Tuesday, March 27, 2012

"I'll Just Hold Until Maturity....."

As we suggest that municipal bond owners check their premise against the backdrop of reality, no one seems to comprehend what we are saying.  We must resort to a pictorial sketch of the severe principal reduction they are about to experience.  Look at the bright side, they will have 10 more years of 3% coupon payments to help them survive 10% per annum price inflation.  Those coupon payments will make them feel smarter than the ignorant gold bugs who receive no dividends.  The gold bugs will be jealous of the bondholder's unrealized 40% losses.  Goldies will actually have to pay taxes if they sell their appreciating bullion and mining shares.

Maybe those blindly pouring money into the "safest" investment, bonds, are the smart ones?  

Sunday, March 25, 2012

Understanding Bubbles

We have written at length about the physics of bubbles.   Hot money flows into a sector and humans instinctively respond in accordance with their herd nature.  They almost can't help themselves.  Once other herd members boast of their genius they are subconsciously determined to get in on the action so as not to be perceived as slow or stupid.

What we are trying to show you is that most sheep get sheered over and over again because they spend their entire existence worried about what the sheep next to them is doing and how they are being perceived.

If your main concern is generating capital gains and protecting said capital, you tend not to care what others think of you.  You will also begin to expect your opinions to be unpopular and keep them to yourself.  As our mentor famously says, "When you are first, you look wrong."

In order to accurately spot a bubble waiting to burst, you must look for one key indicator.  The pool of possible buyers must be exhausted or nearing exhaustion.  Then, you can seek confirmation by watching for a rapid double in price taking place in a 6 month period.  This will be followed by a waterfall event.

Let's take the technology bubble of the late '90s as an example.  The Nasdaq QQQ experienced strong yet normal capital inflows during the latter half of the '90s.  Then the index doubled between Q3 '99 and Q1 '00.  Notice the highlighted area in this chart:
That was a really big move as the index rose from 2,500 to over 5,000.  Most alarming is the nature of the move.  The horsepower was entirely retail oriented.  We remain shocked at how many average people owned shares of firms that they knew nothing about.

In more recent memory we had the housing bubble.  February of 2007 remains our peak date for the sector.  At that time even your editor's local Starbucks Barista was boasting of expected future profits in a condo deal.  He had no ability to compute the comparitive cost of renting or view housing as a consumption item.  With no money down, no sector knowledge and poor capitalization, he fit the profile of the last available buyer.

We know that the current bubble is of a sovereign debt nature.  This will be the most painful burst as the counter-party faith is blind and unquestioned.  Another hallmark of bubble formation is unquestioned loyalty.

So, we are charged with spotting sectors that no one notices.  They are economically dislocated and characterized by extreme value gaps.  We are unable to ignore the precious metals mining sector.  For over 30 years the sector has been hated.  As we comb the surface for values, the sector looks like a poorly advertised Neiman Marcus after Christmas sale.  Debt free firms producing gold profitably are run by committed managers with large personal share holdings.  Combine this with the sheer hatred of the sector and our instincts seem to be confirmed.  As the sovereign debt bubble wipes out the sheep's percieved safety vehicle, we expect precious metals prices to soar as they form the next bubble.  We can already hear the Starbucks Barista, "I'm taking what's left and buying one gold coin I found on ebay.....I don't want to get burned again."

Could this be an indicator that we are nearing the realization that social media share offerings and iPad introductions are not the foundations of a real bull market?  Remember, we need to see total disdain in order for valuable shares to be abandoned at rock bottom prices.  This is the ideal entry point which the sheep are unable to understand:

Consider that the average market participant gives no consideration to mining shares while the companies are experiencing record margin growth:
Average Gold Producer Profit Margins
When we see a sector this fundamentally strong being ignored on a wholesale basis, our attention is peaked.  The continuing and impressive growth in earnings is going to make this space increasingly difficult to ignore.