Category Archives: Gold

what do gold and AAPL have in common?

April 22, 2013 By in Gold, hedge funds, Recent Market Action, Stock ideas, Technology, Wireless Tags: , , , , , , , , 1 Comment

common factors

–they’re both large positive bets (large holdings) of hedge funds–and of many retail investors

–both have delivered weak performance over the past year, after extended periods of substantial gains.  And the losses have occurred during a time of generally stable conditions for the world economy, with ample liquidity and strong inflows of money into financial products

–recent trading in both seems to me to be giving signs of forced or distressed selling

are these factors connected?  

It’s hard to know, since global hedge fund disclosure is incomplete–and there’s ample evidence that what disclosure there is can’t be relied on.  However, I think it’s reasonable to assume they are.

if so, what does this imply?

In my experience, a professional investor goes through a three-step process as he realizes he’s made a mistake–or that his previously good idea is no longer working.  He:

–stops adding to the position when new money comes in, effectively shrinking its relative size,

–begins to sell, to further lessen the negative effect of the position on performance, and

–accelerates the selling when the position is small enough the extra visibility and extra downward pressure on price make little difference.

A professional investor can go through these states in the blink of an eye, or it can take a long period of time. A lot depends on style, self-awareness and how ugly the underperformance is.  Anyone who operates on margin may also get additional feedback from his lenders.

Many retail investors, in my experience, just panic–very close to the bottom.

Recent price action in gold and in AAPL strike me as Stage-Three end-game activity–some combination of panic, response to margin calls and/or dumping of the remainders of positions being sold over long periods.

is this an opportunity to buy?

gold: 

For me, the answer here is easy.  It’s “No.”  The key supply-demand issue is whether central banks in emerging markets will continue to buy gold in the aggressive way they have done over the past several years.  I have no idea.  So I’m clearly the “dumb money” in this arena–the strongest reason there is to stay away.

AAPL:

We’ll have more information tomorrow, after AAPL reports its latest quarterly earnings.

The stock is now trading at less than 9x historic earnings and yielding 2.7%.  The shares have underperformed the S&P 500 by more than 50 percentage points since last September.

The company has no debt and its cash holdings are approaching almost half the market cap.

If there’s anything “wrong” with the stock, it’s that its fall from grace has been so extreme.  That prompts the question, “What must sellers know that I don’t?”

How do you overcome aversion, based on an extended decline, to a stock that looks like a $100 bill lying on the street?  The first step, I think, is to look for signs that the waves of selling that have pummeled AAPL are over.   This means having AAPL announce bad news and have the stock go up, rather than sell of further.  That’s why tomorrow’s earnings report may be important.

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commodities cycles

April 18, 2013 By in Capital-intensive firms, Current Market Thoughts, Gold, Industry Analysis, Mining, Trading Tags: , , , , , , , , , 2 Comments

commodity rhythms

agricultural

The co-owner of one of the smaller investment companies I’ve worked for was a farmer.  He made me realize that there are no long cycles for most agricultural commodities.  If prices for a particular crop are high, farmers will plant more–usually a lot more–the following season.  That virtually guarantees that prices will either level out, or more likely fall.  The opposite happens–supply falls, and prices subsequently go up–if prices are currently low.

Considering that many crops have two or three growing seasons in a year, price adjustment comes swiftly.

metals

Metals mining, especially base metals mining, is just the opposite.  Mines tend to be gigantic projects, costing billions of dollars and designed to last 20 years or more.  Most of that money is spent up front:  for the mine itself, for all the drilling machines and other earth moving equipment, for the ore processing plants, for the roads or rails to tap into a country’s established transport infrastructure, and maybe even for new sources of electric power.

Because the optimal project size is “humongous,” mines tend to spew out very large amounts of output when they open.

Because–unless you’re very unlucky–the running costs are low relative to the initial investment, projects seldom shut down once they’re up and running.  They normally don’t even consider doing so unless the output price falls below out-of-pocket extraction costs.  And even then a mine may not shut down.  Miners always identify pockets of especially rich ore that they set aside for a rainy day.  So the first response to weak pricing it to turn to these high-grade areas in order to keep going–and spewing even more price-depressing output on the market.

In addition, some emerging countries run their mines to create employment and get foreign exchange.  Because whether they make money or not is a secondary concern, such mines almost never shut down.

The result of all this is a supply/demand dynamic somewhat like the farm one I sketched out above.  When times are good and metals prices are high, miners generally spend their cash developing new mines.  This creates periodic overcapacity when supply outstrips global industrial demand as all the new mines open at once.  But, unlike the case with soybeans or corn, excess capacity doesn’t disappear come winter.  Instead, it can stay for a decade.  What cures the oversupply is the eventual expansion of the world economy to the point where it can use all the raw materials being produced.

an example

I was a starting-out analyst when a supply-demand imbalance sent base metals prices skyrocketing in 1980.  I remember copper briefly hitting around $1.40 a pound and bringing previously loss-making capacity back onstream.  The price almost immediately fell back.  It took nine years for demand to expand to the point where it absorbed all available supply–and for the price to regain that 1980 high ground.

Another wave of new capacity pushed the price back down in the mid-1990s, where it stayed again until sharply climbing demand from China absorbed all the new output.  The price began to rise again in 2003.

For most metals, this pattern of feast and famine is common.  It’s not alone.  Chemicals and shipbuilding are the same way.  The common threads are:  commodity industry; long-lived assets with most of the capital in up front; capacity additions coming in large chunks.

Try to find a copper chart that goes back to the 1980s.  It isn’t that easy–suggesting to me that commodities traders aren’t as up on their history as they should be.

investment significance

I think that for base metals, and maybe for gold as well, we’re deep in the end-game transition from fat years to lean.  It has less to do with the state of demand in China than the state of supply among mining companies.  If I’m correct, time–and the accompanying gradual world economic expansion–is the only cure.

a falling gold price–what does it mean?

April 15, 2013 By in emerging markets, Gold, Industry Analysis, Recent Market Action Tags: , , , , , , , , 3 Comments

Back in the day, I was, among other things, a gold mining analyst.  That period left me with an enduring fascination, not about the yellow metal itself, but about gold “bugs”–the people who are obsessed with gold and who buy it as an “investment.”  I have the same complex mixture of feelings about gold bugs that I have about survivalists, Civil War reenactors, model railroad buffs and people from Brooklyn.  It’s not exactly “There but for the grace of God…”, but that’s the general direction.

I really don’t get gold as an investment.  Yes, it’s shiny and there may actually be gnomes in Zurich.  Until the mid-1970s, gold did serve as a kind of money worldwide.  But no longer.  One exception:  developing economies where either there are no banks for businesses to use, or where people don’t want/trust banks to know about their finances.

Contrary to what I think is popular belief in the US, virtually all the demand for gold comes from the developing world.  The US accounts for 5% of purchases, the EU 10%.  Japan is a non-factor.  Last year, as usual, India was the #1 buyer of gold, at 28% of the total.  Greater China took 25%.

Before the Great Recession, the large bulk, maybe 3/4th, of the world’s demand for gold was for jewelry (although much of this did double duty as chuk kam 99.9% gold trinkets). 10% was for technology or dentistry.  The rest was gold bars and coins bought as an “investment.”  The bulk of that demand was supplied by mine production, with the rest coming from recycling and steady selling by central banks in developed countries.

The GR changed that pattern, in two ways.  Demand for gold bars and coins more than tripled.  Central banks in the developed world stopped selling, while their counterparts in emerging economies began to buy gold like there was no tomorrow.  Between 2009 and 2011–which appears to have been the peak of this activity–the gold price doubled in US$.

Gold ETFs?  They peaked in 2009 at about 17% of world gold demand.  By 2011 they had shrunk to 4%.

What’s happening now?

The gold price has been slowly declining for two years, without attracting much attention, as panicky buying by gold bugs has waned.

What’s new is India.  The biggest drain on India’s growing trade imbalance is its citizens’ continuing demand for gold–both for jewelry and because the country’s banks don’t work.  New Delhi has decided to deal with the steady flow of cash out of the country by taxing gold imports.  At least to some degree, this will put the metal’s chief buyer on the sidelines.  That won’t stop mines from churning out the stuff, however, until/unless the gold price drops below their cash cost of production.  That’s a looong way down.

Elsewhere, “investment” demand appears to be waning.  Less significant in the short term, Chinese tastes seem to be slowly shifting away from chuk kam to fashion or statement jewelry with lower gold content.  And, of course, more dentists are using ceramic teeth and PC demand is slowing.

In other words, the supply/demand picture for gold is looking less favorable for prices.  The price decline has nothing to do with inflation fears in the US or EU subsiding, or renewed faith that either area is suddenly on a sounder economic footing.

a weak 3Q12 for Tiffany (TIF)

November 30, 2012 By in Asian economic development, China, earnings conference calls, Gold, Hong Kong, Industry Analysis, Japanese development, Luxury goods, Retail, Stock ideas Tags: , , , , , 1 Comment

the results

Before the New York open on November 29th, TIF announced 3Q12 earnings results (the company’s fiscal quarter ended October 31st).  Sales were up 4% year on year.   Profits for the three months, however,  were down 30% yoy at $63 million, or $.49 per share–lower than the company had guided to during its 2Q12 conference call.  TIF also revised down its expectations for the full fiscal year to eps of $3.20-$3.40 vs. its prior guidance of $3.55 – $3.70.

What’s behind the earnings miss?

Business was better than expected in Europe and Japan. It was so-so in Asia-Pacific—comparable store sales down 4% yoy—but in line with management’s view. In the US, however, which still comprises about half the company, sales weren’t as good as TIF had expected.

Not only that, but product mix was a problem. Purchases of items costing over $500 each held up well. Sales of less expensive silver jewelry, however, flagged. And they carry higher margins at the moment.

 How can sales be up and profits still fall by almost a third?

As I interpret TIF’s actions in preparing for 2012, the company expected a sales advance for the year of around 10%. So it increased sales space and added staff with that kind of increase in mind. Those extra costs are now acting against the company (negative operating leverage) because sales aren’t yet high enough to absorb them fully.  That cost the company about $6 million in operating profit in 3Q12, I think.  More important,

TIF also build its inventories aggressively. The fundamental choice a firm makes is between:  do I keep inventories small and risk losing sales?  …or do I keep the shelves full, at the risk of having too much?  Based on its sales forecast, TIF picked the second.

In addition, in carrying out its strategy TIF appears to have acquired or made goods containing gold when the yellow metal’s price was relatively high. That decision has two consequences that have also turned into temporary negatives. Because their costs are high, those pieces carry lower gross profit margins than TIF has shown in recent quarters. This wouldn’t be a big deal if sales were growing as rapidly as TIF thought. Better to lose a couple of points of margin on a necklace or ring rather than have a customer walk out empty-handed because there’s no merchandise in the store. But when sales are slow, as they are now, lower-margin merchandise can end up being a big chunk of sales for an entire quarter or two.  As I reckon it, this cost the company about $30 million in operating profit in 3Q12.

At some point, however, maybe in 4Q12 or 1Q13, TIF will have sold all these items and gross margins should rebound.

Finally, to carry out all its plans and still continue to buy back its stock, TIF’s debt has gone up by about $250 million yoy.  Interest expense is $4 million higher in 3Q12 than in 3Q11, as a result.

Do TIF’s quarterly earnings matter at this point?

Yes and no. The stock dropped by about 10% in the pre-market Thursday before rebounding to close down 6% or so. To my mind, that’s not much of a negative reaction, considering how big the earnings shortfall was vs. expectations and how strongly the stock has performed in recent months.

To my mind, investors have clearly been betting that we’re at or near a business cycle low point for high-end jewelry sales. They’re buying TIF in anticipation of a significant upturn in profits. For these investors, the overall story is still intact. Their timing may have been a bit off, but they’re not worried.  And, in my view, TIF’s management didn’t do anything crazy.  It carried out an intelligent plan for 2012 that’s been undermined by a weaker than expected world economy.

On the other hand, I suspect it will be difficult for the stock to advance from the present level without the company demonstrating that the low point is behind it.

One other note: it seems to me that the area of concern for Wall Street based on 3Q12 results can’t be China, even though sales there were down yoy. Why do I say that? Chow Tai Fook Jewellery, which caters solely to the China market, was up 4% overnight in Hong Kong.

Graff Diamonds yanks its proposed Hong Kong IPO

May 30, 2012 By in China, Gold, Hong Kong, Industry Analysis, Luxury goods, Retail, Stock ideas Tags: , , , , , , , , Leave a comment

fuses blown

Bad day in New Jersey.  Yesterday was the first super-hot day of the late spring, with temperatures approaching 100 degrees Fahrenheit.  Creaking power infrastructure reacted in the way we’re unfortunately becoming accustomed to.  It collapsed.  No power for most of our neighbors, no internet or cable TV for us.  Hence the late post.

Graff

According to Bloomberg, the plug was pulled on the Graff Diamonds offering less than two days before the stock was supposed to debut.

I can’t say I was shocked, for several reasons:

–Hong Kong has been pummelled especially badly by selling emanating out of the EU, where another flight to safety by equity investors is in full flower.  It looks almost like last summer.  (Where did they get all the stock?)

–Chow Tai Fook Jewellery (HK: 1929) came public late last year and is now trading at about 2/3rds of the IPO price.  True, 1929 sells mainly chuk kam pure gold jewelry and knickknacks, not diamonds.  But the market is the same–China.

–TIF, whose main problems appear to me to be in the US, nevertheless also reported a deceleration in its China business last quarter.

–I suspect that retail investors in Hong Kong–always important in that market–were especially badly burned by the Facebook IPO.  IF US retail investors got 5x-10x what they expected, Hong Kongers could have gotten double that size.  Hong Kong is a market of veteran stock market participants, so they’ll shrug off their bad treatment by underwriters quickly.  But if I’m correct, they’re still licking their wounds.

–I haven’t tried to locate a copy of the Graff Diamonds prospectus.  My experience is that in Hong Kong these documents weigh a ton, but don’t contain anything like that amount of information.  Besides, they’re not supposed to be available in the US until after the offering.  Media reports do bring up two potentially worrying issues, however.

Apparently, a mere 20 customers make up 50% of revenues.

A large chunk of the IPO proceeds were said to be earmarked for buying diamond inventory from the company’s founding family.  I’d want to know how this inventory is being valued–and how many months’ (years?) sales this represents.  I’d also want to know how the acquisition of the gigantic gems Graff is famous for will proceed from now on.  Does the Graff family act as exclusive agent for the company?  …is the family paid a commission for acquisition?

a paucity of demand

When the IPO was pulled, the underwriters had orders for only half the shares intended to be offered by the company.  In a healthy offering the books would be, say, 5x covered.  A “hot” offering might have books 10x covered.  In Hong Kong, which operates under different rules than the US, 100x isn’t unknown.

my thoughts

In the current economic environment, Graff Diamonds was always going to be a tough sell, especially with the family wanting 25x earnings for its shares.  I think FB did much more to suck the life out of this offering than most brokers would be willing to admit, however.

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