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Posts from the ‘Market’ Category

Week 47 Update: When in doubt – Get Small

Portfolio Performance

Portfolio Composition

For the last two weeks of moves, click here.

Letting Go…

The occupation of investing is really one of evaluating risk.  If you run a large institutional fund or a hedge fund or some other large sum of money, you perform this evaluation on a formal basis, giving its conclusions a formal sounding name like risk adjusted return or something of the like.  If you are an individual investor your process is much more informal, your conclusions are often not written down (though a blog helps in this respect), but nevertheless you are continually going through the same basic process of evaluating the potential risk against its potential return.

I try to eliminate risk through exhaustive research of the companies I invest in.  That elimination process involves getting up at five in the morning on weekends and spending hours readings through 10-Q reports and MD&A’s. It involves staying up late on week nights listening to conference calls and reading industry publications.  All this effort is done in the attempt to understand what makes each particular business tick, and to understand if the fundamentals of that business are improving in such a way that value is about to be realized.

I find this to be time well spent.  On the one hand I enjoy the investigative process.  On the other, it is profitable.  I am often able to narrow my focus to sectors that should experience positive fundamentals, and then to further narrow my focus to companies within those sectors that have competent management teams and solid assets that can deliver on a consistent basis.  Whether the sector is mining or mortgages, paper or potash, banking or bitumen, it makes little difference to me.  Given the time I can understand the business and develop a thesis to invest or not, and more often than not I am right.

In the 1990s and in the early part of this decade that was all you needed to do to consistently beat the market.  You could do the work, pick good companies, understand the industry trends and wait for it to play out.  It was a simple time.

Nowadays however, following that recipe in a vaccuum can you leave you without a leg to stand.  The market today is analogous to playing a hand of cards where within the deck lies a single trump card that if played automatically will lose the hand for you.  You can manage the cards you are dealt the best you can, do your darnest to evaluate the probabilities and make the best risk adjusted decision, but if that trump card is played you will lose it all.

That trump card was the US banking system in 2008 and it is the European sovereign system now.  In either case the details differ, but the trump-like nature is essentially the same.  The risk is systemic, the probability of that risk occuring is unknown, the outcomes of that risk impossible to quantify.  Whenever you play a hand in the market these days you put yourself in danger of the consequences that the risk happens to be realized while your money is still on the table.

Because this is a risk that is so difficult, perhaps impossible, to understand, there is no way to hedge against it.  I have yet to hear anyone, expert or otherwise, offer up a coherent and definitive conclusion on what to expect if Greece exists the Euro.  Do markets open down 10% and continue to fall? Is it a non-event and an opportunity to buy?  Is Greece this years Bear Stearns, to be followed by a few months of a false reprieve before the big one hits, perhaps it being Spain that takes on the role of Lehman this time around.

There was an excellent conference call held by Donald Coxe this week.  During the call Coxe laid out the situation in Europe as well as anyone has.  It appears to be coming to a head.  More and more what we are seeing is that people, organizations and banks are making adjustments on the assumption that the Eurozone will not hold.  Banks in the Eurozone are frantically trying to tie their loans to countries that may be forced to leave by getting financing from within those countries rather than abroad.  Assuming there is an exit, the potential for a true global financial crisis is great if it is not an orderly one.  Along with that would very likely come a global recession.

While it is not clear whether Greece will leave this week, next week or next month, it has become more clear that they will indeed leave eventually.

What is unclear is how such an event will ripple through the system.  To provide a few examples, consider the following:

  1. Right now the Eurozone countries run deficits with one another.  Primarily Germany runs massive surpluses against southern periphery deficits.  These imbalances are currently tallied in something called the TARGET2 mechanism.  Target2 is essentially a way of transferring funds to countries (like Greece and Spain) that are running current account deficits so that those countries don’t run out of money.  As long as all the countries are in the Eurozone these liabilities are just a paper trail between the individual Euro nation central banks and the ECB.  However if a country with a large Target2 liability leaves the Eurozone, suddenly that liability needs to be paid back (the ultimate owner of the liability is the ECB).  But will it be paid back?  If it isn’t the ECB will take a big hit to its capital, potentially one that is big enough to cause the Central Bank to run out of capital completely.  What happens when a Central Bank runs out of capital?  I don’t think anyone really knows.  Without a doubt it will be damning to confidence at the least.
  2. What exactly is going to happen to Greece (or a little later, to Spain) if they leave the Euro and stop receiving funding from the rest of the Eurozone?  The reason Greece is able to make basic payments such as salaries, pensions, drug and medical benefits, is because of the inflow of money from outside the country.  If that inflow stops, what happens to the country?  Does it devolve from borderline chaos to complete chaos?  You have to wonder.
  3. There are pension funds and insurance companies and other large entities that perform basic public services that likely have large balances of periphery debt.  I was listening to the Goldman Sachs Insurance conference before bed last night.  William Berkley, who is the CEO of the William Berkley Corporation, gave a fascinating talk about the industry.  Most interesting perhaps is that Berkley believes that the biggest source of upside in the insurance industry over the next 24 months is likely to come from the failure of one or more of the large insurance giants in Europe.  He gave it a 50/50 chance of happening.  The reason he expects it to happen is because he is fairly certain that these companies are holding the bag on a large amount of peripheral sovereign and corporate debt.  If this doesn’t scare you, it should.  While 2008 began with the crisis of Lehman, it was amplified and extended by the crisis of the insurer AIG.  Had AIG not been dealt with, that crisis could have been far worse.
  4. What will bond holders of Spanish, Portugese, and Irish debt do in response?  You always have to remember that, as Donald Coxe has described, the situation is existential.  What that means is that the perception of weakness is weakness, and it will breed weakness.  Will a Greek exit destroy the perception of Spain to such a degree that it becomes inevitable they will leave to?  Do Spanish bond rates skyrocket in response?

Look, I am not an expert on the Eurozone or the consequences of a break-up.   I’m just throwing out these ideas to highlight the complexity of situation and to illustrate how it is basically impossible for any of us to make a legitimate assessment of it.  What it means to our investments is anybody’s guess.

Lighten Up

All I think I can do in a situation like this is to get smaller.  Take on less risk, don’t take too many chances, wait for it to play out one way or another before wading in too far.  Remember that even after Lehman went bankrupt, it took a few days for the market to recognize the consequences that were about to be felt.  I don’t think this was because the market was ignoring those consequences so much as that no one really knew what they were until they started to happen.  Same considerations this time around.   It could be Y2K all over again.  It could be Lehman all over again.  We will just have to wait and see.

As an individual investor you are at many disadvantages.  You don’t have access to the research, you don’t have access to the capital, you don’t have the range of strategic alternatives (hedging, taxes, etc) that a larger investor would be privy too. But the one advantage that you have as an individual investor is your ability to act quickly and to the extreme.  A mutual fund, pension fund or hedge fund would have a lot of difficulty going to all cash, both from a logistical and a performance perspective.  As an individual you answer to no one but yourself.  You generally can cash out with little to no movement of the underlying stock price.  If things get hairy, you have a legitimate choice as to whether or not to wait it out until they aren’t anymore.

Such is even more the case for my particular circumstance.  The reality of chasing above market returns is that I am constantly venturing into areas that are volatile.  Such is the case with gold stocks, oil stocks, even to an extent with the mortgage servicing stocks and smaller banks.  These companies trade up and down to a greater extent than the market.  Whether the fundamentals dictate it or not they will move down hard if the general market moves down.  There is no amount of analysis  that I can do to mitigate or prevent this.  I can only accept this consequence as the likely reality, and plan accordingly.

I completely sold out of Gramercy Capital, Bank of Commerce Holdings, and Shore Bancshares in the last two weeks.  I lightened up on the rest of my holdings by 10-20%.  I ended this week with a little less than 30% cash.  I plan to raise that cash level to 50% in the next week or two.

I would have an even higher cash level already, except that I have also entered into two short term positions as well.  OceanaGold and Mart Resources.  My thesis for OceanaGold is that the situation for the gold stocks appears to be turning.  There have been a number of days where the stocks have outperformed the bullion, and there was even one day were gold was down substantially while many of the large cap mining stocks were up.  This appears to me to be the start of something.  OceanaGold remains one of the cheapest gold producers out there.  It is by no means the most efficient producer, and thus it has also been beaten down substantially during this bear market in gold shares.  I bought some shares at $1.80 simply on the notion that if this is a turn in gold stocks, OceanaGold should see some outsized gains as it recovers the ground it lost.  If gold weakens further or if the gold stocks resume their downward trend, I will bail quickly.

Mart Resources is purely an event driven purchase.  I own Mart in another broker managed account already and so I follow the story closely, but have never owned it in the account I track here so I don’t talk about it much.  The company has two news events that I suspect are going to occur shortly.  The first is the potential for an announcement of a dividend.  I believe that such an announcement could result in a significant pop in the stock, as it gives credibility to what is otherwise looked on warily as a Nigerian story.  The second is a pipeline deal with Shell, which would allow Mart to increase their production, perhaps substantially, and allow the brokerages that follow the story to up their targets based on larger 2013 volumes.  Again, I am looking for an event to occur in somewhat short order, but I am not holding this stock for the long run.  If the events in Greece take a turn for the worse, I plan to cut and run.

I come back to the quote I gave last week from Peter Bernstein.  I think this is something worth repeating at a time like this:

The trick is not to be the hottest stock-picker, the winning forecaster, or the developer of the neatest model; such victories are transient. The trick is to survive.

We live in impossible to understand times.  You have to accept your own limits of knowledge and simply walk away from the table.  Will I miss opportunities by having such a high level of cash?  Quite possibly.  But you can’t chase shadows.  You have be a prudent manager of risk.


A Light Goes On (understanding why Greece matters again)

I’m can be slow to understand the implications of things. I don’t immediately see what in retrospect should be obvious.  Instead I have to get people to spell things out for me before I get it.

I think this is partially a consequence of not being able to spend as much time thinking about the world as I need to.  I have a job, I have a family and so I really don’t get a chance to sit down and work out all the potential impacts on a regular basis.

I’ve been looking at some private equity stocks lately, trying to understand them better and determine whether they are buys.  As part of this research I stumbled upon a market commentary from Michael Novogratz, a principle at Fortress Investment Group.  He crystallized for me why we are seeing the carnage we are in the markets (you have to wait until about 4 minutes in).

The key moment in the interview for me was when Novogratz spelled out that the Greek election was a game changer.  If Greece leaves the Euro it is, in his words, a Lehman moment.   If they leave, we don’t know for sure who owes who what or whether they can pay it back or if the assets and liabilities of any particular entity are going to balance out.  Novogratz is saying that Greece could breed the sort of counter-party uncertainty that could cause credit markets to seize.

That’s when I suddenly got it.  Its not that anyone can say with certainty that its going to end well or end badly.  Novogratz himself said that the ECB and the Europeans governments have been preparing for a Greek exit for months.  Its possible that they have worked out all the contingencies.  But at the end of the day no one really knows.  If Greece leaves it all goes out the window.   You are really just guessing to bet what happens next.

Just to throw out some of the uncertainties, there is the effect of funds and banks with mixed liabilities of Euro’s and Drachmas’.  There are the TARGET2 balances between Greece and other Eurozone countries that now become debt.  There is the strange consequence that a Greek exit destroys all the capital of the ECB.   There are the cross-border balances of companies that trade across the Eurozone.  There is the deep recession in Greece that results.  There is the investor response to Portugal, Italy and Spain sovereign debt.  There are simply a lot of moving parts and it is perhaps impossible to estimate how they all play out.

It has the same flavour of uncertainty as Lehman did.  And one thing that I learned from Lehman is that the decision makers know far less about the consequences then I thought they did.   They aren’t that much smarter than the rest of us.  Nobody knew what was going to happen when they let Lehman go until stuff started to happen after they let it go.  I think its the same thing with Greece.

Today I raised 20% cash.  I just sold a bit of everything, and I sold all of Gramercy Capital (GKK) because I wasn’t sure about it anyways.  It helped that gold stocks rallied.  It hurt that PHH and Newcastle had bad days.  Maybe this is a terrible time for it.  We could rally because we are so oversold. But I feel like I have no choice.  Now that it makes sense to me it seems like too much risk.  I want to get back to at least 50% cash by the Greek election or until there is a resolution that makes it clear Greece is staying.

Cat and Mouse

Quite often these days I feel like I am playing a game of cat and mouse and I am the mouse.  I sneak out of my hole and buy a few stocks that look to me like they are cheap, and I hope that I can make some money with these stocks and get back to my hole in the wall before Europe the cat comes into the room and raises its own form of hell.

This weekend I read another terror inducing installment about Europe from John Mauldin.  What I appreciate about Mauldin’s pieces is that they actually delve into the numbers involved.  I find it difficult to wrap my head around just how bad it is without getting into the numbers that demonstrate that badness.  Of course once you do get into the numbers, it becomes clear that the numbers don’t add up and that, at some point, more numbers are going to have to come from somewhere.  It also becomes clear that if no more numbers do come from somewhere (ie. the ECB doesn’t create any new numbers out of thin air) then the numbers in my portfolio are going to be smaller numbers than they are right now.

Such is this game of cat and mouse.

One new number that I learned from the piece and thought worth mentioning was that of the Spanish banks non-performing assets.  According to Mauldin non-performing assets are about 20% of assets on average.  He actually says capital in the report but I am pretty sure he means assets because 20% of capital is really nothing terrible in the grand scheme of things.  But 20% of assets is and so that scared me quite a bit.  But it seemed like such a high number that I thought I should get it from another source and the best source for all things Europe remains FT Alphaville.  They came through once again with the following chart:

As an aside I wonder if Mauldin looked at this same graph but got the left and right axis mixed up.  Right is unemployment, and it is indeed at 20% plus.  Left is bad loans, and they are at a little over 8%.  8% is less than 20% but 8% is still not very good.  Especially when its the average of all the banks.  And extra-especially when the trend seems to have taken on the look of a hockey stick.

So regardless of whether Mauldin has his numbers right or not, they still don’t add up without help from the ECB.  That was the basic point of Mauldin’s article this week. It basically still comes down to a stark choice between the 3 alternatives described in this old Edward Harrison article that I have brought up in the past.  Harrison stated those three alternatives as being:

  1. Monetization
  2. Default
  3. Break-up

When Harrison wrote his piece in late 2010 he figured the response would be some combination of default and monetization.  He has since tweaked his view with the addendum that Greece will likely have to leave the Eurozone, so now we have a combination of all three.  But monetization has always been the expected route to get through most of the angst, as it is in the easiest one.

Back to Mauldin, he points out that there are signs that the Germans are warming up to the idea of monetization.  There was news this week from the German Bundesbank that the German are expecting (read: grudgingly accepting) higher rates of inflation.  They expect this because they anticipate that higher rates will be necessary to stabilize the Eurozone.  That sounds an awful lot like “we realize that Spanish bonds are going to go back up through the roof if we don’t get the ECB to continue their paper money patch job of the hole in it.”

Anyways that’s what it sounds like, and if its true its good in the short term because if they do then the cat will leave the room for a while and I can come out and actually make some money instead of being on a rollercoaster ride where all I really need to do in  the morning is watch CNBC and check the Spanish stock market quote to know whether my portfolio of regional banks, mortgage originators and servicers, junior gold stocks and the odd oil stock, all of which have virtually no business is Spain, will be up or down.  It gets tiresome.

So I welcome another respite from the ECB.  I would only ask that they do it sooner rather than waiting until the world is back on the precipice as it was in late November.  These last two months haven’t been a lot of fun.

The US Economy: Is the data bad?

I put a lot of emphasis on the Weekly Leading Index published by the Economic Cycle Research Institute.  The index is a leading indicator of US economic growth.  The index and its smoothed annualized growth rate have both turned up recently.

Presumably this suggests an improving economy.   Yet the ECRI has been sticking to a prediction that the US economy is going to fall back into a recession.


I was reading through the ECRI’s publically available articles trying to find out why when I ran into this article.  It describes a problem that has developed with the seasonal adjustment algorithms.  It seems that the economic collapse that followed Lehman Brothers in 2008-2009 has led to a skew in the adjustment that is being made.  Many of the seasonal adjustment algorithms are interpreting the downturn that occurred in Q4 2008 – Q1 2009 as a seasonal event that should be adjusted for.

Most data, both public and private, are seasonally adjusted. But the nature of the Great Recession seems to have had an unexpected impact on the statistical seasonal adjustment algorithms that are hard-wired to detect when the seasonal patterns evolve and change over the years. This is normally a good thing, but when the economy fell off a cliff in Q4/2008 and Q1/2009, it was partly interpreted by these procedures as a lasting change in seasonal patterns. So, according to these programs, data from Q4 and Q1 would be expected thereafter to be relatively weak, and therefore automatically adjusted upwards. Our due diligence on this subject indicates a widespread problem, resulting in many recent economic headlines being skewed to the upside.

The article was written in mid-March but as recent as last week the ECRI remained behind its conclusions and their conviction that the pick-up in growth is illusory.  This SeekingAlpha article quoted Lakshman Achuthan (who is the chief economist and spokesman for the ECRI) recentlyas saying that year over year (yoy) growth, which would not be distorted by the 2008-2009 numbers, is not improving.

Please note that PCI growth yoy is still -2.2% and even q-o-q is -4.9%… With yoy growth in all the coincident indicators (GDP, industrial production, personal income and sales) all staying in cyclical downturns, and yoy payroll job growth, which had been the only holdout, now rolling over — as we had predicted a few weeks ago — it’s pretty clear that for now U.S. economic growth is worsening, not improving.

The rub is that the data we have been looking at from January through March may be overly optimistic.  It is being overly adjusted to the high side.  Now that we are into April, that is about to end.

The data isn’t great

Indeed we are seeing something like that in the recent numbers.  The monthly jobs report was a big disappointment.  The jobless claims number that came out last week spiked to 380,000.

Home sales, which to me would be the true sign of a pick-up in the economy, remain depressed.

Add to this the fact that gasoline prices are about the only thing that have recovered to pre-recession highs.

What does it mean?

The situation feels to me like another false start.  To use the phrase coined by John Maudlin, we are in for more muddling through.  Low growth rates, low interest rates; maybe the ECRI will prove to be right and we will dip into another recession.

As for my portfolio, I am of the mind that I am mostly in stocks that should perform well in this environment.

Given the bleak outlook, gold and gold stocks should do well.  Of course gold stocks have done anything but well lately.  I have to remind myself of the volatility of these stocks, how they can bounce up and down like a yo-yo and turn on a dime.  I think that as it becomes more clear that the skies remain grey and the horizon dark, the gold stocks should recover.  I am certain that the reason we have not seen a breakdown in the price of gold itself is because there is smart money out there that sees the same picture I am drawing.

The mortgage servicers, Newcastle, Nationstar, and PHH, should hold their own in this environment. Servicing revenues are not dependent on an uptick in home sales to the same extent as other housing related businesses.  Interest rates remain at such low levels that these companies continue to accumulate incredible assets (in the form of new servicing rights) that will outperform in years to come.

The regional banks are a bit of a tougher choice.  However when I look at many of the regionals, they remain below their price level before the European shock in the summer.  The US economy may not be getting that much better, but it is slowly healing, and to see these stocks at lower levels is, in my opinion, a disconnect.

Week 34: Its a bull market (for the moment)

Portfolio Performance:

Portfolio Composition:


Europe to the sidelines (for the moment)

Eric Reguly had a worthwhile article in the Globe and Mail this weekend.  He outlined the reasons why Greece and Europe are still as badly off as they were a couple of months ago.   Apart from the markets perception, nothing has changed.

The basic problems in Greece, and in the rest of the periphery, he says, remain.

The country’s economy and its social fabric are unravelling at an alarming pace and the second bailout, combined with a sovereign bond haircut, will do next to nothing to stop the horror show.

So why is the market rallying when these problems have not gone away?

I think that there are a lot of similarities between the markets reaction to Europe today and the reaction of the market in 2007 and 2008.  During the housing crisis, what drove the market down was not so much the fear of falling housing values, as it was the fear that falling housing values would cause banking problems.

At times, when it appeared that the housing problems were going to create only housing problems, the market rallied.  When the spillover to the banking system was evident, the market fell.

There are different types of bear markets.  There are bear markets that are economic and those that are financial.  When an economic bear market hits, some sectors get hit hard, some get hit, and there are always some that actually don’t do too badly at all; the idea being that there is always a bull market some where.

When a financial bear market hits, everything goes down.  Because in this case what drives the bear market is a lack of liquidity to buy stock.  So all stocks fall.  To be sure, this eventually hits the economy and causes a financial bear market, which happened in late 2008-2009 and compounded the problem.  But there is a fundamental difference here in that during an economically driven bear market, though it may be more difficult a stock picker can still pick stocks.  In a financial bear market you can’t pick anything and you just have to get the heck out.

How this relates to today is seen in how the market does not seem to care whether Greece goes into a severe recession.   This is because Greece is an insignificant spec in the world economy.  The market only cares if the problems in Greece spill over into the banking sector and cause banks to fail, not lend, seize up, and other worrying verbs, thus precipitating another financial bear market.

I wrote a long piece on the LTRO a month ago.  As it turns out this has been the most popular blog post that I have ever written.  This is somewhat unfortunate because this isn’t intended to be a blog about Europe, I am not an expert on macro economics or on banking, and the post is only tangentially related to the purpose of this blog; the stocks I own.  At any rate, in the post I argued that the LTRO may have a short term psychological impact, but over the long run it wasn’t going to do much for the Greek, Portugese, Italian and Spanish economies because none of the problems those economies are having have been dealt with.

I still think this will be the case.  Reguly highlighted the reasons why (referring specifically to Greece) in his article:

Labour costs remain too high. The economy is sinfully undiversified and laden with low-value industries, like stuffing tourists onto cruise ships. Corruption is rife. The tax-collection systems are primitive. The professional protection rackets – from truck drivers to doctors – remain intact. The country lacks a working land registry. The bureaucratic red tape leaves entrepreneurs and land owners in despair.

This is all really bad stuff.   And its stuff that applies in large part to Italy, to Spain, and to Portugal.   However, what is forgotten, and what I think I neglected  in my post about the LTRO, was that while all this is true, it was also true a year ago, two years ago, long before Greece came to be a headline and before it began to cause markets to collapse.

The LTRO has accomplished an extremely important objective and that is that is has (temporarily) removed the mechanism for a banking collapse.  The banks in Europe were on the precipice because they were overlevered (see my analysis of Deutsche Bank which remains levered at an insane 60:1) and they faced problems funding that leverage.  Now, with the help of the LTRO, the banks are still overlevered but can get all the funding they want from the ECB.

Juggling Dynamite

I was listening to the Canadian money program Money Talks yesterday.  The had Danielle Park, who writes the blog Juggling Dynamite, on as a guest.  You can listen to the interview here by selecting the 10:00 am segment for February 25th.  Parks basic argument is that this rally is a sham.  Its built on liquidity, will die by liquidity, and there is no evidence that the economies of the world are getting better.

The main theme is the incoming recession… its already underway in Europe, Japan and the UK, what has been going the last several months is all about liquidity injections again, but the reality is it doesn’t fix things, we don’t have any solutions, debt has to be written off…

She argues that individual investors have to be very careful right now.  They have to be careful about chasing the market up here, careful about jumping into dividend stocks to try to get a bit extra yield, and to be extra careful about fixed income because the yield you are getting there are miniscule.  She has some very good comments about how dangerous the current environment is to the individual and moreover, how criminal it is that central bankers continue to punish savers and try to force risk averse individuals into risky assets.

Now, if you look at what I have done over the last few weeks, I have moved from almost 50% cash to basically no cash.  So I must be completely at odds with her assessment right?


I think she’s dead on.

This is a false rally.  This is a liquidity driven rally.  This remains “the banks in Europe are not going to implode tomorrow so they must be worth more today” rally, which is not a positive pronouncement about anything other than that the end of the world is postponed.

CNBC had Lakshman Achuthan on this week to talk about his recession call from a few months ago.  Last week I talked about how one of the indicators I follow, the ECRI’s WLI, was perking up, and that this perhaps portended to a strengthening US economy.

Maybe I have been too quick to look for confirmation.  The counterpoint is that it is indeed simply a liquidity driven event.  Achuthan also argues, much like Park, that it is.  Central bankers are printing money and that money has to go somewhere.  Real economic activity is weak and so the money goes into speculative investments instead.  Achuthan said that given the amount of money being pumped into the system, he is surprised that the WLI has not risen more than it has.

Here’s the entire clip:

But what can you do?

So rally is on weak legs.  Nevertheless, its a rally. If you recognize it as a liquidity driven rally then really, what you want to invest in (temporarily) is liquidity driven stocks.  If you look at the stocks I am buying lately, they are exactly that. I am doing the right thing, even if perhaps I have not fully understood the reasons.

I like to call the junior gold explorers, companies like Geologix, Golden Minerals, Canaco, little liquidity eaters.  The stock price of these sorts of companies have much more to do with the availability of liquidity then they do with the price of gold.  That is plain to see by looking at a chart of any stock in the sector.  Every stock suffered through 2011 even as the price of gold rallied hard.  Every stock soared beginning in 2012 once the LTRO was announced and it became clear that liquidity would be in abundance again.

But these are trades.  I do not expect to be holding any of these stocks 2 years from now.  Absent some sort of paradigm shift like a move to the gold standard, these are stocks to hold for the run up and then cut loose when it looks like they are turning the taps off again.

But in the mean time, in the words of Jesse Livermore, from whom I stole my blog title and my avatar:

“But I can tell you that after the market began to go my way, I felt for the first time in my life that I had allies- the strongest and truest in the world: underlying conditions”

The underlying condition right now is one of liquidity.  It is not the intent of this blog to philosophize (too much) on the eventual consequences of such liquidity.  There are plenty of folks, like the wonderful Ms. Park, who are already describing those consequences eloquently.  The intent here is to try to evaluate those conditions clearly, and to describe how I am acting to capitalize on those conditions.

For the moment anyways, that means that I own stocks.

Of course next week could be a different story.

Not Buying this Rally

While I have been happily taking part in the rally this week I remain skeptical in its sustainability.  The positives right now are all in the “price action”.  If you look beyond the improving prices of the stocks, there is not very much positive to be said about the underlying conditions.

Lets take, as our first exhibit, Europe.  The market rally seemed to get kicked off this week with the news out of Brussels that Sarkozy and Merkel had a plan.  Or the makings of a plan.  Or a plan of a plan.  They had talked anyways, and the market deemed this to be significant and positive.

It is worthwhile here to look at some of the details of what was said by the two leaders.  In particular, the emphasis that they made that changes were needed to the actual constitutional treaty that underlies the EU.  Here is what Dennis Gartman said on the matter:

We continue… perhaps too dramatically… to dwell upon the statement by Ms. Merkel that France and Germany “will make proposals in a comprehensive package… that will include changes to [the] treaties” that established the European monetary and political unions. Ms. Merkel went out of her way Sunday and again yesterday to reiterate that “treaty” statement so that no one anywhere would misunderstand the seriousness of the situation. Changes to the treaties of Maastricht, Amsterdam, Lisbon and Nice require passage by either public referenda or by vote of the parliament in individual nations… that is left to the nations themselves… and importantly the votes must be unanimous. Not one… not a single nation in the “unions” in question… can vote against such changes. They are not passed by mere majorities of the member nations, nor by super-majorities, but by unanimity. Essentially, Slovakia must agree with Germany and Germany must agree with Ireland and Ireland must agree with Austria and so on to unanimity… Unless Ms. Merkel was lying openly and often in the past two days regarding the need to revise these seminal treaties at the core of the political and monetary unions, we find it difficult if not wholly impossible to believe that this unanimity can be achieved within anything less than one year…

The situation in Europe is far from resolved.  I would even argue that given the difficult nature of what it looks like they are now trying to accomplish, things just got a bit worse.

Meanwhile, one of my most trusted gauges of economic forecasting, the ECRI, has been getting more and more negative on the outlook for the US economy, and last week they tipped officially into the recession camp.  Now these guys are no David Rosenberg; they are not making a recession call based on a theory or the historical precedent of credit contractions elsewhere, no the ECRI is looking at the long leading indicators that have traditionally foretold economic strength and weakness and these indicators are, right now, pointing solidly downward.

I think its worth mentioning that during the sharper but shorter downturn in the index that occured in the spring of 2010, the ECRI was adamant that this did not signal a recession.  A lot of other bears did, I remember reading Rosenberg at the time and he conveniently used the WLI data to foretell a recession that never came.  But the ECRI did not.  I think they key difference is the “persistance” of the current move down.  The index has been moving down steadily since March.

The index also seems to be a very good indicator of stock market turns.  It turned almost co-incidentally with the market during the March 2009 bottom.  As you can see from the chart above, this year it turned down almost at the same time as the market topped.  I would have somewhat more faith in this rally if the index was not foretelling more economic weakness ahead.

This week I sold out of Gramercy Capital.  Gramercy was the last of my US real estate related holdings, as I have already sold out of Oneida Financial and Home Federal Bank of Louisiana.  With the US economy slowing, this doesn’t seem like a particularly good time to be making long bets on real estate. FT Alphaville posted an interesting article on the state of prime mortgages in the US.  It seems that a number of the prime mortgage indexes have fallen off preciptiously in the last few weeks.

Now these indexes only represent a sampling of the outstanding MBS, and it very could be that they are skewed to areas of the country (ie. Califronia) that are currently experiencing more weakness then the country as a whole.  Still its a sobering thought to contemplate that the housing downturn has another leg left in it.

Tying this back to Gramercy, while the company remains in a much better position than it has been in for the last few years, being no longer overly leveraged and generating significant cash flow, the lifeblood of that cash flow is still tied to the US economy, and so Gramercy is not going to be immune to a US recession.  You saw that this was the case last week when news came out that CDO-2005 failed its overcollateralization test for September.  When the company released their delayed 10-Q’s, they had this to say about CDO-2005:

“We expect that the overcollateralization test for the 2005 CDO will fail at the October 2011 distribution date”

Now this is not the end of the world for the company.  Indeed, Plan Maestro pointed out on one of the boards that it likely gives Gramercy more chances to buy the CDO bonds at distressed prices.  CDO-2006 is still generating lots of cash flow.  My point is that in an environment of a deteriorating economy, and in a world where the collapse of the second largest reserve currency is still very much a possibility, one needs to err on the side of caution.

I suspect that absent some sort of private equity take-over of the company, I will be able to buy Gramercy back at a cheaper price than I sold it at.  Just a couple weeks ago the stock was trading in the $2.60’s.  I sold at $3.20.  I suspect I will be able to pick it back up in the $2.60’s once the dust settles and Europe is found to be still wearing no clothes.

Some last bits of news, again of the positive sort, was, first of all, that Crescent Point participated rather significantly in Arcan’s recent financing.  So while retail was selling stock at sub $4, Crescent Point was buying it at $5.45.  The market is somewhat ridiculous, isn’t it?  I picked up a few shares of Arcan during the “panic”.  I’ve been contemplating reducing my position back to its normal size now that the stock has moved up, but I haven’t done so yet.  But I will; I want to use this rally lower risk in my portfolio right now, and so scaling back on everything is prudent I think.

Last night Coastal Energy released what looks like some very good news.  The hope has always been that the Bua Ban North A and B reservoirs were actually a single, larger reservoir.  The latest well seemes to confirm this:

“We are extremely pleased with the results of the A-08 well, which further supports the conclusion that Bua Ban North A & B are likely in communication in the western fault closure of the structure. We now plan to drill an additional delineation well halfway between the A & B fields on the western side of the structure to further confirm this. This well will spud by this weekend.

Coastal was another stock that I bought a bit more of on fire sale.  I don’t think I’m going to sell any of this one.  Its too cheap and the results remain too good.

The last thing I have been doing this week is paring my positions in my junior miners in favor of a position in Newmont. Why Newmont, you might say.  A couple reasons.  First, as the below snapshot from BMO illustrates, Newmont is not expensive.  In fact the stock is trading as cheaply now as it ever has.

Second, if you look at the price performance of Newmont through the recent downturn, it has performed admirably well.  While the juniors got decimated during the two week downturn, Newmont did not.  An while I still really like the idea of gold stocks, I don’t totally trust that if Euope goes into freefall again that they won’t put in a repeat performance of this themselves.  I’d rather own a little bit less of the volatility provided by Jaguar and OceanaGold and a little bit more of the stability (and dividends!) provided by Newmont.


Going to Cash

There was another fairly high profile figure came out with some less than inspiring comments about Europe yesterday.  The following came from Attila Szalay-Berzeviczy, global head of securities services at Italy’s biggest lender UniCredit SpA. (UCG), as per Bloomberg.

“The euro is beyond rescue,” Szalay-Berzeviczy said in an opinion piece for, a Hungarian news portal, which he signed as former chairman of the Budapest Stock Exchange. “The only remaining question is how many days the hopeless rearguard action of European governments and the European Central Bank can keep up Greece’s spirits.”

There is getting to be a fairly long line of high placed officials giving extremely dire warnings about the outcome in Europe.  Given the predisposition of people in high places to keep their mouth shut, this is more than a bit concerning.  We also have the unnamed BNP Paribas executive:

“We can no longer borrow dollars. U.S. money-market funds are not lending to us anymore,” a bank executive for BNP Paribas, who declines to be named, told me last week. “Since we don’t have access to dollars anymore, we’re creating a market in euros. This is a first. . . . we hope it will work, otherwise the downward spiral will be hell. We will no longer be trusted at all and no one will lend to us anymore.”

On the analyst side we had the following from Jefferies:

The road map for Europe is still 2008 in the US, with the end game a country by country socialization of their commercial banks.

And UBS:

It is also worth observing that almost no modern fiat currency monetary unions have broken up without some form of authoritarian or military government, or civil war.

I don’t think that this is a time where you can reason out an end game.  And you cannot look to the economy for clues.  I remember saying over and over again throughout September 2008 that the economy looked fine. The numbers were fine, well they suggested slowing but they didn’t suggest a collapse.  Coal imports were ok, ag trade was ok, oil demand was ok.  You can go back and read my posts in Sept 2008 on the Investors Village board and see what I said, how I scratched my head over why there was no sign of what the market was pricing in, and how that turned out to be wrong.

In 2008 the stock market was the first thing to collapse and then the economy collapsed.  There was no foreshadowing.

And remember, the stock market didn’t collapse until after Lehman.  It wobbled and got volatile before Lehman, just like now, but it wasn’t until after Lehman that it really fell hard – I think that was because the market just can’t price in such a tremendous collapse until it actually happens.  Until the probability is 100%.  It would hedge its bets by falling some, but you can’t price in that kind of event until its taken place.

In my opinion this situation has the potential to have a similar outcome.  If one of these sovereigns default and there is not adequate capital provisions and adequate emergency facilities in place then it could turn out badly.  And I’m not so sure the market can price something like that in until it happens.

Of course this might not happen.  If everyone is fully prepared and banks do not lose confidence in one another, then it may be a non-event.  But how can you predict that?  Who has enough insight into the banks in question, into the derivitives of the sovereign debt that they do or do not hold, to be able to conclude how it will turn out?

I sure don’t.

I sold a significant amount of stock yesterday.  I managed to get out of some of the gold stocks before the price of gold fell further, and I managed to sell some Coastal before it began to fall.

I admit I have been wrong about gold.  What worried me is that it is now behaving like a risk asset, like a commodity.  Thats why I sold OceanaGold and some Lydian today.  If the market isn’t going to view gold as a safe haven, then who am I to argue.  I am still persauded by the idea that gold will be a safe haven as this crisis persists, but until it starts behaving like one again (and going up when bad news comes out) I am going to be defensive.

I am now am about 50% cash.  And it could go higher.