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Month: February 2013

Four Views On Gold And Gold Miners (#gold, #investing, @atyantcapital, @valresproj)

Four Views On Gold And Gold Miners (#gold, #investing, @atyantcapital, @valresproj)

1.) Atyant Capital, “What is gold saying?”:

Gold stocks lead gold and gold leads currencies and currency moves correlate with stocks and bonds. Gold stocks have been declining for two or so years now. This is in part due to unavailability of capital and credit for gold mining projects, but in our assessment, not the whole story. We believe gold stocks are also correctly forecasting lower gold prices.

Long term readers know my gold pricing model puts fair value at $1100 per ounce (Alpha Magazine Aug 24, 2011). So at $1700-$1800, gold was about 60% overvalued, floating on a sea of credit. Gold declining now tells me the sea of credit is receding here and now. This should translate to a higher US Dollar and pressure on asset prices globally.

2.) Value Restoration Project, “Gold miners – Back in the Abyss – An Update“:

Gold mining stocks remain cheap by almost any objective measure.

One way to look at mining stocks is to compare them to the price of gold itself.

Comparing miners to the price of gold itself, show miners are cheaper today than they have been in decades.

[…]

Today, gold appears undervalued relative to the growth in the monetary base that has occurred up to now, and in light of the monetary expansion the Fed and other central banks are currently undertaking, gold appears more undervalued. The Fed’s current quantitative easing program probably won’t be curtailed until households stop deleveraging and the government can handle the rising interest expense on its expanding debt.

Yet, in the face of all this, many gold mining stocks are now selling at valuations that suggest the market has priced in a decline in the price of gold back to 2007 levels, before the Fed began expanding its balance sheet during the financial crisis. Many gold mining stocks are now selling near or below their book value, which is the market’s way of saying that these businesses won’t be able to add shareholder value in the coming years by mining gold and silver. If the price of gold were to decline below $700 or so, it would certainly be the case that most mining companies wouldn’t be able to profitably sell gold. Yet such a decline in gold is the main implied assumption being priced in by the market today, and this has sent valuations of gold mining stocks to their lowest levels since the current bull market began.

3.) Robert Blumen, “What is the key for the price formation of gold?“:

The gold price is set by investor preferences, which cannot be measured directly. But I think that we understand the main factors in the world that influence investor preferences in relation to gold. These factors are the growth rate of money supply, the volume and quality of debt, political uncertainty, confiscation risk, and the attractiveness (or lack thereof) of other possible assets. As individuals filter these events through their own thoughts they form their preferences. But that’s not something that’s measurable.

I suspect that the reason for the emphasis on quantities is that they that can be measured. Measurement is the basis of all science. And if we want our analysis to be rigorous and objective, so the thinking goes, we had better start with numbers and do a very fine job at measuring those numbers accurately. If you are an analyst you have to write a report for your clients, after all they have paid for it, so they have to come up with things that can be measured and the quantity is the only thing that can be measured so they write about quantities.

And in the end this is the problem for gold price analysts, you’re talking about a market in which it’s difficult to really quantify what’s going on. I think that looking at some broad statistical relationships over a period of history, like gold price to money supply, to debt, things like that, might give some idea about where the price is going. Or maybe not, maybe you run into the problem I mentioned about synchronous correlations that are not predictive.

Part of the problem is that statistics work better the more data you have. But we really don’t have a lot of data about how the gold price behaves in relation to other things. The unbacked global floating exchange rate system has never been tried before our time. How many complete bull and bear cycles has the gold/fiat market gone through? My guess is that when we look back we will see that we are now still within the first cycle. Our sample size is one.

[…]

I do think we will have a bubble in gold, although it may take the form of a collapse of the monetary and a return to some form of gold as money in which case, the bubble will not end, it would simply transition over to the new system in which gold would go from being a non-money asset to money.

I have been following this market since the late 90s. I remember reading that gold was in a bubble at every price above 320 dollars. I very much like the writings of William Fleckenstein, an American investment writer. He has pointed out how often you read in the financial media that gold is already in a bubble, a point he quite rightly disputes. Fleckenstein has pointed out that the people who say this did not identify the equity bubble, did not believe that we had a housing bubble, nor have they identified the current genuine bubble, which in the bond market. But now these same people are so good at spotting bubbles that they can tell you that gold is in one.

Most of them did not identify gold as something which was worth buying at the bottom, have never owned a single ounce of gold, have missed the entire move up over the last dozen years, and now that they’re completely out of the market, they smugly tell us for our own good that gold is in a bubble and we should sell.

So, I don’t know that we need to listen to those people and take them very seriously.

4.) Me:

I don’t know what the intrinsic value of gold is. I don’t think gold mines are good businesses (on the whole) because they combine rapidly depleting assets with high capital intensitivity and they are constantly acquiring other businesses (mines) sold by liars and dreamers and schemers. And I don’t think this will end well, whatever the case may be. So, I am happy to own a little gold and wait and see what happens.

I wonder what the short interest is on gold miners?

Review – The Outsiders (#management, #capital, #business, @HarvardBiz)

Review – The Outsiders (#management, #capital, #business, @HarvardBiz)

The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success

by William N. Thorndike, Jr., published 2012

Capital allocation uber alles

“The Outsiders” rests on a premise, that the increase in a public company’s per share value is the best metric for measuring the success of a given CEO, which lends itself to the book’s major thesis: that superior capital allocation is what sets apart the best CEOs from the rest, and that most modern CEOs seem to be only partially aware, if at all, of its critical performance to their companies long-term business success.

Notice! This book is examining the efforts and measurements of CEOs of public companies, not all businesses (public and private), so as a result in comes up a bit short in the “universal application” department. Yes, capital allocation is still critical even in a private business, but you can not measure a private business’s per share value (because there isn’t a marketable security price to reference) and the CEO of a private company is missing one of the most powerful capital allocation tools available to public CEOs, the share buyback (because there is no free float for them to get their hands on at periodically irrational prices).

The CEO capital allocation toolkit

Thorndike describes five capital allocation choices CEOs have:

  1. invest in existing operations
  2. acquire other businesses
  3. issue dividends
  4. pay down debt
  5. repurchase stock

Along with this, they have three means of generating capital:

  1. internal/operational cash flow
  2. debt issuance
  3. equity issuance

With this framework, Thorndike proceeds to review the business decisions of 8 different “outsider” CEOs, so labeled because they tended to use these tools in a contrary fashion to the mainstream wisdom of their time and to much improved effect as per comparison to their benchmarks. Some of the CEOs are well known and oft mentioned and studied (Warren Buffett, John Malone, Kay Graham, Tom Murphy) and a few are known to the value cognoscenti but may have managed to escape notice of the wider public, academic or otherwise (Henry Singleton, Bill Anders, Bill Stirlitz and Dick Smith).

The author tries to tie together the various common threads, such as how,

All were first-time CEOs, most with very little prior management experience

and many of which (such as Singleton, Buffett and Graham) were large or majority equity holders in their companies, making them part of the vaunted owner-operator club with its resulting beneficial incentives.

Thorndike also tries to use the hedgehog vs. fox metaphor, claiming,

They had familiarity with other companies and industries and disciplines, and this ranginess translated into new perspectives, which in turn helped them to develop new approaches that eventually translated into exceptional results

Interestingly, the share buyback stands out as a particularly effective capital allocation tool for all and the author claims that during the difficult inflationary conditions and market depression of the 1974-1982 period,

every single one [emphasis in the original] was engaged in either a significant share repurchase program or a series of large acquisitions

In broad strokes, Thorndike’s efforts to paint these CEOs with a common brush works, but there are numerous times where his attempt to establish commonality  in genius comes across as forced and unworkable. Often, one of these CEOs will operate in a way inconsistent with Thorndike’s major thesis and yet he’ll end up praising the CEO anyway. In poker, we’d call this the “won, didn’t it?” fallacy– judging a process by the specific, short-term result accomplished rather than examining the long-term result of multiple iterations of the process over time.

Some quibbles

This is actually one of the things that rubbed me rather raw as I read the book. In every chapter, Thorndike manages to strike a rather breathless, hagiographic tone where these CEOs can do no wrong and everything they do is “great”, “fantastic,” etc. Unfortunately, this kind of hyperbolic language gets used over and over without any variety to the point it’s quite noticeable how lacking in detail and critical analysis Thorndike’s approach is at points.

Eventually, I reached a point where I almost wanted to set the book down, take a deep breath and say, “Okay… I get it, this guy is absolutely amazing… can we move on now?”

The editing seemed a bit sloppy, too. Thorndike is a graduate of Stanford and Harvard and runs his own financial advisory. He’s obviously an accomplished, intellectual person. Yet his prose often reads like an immature blog post. It’s too familiar and casual for the subject matter and the credentials of the author. I’m surprised they left those parts in during the editing process. I think it makes Thorndike’s thesis harder to take seriously when, in all likelihood, it’d probably be quite convincing if you happened to chat with the author on an airplane.

From vice to virtue

Something I liked about “The Outsiders” was the fact that there were 8 profiles, rather than one. It was reinforcing to see that the same principles and attitudes toward business and management were carried out by many different individuals who didn’t all know each other (though some did) and ALL had huge outperformance compared to their benchmark.

And I think for someone who is just jumping into the investing, management and agency problem literature, “The Outsiders” is a good place to start to get a broad outline of the major thesis which is that companies that are run by owner-operators, or by people who think like them, where the top management focuses on intelligently allocating capital to its highest use (which, oftentimes when the company’s stock remains stubbornly low compared to its estimated intrinsic value, makes buybacks in the public market the most intelligent option versus low margin growth) consistently outperform their peers and their benchmarks on a financial basis.

I think if this was one of the first books I had read on this theme, I would’ve found it quite illuminating and exciting, a real eye-opener experience. As it were, I read this book after reading a long train of other, often times significantly more comprehensive and detailed literature, so my personal experience was rather flat– I came away thinking I hadn’t learned much.

More to the story

There’s more to this story in two senses.

In the first sense, I actually highlighted many little comments or ideas throughout the book that are either helpful reminders or concepts I hadn’t fully considered myself yet, pertaining to best operational and management practices for businesses and the people who invest in them. In other words, the book is a little deeper than I bothered to share here. As a collection of anecdotes and principles for mastering the concept of capital allocation, it’s a good resource.

In the second sense, I think there’s a lot more to the success of the businessmen and their companies profiled (along with many others) than just good capital allocation. The text alludes to this with quotes from various figures about how they operated their businesses and managed people aside from the specific challenges of capital allocation. But it never goes into it because that isn’t in focus.

And as a business person myself, I know from my own reading, thinking and personal experience that capital allocation IS a critical factor in successfully managing and growing a business over the long-term — after all, if you can’t find good places to put your cash, you’ll inevitably end up wasting a lot of it — but you won’t have capital to allocate if you aren’t operating your business and managing your relationships with employees and customers well, in addition. The book just doesn’t do much in the way of explaining how it was that Ralston Purina, or General Dynamics or Teledyne or what have you, had so much capital to allocate in the first place.

I think people like this book so much because it’s exciting to read about outsize success, regardless of how it happened.

2/5

Review – Professional Investor Rules (#investing, @harrimanhouse, #WallSt, #books)

Review – Professional Investor Rules (#investing, @harrimanhouse, #WallSt, #books)

Professional Investor Rules: Top Investors Reveal The Secrets of Their Success

by various, introduction by Jonathan Davis, published 2013

The many faces of money management

A 1948 Academy Award-winning film popularized the slogan “There are eight million stories in the Naked City”, and after reading the eclectic “Professional Investor Rules”, I’m beginning to think there are almost as many stories about how to manage money properly.

Value and growth, momentum and macro-geography, market-timing and voodoo superstition; all these major investment strategies and themes are on display, and many more to boot, and all come bearing their own often-tortured metaphors to convey their point.

What’s more, it seems the pacing and style of the book change along with the advice-giver: while some of the entries follow the books eponymous “rule” format for organizing their thoughts, others involve myths, lengthy prose paragraph-laden essays and headings with sub-headings. Some have charts, and some do not.

One things consistent, at least– all the advisors profiled contradict one another at some point or other, and some even manage to contradict themselves in their own sections.

But it’s got this going for it, which is nice

Those are some of the glaring cons to the book. It’s not entirely without it’s pros, however.

One of the things I liked about the book is, ironically, also one of its flaws– the great variety of personas. They run the gamut from the known to the unknown, the mainstream to the contrarian, the sell-side to the buy-side. This book is published by a UK outfit (Harriman House), which means many of the professional soothsayers will be unfamiliar to US audiences, but it also means you get a selection of icons from the Commonwealth and former British territories (such as Hong Kong and other Asia-based managers) that you’d likely never hear about on CNBC or other American publishing sources.

Following this contrarian inversion theme, I liked that all the phony  fuzzy thinkers were right there next to the sharper pencils because it made their baloney that much more rotten. I think this is a great service for an uninformed investor picking up this book. If they had come across some of the more foppish money dandies on their own, elsewhere, they’d be liable to get taken in and swindled like the thousands of others who sustain such frauds. But at least in this case you’ve got a go-go glamour guy saying no price is too high for a growing company right next to a value guy warning that that way lies the path to certain, eventual doom.

And maybe this isn’t a big deal to others but I like the packaging on this hardcover edition I’ve got– it’s truly a HANDy size, the fonts and color scheme are modern and eye-catching and the anecdotal organization of the book makes it easy to pick up and put down without feeling too upset over whether or not you’ve got the time to commit to a serious read right then.

Fave five

Here are five of my favorite ideas from the book, along with the person(s) who said it:

  1. At any one time, a few parts of your portfolio will be doing terribly… focus on the performance of the portfolio as a whole (William Bernstein, Efficient Frontier Advisors)
  2. Far more companies have failed than succeeded (Marc Faber, The Gloom, Boom and Doom Report)
  3. Fight the consensus, not the fundamentals (Max King, Investec Asset Management)
  4. When someone says ‘it’s not about the money,’ it’s about the money (H.L. Mencken… consequently not actually a money manager and not alive, but it was quoted in one of the in-betweens spacing out the chapters)
  5. Academics never rescind papers and never get fired (Robin Pabrook and Lee King Fuei, Schroeders Fund, Asia)

Conclusion

Who is this book for? Accomplished, well-read pro-am investors will find nothing new here and much they disagree with, so I’d recommend such readers stay away. Someone completely new to investing and the money management industry might find the book valuable as a current snapshot of the gamut of strategic strains present in the money management industry.

Overall, while “Professional Investor Rules” has its moments, overall I came away less enthused than I did with Harriman House’s earlier offering, Free Capital. For anyone looking to learn investing techniques from accomplished, self-made millionaires, that’s the book I’d point them to– the advice therein is worth multiples of that being given by the mass of asset gathering managers of OPM contained in this one.

2/5

 

The Best Interview On Gold, The Gold Market And Investment Implications I’ve Ever Read (#gold, #economics)

The Best Interview On Gold, The Gold Market And Investment Implications I’ve Ever Read (#gold, #economics)

In “What is the key for the price formation of gold?” at GoldSwitzerland.com, SF-based software developer Robert Blumen covers a lot of fascinating and, to my eyes, original ground in an interview with the site’s host.

This has got to be the best interview on the subject of gold in general, the functioning of the gold market and the implications for investors that I’ve ever come across. Blumen not only covers these specific subjects related to gold, but also discusses the Chinese economy, the US economy and the state of monetary and fiscal affairs and even the attitudes of value investors, demonstrating thoughtful familiarity with all he touches. Blumen is well-versed in Austrian economic philosophy and applies this theory to the various practical considerations resulting in surprising new perspectives on common themes.

It’s a long interview and it will only fully reward those determined to dive all the way in. Here’s an excerpt:

There are two different kinds of commodities and we need to understand the price formation process differently for each one. The first one I’m going to call, a consumption commodity and the other type I’m going to call an asset.

A consumption commodity is something that in order to derive the economic value from it, it must be destroyed. This is a case not only for industrial commodities, but also for consumer products. Wheat and cattle, you eat; coal, you burn; and so on. Metals are not destroyed but they’re buried or chemically bonded with other elements making it more difficult to bring them back to the market. Once you turn copper into a pipe and you incorporate it hull of a ship, it’s very costly to bring it back to the market.

People produce these things in order to consume them. For consumption goods, stockpiles are not large. There are, I know, some stockpiles copper and oil, but measured in terms of consumption rates, they consist of days, weeks or a few months.

Now for one moment I ask you to forget about the stockpiles. Then, the only supply that could come to the market would be recent production. And that would be sold to buyers who want to destroy it. Without stockpiles, supply is exactly production and demand is exactly consumption. Under those conditions, the market price regulates the flow of production into consumption.

Now, let’s add the stockpiles back to the picture. With stockpiles, it is possible for consumption to exceed production, for a short time, by drawing down stock piles. Due to the small size of the stocks, this situation is necessarily temporary because stocks will be depleted, or, before that happens, people will see that the stocks are being drawn down and would start to bid the price back up to bring consumption back in line with production.

Now let’s look at assets. An asset is a good that people buy it in order to hold on to it. The value from an asset comes from holding it, not from destroying it. The simplest asset market is one in which there is a fixed quantity that never changes. But it can still be an asset even when there is some production and some consumption. They key to differentiating between consumption and asset is to look at the stock to production ratio. If stocks are quite large in relation to production, then that shows that most of the supply is held. If stocks are small, then supply is consumed.

Let me give you some examples: corporate shares, land, real property. Gold is primarily an asset. It is true that a small amount of gold is produced and a very small amount of gold is destroyed in industrial uses. But the stock to annual production ratio is in the 50 to 100:1 range. Nearly all the gold in the world that has ever been produced since the beginning of time is held in some form.

Even in the case of jewelry, which people purchase for ornamental reasons, gold is still held. It could come back to the market. Every year people sell jewelry off and it gets melted and turned into a different piece of jewelry or coins or bars, depending on where the demand is. James Turk has also pointed out that a lot of what is called jewelry is an investment because in some parts of the world there’s a cultural preference for people to hold savings in coins or bars but in other areas by custom people prefer to hold their portable wealth as bracelets or necklaces. Investment grade jewelry differs from ornamental jewelry in that it has a very small artistic value-added on top of the bullion value of the item.

So, now that I’ve laid out this background, the price of a good in a consumption market goes where it needs to go in order to bring consumption in line with production. In an asset market, consumption and production do not constrain the price. The bidding process is about who has the greatest economic motivation to hold each unit of the good. The pricing process is primarily an auction over the existing stocks of the asset. Whoever values the asset the most will end up owning it, and those who value it less will own something else instead. And that, in in my view, is the way to understand gold price formation.

Many of the people who follow and write about this market look at it as if it were a consumption market and they look at mine supply and industrial fabrication as the drivers of the price as if it were tin, or coal, or wheat. People who look at gold as if it were a consumption market are looking at it the wrong way. But now you can see where the error comes from. In many financial firms gold is in the commodities department, so a commodities analyst gets assigned to write the gold report. If the same guy wrote the report about tin and copper, he might think that gold is just the same as tin and copper. And he starts by looking at mine supply and industrial off-take.

I wonder if more equity analysts or bond analysts were active in the gold area, if they would be more likely to look at it the same way they look at those assets.