Contrarian or Victim, Part II
At the Agora Financial Investment Symposium in Vancouver this past July, Rick Rule made attendees aware of a simple investing rule of thumb: Buy stuff that is run by good people.
In addition, if you don’t have a reason to own a particular stock…don’t buy it. Try to stay out of extremely popular sectors…in other words, Rick advised, be a contrarian.
In today’s guest essay, Rick expounds upon his theme from the symposium, as it relates to the natural resource sector:
“The month of August was ‘wake up’ call for resource investors. And now that the markets have bounced back a bit, we’ve got a nice opportunity to examine our investments from a fresh perspective. Take this opportunity to review the reasons you became a resource investor and/or speculator. Are those reasons still valid in your view? Do you have the emotional strength to be a contrarian, using cyclicality, welcoming volatility, buying panics, and selling rallies?”
September 6, 2007
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Over to Short Fuse, reporting from the Golden State…
Views from the Fuse:
*** The Fed’s Beige Book was released yesterday afternoon…although, as Addison puts it in today’s issue of The 5 Minute Forecast, “the Fed should rename the book ‘Lilywhite Book’ on account of what’s printed inside.”
And what was printed inside, you ask? Here’s a snippet:
“Outside of real estate, reports that the turmoil in the financial markets had affected economic activity during the survey period were limited. Credit availability and credit quality remained good for most consumer and business borrowers.”
Riiight…in related news, the Mortgage Bankers Association released data from their quarterly delinquency survey, showing the number of mortgage loans entering foreclosure in the second quarter has set another record. 286,000 loans going into foreclosure, if you want the exact number.
Every time we turn around, it seems like the U.S. economy is setting another record…and none of them very good. Record lows in the stock market…record lows for the dollar…ooh, but here’s something good:
Gold for December delivery climbed $11.30, to $702 per ounce.
“It appears that investors are getting back into the market based on traditional fundamentals in order to protect and grow their investment portfolios,” said David Beahm, a vice president at Blanchard.
In other words, nothing is better wealth insurance against a falling dollar and a bipolar stock market than some of that yellow metal.
And one last note…
The Chinese have had a hard time with goods they’ve been exporting to the United States lately…tainted pet food, “filthy” fish, lead toys…and now – faulty condoms? Yikes…
The Washington Post reports that “tens of thousands of condoms provided free by the District to curb HIV-AIDS have been returned to the health department because of complaints that their paper package is easily damaged and could render the condoms ineffective.”
Organizations that give prophylactics out for free reported an 80% decrease after introducing the Chinese condoms.
Added to the complaint that the wrappers were easily torn is that the expiration dates were often illegible and “as a result, recipients said they had little confidence that the condoms would offer protection.”
“All is well.”
Investors are being told that they have a great opportunity before them – because, the market has ‘bottomed out,’ and stocks are the cheapest they’ve been for 12 years.
As to the first proposition, they point to the stock indices. And it is true, after falling nearly 10% after July 19th, the indices seemed to find their feet in August…and have been gaining ground ever since. Of course, if our memory is correct, this is not the first time the stock market was shaken in the summer. It happened in the late ’20s too. And then, investors recovered their nerves, stocks rose…and later collapsed in the fall.
Optimistic voices continued to say that the tumble was very temporary…and that these lower prices created a great buying opportunity. But stocks sank…and sank…and sank…and didn’t return to their ’29 high until the 1950s!
Yesterday, the Dow fell 143 points. The day before, it went up. Which direction will it go tomorrow? If we only knew!
Also, the dollar is down this morning, against most major currencies…but guess what’s up? Our favorite precious metal…
“Warren Buffett, investor extraordinaire, offers two ways for you to protect your purchasing power against a weakening dollar,” our friend Chris Mayer tells us. “The first is your own earnings power. The second is ownership in a wonderful business, which an individual investor can get by holding onto great stocks. A stock is, after all, a share of ownership in a business.”
Which brings us back to the second proposition – that stocks are cheap – deserves more comment. Stock prices, generally, are about where they were eight years ago. For all his risk and trouble, the average stock market investor has almost certainly lost money – after commissions and inflation – over that period. Still, corporate earnings have gone up – for the various reasons we have discussed in these reckonings.
Without once again examining the unreliable and perverse nature of these increased earnings, we merely note that higher margins may be a good reason to pay more for a single company, but not for an entire market. In a single company, higher margins may reflect efficiency, good management, or a near-monopoly franchise.
“While I have nothing against owning gold or silver – in fact, I think it’s good to own some – it’s also helpful to think about solving the problem of dollar erosion more creatively,” continues Chris. “In the stock market, you can own many great companies with valuable tangible assets that will probably be worth much more in the future than today.”
But when looking at the entire market, not just a single company, high margins are always followed by low margins. Competition, increased output, and higher costs inevitably reduce the gap between revenue and expenses.
The news is full of encouraging words about how stocks on the S&P are the cheapest – in P/E terms – they’ve been since ’95. Still, they are trading at nearly 17 times earnings. That may be relatively cheap…but it’s not absolutely cheap. At genuine market bottoms stocks sell for as little as eight…or even five…times earnings. We have a long way to go before we get there. And getting there will be especially painful, because margins will fall along with prices. In the coming slump, companies will have lower sales…and lower margins. As the denominator of the P/E ratio falls…the nominator will have to fall even more to keep up with it.
Not that we know what direction stocks will go in the near term. Even Richard Russell thinks we are in a bull market that will carry prices considerably higher before the collapse comes. Maybe he is right. But anyone who buys stocks because he thinks we are at a real ‘bottom’…or that stocks are ‘cheap’…probably works on Wall Street.
Home sales fell more than expected in July. Much more. And the financial media is full of opinions about it. Some say the housing crisis has been discounted. Others think it will be much worse than analysts think.
How bad it will be, we don’t know. But it is surely a long way from being over. Next month, a peak in ARM adjustments for 2007 will be reached. Then, in March of 2008, the ultimate peak will come. This will mean as many as two million homeowners with substantially higher monthly payments to make – and a mortgage industry unable to bail them out by refinancing their homes. Fifty mortgage lenders have already closed their doors. Others have turned cautious.
House prices nationwide, says Jeremy Grantham in Fortune Magazine, are pushing six times family income. Ultimately, after the speculation fever subsides, families have to be able to pay for their lodgings. And historically, they’ve been able to do so at house prices of no more than four times family income. House prices are coming down, he says.
When house prices come down, it sets off a whole chain reaction of explosions – in the financial industry…the homebuilding industry…the retail industry…and ultimately, even the manufacturing sector! The result is recession…lower consumer spending…lower asset prices…less speculation…more fear/less greed.
Is that a bad thing?
“Sometimes it sounds as though you WANT stocks to crash…it sounds as though you’d be happy if a recession were to hit,” writes a concerned Dear Reader. “Isn’t that a little mean spirited?”
Yes, we would like to see a real crash on Wall Street. And yes, we would like to see a real recession. Is that mean spirited? Not at all. Au contraire, it comes from the deepest, most public-minded, most generous impulses of our entire idealistic nature.
This boom is a fraud, we keep saying. The sooner it ends, the better. It is a fraud because it is not based – at least not in America – on greater output, capital formation or wealth creation. Instead, it is a wealth destroying boom…one that rests on consumption, speculation and debt. Speculators and Wall Street itself get rich. But most people merely go deeper in debt…and become poorer.
What’s worse, the longer this humbug boom goes on, the more popular attitudes and habits are shaped by it. “Prices always go up,” say the lumpen, “so buy now.” “You can’t go wrong in stocks and real estate,” say the turnips. “A nice young man just offered to refinance our house,” say the homeowners. “Don’t worry…Ben Bernanke is not going to let us lose money,” say the speculators. “Deficits don’t matter,” says the Vice President.
Corrections, like revolutions, confessions and forest fires, are unpleasant. But they are often necessary. They clear away the dead wood.
Porter Stansberry sends this note…to keep us up-to-date on what this great, worldwide boom has wrought:
“You might have missed the story…but in the WSJm I saw a story about (and a picture of) Tom Perkins’ (of Kleiner, Perkins) yacht, the Maltese Falcon. It’s a 289-foot sailboat (with 15 sails that are 20 stories tall) that operates with a complete crew of only 15 people. It can reach speeds of up to 29 miles per hour under sail.
“A book has been written about the boat (Mine’s Bigger) by David Kaplan. You can rent the thing for about $1 million per week. And, you know what they say – if it flies, floats or (you know what) it’s always better to rent.”
And here in London, Bloomberg reports on Damien Hirst’s latest and greatest proof that rich people are chumps just like everyone else:
“Aug. 29 (Bloomberg) – Damien Hirst, the U.K.’s wealthiest artist, is selling his diamond skull to an investment group for $100 million, said Frank Dunphy, Hirst’s business manager.
“The platinum skull, studded with 8,601 diamonds, has been on the market at least since June 3, when it went on show at London’s White Cube gallery. Dunphy, reached by telephone, said the price hadn’t been discounted and would be paid in cash, though he wouldn’t say over what period, or identify the investment group.”
Too bad. We’d like to know. What kind of rabid speculators would put $100 million into such a cockamamie scheme? What else are they buying? Can we short their stock?
The article continues:
“‘The buyers probably wouldn’t be “diamond people,” because the skull’s price was so much higher than the value of the diamond content,’ said London jeweler and art collector Laurence Graff, who looked at the skull when it was on show and didn’t buy it.
“‘I’m in the diamond business and I would only be interested in diamonds at diamond prices,’ Graff said in a telephone interview today.
“The skull’s sale would enrich Hirst, 42, whose fortune has been valued at 130 million pounds by the London-based Sunday Times and who may get 75 percent or more of the proceeds of a sale, according to art professionals.
“Hirst’s record of 9.7 million pounds – the highest for a living artist at auction – was set in June at Sotheby’s, when a telephone bidder bought a pill cabinet, ‘Lullaby Spring,’ that cost the New York seller about 730,000 pounds in 2002, auctioneers said…
“The singer George Michael paid 3.5 million pounds for ‘Saint Sebastian, Exquisite Pain’ – a glass tank containing a black calf, its suspended body tied to a post and pierced by dozens of arrows. A split shark fetched 10 million pounds and three ‘crucified’ sheep sold for 6 million pounds…”
We don’t know what to say. So we ask that noted art critic, The Great Mogambo, for his opinion:
“Hahahaha….,” he chortled, “hahahaha…hahaha…”
The Daily Reckoning