Posts from the ‘Portfolio’ Category

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 index.hu., 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 vt.to 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.