Friday, July 5, 2013

"Those who matter don't mind, and those who mind don't matter." --Bernard Baruch

DISAPPOINTMENT OVER THE SECOND QUARTER POINTS THE WAY (July 4, 2013): Many investors in recent years became disenchanted with receiving one percent or less in interest on their bank accounts and similar time deposits, and therefore crowded into high-yielding assets of all kinds: high-dividend equities, REITs, and almost anything else paying a few percent or more per year. Nearly all financial advisors encouraged this kind of herd behavior. As a result, many of those securities became irrationally overvalued in recent months. In late April and early May, many of them began to slump, as will inevitably occur with any asset class which becomes far too popular. Utilities shares, consumer staples, telecommunications companies, health-care names, high-yield corporate "junk" bonds, and almost anything relating to real estate or mortgages has been retreating. Even U.S. Treasuries were hit, although they are really part of a different category.

As a result, investors who had been running on autopilot are no longer content to maintain the status quo. Especially for those who only check the financial markets when they receive their quarterly statements, many are discovering that these assets--which they foolishly believed were almost as safe as guaranteed time deposits--can experience notable volatility in both directions. Therefore, many more investors in the second half of 2013, and perhaps into 2014, will be looking for alternatives to their previous favorites. So far, many have been selling without any idea about what to do with the money, thereby causing cash deposits to surge. Some people will prefer to remain in cash, but others would prefer to switch into the latest "hot" sector. So far, almost no important sectors have been rallying sufficiently to take over the key role of the new kids on the block.

However, I expect this to soon change. Deep-value investors have already been slowly buying those assets which are trading near their lowest points since 2008 or 2009, including many shares of commodity producers and some emerging-market equities. This buying has been tentative and gradual, and hasn't yet resulted in sufficient percentage gains to excite momentum players or many others who prefer to see outperformance first before participating. Some subsectors such as gold mining shares have never been so far below their respective 200-day simple moving averages since at least 1938. Others are experiencing unusually undervalued characteristics including coal mining shares where the price of the commodity is below the cost of production of the most efficient companies.

The traders' commitments show that commercials, those who are most closely connected with the physical metal as part of their livelihood such as jewelers and fabricators, are the most heavily net long copper and the least net short silver (commercials have never been net long silver) since records were first kept. For gold, commercials are the least net short since August 27, 2002. The unusual nature of these and similar extremes likely signals that those most knowledgeable about these industries are anticipating a significant price rebound. Exactly when it will occur and how is a mystery, but now that many investors are motivated to switch out of their previous top choices, eventually cyclical assets like mining shares will probably become one of the next group of favorites.

Disclosure: Since May 2012 I have been progressively accumulating long positions in funds of commodity producers whenever they have been most disfavored. I completed selling many funds of general equities which I had bought near their important low points in 2012, and which I unloaded on a gradual basis from January 28, 2013 through May 3, 2013. From my largest to my smallest position, I currently own GDXJ, KOL, XME, SLX, REMX, GDX, COPX, SIL, GXG, GLDX, VGPMX, RSX, EWZ, FCG, BGEIX, ZJG (Toronto), and PLTM.