The 'Buy & hold' strategy

A popular strategy supported by a great deal of financial advisors is the "buy and hold" strategy. There are times when this strategy makes sense, but it isn't because of the veracity of the strategy so much as:
1. The merits of a specific stock
2. The commitment of specific companies to a winning strategy. Some strategies can endure for decades before they fail. In other cases, corporate teams prove themselves adept at changing strategy.

I don't take much interest in my father's investment activities. For years he was telling me that he's not looking for capital growth but rather regular incomes. He was of course trying to avoid taxes by nor selling. In Australia this logic makes less sense with a 'generous' 50% capital gains tax concession after one year. He bought  QBE Insurance at  $9.00, watched them rise to $35.00, only to tolerate a fall back to $10.00.
Why did he persist with this stock as its capital gain eroded? Until the very end, when he finally asked me if he should keep QBE, he said to me "Should I keep QBE, it pays a good dividend"?

People's psychology is the greatest obstacle to their success. My father manages his own wealth but he has a broker who recommends stocks to him.
Despite being a mining analyst, he scantily trusts the stock's I buy. "Too risky" according to him.  Yet I can diversify risk. More importantly, these are small stocks with a single project that are relatively easy to understand. But it is a different world. It's an analytical world compared to the purely empirical foundation for valuing blue chip stocks. Just my father didn't see the capacity to mislead investors with empirical evidence. He lacked analytical insight which would have undermined his confidence in this particular stock.

Why was my father seduced by this stock? Why did he retain it in the face of a falling share price. Well there are several reasons:
1. Strong dividend: The company could payout more dividends from the strong share premium reserve.
2. Share price volatility: This would give him confidence at times because it fell before and rallied.
3. Historic legacy: It was a growth stock before so it will remain so.
4. Long term investor, who is seemingly oblivious to significant marker swings. Ask yourself who benefits from that strategy - his opponents - professional fund managers vying for the opportunity to manage his money. One cannot tolerate large swings in share price. Draw a line in the sand and forgo only so much money. We are all capable of being wrong and stocks are conditionally good or bad.

I don't buy blue chip stocks. In fact, I have no interest in investors like my father. My interest is in investors with a desire to make capital gains or early investments in great stocks before they become low growth "yield propositions". These types of stocks make even less sense today. It was a forgivable strategy in the 1990s until 2007. I warned my father. In any case, I'm interested in engaging 10 to 35 year old investors who want to take the time to develop intellectual, technical and commercial efficacy, which will aid their capacity to make money in the market or in business. There is utility in one's entire life. Am analytical thinker ought to be open to evidence. My father was compartmentalized. He diminished the importance of certain information that didn't reconcile with his narrative. This can be lucrative until it's wrong: then it's expensive due to the systemic risk.

Why blue chip mining stocks are making less sense

We have always sung the praises of speculative mining stocks. The truth is that the 'under-loved' speculative or emerging mining stock has never been more under-loved, and yet offered so much opportunity. This can be attributed to a number of developments. Conventional wisdom was that the larger multinational miners were 'low risk' because they offered diverse exposure to different countries. I've always questioned this wisdom as a dogmatic truth, but its becoming ever so apparent in mining. In the 1990s I observed how power generations  sponsoring big power plants were targeted for all manner of political reasons. Their attempts to commission plants were just thwarted at every turn. The same is true now for miners. Increasingly miners are confronting governments which are reneging on their taxation arrangements, whether its Australia, Ghana, Mongolia or China. The times are changing. The other problem is that the pricing powers of these major companies are being unwound, not simply by more competition (often sponsored by China, India, Korea, etc), but also pricing regulations in consumer nations. China, with out a doubt the most important consumer market, in August 2008 adopted an anti-monopoly law to prohibit price fixing.

The law prohibits 'abuse of a dominant market position; and the concentration of business operations that which may exclude or restrict competition' (Ref.1)

The iron ore and coal markets have witnessed a great deal of concentration in market share over the last 2 decades. There is good reason to think that market pricing power is over. But you could also argue that its simply just about to resume again. The Chinese government blames to be cutting down on corruption. Call me cynical, but I'd argue corruption just acquired a new rationalisation. Never believe the rhetoric. Having said that, markets are adjusting, and the outlook is for rapid expansion in traded volumes rather than prices.  Will there be new pricing patterns? Expect price regulating agencies to get a kickback. How can you stop higher prices without breaking the high market concentration. Major companies can't be stopped from driving higher prices. All it takes is for a few major companies to decide that the biggest producer on a certain date sets the prices, and everyone asks for ridiculously high prices until the 'leader' settles, in which case, that price becomes the reference price. That will be the new tradition. There doesn't have to be any secret handshakes or encrypted message; simply a tradition. Matters for the major companies are far worse in Australia, where sovereign risk was once considered far less. Such conventions have been proven wrong again. The Australian Labor Party-led government has appointed a new Resources Minister Gary Gray, who  has ruled out making any changes to the mining tax but has conceded it could have been handled better. Of course he is probably not going to repay lost earnings to shareholders. Gray said it will be “business as usual”. I guess that means taxpayer extortion 'as usual' (Ref 2). The Mineral Resource Rent Tax (MRRT) was originally adopted by former leader Kevin Rudd. He was dumped over his handling of the tax.

Thirdly, there is another huge problem for large miners and that is all-manner of objections to their projects, whether because they are large, because of their impact on alternative land uses, the environment. The liberals in the environmental movement seem to take special pleasure in targeting these large projects, and legislation often gives them powerful tools to obstruct them. The courts have proven particularly useful in blocking developments. Such objections can stop or  slow smaller projects as well, but largely the focus is on the major. These conflicts can obstruct development or they can drive huge compensation pay-outs for contamination of aquatic (maritime, rivers or estuarine) environments. The most famous case is BP's oil spill in the Gulf of Mexico, however BHP's Ok Tedi gold-copper mine in PNG also comes to mind. Multinational companies today are less able to rely on the complicity of government officials, who receive a royalty from such mines, or who might even have equity.

The multinational miners have historically traded at large premiums or earnings multiples on the premise that they were low-risk propositions. This premise needs to be questioned, and its not just miners. Facebook has experienced a roller-coaster ride since listing. These companies are enormously liquid, so its easy for large funds to play 'trading games' with them, but given that these companies take large leveraged bets on these companies, investors need to trade wisely.

These risks bring me back to the benefits of small companies. Small companies, unless they have a highly profitable mine, will not be offering sustained earnings in this period of recession. Most commodity economies have high currencies and prices are softer, costs are high, so we can expect some to struggle. But these companies are also taking this recession to rebuild resource provisions so they will be better prepared moving forward. They can therefore be expected to be more competitive cost-wise when commodity prices do recover. If you are interested in the speculative stocks, we have a eBook 2-volume set dedicated to investing in 'Speculative stocks', as well as a blog for describing a number of the companies, as well as a blog where we discuss the commodity outlook.

References:

1.  “CHINA IN TOUCH: A newsletter for Northern Territory”, Northern Territory Branch, Australia-China Business Council, website, 6th Aug 2008.

2. “Gray won’t change mining tax” by Alex Heber, Mining Australia, website, 26 March, 2013.

Asian property markets outperforming Japan Foreclosed Guide Philippines Property Guide

Profit from mining with Global Mining Investing eBook   Global Mining Investing Community.

Author Andrew Sheldon| Applied Critical Thinking | www.SheldonThinks.com

Why Facebook shares dived

It’s not surprising that Facebook shares dived – I can give you a number of reasons:

1. Facebook does not control much of a revenue stream – it controls a conduit which is proving hard to make money from.
2. Clicks and impressions simply are not converting into sales
3. Investors wanted out at the top – that is why the company was listed
4. The initial listing is the best opportunity a company will get to offload stock because of the liquidity floating in the market.

At some point the company will support the stock with a buy-back. It will do that in order to support placements of more stock at comparative prices. Facebook is a high-risk proposition. It is still very easy for competitors to challenge its market position. 

People can look at the collapse as a testament to market weakness; but I see it as a strategic decision by long-term stakeholders to exit a risky stock. That rationalisation however will serve as a useful basis for manipulating a recovery in the stock price. Facebook is trading at an EPS of 74x earnings compared to 18x for Google.[i] Facebook of course has the less well-proven revenue model, but that is just part of the risk. The way we interact with the internet is open to big changes, and there is no reason to think that Facebook can buy out ever fad that threatens it, or even pick the right ones. It is going to struggle to prove that it has the capacity to raise earnings 40-500% in the next few years. There isn’t enough stock in the market to see a huge collapse, but expect such a move with the next offloading of stock.

References

---

[i] “Facebook shares plunge 11pc, spooked investors look for answers”, NZ Herald, website, May 22, 2012.

Asian property markets outperforming Japan Foreclosed Guide Philippines Property Guide
Profit from mining with Global Mining Investing eBook   Global Mining Investing Community.

Author Andrew Sheldon| Applied Critical Thinking | www.SheldonThinks.com

Adamus Resources (ADU.ASX) & Endeavour Mining Corp (EDV.TSE) merger

Its not really a blue-chip proposition, however the forthcoming merger of Adamus Resources (ADU.ASX) and Endeavour Mining Corp (EDV.TSE) strikes me as a good deal for all concerned because:

1. The merger will raise the ranking of two gold stocks - so more attractive to institutions

2. The two listed entities will be on two stock exchanges - at least

3. The two companies are a good fit - Endeavour is cashed up

4. They will be able to wipe out a hedge book

5. They have a lot of upside from project expansion and exploration

6. The gold price can be expected to rally in coming months as uncertainty arises over the recapitalisation or debasement of the EUR. I'm expecting gold to reach $2500/oz.

7. Benefits of a diversified mine operator

Anyway, this seemed like a compelling time to buy an emerging gold stock, even if I was a little late in doing so. I've been focused on other things lately with the election in NZ, and the preparation of a book. In any respect, this is my first stock investment in a few months.

------------------------------------------

Andrew Sheldon www.sheldonthinks.com

Rio Tinto alumina spin-off a dog listing to retail investors

The financial 'vultures' are circling. What type of asset is well-suited for a listing on the NZ stock market? A dog like Rio Tinto's alumina assets? You watch as a number of large investment bankers swarm to engage in a capital raising for this 'spin-off''. Small investors will be offered stock and brokers I guess will be looking for a very lucrative 7% commission to cove their asses. Why would they jeopardise the reputation of their company? Perhaps because they work on commission? Perhaps because they have performance-base options which encourage them to think short-range.

I have already commented on the quality of these assets being sold off by Rio Tinto. One has to wonder whether these financial companies actually insure their exposure to these 'clients' in terms of their handling of these capital raisings. Of course these investment bankers have not done anything wrong yet by showing interest in the sale of their assets....but what exactly will they be getting paid millions for? To paint an objective picture of the assets for sale? I don't think so. To create the illusion of quality. Remember, like like POLITICS 101, perceptions are more important than facts.

You could well argue that any asset is a buy at some price....but this asset will be offered to long term investors, not day traders looking for stag profits.

I've seen this all before. I am reminded of a company called Queensland Magnesium which was raising capital in Australia about a decade ago. As an analyst at the time working for a broker, I noted that the major financial institutions were earning a 7% commission in order to sell this dog. Why was it a dog? Well, it was the nature of the magnesite market - the raw material for producing refined magnesium. I was negative about the project as a mining analyst. In fact - very negative. My boss said that they would not recommend it, but if the investors wanted it, then of course they give it to them. Rest assured that no stockbroker selling such a 'dog' to clients was going to knock back the opportunity to make 7% commission. In most cases they would typically get only 5%.

PS: Queensland Magnesium Corporation went broke within the year if I recall correctly. I'm a bit hazy on the dates, as this was a decade ago. Shareholders lost a great deal on that deal. The way markets are regulated, there is just utterly no sense of reality. The risks are not being borne by the people who should be bearing them; whilst some law suit is destined to hit a corporation's current shareholders long after the parasites have taken off with their stock options. Just consider the current example in Australia. There is a legal firm taking a class action against the banks over their misappropriation of bank fees. Who will pay? The executives who got stock option bonuses at the time - or current executives. We teach our children that their are consequences for their actions. Where are the consequences for the executives who cause systematic pain across a nation? Where are the consequences for the politicians who sanction or facilitate law changes which help these executives to be corrupt legally. We have ombudsman to ensure that government depts and corporations act in compliance with the law. But what is the law is skewed to allow people to profit 'legally' but immorality?

That is why I have a concern about sanctioning the election of Don Brash, the leader of the ACT Party, the former leader of the National Party and former Governor of the Reserve Bank of NZ, for this 2011 NZ election. His ignorance is woeful...though he does respond to my questions; at least until they become uncomfortable. Here is my dialogue with Don Brash about the fiduciary duties of Reserve Bank governors and governments.

-------------------------------------------

Andrew Sheldon www.sheldonthinks.com