Beruflich Dokumente
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2037
Third Quarter
October 2011
Here we go again. Markets around the world tumbled in the quarter just ended, on ongoing debt concerns and a slowdown in the global economy. Investors fear a repeat of 2008. Notwithstanding our concerns about the global situation, two essential differences are discernable. First, the debt problems are well known and have been headline stories for the past year; housing and credit bears were sidelined in 2007 and early 2008. Secondly, asset prices, including real estate and equities, are not nearly as overpriced as they were three years ago. Indeed, in many cases they are reasonable value. So, while far from complacent about the economic and financial outlook, or the markets in the near term, and while looking for sensible opportunities to raise cash, we are not panicking, realizing that six months, a year from now, prices will be higher.
But for the most part, the stocks in your portfolios represent ownership in solid companies that will survive, while the stocks themselves are frequently trading in single-digit price-to-earnings multiples; or below net asset value; or pay reasonable dividends. These are all measures of acceptable value. Markets overall are selling at valuations lower than they did for most of the past decade, other than perhaps a few weeks at the beginning of 2009. If the companies are positioned to survive, it seems panicky, or at least very short-term oriented, to sell at these levels. So, once again, we are holding inexpensive, quality companies, riding out the volatility, and will no doubt look back 12 months from now and be astonished at the low prices that were available. Where cash is available, we are buyingselectively, no doubt, and in a disciplined mannerbut buying nonetheless. I dont know when the turn will come, but we want to be positioned when it does.
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We discussed this extensively last Review. Though the rate of increase in Fed credit has slowedup at only 10% annualized in the last quarterits significant that it is still expanding at all, despite the end of QE2. The Fed is far from withdrawing the credit it earlier put into the economy (and now, of course, under Operation Twist is rolling over its short term notes into longer-term bonds). As weve noted before, inflation (as measured by the ludicrously under-estimating CPI) is accelerating. The latest figures, for August, show the Consumer Price Index up 3.8% over the past year. Thats up from 3.6% in July, and 1.6% in January. (While not putting much credence in a single months number, August rose at an annualized 4.8%). The direction seems fairly clear. Bernanke meanwhile blathers on about avoiding deflation, and recently made it clear that if inflation fell too far, below peoples expectations, the Fed was prepared to stimulate again. Mmmdidnt work the first time, or the second, so lets try again. How was it Einstein defined stupidity? Whats clear is that interest rates will remain lowfor the next two years most likely, says the Fedand the printing presses will continue to work overtime. The Fed cant raise rates not only because the economy, particularly housing, could not withstand higher rates, but because of the massive government borrowing requirements; even with rates at 70-year lows, borrowing costs are 10% of revenues.
Stocks: Up or down?
This is one reason we are not more bearish on equities. Typically, monetary inflation is positive for stocks (at least in terms of the domestic currency). We would also note that investors are underweighted to stocks (meaning there is buying power on the sidelines); corporate insiders are buying; and valuations are not particularly stretched. On the other hand, the economic outlook appears anything but rosy; corporate earnings growth is likely to slow in the reporting period ahead (for most sectors) as the slowdown in consumer spending combines with less impact from corporate cost-cutting; there is growing distrust of the administrations business and tax policies, as well as the Feds ability to manage the economy; and lastly, as weve discussed, stocks never did fall to typical bear-market levels, not even in early 2009. They may yet. So while we are certainly underweight the broad U.S. stock market, and not aggressively buying, we are holding what we have. As mentioned, most of our stocks are trading in single-digit p/es (for example, Staples or Ares Capital); below net asset values (Loews or Gladstone Capital); and are paying decent dividends (the BDC sector or Collectors Universe). We may shift from one particular company to another, but are in no rush to sell such companies.
Europe drags on
Our thoughts on Europe are not so terribly different. Again, one would have thought that with Europes debt problems dominating headlines over the past year, this would be priced into stocks by now. And the prescription of the European monetary authorities is much the same as the Feds. Short of the breakup of the structurally inane Euro, which would allow Greece to devalue (again), the Europeans will print more money. But each one of these interventions, whether by the Fed or the Europeans (including the massive coordinated dollar injections into Europe last month), has less and less of an impact. The common-place metaphor of a drug addict requiring larger and larger doses is not so inappropriate.
discount to book and yielding 4.4%; Cermaq, selling at four times earnings; Telefonica, yielding over 11%. A collapse in the Euro would hurt the dollar price of these stocks, but these are companies that earn from all over the world. Anytime one sees such extraordinary valuations, one must question them. Telefonica, for example, is down sharply in recent months because of a misplaced association with Spain and its troubled economy. But Spain represents only a third of the former Telefonica dEspanas earnings, and a declining percentage at that. At less than seven times earnings, Telefonica can afford its payout. The European big caps are in fact now the cheapest of stocks in all advanced countries. The so-called Euro Stoxx 50 sells at just nine times earnings, one times book, and yields 5.5%. Also inexpensive are the developing countries markets, trading at around the same valuations, with most of Asia and Brazil yielding in the 4-5% range, and only seven times earnings. They have been among the hardest hit in the recent market turmoil, incongruous though it may be that Asia falls on European debt problems.
Wither China?
Not that Asia is without economic concerns. Perhaps the biggest change in the global economic landscape in recent months has been the slowdown in China, where one manufacturing index has declined for the third month in a row. However, the decline could have bottomed as another indicator, of new export orders, moved up for the second month. More worrying are signs of a downturn in the property market, with not only prices down but overleveraged developers having difficulty obtaining new funding. Given this leverage, a decline could cascade. The response from China would likely be another round of monetary stimulus; its about all central bankers around the world seem to know. Given that inflation is already ticking up above target levelscurrently 6.2%--this could be damaging for the economy, though it would spark another round of gold buying. Also very worrying is legislation passing through the U.S. Senate, championed by Charles Schumer and Lindsey Graham to add duties to imports from China. Maybe these bi-partisan economic illiterates dont realize the yuan has already appreciated about more than 7% over the past year. Though not buying Chinese stocks, we are looking for quality, undervalued Asian companies. As discussed before, throughout the region (taking out China and Japan), government finances are stronger, household savings higher, banks more solid, and currencies undervalued relative to the U.S. and Europe. Given this area also has the highest growth prospects, this is where we will be looking, though prices could come down a little more in the near term.
higher over the coming years. Many of the stocks are fundamentally inexpensive: Freeport Copper sells at just five times earnings, with a better than 6% yield over the past 12 months, carrying very little debtand down almost 50% since July; BHP trades at eight times earnings and yields over 4%; and Canadian Oil Sands, with high leverage to oil prices, sells at nine times earnings and yields almost 6%. Unless the long bull market in resources is over, these are compelling valuations for top companies, companies whose stocks are likely to rebound strongly when the market turns.
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The September decline of 15% from the peak is a larger short-term decline than normal, but gold has corrected more than 10% four times in this bull market, and each time bounced back strongly within a few months. We see this level as a good one at which to be adding.
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Gold Accounts
We started the quarter fully invested and ended it with barely 2% in cash. Most of that was set aside for the exercise of puts (and unencumbered cash was mostly from new accounts). So we are fully loaded, and expect to see some opportunities for raising cash in the coming months. As discussed above, we remain very bullish on gold, even though the next several weeks could well see some volatility in the gold stocks, particularly with tax-loss selling among the juniors.
largest gold mining company, and explorer Renaissance Gold, a prospect generator with proven management and a solid balance sheet. We also participated in a private placement in a new company, a spin off from Reservoir Capital of its mostly gold properties in Serbia, called Reservoir Minerals. We may buy more in the market when it starts trading, probably early next month. The next few months may provide some opportunities for profit taking, including some short-term speculative trading, in addition to some selling of laggards ahead of tax-loss selling, switching into stronger companies. This may include a further modest shift towards larger companies. We are patient holders of quality companies, large and small, however, and very positive on gold, so expect to remain fully exposed to the sector.
up resource accounts this past quarter, as prices of quality companies came down, buying two new companies: Petrobras, which owns the large offshore Brazil deep oil fields (and which we had sold earlier at higher prices); and Hyflux, a Singapore manufacturer of water systems. The majority of our buying, however, has been adding to favorites at depressed prices, including Freeport Copper, and diversified miners BHP and Xstrata, as well as two juniors in the renewal energy space, Alterra Power and Reservoir Capital. We expect both these companies to be successful in the years ahead. Overall, we expect to remain fully exposed to the broad resource area, though always looking for trading opportunities to shift from one sector to another as conditions dictate. The period ahead may see us increase exposure to oil which has lagged now for the better part of a year. In sum, this continues to be a very difficult year for investors, and the near term promises more volatility and perhaps further weakness. We will use this volatility to acquire quality companies cheaply, as well as, where appropriate, to raise some cash. But we own stocks that for the most part are very inexpensive, and recent history has confirmed again that it is not a good idea to panic out of positions on market declines. Recoveries can be sharp when sentiment changes or simply when selling dries up. Although we will be looking for opportunities to raise a little cash, we intend to be there when that market turn comes. Adrian Day, October 1st, 2011
Resource Accounts
We remain long-term bulls on the resource sector, predicated on growing demand from China and other developing economies, and constrained supply. However, the short-term risk has increased, due to the slowdown in Chinas manufacturing and heightened risk in the real estate sector. As discussed, we expect any slowdown to take Chinas growth from double-digit levels to still-strong growth in the mid-single digits. For an economy the size of Chinas, such economic growth still requires more resources. Our focus remains on gold, copper, energy, the PGMs, agriculture, and uranium. We have topped
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