overall higher price.
  
  I've only been "playing" the stock market for myself for the past 6 months and now I evaluate every stock for itself. I see the "experts" giving buy recommendations on stocks that aren't worth half of what investors are currently paying for them, and I see sell recommendations on grossly under valued stocks.
  
  I see buy and sell recommendations that aren't updated. I see down grade recommendations, I go back and look at the date, check the price and find that the share is now selling for half price, and I perceive that that down graded recommendation is still scaring investors away when in fact the stock has become undervalued. And I see stocks becoming overvalued because of buy recommendations that are also not changed as a stock doubles in price. These buy and sell recommendations are the most crazy thing on the market as they are useless without parameters, ie, strong buy to $18, buy to $20, and hold to $24, sell to $26, strong sell over $26, or something like that.
  
  I see people making investment decisions not on the fundamental valuation of a company, but on a belief of where the market will go, with a tight-wire plan to jump out before it declines, basically, unload their over valued shares on a not so experienced investor because they know a sector is hot.
  
  I'm not an experienced investor in that I've got years of experience on the stock market, but I can read financial reports, I have an understanding of the world around me and what sounds like reasonable expectations, and everyday I see both over valued and undervalued stocks based on what I'm reading about a company.
  
  I read an excellent article about Warren Buffet's investing yesterday. It simply said you'd do well by paying a fair price for a stock, not even necessarily a bargin price.
  
  So, my two main "rules," for looking at a stock:
  
  1) What are the assets? How does the book value compare to the share price?
  
  I can't believe how many stocks I've found where book value is 1/10th or 1/20th of share price. I mostly walk away if the book value is less than 1/3rd of share price, and it takes a real good look at the company to convince me to buy in the 1/2 to 1/3rd range.
  
  And I look at if the assests are real. A stock carrying overvalued other stocks as investments can have an over stated book value. And Goodwill isn't a real asset either.
  
  2) What's the P/E and how reasonable is it?
  
  Investing is risky, and to me, earnings are the bottom line. It is the bases of what determines valuation. A mature company has little ability to change their relative earnings from one year to the next. I see lots of mature companies trading with P/Es of 20, 30, 40, and more. At 20, the company is making 5% earnings. I strongly question why take a risk when you do similar in far safer investments. At 40, it is 2.5% and pathetic, yet people buy these stocks daily.
  
  Some of these companies are in start up, or have had huge one time only write-off, but most aren't, so a high P/E is mostly a signal to walk away for me, but sometimes using my broader knowledge of the world, I can see something that will justify that that stock has the potential to grow in earnings to make the P/E reasonable. Few mature companies can change their earning significantly.
  
  And if a company has a very low P/E, why? There are tons of stocks that have one time only sale of assets that give an impression that the earnings are 20, or 30% per share. So, you still have to "chase" the money of a company through its financials and have some kind of understanding of where it is coming from.

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•  
  • dwot
  • 14 Comments

  Jan 01 02:59 PM
  I went to have a read on your study and I'm not sure because I didn't finish the study, but I seriously question a conclusion that I think I read regarding gold stocks, and I'll outline it. I may be jumping to a conclusion that isn't there, but this is what I pick up from the first page, and it is implicitly implied, even if it wasn't intended.
  
  From the first the page it has gold stocks in both bull and bearish market conditions, but where I would be highly critical of what I see is how limited the time frame is for evaluation, starting only in the year 2000.
  
  My assessment on gold would be that gold had been in its own private bearish market for a generation before, since its run up in the late 70s, early 80s that investors lost their life savings on. Gold simply hadn't been much a performer since, so, gold was already undervalued going into the bear market. An undervalued stock simply isn't going to do that badly in any market, bull or bearish.
  
  Going into a new bearish market gold is hardly undervalued, indeed, I can give a strong mathematical evaluation for gold stocks being in a bubble valuation area that even the doubling of gold prices won't save them.
  
  The conclusion at the very least that is implicitly implied, whether intended or not, is that gold is safe in a bull or a bear market. Gold is in a bubble, and it may continue to go up based on people's belief that since there performance was stellar with the increases in gold prices, more increase will deliver the same types of returns, but mathematically that is impossible, and I will outline why, because people do need to protect their investments.
  
  Gold did exceptionally well simply because of 20 year preceding bear market and then went into a bull market. Take out the 20 year previous bear, and gold wouldn't be so immuned to the S&P bear market. Gold was immuned because it was undervalued going into the bear market, plain and simple. It could have been any undervalued stock, it just so happened by coincidence to be gold, which then headed for a bull run on gold bullion prices.
  
  Take Goldcorp, for example, earnings per share over various years (challenging as some years the reports grossly change and restate earnings):
  
  1999-2001 Reports show
  
  1996 - Share price $4.12
  1997 - loss $1.38 -- Share price $1.91
  1998 - loss $0.03 -- Share price $3.00
  1999 - gain $0.14 -- Share price $2.81 -- 5%, PE 20
  2000 - loss $0.24 -- Share price $2.97 -- 8%, PE 12
  2001 - gain $0.63 -- Share price $6.25 -- stock split
  
  2002 Report (2001 change due to stock split)
  
  2001 - gain $0.31 -- Share price $6.25 -- 5%, PE 20
  2002 - gain $0.36 -- Share price $13.25 -- 2.7% PE 37 or...
  
  2003 Report (No idea why the change... Looking in the wrong place perhaps?)
  
  2002 - gain $0.57 -- Share price $13.25 -- 4.3% PE 23
  2003 - gain $0.51 -- Share price $15.59 -- 3.3% PE 31
  
  2004 Report
  
  2004 - gain $0.27 -- Share price $13.79 -- 2% PE 51
  
  2005 Report
  
  2005 - gain $0.82 -- Share price $24.50 -- 3.3% PE 30
  
  2006 - 9 months $0.89, linear annualization $1.19 Est -- Share price today $28.44 -- 4.2% PE 24.
  
  First, I think that my end year estimate for earnings is way high, but I did it simply by extrapolation. For Goldcorp roughly 60% of those earnings have come from copper, not gold, and copper went through a bull nothing like gold has seen, ie, from a low of under $1 to a high where copper prices realised averaged over $4/lb for Q2/06. Gold needs to go to $1300/oz to match that bull.
  
  The decline in copper prices means that Q4 earnings are likely to be half of what I estimated, giving earnings around $1.04, which gives 3.7% and a PE of 27.
  
  For 2006 average prices realised for gold exceeded $600. For Goldcorp, because of cash credits from other metal, "costs" were very low, and they simply won't be matched ever again because of increasing acquisition costs and copper also is highly unlikely to match its performance.
  
  Specific to Goldcorp gold needs to go up by about $150/oz just to compensate for the loss of copper revenue.
  
  The costs of aquiring land for future mines has increase from around $40-50/oz for gold in the ground to $150/oz for gold in the ground. Gold has had premium returns because of picking up land low cost, but as gold has increased in price so is the price of replacement activities, so now gold also must increase just to cover this extra cost as well. All gold producing companies face this challenge.
  
  Some of the increased profits have come from expansion of mining operations. The companies are bigger now, and they can't expand at the same rates, so there simply won't be this kind of leverage built into profits anymore.
  
  There is disgraceful understanding of how the earnings were leveraged by increasing prices. Here is a simplified look at it. Say gold was $300/oz, and $10 of that made it to profits and the company was trading at 4% earnings. Now, say gold is at $600/oz. All things the same, the leverage of those earnings is 30x, so 4x30 is 120% -- wow!!!
  
  Now, say gold goes to $700 and the share price adjusted itself back to 4% earnings. Now the leverage on earnings is 1.33 x so earnings can go to 5.3%, big stinking deal. And at a PE of say 40, 2.5% earnings would increase to 3.3%. The higher the PE, the worse the increase in earnings, if at all, because of increasing costs.
  
  But, that hasn't taken into account the increasing costs, so leverage is entirely wiped out by increasing costs. Gold has to increase to keep-up the earnings, never mine increase them.
  
  Now, look at what today's PE's are compared to what they were prior to the bear run. Part of the stellar performance from gold is due to reduction in the more reasonable PE's of 12 and 20, which imho are still excessive when you consider that a mine is a depleting asset, like a car. At the end of its life, it is worth almost nothing...
  
  At the current rate of mining say 3 million ounces per year, you can expect the 41 million ounce reserve to be used up in 13-14 years, but the 5 year plan is to go to 3.5 million ounces, so that's actually 12 years and without replacement activities all you own is a hole in the ground.
  
  Furthermore, analysis of the gold market is showing that big gold finds ie bigger than 2.5 million ounces, are becoming few and far between. At 3.5 million ounces per year, Goldcorp need to find 1-2 of these each year just to maintain. The story isn't that different for other producers. It certainly steers to opportunity for juniors because the big monsters must be fed.
  
  Out of 10 mines I looked at for Goldcorp, 2 were responsible for 80% of the earnings. All mines are simply not created equal.
  
  Another point, I looked at price elasticity versus gold bullion for several gold companies. If gold goes up $100, and you own gold bullion, your investment has increased by 16%. For gold stocks the best I found was Kinross, with I believe a 4.5% increase to earnings, but I didn't do that many, maybe 5 companies, and I found a low of 0.5% increase in earnings to market cap, ie, earnings could go from 2 to 2.5% with a 16% increase in gold prices, and that doesn't take into account the increasing costs, nor the fact that after those earnings you no longer own the gold, but have exchanged it for a hold in the ground. With the bullion, you still own the gold.
  
  Generally, the high cost producers have a much lower price elasticity to gold right now, and furthermore, I believe the higher cost producers are far less likely to see their costs increasing at the same rate as the low cost producers.
  
  And maybe I completely read something into your report that wasn't there, however, if I did, others could do so easily as well. It is implicitly implied, if not intended.

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•  
  • S A
  • 7 Comments

  Jan 01 11:02 PM
  Thank you for the very intersting article.
  
  A few questions if I may:
  
  The article mentions the following general equity categories used to create the portfolio:
  " * U.S. stocks (married with hedging strategies discussed on page 3)
  * U.S. bonds (varied durations)
  * Physical commodities (such as oil, wheat, corn, etc.)
  * Commodity stocks (energy, base metals, etc.)
  * Timberlands
  * Physical gold & silver
  * Gold stocks
  * U.S. commercial real estate
  * Foreign commercial real estate
  * Foreign bonds
  * U.S. dividend-paying stocks"
  
  1. Can you please describe what you use as a proxy for each category?
  
  2. Can you please add more details on the weighting of each category?
  
  3. The article studies the performance of the portfolio during only one market cycle - specifically, only one bear market period is examined (2000-2002). Have you studied the performance of the same portfolio during other bear market periods for the S&P 500? In other words how do we know that the portfolio is not a one "trick pony" tailored to one time period and may not work for the next cycle?
  
  Thank you,
  SA.

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  • Geoff Considine
  • 296 Comments
  • My Website

  Jan 02 12:09 PM
  I agree with your basic premise but it is really very simple. You need to look at correlations--actually look at statistics rather than simply diversifying by style. I have written a number of articles on this topic on SA and elsewhere. It is actually not hard to do, but many people do not understand that you can quickly evaluate correlations. Emerging markets indices, for example, show surprisingly high correlations to the s&P500. If you want real diversification, there are metrics that measure this for a total portfolio.
  
  This article shows correlations among a series of asset classes that many people THINK diversify them, but really are not very good diversifiers:
  
  etf.seekingalpha.com/a...
  
  This article shows some big U.S. equities that have really powerful diversification benefits:
  
  usmarket.seekingalpha....
  
  Investors must understand basic statistical performance measures if they want to achieve real diversification.

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  • Ganesh Kumar
  • 18 Comments

  Jan 02 01:24 PM
  In all asset diversification articles I have only seen "Inflation Hedges". I think all asset allocation models concentrate too much to shield against inflation. Real Estate, Commodities, Equities , TIPS all guard against inflation.
  Other than treasury securities is there any other asset class that will guard against "Deflation"?
  I think long term US treasury securities are over valued(Untill 10 year yield crosses 5.25%). Is there any other asset class we could consider as a hedge against deflation?

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  • Richard Shaw
  • 201 Comments
  • My Website

  Jan 02 01:59 PM
  This is all off the top of my head -- so forgive any logic errors. I offer this in hopes of an interest discussion thread that could follow. Thanks for askg the question.
  
  Contracts providing fixed streams of dollar income would protect against deflation in the US.
  GICs might be such an example, as would fixed annuities. Perhaps preferred stocks with required and cummulative dividends would be a deflation hedge. Then with careful research one could probably identify companies with long dividend histories that would also prosper in a deflationary enviroment -- they would probably need to be actually or nearly debt free because debt repayment would become more difficult in a deflationary enviroment. Perhaps certain debt-free fixed rate lenders with fully credit worthy debtors who would not default in a deflationary environment would do well. What other kinds of companies would do well?

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