Archive for September, 2010

Taking Profits in Gold

Thursday, September 30th, 2010

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The technical picture for gold is telling me that its time to take some profits. Its been a great push forward, but we are severely overbought and ready for a pull back. We are booking profits on 20% of our holdings of the GLD exchange traded fund today, and will be examining other positions in the miners in the next few days.

Readers of the blog know that I never like to be on the same side of the boat as everyone else. You are always the first to drown when the boat tips over in that situation. Following this analogy, everyone has been buying gold in recent weeks, and we are now at one of the highest overbought situations I’ve ever seen.

Looking at the chart above, I’ve annotated some things that led me to this decision:

1. the blue arrow near the top points to the relative strength index showing a reading that has moved above 90 – my experience with this indicator is that whenever it gets so overbought, we have a correction in either price or time (either the price falls or it plateaus for a significant period of time) – this reading is supported by the overbought reading in the Stochastics graph below (see the orange circle above 80 – both indicators show a correction is coming (either in time or price – you just don’t know until you are into it)

2. the blue circle between the moving averages on the price graph is where I anticipate the price to fall to and we will reassess the situation – we’ll either buy some shares at that point (either some or all of what we sell today – that will depend on what the market shows me at that point) or we will look to diversify into either a different gold commodity fund or the miners or maybe silver, platinum or palladium – we invest what we see not a preconceived notion of what should be

3. the upsloping green lines on the OBV and the Accum/Distrib indicators below show me that the pervasive trend remains up so any correction will be contained by interested buyers that want to own gold but missed the earlier move higher and have been waiting for a buy-in point

So that is our strategy. For the long term, gold will be higher as paper money loses value due to our mounting national debt. We will definitely be a buyer of gold or one of its higher beta derivatives (silver, platinum, and palladium) once the current euphoria subsides and prices come in a bit.

Right now, let’s book some gains and wait for the prices to come back to us.

Mark

New High For Gold

Tuesday, September 28th, 2010

ny-spot-gold

Gold hit a new high today in New York trading, moving to $1,310 per oz before settling down to $1,307 as of this writing.

Investors are moving into gold and other hard assets (silver has been hitting new recovery highs as well platinum, palladium, cotton, iron ore and many of the grains). The announcement of additional quantitative easing by the Federal Reserve, with the intent to add another 1/2 trillion dollars or more to the economy, has investors moving into the “stuff” and “stuff stocks” to take advantage of any inflation that might be coming down the road.

The Fed is very concerned about deflation, not inflation. They want to liquefy the economy to get core CPI up to their target levels in an effort to make sure the US does not follow the same path Japan has followed for two decades. However, not apparent in the CPI are the cost increases of raw materials – those have already begun to skyrocket.

The question is whether the producers here and abroad can increase prices to compensate for their increased costs or whether they will have to absorb those cost increases and their shareholders net a lower return. If they can increase prices, you will begin to see inflation as measured by the CPI increase. If not, look for it to impact stock prices as corporate earnings come under pressure.

We are taking a very cautious stance right now in regard to our investment management activities. Much is murky in the investment world and until it gets clearer, we are raising cash as the stock market moves to the upper edge of the trading range. But we aren’t selling our gold or hard asset stocks – its not yet time to take shelter from those.

Mark

Senate Punts on Tax Cut Legislation

Friday, September 24th, 2010

The news today started off with an announcement that the Senate would not take up the issue of whether to extend the expiring income tax cuts.

President Obama has made it one of his key economic policies that the cuts would be extended for those making less than $250,000, but in the height of the political campaign season, the Senate could not get together and make a decision.

As we get closer to 12/31, if the government does not make a decision, you may be faced with significantly higher taxes, no matter what your level of income.

So that you can do some planning, you may want to use the following website ( http://www.mytaxburden.org/ )from the Tax Foundation that compares your tax situation under the following four possible scenarios:

(1) EXPIRATION: Congress allows the 2001 and 2003 Bush tax cuts to expire as scheduled;

(2) REPUBLICAN PLAN: Congress passes the Tax Hike Prevention Act of 2010 (S.3773), which fully extends all of the Bush tax cuts, and is supported by most Congressional Republicans;

(3) OBAMA PLAN: Congress passes the tax laws suggested in President Obama’s budget, letting cuts expire for families making over $250,000 a year (and singles making over $200,000), as well as extending some stimulus measures and imposing new limitations on itemized deductions; and

(4) DEMOCRATIC PLAN: Congress passes a tax bill that reflects limits set by the Statutory Pay-As-You-Go Act of 2010, passed earlier in the year by Congressional Democrats.

You can take your 1040 from from last year and plug in some basic summary information. It will then calculate your taxes based upon the four scenarios above.

I have no idea if this is a partisan website or not – the Tax Foundation has been around since 1937, so I assume it is above the fray, but if its not, please do not yell at me. The intent of this post is to give you a tool so that you can plan for the future. I used it and it showed that my taxes will go up by $4,000 if the government does nothing – so I just wanted to give you the same opportunity to think about the future.

From a personal standpoint, I can easily see the recession lasting much longer than expected if $4,000 comes out of my spendable income. I certainly won’t be consuming to the level that the economists anticipate necessary to generate new jobs for the unemployed.

As always, politics gets in the way of sound policy…

Mark

Gold Marches Higher

Thursday, September 23rd, 2010

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As you can see on this multi-year chart, gold has been in a sustained upward move with only a couple of pullbacks. We are at new records nearing the $1300 target that Goldman Sachs set for it earlier this year.

Its really odd to me but everything I read gives a justification for buying gold right now. I see articles saying that we are on the edge of inflation and gold should go up. I see articles saying that we are on the edge of deflation and gold should go up. I see articles saying that the upcoming holiday season in Asia will drive up the price as people celebrate the holidays with gifts of gold. I see articles saying that in Asia people are afraid of paper currencies and want gold to protect themselves.

Intuitively, when you see everyone justifying a stance, much like the rush into bonds I wrote about in earlier posts, I get suspect. Clearly, I believe gold will be much higher (based upon the need for this country to devalue our currency over time), but maybe its gone too far too fast and needs to back off a bit before its safe to add some to portfolios.

In that earlier post, I noted some “add to” levels that investors could use as purchase points with some degree of safety. But, an alternative thought came to me as I read stories about Japan and Europe wanting to do the same thing that the US is doing – why hang your hat all on gold as a way to protect yourself against a dollar devaluation.

Why not look at a foreign currency fund that is comprised of the currencies that will gain ground when the dollar, yen and euro all get devalued together. I have begun to look at the fund AYT, Barclays Asian 8, as a means of accomplishing that trade. I have some reservations since it is an ETN and not and ETF (ETN’s carry the credit risk of Barclay’s going under) and it is very thinly traded.

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I am quite certain that five years from now, the dollar will be much lower than the currencies of countries to which it is so heavily indebted and those currencies will be a nice diversification from gold and precious metals that will receive much of the investor interest.

Mark

Broke Through Trading Range

Monday, September 20th, 2010

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As you can see from the graph above we have broken out of the range defined by the green box and into the target upper end of our trading range. You will recall that I’ve written here that we use the pink box as our signal to start taking some profits in our holdings, starting with the weaker ones.

As the market digests this action, we’ll be taking some profits and waiting for the market to move back toward the bottom end of the green box.

As with everything we do, we invest what we see. If, and its a big if, we break above the the top end of the pink box, we will likely not sell anything else as that will be a sign that the top end of the wider range, 1250, is in play – most likely the 2010 high at 1217 (the blue box on the chart).

I’d give odds at less than even that we will break through the top end of the pink box and make the assault on 1217 or 1250 without the bears and shorts trying to take us back into the green box. However, we will keep a watch on the trends and the price action to get a feel for whether there has been a change in the market. If there has been, we will see it and report it to you here.

This video has no tie to this post – I was just in the mood for it.

Enjoy your night!

Mark

All That Glitters

Thursday, September 16th, 2010

gold

One of the most profitable investments over the past 10+ years has been gold.

It had a rocky moment in 2008 as you can see on the chart above when it fell to $680 an oz., but since then it has moved up to a new high of $1276 per oz., or almost doubling in two years.

There are multiple reasons for this move, but you can some it up to scarcity – this is really a supply and demand phenomenon and that dynamic is one that can provide investors with big returns if they play it right.

    Supply

– The production of gold (its mining and refining) has fallen by 12% on average each year for the past decade while the cost to produce it has risen to $500 per oz. Producers are not opening new mines due to the prohibitive cost and regulation but rather trying to buy up the mines of small producers.

    Demand


(1) In the developing world, buying gold – jewelry and otherwise – is a sign of wealth attainment. Gold purchases by the the burgeoning middle class in India and China are on the rise.

(2) The world’s central banks have as a whole shifted to buying gold, particularly those that have significant foreign currency reserves and little foreign debt (China, India, Brazil, the Emirates and others) as a way of diversifying away from the dollar which they see will likely be a declining store of value.

(3) Individuals and investors who view inflation as the most likely outcome to the developed world’s economic policies of easy money and currency debasement are stocking up on gold as a hedge against future losses.

So, with gold at an all time high, the question remains – is there still time to buy it or are we headed for a fall?

From a macro standpoint, the supply and demand dynamic dictates that gold will go higher over time. However, as with any investment, it can certainly get cheaper before it gets more expensive.

A San Francisco based hedge fund manager that I read points out that there are some natural support levels (his target for gold is $2300 per oz over the next three years): the 50 day moving average and the 200 day moving average are easily identifiable as well as the 2010 low and the 2008 low. You can spot each of those on the chart above. I think you can also view $500 (the average cost of production) as a floor – if gold falls too much, production will shut down with the most expensive ones first. As production capacity lessens, supply gets even tighter, and further supports the price of gold.

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On the chart above, I’ve used moving average envelopes to overlay the price chart. Sometimes it is easier to see how a stock trades within a range in this view, and you can see that the mid-point and the bottom of the envelope have provided low risk entry points to establish positions in Gold.

A buying strategy for something that has move up as high as gold has, but which has definite downside support would be to slowly build your position on any pullbacks to the the support levels and low risk entry points detailed above.

Fortunately, we have had gold exposure in client portfolios for several years, both with the commodity itself through the ETF and through the miners.

Your decision if you do not have a position and want to start one (please note that this is not a recommendation to start a position or a recommendation for any sort of investment decision) is whether you want to own the actual commodity or the miners.

In your decision process, you have to take into account that the miners will be a higher velocity play on gold (meaning that their share prices should go up faster than the price of gold, all things being equal) however, they will also be impacted by the movement of the stock market in general and they have company specific operating and regulatory risks that can negatively impact share prices even if gold is rising.

Mark

Investment Practice Discussion

Tuesday, September 14th, 2010

Last night I made a presentation to a local investment club.

They provided me with a list of questions that they wanted answered so that they could compare what we do to how they manage their portfolio as a club.

I thought you might find some it interesting, so I am posting it here to share with you.
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Mark, attached is our latest monthly report, showing stocks in our current portfolio and a summary of activity over the last 13 months. We have made very few purchases and very few sales over the last year or
two. We are not looking for specific recommendations on each of these holdings, but this will give you an idea of our type of holdings. We have done fairly well versus the market until the last 2 or 3 years.

On the attachment you sent, I have listed our proprietary rankings for your holdings.

Our ranking system is based upon the theory of Growth At Reasonable Price – a sheet that explains the components of our ranking system and its performance track record is also included. [ for you readers, I have excerpted the information immediately below ]

BankChampaign Earnings Growth Model

    Ranking System Components

30% Earnings Per Share Ranking: based upon announced earnings surprises

20% Technical Ranking: based upon stock price performance

40% Valuation: based upon earnings growth rates and cash flow ratios

10% Industry Leadership: based upon operating margin and return on equity calculations

This set of ratios and performance numbers weighted in this manner has proven over the years to provide the best predictive value of future stock price performance of company, and helps guide us in our equity selection process.

earnings-growth-model-returns

This graph shows the average annual return for the various rankings compared to the S&P 500, since 2001. Further discussion about the rankings and returns is below.

I’ve developed this system beginning in the 1980’s and with the advent of technology that provides the data, it can now cover a wide range of publicly traded companies. It has its roots in my Master’s Thesis on the Efficient Market Hypothesis from the mid-80’s and has been expanded with the advent of technology and access to information over the years.

We receive a data download of information on over 5,000 publicly traded equities. The data includes information on their balance sheet, income statement and price performance.

On an annual basis, I retest the system to make sure that its predictive value is sound. I will change the weightings and add/subtract other data points and then back-test the system to see if any tweaks need be made. I’ve always thought that the system should intuitively include a debt-to-equity component, but in all testing that ratio did not improve the predictive ability of the system.

The system calculates the various ratios to rank the companies from 100 (the top rating) to 0 (the bottom rating) on a bell curve. This indicates that there are fewer companies with very high and low ratings than companies with mediocre ratings. As you can see on the graph above, those stocks with the highest ranking performed on average well above the S&P 500, and those with the lowest ranking performed on average well below the S&P 500.

When we buy companies, we tend to buy them rated 90 and above as those companies have the strongest balance sheets, earnings growth, and price momentum/investor sentiment.

If companies drop below 60, we view them as sale candidates because historically they underperform higher rated companies due to weaker balance sheets, stagnant or falling earnings, or neutral to negative investor sentiment.

One item of note is that deep value companies in turn around situations will almost always be rated poorly by this system.

Also here are some questions we would like to discuss with you. I am sure many of these are common questions for many investors in these times. Many do not have objective answers, but are the basis for good
discussions.

1. What sectors of the market do you think will do well in the next year or so?

We currently have a barbell approach in our domestic equity portfolios:

My favorite sector is Agriculture, so having a core allocation to the fertilizers and the machinery makers is key, as well as to the commodities themselves through ETF’s like DBA and CORN.

I am also a big fan of the industrial commodities required for much of today’s technology as opposed to those required for industrial uses. China has a 97% market share in commodities that are required in the production of cell phones, alternative energy, defense systems, computers, etc. There are a few companies outside China that produce some of the remaining 3% and they are in the early stages of a major bull market cycle.

Gold, Silver, Platinum and Palladium should all do well in coming years as the dollar is weakened by our fiscal imbalances.

I also believe that you need to look at where the mergers are happening to see where corporate America sees value. Today, the people that operate successful business are paying premiums for companies that operate in Agriculture, Technology, Biotech, Energy and Commodities (ag, base metals, rare metals).

However, I believe the US Market will be in a trading range for an extended period of time as the battle between inflation and deflation plays out. To be successful and beat the broader market, an investor must have a strategy to deal with a market that is stuck in a narrow range over a long time.

We could easily see the market move up and down within a range much as it did in the 1970’s. On October 11, 1973, the S&P 500 Index was 116.03. On August 31, 1982, it was 119.51. Between that time, it moved up and down within a range, but buy and hold investors spent a decade going no where.

Today’s market is in a similar position, if you look at this graph:

sp-500-long-term-range

Secular bear markets like the one we have been in since 2000 generally last from 13 to 18 years. My best guess is that we will not break out of the range for several years. In fact, we will remain in the current cyclical bear stage until we break above the moving average line. At the moment, the market is consolidating around the midpoint of the range.

Conversely, what sectors do you think will not do well?

Unemployment will be high for a long time to come. Avoid any sector that relies upon consumers for its earnings growth. Avoid housing related investments as my gut feeling, based upon the shadow supply of houses that banks have in OREO across the nation, is that we won’t see a significant rebound in housing prices for a long time.

Government regulation will continue to burden much of corporate America. Any sector that sees the likelihood of increased regulation (think banking, health care – particularly health insurance – and domestic energy production) will have significant headwinds. It’s not to say you can’t make money in them, you just have to understand that you are pushing the stone uphill as in investor.

Fixed Income investments will also have difficult times in the years ahead – too many people have rushed into bonds paying negligible interest or have assumed too much risk by moving too much money into junk bonds. This generally means that REITS will also have trouble along with preferred stocks.

2. What are your thoughts on foreign investments– are there some specific countries or areas of the world we should be looking at?

Traditionally, the developed world was the safest place to have money invested and the developing world was a speculative investment. No longer. The levels of debt in the US and Europe make those areas less desirable than the developing markets that are loaning them the money.

Much of it is due to demographics – the US, Japan, and Europe put significant resources into social safety nets as their populations approach retirement age. The US is better off than Japan and Europe and more likely to weather its financial problems as its birth rate is only slightly below the replacement rate. Japan is in the worst shape with Europe somewhere between. There just are not enough young people entering the workforce to pay for the needs of the growing elderly populations in the developed world.

Post WWII, demographics in the US and Europe allowed those regions to flourish as a wave of births brought new consumers into the middle class. Today, that is happening in the developing world. A rising middle class population drives production and home ownership. A falling middle class population leads to falling GDP.

I think to be successful, you have to look at the economies of the world that are drawing investment money to them based upon their sound financial position, sound currency, and GDP growth prospects (much of which comes from positive demographics): Chile, Taiwan, South Korea, India, Brazil, and Poland.

Then, you have to look at the countries that are on the cusp of joining the group above based upon desirable demographics and significantly improved fiscal situations: Vietnam, Indonesia, Turkey, South Africa and Columbia.

For developed markets, overweight your positions in Canadian, Australian, German, and Swiss index funds as well as individual companies in those countries. Canada and Australia have abundant resources that they can export to the counties with growing middle class populations. Germany is an export driven economy that focuses on those growing middle class populations. Switzerland is fiscally prudent, wealthy, and will have a strong currency.

We use the country specific ETF’s for these countries to gain exposure to their stock markets.

3. How can we make the most of the growth that is happening in China and other emerging markets without taking a monumental amount of risk?

We use the country specific ETF’s to gain exposure to their stock markets. Start with small positions in a number of countries but have in mind a percentage of your portfolio that you want invested in this sort of strategy. Use significant technical levels to add to the positions and build up to your desired levels. Don’t view it as something you have to accomplish all at once.

One caveat – China’s one child policy will have a significantly detrimental demographic impact at some point in the future and they will resemble Japan in terms of the number of elderly to young. That is a generation away, but given their size it will have a major impact on the rest of the world.

4. What is your overall forecast for the stock market– do you see another massive correction coming?

We will be in a trading range for a significant period of time. Near-term, look for swings on the S&P 500 between 960 and 1250 – a roughly 30% range.
We have adopted a strategy of selling weaker positions as the market approaches 1150 (we will be hard pressed to get to 1250 until after the November elections, and maybe not for some period of time after that) and buying as the market nears 1040 (with the Fed adopting an easy money policy and stating they will do whatever it takes, getting to 960 will require some very dire exogenous event).

There can always be a massive correction based upon some dire exogenous event – 9/11 terrorist attacks, the government allowing the bankruptcy of Lehman Brothers to shake faith in the entire financial system, etc. But, absent one of those things and with the Fed in liquidity mode, I think the trading range scenario is most likely.

Longer-term, look for us to swing within the wider range shown in the chart above. Given the liquidity that the Federal Reserve has pledged to be available, we hope not to see a return to the bottom of the range but those exogenous events can occur at any time.

5. What are your broad thoughts and recommendations on the stocks in our current portfolio?

Overall, our rating system shows you own, in general, solid companies.

[specific company comments have been deleted]

6. What publications/web sites/analysts do you follow regularly, and whatdo you recommend for us? What weekly/monthly reports are most significant to investors?

Most individual investors should follow Jim Jubak. His writing is easy to understand and he has a world view similar to my own.

You can also find good global information at CBS Marktwatch with their opinion writers.

The Street.com can also be a good source of writing – but you need to be careful to sort through the fluff and hype.

Standard and Poors has very good stuff that your brokerage may provide, and if they are a full service brokerage they may have their own proprietary information that you can use.

I read Goldman Sachs and Morgan Stanley stuff, plus the Economist and Wall Street Journal can provide clues to things happening in the world that will eventually become investment trends. However, for the most part, we do not use analysts from the brokerage houses for information, preferring independent data collection and our own systems/analysis for decision making purposes.


7. What criteria/analysis do you personally use to determine when it’s time to sell a stock, and at what price to sell it?

I don’t use analysts from the major investment houses to tell me when to buy or sell.

I use the news reports, earnings releases (relative to meeting, beating or missing expectations), and my own ranking system that keeps me abreast of changes to their financial health.

For individual investors, I always recommend you set up your portfolio on MSN Investor and follow their ratings. Their ratings are pretty good and if you adopt sales a methodology centered around the ratings, it will give you a discipline to adhere to that will work better than average.

As with all systems, nothing is perfect and it is not a substitute for actual decisions on your part, but if you use it as a tool it can help you make good decisions.

8. What criteria/analysis do you personally use for selecting stocks to buy, and at what price to buy them?

I don’t use analysts. I use my own analysis and ranking system.

Some of it is macro determined (sectors, timing of the market within the range, etc., will it provide exposure to an underweight area or make me overweight in an area and increase my overall risk)

Some of it is company specific things I look for:

1. Always start with the fundamentals – is the company performing the way it should –OR- am I looking at a turn-around situation and has this company turned the corner?

2. Then I look at the technicals: does the chart tell me the timing is right:

a. Where is it in relation to its moving averages? Is it trading above, below or between them?

b. What does the volume look like compared to price levels and moving averages?

c. What does the money flow look like – are the institutions pushing it higher?

d. Where is its relative strength?

This is the chart format and indicators I use the most:

ppdi

• The Relative Strength on this chart shows that it is above 70 – statistically when the reading is above 70 the stock will pull back

• The stock price is having difficulty breaking through the 50 day moving average.

• At $26, you have a significantly greater number of previous buyers than sellers – those buyers will be looking to break even on their trades so they present an overhead resistance to the stock pushing above that until equilibrium is reached.

• Volume compared to the moving average is low.

• The On Balance Volume indicator is relative flat showing that the recent price advance has been on low volume – a weak trend for this money flow indicator

• The Stochastics indicator shows that short-term momentum has reached a peak – readings over 80 generally present short-term tops that have to be worked out either by a stagnant price for a period of time or by a falling price in a short time.

• The MACD indicator shows that intermediate term momentum is rising but hasn’t gotten above the 0 line. The good news is that the black line is rising faster than the red line

• The money flow indicator at the bottom shows a change to positive but the Accumulation/Distribution line is relatively flat – another weak trend for money flow that confirms the On Balance Volume indicator.

    Summary of this chart

: I would not be a buyer at this time. I’d want to see the Stochastic reading nearer to 20 or the relative strength between 50 and 70. I’d wait for the price to challenge the $26 level to see how investor psychology reacts – will all of those previous buyers hold or buy more or will they try to break even once the price comes back to them. I might also wait until the money flow indicators shows a change in the institutional buyers mentality – its hard for stock prices to push higher without support of the institutional markets.

9. What is your opinion of ETF’s in a portfolio?

ETF’s have a definite place in a portfolio as discussed above

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I hope you’ve found this helpful – the investment club seemed to like it although it may have been a bit overwhelming.

Market Moves Up on News

Friday, September 3rd, 2010

sp-500-today

We had the non-farm payroll report this morning and the news was better than expected for the headline number: 54,000 new job losses Vs the anticipated 120,000 losses. Also, the government revised the July number to 54,000 losses as well from the previously reported 131,000 losses. This juiced the stock market today up 1.32%.

What I find odd, and I don’t mean to rain on anyone’s parade here, is that the four-week moving average of jobless claims is still terrible, worse than after Lehman Brothers failed, after Bear Stearns failed, after Enron failed, after the 9/11 attacks, after the NASDAQ crash, etc., (source: Gluskin Sheff). The only difference now is that we’ve gotten used to it and we seem to be sliding into the same long-term malaise that Japan has been dealing with since their stock market crash in 1989.

But, more on the similarities to Japan in the near future. For the time being, the August new job losses and revised July new job losses were enough to get investors excited and push the market above 1100 again. The volume in the market was low, well below the 20-day moving average, as many Wall Street participants had left work early for the holiday weekend, trying to be Hurricane Earl to the Hamptons, the Cape, the Shore, and the Vineyard.

Enjoy the holiday weekend for which you’ve worked so hard.

Mark