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Week 63: Bending History

Portfolio Performance

More on my Tepper moment

In a response to my post Yesterday’s David Tepper Moment, the comment was made that the original David Tepper moment came after stocks had already moved quite a bit and that, if this was to be another David Tepper moment, it would be because we are far closer to the top than to the bottom.  The comment was directly especially at gold stocks.

This made me think twice.  As I remembered it the months after the original Tepper moment were some of the best for my portfolio.

Of course it was possible that I was re-imagining history in the most flattering way.  Rather than take my memory on its word I decided to go back and check the stats.

2010-2011 Portfolio Holdings

As it turns out, the 5 months following David Tepper’s comments were very good for my portfolio. They were also fairly good months for stocks as a whole. The S&P returned 13% over that period.

What can we learn from QEII?

A closer look at my portfolio of stocks and at stocks as a whole during that period shows a number of other nuances.  One of those was that while not all stocks went up, those that did were more inclined than usual to go up a lot.

QE II created a benign market for stock pickers. It numbed the market from all the bad macro noise and made investors look at positive potential rather than negative possibilities. In this environment stocks that had things already going right for them did extremely well. Stocks that should have gone up had less resistance to going up.

The market was willing to suspend the cyclical reality of business, as it did for Tembec and Mercer International. The pulp business is terribly cyclical, but for a brief moment these stocks were treated as if it wasn’t. The same could be said for the metallurgical coal business.  While I don’t have a final March 1st for Western Canadian Coal, I know it got taken over by Walters at over $10, a price I am sure Walters is regretting today.

Speculative stocks went up more. You can see this in my portfolio, where Mirasol Resources and Avion Gold more than doubled, while Furiex Pharmecuticals went up 60% on essentially no news at all. You can see this even more clearly by looking at the best speculative meter in town, the TSX Venture index, which rose from 1,699 to 2,404 during those 5 months.

Not all gold stocks went up.  In fact, some did quite the opposite.  Gold itself was only up 11%, and after the actual QE announcement gold was hardly up at all.

I was listening to Paul van Eeden yesterday on a Saturday morning money show we have here in Canada called Money Talks. Van Eeden is a promoter that I consider worth listening to, even if I don’t always agree with him.  His opinions are well thought out.  He said today that he had “no interest in a basket of gold shares but is very interested in buying a particular gold share.”

You only have to look as far as OceanaGold and Avion Gold to see how disparately gold stocks performed under QE II.  I think the reason is that the anticipation of QE works both ways. In the case of Avion Gold, which achieved positive momentum with production and costs, the rising price of gold led the market to price in rosier expectations, and the stock price tripled.

In the case of OceanaGold, less than impressive cost numbers (they were beginning a dramatic rise at the time) led to a less than enthusiastic response to the QE announcement, and once the enthusiasm waned it perpetuated itself, with selling begetting more selling.

QE exaggerates the move in individual gold stocks in both directions.  Gold stocks that are in favor take advantage of the benign backdrop and are bid up.  Investors that are in gold stocks that are out of favor take advantage of the initial liquidity and sell, which dampens any price rise and, if its strong enough, leads to the momentum killing perception that “something must be wrong with the stock”.

If I were to rank the gold stocks in my portfolio on the basis of how I expect them to perform from best to worst in this environment, this would be my ranking:

  1. Atna Resources
  2. Brigus Gold
  3. OceanaGold
  4. Esperanza Resources
  5. Lydian International
  6. Aurizon Mines

Lydian and Aurizon are short term trades and I don’t plan to hold these positions very long.  Atna, Brigus and OceanaGold all have positive catalysts that should take place over the next 6 months. Atna will begin producing ore at Pinson, which should enable the market to value the stock on much higher production numbers.  OceanaGold will begin producing ore at Didipio, which will have much the same effect for them, with the main mitigating factor here being that it has risen so much already.  Brigus will release a new resource estimate at the Grey Fox zone and will continue to ramp up production at the Black Fox underground.  Esperenza was and remains undervalued compared to its deposit and cash on hand.  I wouldn’t be surprised if it got taken over, or taken private at some point.

We’ll check back on this in 6 months.

Gold stocks weren’t the best thing to own in QEII.  Not even close.  For me, my best performers were the pulp industry; Tembec and Mercer.   The pulp  industry had positive fundamentals at the time and QE II exaggerated those fundamentals.

But the important point is that this exaggeration happened to industries that had positive fundamentals to begin with.  Whether the same thing happens to the commodity complex this time is going to depend on what happens in China.  Whether demand there comes back.  What I have to look for are the industries where things are already improving.  The momentum of this improvement will be amplified by QE III.

One commodity that could benefit from this dynamic is the lumber industry.  Lumber is tied to housing and  housing, while still only in the early stages of recovery, is seeing improving fundamentals.  The unfortunate thing is that many of the lumber stocks I follow (WEF, WFT, IFP-A, CFP) are well off the lows.  That is not to say that can’t go higher.  When I analyzed these stocks a couple of years ago I concluded that when the turn comes the earnings should lead to doubles and triples.  But since they’ve already moved, it does increase the risk that if I’m wrong, I will lose more.

I think that Western Forest Products (WEF in Canada) looks particularly interesting.  This is a company that could earn 40 cents per share on a lumber price recovery.  If that occurs, the move thus far is going to be a fraction of where it ends up.

I think the mortgage insurers could do very well in this environment if the fundamentals continue to work in their favor and they are not overwhelmed by their legacy books.  I am spending sooooo much of my time trying to understand the mortgage insurance business.  As a quick look at my trades over the last few days will attest, I had a great deal of consternation over what to do with Radian and MGIC.  I spent yesterday building out a cash flow model of the Radian Guaranty subsidiary to see if they are indeed going to run out of cash as the SeekingAlpha piece written last week suggested (I still don’t have a conclusion).  But I’m spending so much time because the upside here is really tremendous.  QEIII could exaggerate that if things work out right.

Another sector that I want to start looking at again is the Oil Services sector.  These names remain beaten down.  QEIII should take away some of the uncertainty with respect to oil prices, which should help drilling.  The unknown here is whether natural gas prices are going to stay where they are or fall back.  A $3-$4 per mcf price on natural gas and these stocks could take off.

I bought a little contract manufacturer called Nam Tai (NTE) this week.  I got the idea for the stock from a fellow that I met via this blog.  He gave me the idea for Rurban Financial, which turned out to be one of the best performing bank stocks, and he originally recommended Nam Tai when it was under $5.

Nam Tai is a contract manufacturer.  I was employed by a contract manufacturer at one point and I saw first hand that it is an ugly, low margin business.  That’s why I didn’t jump at the stock in the first place.  But Nam Tai has an evolving catalyst, a contract with AAPL (through Sharp) for LCD screens.   This contract could impact earnings substantially.  The stock has moved a lot but when I looked briefly at the numbers I concluded the stock could go to $15-$20 based on what the company is saying about the volumes that will be coming from the contract.  There is a good SeekingAlpha piece

And finally, I think that gold and gold stocks will perform better as a group this time around, though it will still be worthwhile to look for the overachievers in the group.

Here are a few reasons to consider before I sign off:

  1. The Indian Monsoon is making a comeback
  2. South Africa labor issues could dent supply
  3. There was much less expectation that QE would actually occur this time around
  4. QE has gone global and the Fed, with the ECB, the BOJ and the BOE all easing
  5. The Fed and ECB programs are open-ended, while the BOJ program is neverending

Unfortunately, gold has a way of surprising.  Being that its value is determined from the value of trust, I never really feel like I can trust it.  It will all depend on how well the masters of men can bend history.  And the jury’s still out on that.

Portfolio Composition

Note: I have begun to add all new US holdings in US dollars. This will make it easier to distinguish between US dollar and CDN dollar holdings. However, I cannot move currencies for existing stocks and preserve gains so existing US stocks in the portfolio will continue to show up in the CDN Holdings portfolio.

Click here for the last two weeks of trades.

5 Comments Post a comment
  1. Will Estes #

    Gold stocks are probably a special case since they benefit from both being 1) a commodity targeted by loose money, which the Fed is making available, and 2) the chosen commodity for voting against abusive excesses of monetary policy.

    Having said that, I would like to challenge your very excellent blog to start identifying short candidates. Because this Fed-induced rally is going to – at best – last for three to four months, and it is going to set up a very difficult 2013.

    In terms of the stated Fed goal of clearing housing inventory, I just don’t see how the Fed can print its way out of the huge shadow inventory of foreclosures that most big banks hold. It will take the better part of the next six years to clear that housing inventory. I cannot see the Fed buying $40B a month for 72 months.

    In terms of commodities, ultimately commodities price on supply and demand. Demand from China will continue to decrease for the next three years. Quantitative easing can in no way substitute for real demand, particularly not the huge secular demand from China that defined the last 10 years. So for me most commodities like Copper and Iron Ore will set up for shorts in the next three months.

    September 17, 2012
  2. Will Estes #

    Another possible reason to own Gold as an insurance policy here is the possibility that the Israeli’s attack Iran before the US election. Remote possibility, but some have speculated that the Israeli’s want to influence the election towards a more conservative party.

    September 17, 2012
  3. Steve T #

    Re: gold stocks. I think your Brigus Gold pick is a very good under the radar selection and would rank it number one assuming management executes on all of their objectives. Atna appears undervalued but they are a very high cost producer (even Pinson) and the market always discounts this type of company so I would rank/rerate it lower even though it can make some money. Lydian requires buyout to crystalize on gains but it is based in Armenia and there is recent increasing conflict with Azerbaijan for potential all out war (google it for details).

    For some other gold plays worth checking out. Since you are familiar with Aurizon then take a look at one of their JV partners Niogold (NOX) that is exploring the Marban block. I made a Stockhouse post making the argument that at recent prices you could be buying 640K ounces of gold for as low as $1.60/oz and realistically 800K ounces for -$11/oz (after phase 3 drilling) when you factor in Aurizon’s resource payment to fulfill their option agreement in late 2013. Either that occurs or it simply gets taken over by them but it is a development play that is akin to watching paint dry to realize its full value similar to Esperanza.

    Another off the radar pick is Mandalay Resources (MND). The stock when it was trading under 60 cents was very good value. It is now in the low 90’s and margin for error possibly gone. But based on financials with huge increase in production it is very cheap (similar to Atna) but based on relatively shorter life reserves it is only average. High shares outstanding with some institution owing like over 30% of it which makes it thinly traded. But possibly good pick for silver exposure and it could produce 5M ounces Ag in 2013 at low cost in the $4.25/oz range?

    But personally I like Brigus presently and happy to build up a position without thinking at any price under 95 cents.

    September 17, 2012
  4. Fredrik #

    I like Rio Alto for the long term, even though we have seen a double during the last year. Fairly low cost, safe jurisdiction in Peru and a lot of growth from the sulfide part, even though 75% of the income will come from copper. My biggest holding.

    Aurcana is another one I’m looking at, if you like silver, low cc and a lot of growth, and a lot of warrants in the money. Watch out for dec 2013.

    Argonaut and B2Gold are quality, but expensive in my opinion. EDR/Avion look interesting, if you can handle West Africa.

    September 19, 2012

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