- Interim Update 21st April 2010
Copyright
Reminder
The commentaries that appear at TSI
may not be distributed, in full or in part, without our written permission.
In particular, please note that the posting of extracts from TSI commentaries
at other web sites or providing links to TSI commentaries at other web
sites (for example, at discussion boards) without our written permission
is prohibited.
We reserve the right to immediately
terminate the subscription of any TSI subscriber who distributes the TSI
commentaries without our written permission.
Don't be financially limited by your location
Spread your financial assets between institutions and between countries
If most of your financial assets are held by a single financial
corporation then you will have a problem if that corporation goes bust
or ceases to operate for a while. This even applies to
government-insured deposits at banks, because there could be an
inconveniently long period between a bank going under and the insurance
kicking in. Also, governments have been known to renege on their
commitments, so we would never leave our financial security in the
hands of any government. You should therefore spread your assets across
multiple financial corporations.
It is equally important to spread your financial assets across multiple
countries to mitigate the risk to your financial security of any single
government doing something untoward. This is the case regardless of
where you happen to live. Furthermore, the time to diversify
geographically is when there is no sign of an imminent problem, because
it will usually be too late to do anything after evidence of a problem
emerges. For example, it would be 'par for the course' for a government
that was planning to take actions that would likely cause capital
flight to introduce capital controls before announcing its plans.
The extent to which you should diversify geographically will depend on
your wealth, in that the greater the monetary value of your assets the
more diversification you should probably opt for.
The decision about where to relocate some of your assets will depend on
personal preferences and current location, but in general terms the
best country or countries in which to store wealth will be those that:
a) you enjoy spending time in, b) do not have close political ties with
your home country, and c) have a history of respecting property rights.
For example, someone in Hong Kong would not achieve any diversification
by shifting wealth to China, and a US resident could probably not
achieve sufficient diversification by only shifting wealth to Canada.
Also, nobody should seriously consider shifting wealth to Venezuela or
North Korea. Some ideas of countries to consider for wealth
diversification purposes are Hong Kong, Singapore, Malaysia,
Switzerland, Panama, Uruguay, Canada, Australia, and New Zealand.
Lastly, the mechanics of internationalising your wealth will depend on
the rules and regulations -- including the tax laws -- of your current
jurisdiction. You should consult local experts regarding the best way
to go about it.
Don't let your location limit where you trade
People tend to focus their stock-market-related trading and investing
on the stock market of their home country, especially if they live in
countries with highly developed markets. However, while it was once
difficult for the average retail investor to do anything other than
trade on his/her local exchange, it is now easy for most people to
establish accounts with brokers that provide access to many different
markets around the world. Consequently, there is no longer a good
reason to let your physical location limit the markets on which you
trade.
Your objective should be to trade where the best opportunities are,
rather than restrict yourself to the opportunities that arise in your
own backyard. And during a resource bull market, many of the best
opportunities will be found on the Canadian stock market. The reason is
that something like 80% of worldwide mineral exploration is carried out
by companies listed in Canada.
So, everyone should have a brokerage account that gives them ready
access to the TSX and the TSXV. For this purpose we have, in the past,
suggested Interactivebrokers.com, which enables access to numerous
stock markets around the world, and Penntrade.com, which enables access
to the Canadian and US markets. These are US-based brokers, but
accounts can be opened by people from most countries.
Goldman and Paulson
A
lot has been written since last Friday about the SEC's decision to
bring charges against Goldman Sachs (GS) and about the involvement of
John Paulson's hedge fund (Paulson and Co.) in the deal that led to the
SEC's charges. The upshot is that during 2007 Paulson & Co. (PC)
wanted to place large bets against the US residential mortgage market
and asked GS to create a financial product that would tank if there
were major problems in this market, the idea being that PC would
'short' the product. GS created a billion-dollar "synthetic CDO" based
on Residential Mortgage-Backed Securities (RMBS) for the purpose, with
some input from PC regarding the CDO's structure. The synthetic CDO was
insured by a now-defunct credit insurer (ACA) and subsequently
purchased by a couple of institutional investors, which, judging by
their actions, were convinced that there would be no major problems in
the US residential mortgage market for the foreseeable future. So,
these institutional investors ended up on one side of the trade and PC
ended up on the other, with GS acting as intermediary. As is now common
knowledge, PC was absolutely correct.
The question, now, is whether GS misled the institutional investors and
violated regulations by not disclosing PC's involvement and by failing
to mention that the synthetic CDO had been designed in such a way that
it would implode if the US housing market continued to weaken.
We have no desire to get into a detailed analysis of the GS-PC-SEC issue, but we will make the following brief comments:
1. PC did not misrepresent anything and does not appear to have any
liability here. The lack of any liability on PC's part has been
confirmed by the SEC.
2. To put it mildly, the investors that lost on this deal should have
known better. Their desire to make a large bet on the continuation of
the mortgage boom at a time when considerable evidence of a trend
reversal had already occurred brings to mind the adage: "A fool and his
money are soon parted". Furthermore, had they not lost $1B on this
particular deal they would almost certainly have lost the money on a
similar deal given their apparent confidence that the mortgage market
was sound. However, the stupidity of these investors does not relieve
GS of all liability. The question is not whether the investors should
have acted more sensibly, but whether GS acted in good faith and within
the regulatory bounds.
3. Paulson was largely unknown at the time this deal was done.
Therefore, being made aware of PC's involvement would probably not have
altered the behaviour of the investors that lost money. Again, though,
this does not mean that GS has no liability.
4. Although the buyers of the synthetic CDO may not have been aware
that Paulson was on the other side of the trade, they MUST have known
that a large speculator was betting against them. The reason is that a
synthetic CDO is a zero-sum trade with a 'long side' and a 'short
side'. As stated above, it probably wouldn't have made any difference
if they had known it was Paulson because Paulson was not well known
back then.
5. The fact that the SEC has brought a civil case rather than a
criminal case against GS suggests a belief on the part of the SEC that
criminal charges wouldn't stick.
6. GS and some other large financial corporations directly and
indirectly received hundreds of billions of dollars of taxpayer funds
as part of the Great Bailout of 2008-2009. This represents wrongdoing
(blatant theft, not fraud) on a colossal scale. However, we are having
trouble seeing any wrongdoing with regard to the specific charges that
have recently been made by the SEC. Based on our admittedly limited
understanding of the details, the SEC's case against GS can be likened
to the police attempting to pin a trumped-up shoplifting charge on a
serial killer.
7. The financial crisis's biggest wrongdoers will never be charged with
anything because they walk the "hallowed halls" of government and have
always acted in the "public interest".
8. Although the SEC's current case looks flimsy, cases such as this
could create big problems for GS and other large financial corporations
over the coming 12 months as people look for someone to blame for the
economic malaise. However, we do not believe that these legal problems
will be the primary cause of the next major downward trend in the US
stock market. Our view is that the market is destined to head much
lower with or without these issues.
9. It is always possible to concoct an explanation for a market move
after the fact. In this instance, by using some imagination it is
possible to explain last Friday's decline in the gold price as a
reaction to the tenuous link between Paulson (the owner of several
billion dollars of gold-related investments) and GS. However, if such
an explanation 'holds water' then large speculators in gold futures
are, on average, a lot dumber than we currently believe. There is no
good reason to spend much time analysing 2% fluctuations in the gold
price, but as far as explanations for small price moves go the one we
posited in the latest Weekly Update -- that de-leveraging in response
to the declines in financial assets caused the pullback in the gold
price -- is plausible.
Measuring the Money Supply
Click on THIS LINK
for a detailed explanation of what should, and should not, be included
in the money supply. We think the explanation is correct and as clear
as it can be given the nebulous nature of today's money.
The Stock Market
When
trading, the single most important consideration is: how will risk be
managed? In other words, what tactics will be used to ensure that a lot
of money will not be lost if things go wrong?
Although not the only way, the setting of protective stops is the most
efficient way to manage risk when trading in markets with good
liquidity. Before entering a trade, a trader that employs the
protective stop method of risk management must determine the position
of the protective stop. This means that trades should generally be
avoided unless a logical place for a protective stop can be determined.
That's why we wrote the following in the latest Weekly Update:
"A major peak [in the US
stock market] could be at hand, but this is not necessarily a good time
to be making a bearish bet. The reason is that there is no effective
way to manage risk when betting against a market that has consistently
been making new 52-week highs. You may be lucky enough to pick the top,
but you would be gambling rather than intelligently speculating. In our
opinion, if you want to try to profit from the coming intermediate-term
stock market decline then the optimum time to build your bearish
position will be during the rebound that follows the initial decline
from the peak. Risk could then be managed by placing a protective stop
just above the peak."
But while risk management considerations probably mean that this is not
a good time to be making a bearish bet against the senior US stock
indices, there are stock indices and individual stocks that have
substantial downside potential and for which the risk management
parameters are clear. One example is Hong Kong's Hang Seng Index, which
is turning downward after failing to exceed its November-2009 peak.
Charts of three other examples are presented below. Interestingly, each
of these charts is related to the commodity theme.
The first of the following charts shows that major copper producer FCX
has reversed downward after testing its November and January highs. We
mentioned FCX as a put-option candidate when it was trading in the mid
$80s a few weeks ago. The second chart shows that FXI, an ETF that
tracks large-cap Chinese equities, has begun to decline after making a
lower high early this month. And the third chart shows that EWZ, a
proxy for the Brazilian stock market, also appears to be turning
downward after making a lower high. In each of these examples, bearish
speculators could manage risk by placing a stop either just above this
month's high or just above the 52-week high.
Gold and
the Dollar
Gold
The following weekly gold chart reveals an orderly advance over the
past 16 months. It shows that gold hit its channel top in February of
2009, after which there was a routine pullback to the channel bottom.
The advance then resumed. It also shows that gold hit its channel top
again in December of 2010, after which there was another routine
pullback to the channel bottom prior to the resumption of the advance.
At least, that's the way it looks at the moment.
Short-term resistance lies in the low-$1160s.
Gold Stocks
Current Market Situation
As far as we can tell, the HUI's price action over the first three days
of this week contained no clues as to what we should expect over the
days/weeks ahead. The HUI was essentially flat on Monday and Tuesday
before rising enough on Wednesday to test short-term resistance in the
low-430s.
At this stage there
is no way to tell whether the price action of the past 8 trading days
is a correction within a continuing short-term upward trend or the
start of a new short-term downward trend. In favour of the former
possibility is the performance of the bullion market.
New ETFs for silver and copper miners
Here are the opening two paragraphs of a 20th April article about the introduction of new ETFs for silver and copper mining stocks:
"Global X Funds, the New
York-based provider of Exchange Traded Funds, launched today [20th
April] the Global X Silver Miners ETF (ticker: SIL) and Global X Copper
Miners ETF (ticker: COPX). SIL and COPX have a 0.65% expense ratio.
The Global X Silver
Miners ETF is the only ETF in the world targeting silver mining
companies. It tracks the Solactive Global Silver Miners Index,
comprised of the largest and most liquid silver mining companies in the
world. The majority of holdings are Canadian based companies but also
include companies based in the US, Mexico, Peru, and Russia. As of
March 31, 2010, the largest index components were Fresnillo, Industrias
Penoles, Silver Wheaton, and Pan American Silver."
These ETFs don't interest us right now, but they will almost certainly
interest us in the future. In particular, SIL could prove to be a good
vehicle for trading intermediate-term rallies in the silver sector.
Currency Market Update
Our view continues to be that the euro is bottoming on a short-term
basis, although it is certainly having difficulty establishing an
upward trend and has once again pulled back to test its March low. This
pullback has set up a reasonable opportunity for traders of currency
futures to take a 'long' position, because risk can now be managed by
placing a protective stop just below the March low.
We are currently
bearish on the commodity currencies, but we happen to be 'long' the C$
and the A$ in our own accounts. We are long these currencies for two
reasons. First, due mainly to our interest in natural-resource-related
companies we have sizeable investments in assets located in Canada and
Australia. Second, we expect that natural resources in general and gold
in particular will continue to be among the best areas in which to
speculate over the years ahead, so it makes sense for us to have plenty
of C$s and A$s 'at the ready'. Our biggest cash position at this time
is in US dollars and US$ surrogates (the Yuan and the HK$), after which
comes the C$ and then the A$. This is definitely not a recommended
currency mix; it is the mix of currencies that happens to fit our
peculiar objectives and situation.
Because we perceive a lot of downside risk in the commodity currencies
we will be partially hedging our exposure to these currencies using FXC
and FXA put options. For example, on Tuesday of this week we began to
average into September-2010 FXC put options. We would prefer a later
expiry date, but September is presently the most distant month for
which there are FXC options with reasonable liquidity.
Note that the difference between a speculation and a hedge is that a
speculation is undertaken with the aim of making a profit whereas a
hedge is undertaken with the aim of reducing the risk of loss.
Update
on Stock Selections
(Notes: 1) To review the complete list of current TSI stock selections, logon at http://www.speculative-investor.com/new/market_logon.asp
and then click on "Stock Selections" in the menu. When at the Stock
Selections page, click on a stock's symbol to bring-up an archive of
our comments on the stock in question. 2) The Small Stock Watch List is
located at http://www.speculative-investor.com/new/smallstockwatch.html)
Chesapeake Gold (TSXV: CKG). Shares: 38M issued, 45M fully diluted. Recent price: C$9.10
CKG announced the results of the Preliminary Economic Assessment (PEA)
for its Metates gold/silver project after the close of trading on
Wednesday.
The PEA incorporated a revised resource estimate. The M&I resource
is now estimated to be 17.2M ounces of gold plus 467M ounces of silver
(24M ounces of gold-equivalent). In other words, it's an enormous
deposit.
As befitting such a large deposit, the projected capital cost and
annual production are substantial. According to the PEA, it will cost
about $3B to build a mine that produces about 960,000 gold-equivalent
ounces per year during its first 7 years of operation. With zinc as a
byproduct, the cash cost during the first 7 years is currently
estimated to be only $267/oz.
Most importantly, the PEA reveals positive economics at "base case"
metal prices of $900/oz for gold and $14/oz for silver. Specifically,
the base case reveals a Net Present Value (NPV) and an Internal Rate of
Return (IRR) of $2.5B and 13%, respectively, at a discount rate of 5%.
Boosting the assumed metal prices by 10% increases the NPV (at a 5%
discount rate) and the IRR to $3.5B and 15.7%, respectively. These
numbers suggest that the NPV would be close to $5B at current metal
prices.
The PEA was as positive as we had hoped/expected and supports our
bullish outlook for CKG. The $3B cost of building a mine is way too
high for a company such as CKG to manage, but this is irrelevant
because we are sure that CKG's management has no intention of taking
this project into the construction phase. We expect that the Metates
project will be purchased by a major gold miner such as Newmont or
Goldcorp or Barrick -- at somewhere north of $20 per CKG share -- well
before it enters the mine construction phase.
We have no idea how the stock market will react to the PEA. The stock
only trades about 20,000 shares on an average day, so relatively small
changes in supply or demand can cause large price changes.
Current holders of CKG should continue to hold in anticipation of a
buyout within the next 18 months. Prospective new shareholders could
either take an initial position near the current price or wait for the
news-related dust to settle before making a purchase.
Chart Sources
Charts appearing in today's commentary
are courtesy of:
http://stockcharts.com/index.html
|