Monthly Archives: November 2010

higher gold prices ahead: the 3Q10 report of the World Gold Council

November 18, 2010 By in China, emerging markets, Gold, Industry Analysis, Japanese development Tags: , , , , , Leave a comment

The conclusion is mine, but the support comes from the just released 3Q2010 report of the World Gold Council, a leading authority on the yellow metal.

The highlights:

world demand

Identifiable world demand is actually up by 12% year on year, despite a 28% rise in the US dollar gold price over that time.  Buying of gold, year to date, breaks down into the following categories by tons:

jewelry 1468.3 t, up 8% year on year,  comprising 52% of demand

Industrial/dental 320.5 t, up 13% year on year, 11% of demand

investment 1350.2 t, up 19% year on year, 37% of demand.

 

Geographically, third quarter consumer demand (i.e., excluding industry and central banks) breaks out as follows:

India     33.2% of demand.   Purchases up 28% year on year, mostly jewelry

Greater China     22.2%     purchases up 16% year on year, mostly investment

Middle East     9.7%     purchases down 10% year on year, mostly lower jewelry

United States     8.9%     purchases up 8% year on year;  jewelry down, investment up

Western Europe     7.6%     purchases down 3% year on year

Turkey     6.8%     purchases up 35% year on year, virtually all investment

Vietnam     3.3%     purchases up 17% year on year; jewelry down, investment up

Thailand     3.2%     purchases up 139% year on year;  jewelry down, investment up

Russia     2.6%     purchases up 17% year on year, on jewelry demand

everybody else     2.5%.

Industrial demand, which is primarily for technology products, has already rebounded to the pre-crisis levels.

Central bank activity has been, from a private investor’s point of view, really odd.  Until 1Q09 and at prices at or below $900 an ounce, central banks were heavy sellers.  Since then, they have turned into big net buyers.  Russia has added 46.2 t to its stockpiles, Thailand 15.6 t, Sri Lanka 6.9 t and the Philippines 4.2t (through late August).

Investment demand breaks out into three categories:

–hoarding of bars, coins, medals–mostly in developing countries, which accounts for 55% of investment and is up by about a third vs. 2009,

–ETFs and similar products, which accounts for 33% of investment and is down by about 40% year on year, and

–“other” identified retail investment–mostly coins bought in the US and Europe, which accounts for 12% of investment and is  also down by more than 40% year over year.

world supply

Happily, supply is much more straightforward than demand.  It comes from:

mine production     62% of supply, up 3% year on year

recycling     41% of supply, down 1% year on year

central bank sales     -3% of supply (since central banks have turned net buyers)

my thoughts

On the supply side first, I don’t think there’s any reason to expect a large increase in the supply of gold from current levels.

Yes, higher prices will make new gold mining projects (which can be developed relatively quickly) economically viable.  At the same time, however, prudent mining practice calls for existing mines to process progressively less gold-rich ore as prices rise.  That way, they maintain profits in boom times, but save higher grade ore for a rainy day.

Again, higher prices should mean more recycling.  But one of the reasons for the sharp increase in recycled gold over the past few years is the recession-induced development of a gold recycling industry in the US.  Output here has presumably reached a steady-state level.  More important, the World Gold Council thinks the rest of the world has pretty much run out of gold lying around to be recycled.

Central bank sales are harder to figure.  Luckily, they’re not that large in the overall scheme of things.  On the IMF still has about 50 t. of gold to sell.  On the other, Russia is carrying out a program to increase central bank holdings of gold.  And some smaller, less stable governments, appear to want to remain net buyers as well.

As to demand, the figures above should make it clear that gold is a developing world phenomenon.  The US and Western Europe make up only 16.5% of consumer demand and 12% of non-ETF investment purchases. (By the way, Japan isn’t mentioned on the consumer list.  That’s because Japanese individuals have been net sellers of gold this year.)

India alone is a third of the overall market for gold.  It and China together make up more than half of global demand.  In India, buyers want pure gold, to serve both as adornment and savings.  The same is true for China, though 18k jewelry has been making inroads.   So demand in both places should be a function of economic growth.  If the two were to intend to buy gold next year at only half the current pace–and I think that’s a very conservative estimate–this would mean almost over a 6% increase in total demand.

Absent an increase in recycling, which the WGC says is unlikely, I don’t see where the extra gold will come from.  Even ignoring demand from fiscally unstable areas like Turkey or Vietnam, or continuing central bank buying, as positive factors, it think this spells higher gold prices in 2011.


 


 

 

 

 

 

EFPR Global: equity fund flows “surge”

November 17, 2010 By in Current Market Thoughts, emerging markets, hedge funds, Recent Market Action, Shaping a portfolio for 2011, Strategy Tags: , , , , , , Leave a comment

the data

EFPR Global, a data service based in Cambridge, Massachusetts, reported yesterday that investors around the world poured over $15 billion into the equity funds it watches during the week ending November 10th.  This makes the period the best for equity fund inflows since the first half of 2008–before the collapse of Lehman.

According to EFPR, investors put money into virtually all types of equity funds–US, Europe, commodity sector, global and emerging markets.

Bond funds continue to gain assets, but investor enthusiasm for sovereign debt of the US and the EU has clearly begun to wane.

Just published data from the Investment Company Institute, the trade organization for US-based fund companies, only cover flows through November 3rd.  But they confirm a lot of what EFPR is saying.  The ICI numbers show a slowdown in inflows to bond funds, as well as continuing support for equity funds focused on non-US markets.  But the best the ICI can say for US-oriented equity funds is that net redemptions have slowed down.

what to make of this

It’s tempting to say that the “dumb money” that continued to withdraw money from stocks while they were on their way to nearly doubling is now starting to buy back in at much higher prices.  On the idea that “dumb money” stays dumb, this would be a sign that equity markets are near a peak.  IN other words, we should look at the inflows as a contrary signal.

This was my first reaction.  But I’m not sure it’s the right reading of the situation.

In my opinion, there are two reasons for the change in behavior:

1.  I think investors are concluding that layoffs at their firms have ended and that corporate profits are improving.  Therefore their present jobs are secure.  As a result, they won’t need their savings any time soon.  This means they can, at least with new money–if not with investments they already hold–take a more aggressive posture.

Put another way, for most individuals their human capital–their ability to do economically useful work–is their greatest asset.  When the income flow from work is uncertain, it’s no time to take on even more risk with investment capital.  And vice versa.

2.  To some extent, the large amount of publicity about QE II has underlined how little scope there is for government policy to depress interest rates further.  So quantitative easing may be a signal for bond investors to take some profits out of bonds and put them somewhere else.

You might say that this is giving more credit to individuals for having investment savvy than they are due.  On the other hand, we know hedge fund managers are on their way to underperforming the S&P for the eighth year in a row.  And traditional long-only professionals typically end up deep in the top quartile just for matching their indices.  So who’s left as the winners of the investing game?  Brokers and individuals.

Even if you think what I’m saying is crazy, there is still a huge amount of individual money on the sidelines that I think will eventually be pulled into the stock market.  So two or three weeks of positive money flow is at worst a signal for greater attention to the behavior of individuals, not for becoming ultra-defensive.

WMT, DIN: more signs of a stabilizing/strengthening domestic economy

November 16, 2010 By in Constructing a Portfolio, Current Market Thoughts, Portfolio management, Shaping a portfolio for 2011, Strategy Tags: , , , , , , , , , , Leave a comment

the data

–WMT reported earnings before the New York open this morning.  While comp store sales in the US were down for the third fiscal quarter (ends in October), the company has seen sequential improvement in year over year comparisons for the past several months. And it expects comps to turn positive over the holiday season.

–DIN (Dine Equity, parent of Applebee’s and the International House of Pancakes) reported September quarter earnings on November 2nd.  On of the most striking aspects of the recent recession (to me, anyway) has been the reversal of a decades-long trend of American consumers away from preparing/eating meals at home in favor of take-out and eating in restaurants.  Applebee’s, which DIN acquired in 2007, had its comps turn negative in 2006–and stay there.  But third quarter comps for company-owned stores were +3.3%.  Franchisees’ were +3.8%.

It’s not just Applebee’s.  According to the Financial Times, a trade source, the Knapp Track Report, shows the casual dining industry has been comping positive for about four months.  This is the first time since 2006 this has been happening.

–ATVI recently released its latest enter in the Call to Duty series, named Black Ops.  Black Ops had sales of $360 million in the US and UK during its first day (5.6 million copies).  That’s a video game record, and about 20% higher than first-day sales of the mega-hit Call of Duty:  Modern Warfare 2, which was last year’s entry.  Gamers tell me MW2 is the better game.  What’s changed is the economy.

–In its recent earnings call, DIS reported that bookings for its theme parks and resorts were up 5% year on year so far in the fourth quarter, at rates that were 5% higher than a year ago.  It’s a small thing, but higher room rate normally produces lower occupancy, as DIS’s results over the last year illustrate.  The idea is to trade the two variables off against one another in a way that makes revenue (rooms sold x room rate) the highest.  It’s a significant sign of strength when both metrics are moving up at the same time.

what this means

From early in the year, it has been clear that affluent Americans were beginning to feel their jobs were secure and that they could begin to spend a little more freely than they did in 2009.  In fact, sales of luxury goods have been surprisingly strong in the US recently (see my posts on the annual Bain luxury goods report).

These data suggest that everyday Americans have been adopting a similar, more positive outlook–probably starting in the summer.  They’re signs that people think their jobs are safe, that layoffs in their firms are at an end.

This conclusion is reflected in the latest Employment Situation report from the Department of Labor Statistics, which shows the US added about 159,000 private sector jobs in October, and which revised up the August and September figures to 143,000 and 107,000–a gain of 93,000 for the two months over the prior month’s estimate.

It seems to me the evidence points to the US having reached an inflection point where the economy is beginning to heal itself.  Slowly, it’s true, but healing nonetheless.  I’d read the 7%-8% drop in the 30-year bond over the past two weeks as the start of the process of normalization of interest rates, a process that will go on until the 30-year bond yields over 5% and the 10-year yield breaks through 4%.

For stocks, the situation will likely be more complex.  In the past, stocks have held up well during the post-crisis transition period (see my post from April on this topic). The critical question this time around, though, is what individuals do with the mammoth amount of money they’ve poured into bond funds over the past few years.  Do they simply stop allocating money to bonds for a while?  or do they actually withdraw funds?  Where does this money go?  I presume it makes its way into stocks.

measuring equity performance using style indices: growth vs. value

November 15, 2010 By in Basic Concepts, growth vs value, Portfolio management, style indices Tags: , , , Leave a comment

value vs. growth

It’s been my strong impression that in the US market growth stocks have outperformed value stocks this year.  I get that impression, among other things, from looking at my own portfolio (remember, I’m a growth investor).  This wouldn’t be surprising, since in a typical business cycle recovery value stocks outperform strongly in the first year.  But as pent-up demand is gradually satisfied and the economy slows a bit, growth stocks typically take over market leadership.

IWD vs. IWF

But I know I look mostly at growth stocks.  So I thought I’d check the IWD and IWF ETFs.  These are securities that track the Russell large-cap value and growth stock indices, respectively.  They show a neck-and-neck battle until the past couple of months, when the growth index pulls out in front.

Indices like these are the best we have.  And from a practical money management perspective, if a client were to hire me as a money manager and specify the Russell 1000 Growth Index as my benchmark, it would be simple enough to construct a portfolio whose under- and overweights would be geared to that index.

how good are style indices?

But are such indices really good representations of the relative performance of growth and value stocks?   Not so much.  The reason has to do with the academic tilt to their construction.  To be honest, I don’t have a better solution.  And as you’ll see in a moment, the way the growth index is composed may give a manager benchmarked against that index a slight performance advantage.  So I’m sure these style indices are here to stay.  You just have to remember that the growth index in particular has some drawbacks.

Here’s what I mean.

The idea of style indices has its genesis in the reasonable question, posed by academics, as to whether either a value discipline or a growth investing discipline has an inherent advantage over the other.  Their method was to divide a stock index with broad market coverage, like the S&P 500 or the Russell 1000 into value and growth components and then study the relative performance of the two.

constructing a style index

They proceeded as follows:

1.  They defined value stocks, reasonably, as those with some combination of low price to book (or net asset value), low price to cash flow, and low price to earnings.

2.  Using various weightings of these three factors, or other similar ones, they constructed a ranking of index constituents that ordered them from being the most value-like (scoring the best on the value stock variables) to the least.

3.  Using this list, they (usually) took the half exhibiting the best value characteristics and called it the Value sub-index.  They called the other half of the list the Growth sub-index.

4.  They compared the performance of the two sub-indices.

Looking at the relative performance of the sub-indices over time is itself interesting:  until the Nineties, relative outperformance of either style is short-lived.  Starting in the recovery of 1992, however, Growth and Value each have multi-year periods of significant outperformance.

The overall academic conclusion, supported by the sub-indices, is that Value trumps Growth over long periods of time.

the error in logic

The academics make two assumptions that have no factual, or logical for that matter, support.

–They assume that every stock can be characterized either as growth or value.  This allows them to define growth as being what’s left over when value stocks are separated out.  hey don’t consider that there may be a set of “clunkers,” or stocks no one in his right mind would touch (even though there’s research showing that bad-performing stocks persist in underperformance far longer than good stocks in their outperformance).  They all get tossed into the growth pile.

–They assume that the growth stock universe and the value stock universe are mutually exclusive–that growth investors somehow refuse to buy fast-growing companies unless their price-earnings multiples were already high.  That would be crazy.  At the beginning of this year, for example, AAPL–a classic growth stock–was trading at 10x earnings, with no debt and cash making up a quarter of its market value.  Has AAPL been a growth stock for the past five years?  Yes.  Has it been a value stock, too?  Yes, again.  But which sub-index is it in?  Depending on how a particular style index is constructed, it could be either.

Of these two errors, I think the first is the more serious.  My suspicion is that the supposed underperformance of a Growth sub-index is because of the presence of clunkers.

Why don’t growth investors make more of a fuss over their investing style being maligned?  I think it’s the same reason why professional investors don’t make a fuss about many of the other crazy, erroneous things taught about investing in business schools.  Why invite more competition?

 

 

 

 

more on Disney’s September 2010 quarter

November 14, 2010 By in Current Market Thoughts, earnings conference calls, Entertainment, Getting financial advice, Industry Analysis, Investment firms, Lodging, Stock ideas Tags: , , , , , , , Leave a comment

As I mentioned in my post from Friday, DIS reported its September quarter (actually ended October 2nd) results shortly before the close on Thursday afternoon.  The stock dropped sharply on the news release, because the market perceived that the company had “missed” analysts’ expectations for earnings per share by a penny.  Sell-side analysts seemed nonplussed by the apparent weakness.  I heard one analyst, identified is being one of the most highly sophisticated followers of DIS, say in an interview that she hoped to get some clarification of the poor numbers during the company’s conference call that evening.

DIS shares were very strong from the opening bell on Friday and gained 5% on the day, moving counter to an overall market decline.

What happened?

Three factors–other than the unusual release time–conspired to create the initial confusion:

1.  Sell-side analysts who follow the company seem to have been unaware of truly basic facts about how DIS recognizes earnings–although even a casual reading of the company’s earnings releases would reveal them.  They are:

a.  that the fourth quarter of 2009 was 14 weeks ling vs. 13 for this year’s period, meaning last year’s quarter had about $.03 “extra” in eps, and

b.  that $.09 in eps from cable contracts that is normally recognized in the fourth quarter had been already recognized in the third this year.

Together, these two factors meant that the proper base comparison against which to judge 4Q2010 eps wasn’t $.46 but about $.34.  So $.45 in eps represents a 32% gain over last year–a huge quarter and not a “miss.”

It’s true that some short-term speculators scan earnings releases electronically for key words and automatically generate trades when they see positive or negative surprises.  That accounts for the speed of the Wall Street reaction.  But the real issue was that analyst estimates were inexplicably bad.

To my mind, there’s no way the consensus earnings forecast should have been $.46, or that analysts’ estimates should have ranged as high as $.53.  The only way this could have happened is that they didn’t factor in either a. or b. above into their numbers.  The fact that no one issued flash “buy” reports on the stock weakness, and that the “best” analyst on DIS would say on tv that the numbers were bad and that she wanted concrete information and not excuses from management on the conference call, reinforce my conclusion.

I’m dumbfounded.

Welcome to the new Wall Street reality.

Looking on the bright side, inefficiency in the market means a better chance for individual investors to do well.

2.  The DIS management seems to me to have high standards for performance.  I think that’s good.  But I think I can detect a half-scolding tone in management voices when analysts ask for explanations of aspects of company operations that have been covered in prior conference calls.  In other words, it’s unwilling to spoon-feed analysts.  Also, for competitive reason, there’s some information it won’t divulge.

3.  The investor relations function isn’t (…functioning, that is).  Typically, when an analyst wants company background that’s too basic to justify taking up top management’s time–and I read this management as one that doesn’t suffer fools gladly–he/she turns to the investor relations department to explain company structure, philosophy and operations.  If DIS wants better educated analysts (maybe it doesn’t), IR has to do a lot of the heavy lifting, reaching out to analysts if necessary.

The evidence in analyst behavior is that DIS’s IR isn’t doing its job.  I’ve only had one recent contact with this department, when I wanted factual detail on the terms of the acquisition of Marvel Entertainment.  After waiting in vain for a return call for almost two days, I found the data I needed on the Edgar site on the internet.

Yes, I realize I’m no longer in position of power on Wall Street.  But when I called IR to say I had the info and they should take me off their phone list of investors awaiting calls, I detected no sense of urgency, no sense of obligation to provide information to owners of the company or their representatives.  One interaction isn’t enough to generalize from. But the attitude is consistent with one that prevailed among big companies twenty or thirty years ago and has thankfully been changed in most places.

conclusions

Assuming I’ve got a generally accurate assessment of the state of play at DIS, there may be future trading opportunities in this stock based on analysts lack of attention to detail.

I also suspect that as brokerage houses continue to reduce their commitment to analysts, given their view that research is a loss leader, that situations like this one will occur in more names.  Common sense and a little bit of effort may be very rewarding for ordinary individuals like us.