commodities

Wishing For A Gold Mine?

© Can Stock Photo / snokid

We know a fellow who built a gold mine. Whenever we mention this, people usually ask what it was. The answer is…a gold mine. This client worked as a construction superintendent for a very large contractor. He had built coal mines and a gold mine among many other large projects.

This anecdote comes to mind as we prepare to tell you our latest thoughts on investment tactics. We invest time every week looking for the best bargains, trying to figure out emerging trends, thinking about the economy and the markets. In a recent research meeting, Greg Leibman posed the question, “What can we own that might benefit from rising inflation?”

We humans tend to think that recent conditions or trends will persist. This makes it hard to realize the long spell of very low inflation might come to an end, with inflation outpacing expectations.

One way to weather periods of rising inflation is to invest in companies that own things: land, buildings, factories, raw materials, and so on. An oil company already owns the oil in their reserves and the wells to pump it; when prices go up, they get to sell it for more profit but most of their capital expenses have already been baked in.

Miners similarly benefit when the prices of their existing mineral reserves go up. Like oil companies, their stock price tends to move in correlation with natural resource prices, making them a potential inflation hedge. Some mining companies have exposure to the gold market, which some people may see as a particularly important hedge against inflation.

We have had raw material companies on our radar for some time now: they tend to be big cyclical movers, and we have been bullish about the current cycle so far. But we believe that this same sentiment may have created buying opportunities in the mining sector.

We look for potential gaps between expectations and the unfolding reality. That is where profit lives, in our opinion. When Greg posed the question, we put our heads together and started looking at potential opportunities. To summarize,

• Inflation may exceed expectations in the years ahead.
• We believe that some companies within the mining sector are at bargain levels.

There are no guarantees. What we think of as bargains sometimes have the dismaying tendency to get cheaper after we buy them. But we think we have identified potential investment opportunities that may be appropriate for some portfolios. Clients, if you would like to talk about this or anything else, please email us or call.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

The fast price swings in commodities and currencies will result in significant volatility in an investor’s holdings.

Because of their narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies.

Bargain Hiding in Plain Sight

© Can Stock Photo / mrivserg

Imagine a product that has these uses1:
• Vital part of every home and building.
• Goes into every vehicle; hybrids and electrics use up to four times more.2
• Needed for manufacture, installation and use of solar panels and wind turbines.
• Key requirement in making batteries.

One might imagine that demand for this product will rise in coming years, as technology changes our power grid and transportation, and the world continues to modernize.

Now consider the supply side. It takes billions of dollars and four years or more to create a new production facility. The industry that produces it went through a depression as prices for the product got cut in half from 2011 to 20163. Revenues disappeared, losses mounted, spending got slashed. New projects were cancelled.

Rising demand, constricted supply: we know how this works. Prices will rise, revenues and earnings for producers will go up, stock prices may follow. No guarantees, of course, and the timing is always uncertain.

The product is COPPER. There is no replacement for it. The question we face as investors is, can we get involved on a favorable basis?

We know companies that produce a lot of copper, along with other resources. Their stocks are traded on the New York Stock Exchange. The valuation on their shares seems compelling. A dollar of profit in one trades for a third less than that of the average stock; the other one carries a two-thirds discount. One is trading at one-third of its all-time peak a few years back, the other is discounted even more.

Both stocks have been about twice as volatile as the average stock. (This is measured by a statistic called ‘beta.’) We don’t care. Downside volatility is wonderful if you are trying to buy bargains. But owners should be prepared for the roller-coaster.

Clients, we are telling you this story for a reason. When you hear that ‘the market is too high’ or things are at some unsustainable peak, remember that at 228 Main, we are pounding the table and jumping up and down about the bargains we are finding. If you would like to discuss this or anything else at greater length, please email us or call.

1The World Copper Factbook 2014, International Copper Study Group

2The Electric Vehicle Market and Copper Demand, International Copper Alliance

3Federal Reserve Bank of St. Louis

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

Investing involves risk, including possible loss of principal.

The fast price swings in commodities and currencies will result in significant volatility in an investor’s holdings.

Alternative Facts, Alternative Investments

canstockphoto7544055

Over the past few months, there has been a lot of hay made in the press about “alternative facts.” The term is a sarcastic euphemism; when something is labeled an alternative fact, the clear implication is that it is not a fact at all.

There is a certain class of investments which are collectively called “alternative investments.” This term is unrelated to the term “alternative fact”, but the similarities are undeniable.

Traditional investments are based on the notion of putting your money to work in order to generate more money. When you invest in a company’s stock, you are buying a piece of a going concern that generates revenue. When you invest in bonds, you are buying a debt obligation that bears interest. Even if you are just holding cash reserves, when you leave your cash with a bank, they are paying you interest to hold onto your money. In today’s interest rate environment you are probably earning close to nothing, but at least in theory there is some return on cash.

This is not to say that traditional investments are not without risks. You are not guaranteed to break even, let alone make money—companies may go broke, leaving stocks and bonds at a fraction of their former value. But you still have the hope that your money can grow into more money over time.

“Alternative investments” is a very large category which encompasses a wide range of assets. The only common element is that they do not fall into traditional investment categories such as stocks and bonds, and in many cases, arguably do not qualify as investments in the traditional sense at all.

Commodities are one form of alternative investment. These are gold, silver, oil, corn, and so on—actual, physical products, not the companies that produce them. If you buy a bar of gold, all you will ever have is a bar of gold. It will never turn into two bars of gold. If you are lucky, maybe you can sell it to someone for more than you paid for it. But that is speculation, not investment.

Derivatives contracts are another type of alternative investment. A derivative’s value is based on (“derived from”) the value of another asset, such as a stock or commodity. When you buy options to purchase a company’s stock, you are making a bet that the company will be successful, just like owning stock. However, stock options tend to have a very short time horizon. You are speculating on short term price fluctuations, not really investing in a company’s long term growth.

Undoubtedly some people make good money speculating on alternative investments. As a result, some portfolio managers believe in buying small slices of alternative investments for everyone in case they happen to outperform traditional investments. Our response: nuts! We want to build an orchard big enough to live off the fruit crop. We have no interest in owning a smaller orchard and trying to make up the difference buying and selling fruit with other fruit speculators.

Clients, if you want to talk about your portfolio, please call or email. But if someone is trying to sell you “alternative investments”, you should perhaps treat them with the same skepticism you’d give to someone pitching “alternative facts.”

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Alternative investments may not be suitable for all investors and involve special risks such as leveraging the investment, potential adverse market forces, regulatory changes and potentially illiquidity. The strategies employed in the management of alternative investments may accelerate the velocity of potential losses.

Stock investing involves risk including loss of principal.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.

The fast price swings in commodities and currencies will result in significant volatility in an investor’s holdings.