Non-Contrarians Need Not Apply

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In this week's Weekly Insights:

– Non-Contrarians Need Not Apply
– RBA's Glenn Stevens: The Quote
– Enough Excitement In Gold?
– Your Question: Aged Care Homes
– Warren Buffett Likes Growing Dividends
– Rudi On TV
– Rudi On Tour

Non-Contrarians Need Not Apply

By Rudi Filapek-Vandyck, Editor FNArena

I spent eleven years of my life in Amsterdam, during which I built the knowledge and market insights that allowed me to transform into the financial journalist I am today. I got married, had two sons and eventually moved on to Australia.

It was in Amsterdam that I encountered typically Jewish humour with local cafes hanging a big sign beside their entrance or on the wall behind the bar: Tomorrow free beer for everyone.

Of course, if you'd return the next day, the sign would still be the same.

I imagine many an investor in the Australian share market must feel the same way about mining stocks and the contractors and engineers that service the miners. Is tomorrow ever going to arrive again in earnest?

Post Peak Misery

Years ago, I traveled to Perth to announce to local investors: don't buy mining stocks. That view was largely based on my macro assessment that the global context for post-boom, heavy cyclical, price-leveraged vehicles such as mining stocks was not favourable beyond the short term rallies build on investor hope and rising market sentiment.

In hindsight, that assessment has proved absolutely correct. On Deutsche Bank's analysis, commodities as a group in 2015 are en route for a fifth consecutive year of being crowned the worst performer among all financial assets. Worse even than government bonds whose "death" and "destruction" has been forecast by all and sundry for at least two to three years by now.

Even the analysts at Lion Selection Group, "hardcore" believers in the cause by anyone's standard, admitted recently that owning industrial dividend payers has simply been the correct, and rewarding, strategy during that time. Those same analysts are also the promoters of the Lion Clock which aims to show investors where in the cycle the mining sector sits, and whether it's time to again start accumulating exposure.

Two weeks ago, Weekly Insights included an update on the Lion Clock showing it is now 4.30 o'clock. The implication is time has arrived to again start thinking about adding exposure to the mining sector. To revisit the Lion Clock, see the email from the first week of June or maybe this is an opportunity to "discover" the Rudi's Views archive on the FNArena website.

Note on many an analysts' assessment, including the teams at Deutsche Bank and Lion Selection Group, the current "downturn" or "bear market" or whatever term you want to use, has been one of the longest on record, if not the longest. Not everybody agrees with Lion Selection Group's assessment. Certainly I would caution against showing too much enthusiasm as prices for crude oil and iron ore in particular seem at real risk they might roll over in the weeks or months ahead.

The chart below, taken from Lion Selection's market update at the start of June, suggests the downturn started in late 2011 and its duration has been near double the longest previous downturn, and much, much longer than most precedents. Then again, maybe this should not come as a surprise as those same analysts at Lion Selection reported earlier the up-cycle for mining between 1999-2008 had been the longest in living memory.

Do longer booms feed into longer downturns? Recent experience certainly suggests this is the case.

Commodities Are A Contrarian Call

By all accounts, mining and commodities in general are today a contrarian play. Recent data suggest professional investors and global managers of funds have little exposure and no appetite for the sector at all. At a recent event, Deutsche Bank analysts queried a group of institutional clients in Asia and commodities were least preferred for just about anything, including as protection against inflation.

This picture of complete abandonment and near 100% disinterest falls in line with Lion Selection's observed decline in the ASX300 index weight for metals and mining companies. At no more than 10% today (Australia a mining country?) the index representation for producers of bulks, industrial metals and precious bullion is now about half what it was in March 2009 and even significantly below the average for the 2001-2004 years, when mining was emerging from a decade of mostly misery.

These numbers and observations must be music to the ears of contrarian minds.

Certainly, few would contest the fact the majority of mining (and related) stocks look "cheap". It's just that "cheap" is a relative assessment under the best of circumstances and it remains quite hollow in the absence of a sustained upswing in prices for mined materials. Lion Selection analysts are correct in their assessment that mining companies, forced by ongoing tough circumstances, have been hoarding cash and improving their operations, including sharply lowering costs and break-even production levels. And mid-tier players are using depressed asset prices as an opportunity for scrip mergers and acquisitions.

Nothing lasts forever, right?

Few Sellers, But Plenty Of Risks

Nothing lasts forever, in particular in financial markets where today's heroes can turn into tomorrow's zeros in the blink of an eye, and vice versa. Investors looking at potential opportunities among mining and energy stocks today are banking on the "vice versa".

But when exactly is the timing right? And how costly can it be still when one's entrance proves too early?

Taking a holistic view, commodity bulls like the team at Lion Selection argue there is not much selling power left since most institutions not married to the sector have left for greener pastures elsewhere and certainly Deutsche Bank's Asian client survey further reinforces this is the case. But share prices will still move lower when commodity prices take a dive.

Investors can take guidance from Mincor ((MCR)) shares, the rally in which rally in early 2014 extended from 50c to past 90c in the space of a few months on the back of renewed enthusiasm for nickel. By the end of the year, however, the share price was almost back at 50c. The shares are now trading around 60c with many an expert awaiting further signs that nickel is due a revival, soon-ish.

As things stand right now, lead is the only base metal still in positive territory for 2015 thus far, as is silver among precious metals. Crude oil futures have outperformed equities, but has the rally been too optimistic, too soon?

In support of the case for commodity stocks, history shows that when the next upswing arrives it is likely going to be a violent affair. Violent to the upside, that is. Lion Selection analysts are salivating by the knowledge that Private Equity has set aside substantial commitments for investments in mining assets, yet virtually nothing has moved out of bank accounts to date.

On the other hand, recent analysis suggest more than 50% of all listed junior mining stocks in Australia have less than $1m in the bank and less than twelve months to cover their operational costs. The layman translation of these data is: speculator beware!

As indicated by recent announcements from South32, Monadelphous and Energy Resources of Australia, there's plenty of risk waiting to rise to the surface still and gobble up more capital from shareholders.

By the way, were Private Equity to start buying assets it would move the Lion Clock to 5 o'clock, say the analysts (maybe a little too eager).

More Than Meets The Eye

Surely what goes for mining stocks must also apply to the transporters, contractors and engineers providing services to mining, crushing and to exploration? Industry analysts SNL Metals and Mining recently reported 2014 probably was the worst year for the mining industry since 2008 and things simply continued to be really bad in the first three months of 2015. A number of observers are willing to declare things have picked up, a little, in the current quarter.

But does any of this mean share prices in Monadelphous, Ausdrill, WorleyParsons and the like are now representing great buying opportunities?

One theory is that investors should zoom in on companies whose operations are only partially exposed to mining and energy. Were the revenues from mining and energy services soon to find a bottom, this should allow the other operations to resume growth to the benefit of shareholders, and the share price.

Throwing a bucket of ice cold water over the theory is recent analysis by Goldman Sachs that the sector servicing miners and energy companies is much more challenged than simply from the boom hangover. Clients remain cost conscious while technologies and innovation are starting to make an impact too. And now big miners and energy producers have learned to run activities in-house.

Bottom Line

Bottom line: Lion Selection may well be correct in that what we are witnessing in the share market might turn out to be the early stage of a cyclical recovery for commodities and related stocks. But trying to play this theme remains one of high risk, no guarantees, with plenty of potential for losses and disappointment.

If Deutsche Bank's opinion is anything to go by, then institutional investors might consider re-entering the sector by year's end. That's still a long six months away.

I remain of the view the immediate outlook remains uninspiring, at best, while large question marks hang over recent price rallies for crude oil and iron ore. My suggestion would be that most investors will probably do themselves, and their portfolios, a big favour by simply staying away from these sectors, regardless of day-to-day movements and "cheap" looking valuations.

For those with suitable insights, tools and risk appetite, I'd suggest trading strategies only.

Below is SNL's proprietary Pipeline Activity Index, essentially confirming everything you've just read.

RBA's Glenn Stevens: The Quote

Reserve Bank governor Glenn Stevens last week as quoted in local media:

"I certainly agree with the premise that you can't forecast very well. What will we be doing in a year? I don't know."

No more comment required, me thinks.

Enough Excitement In Gold?

The year thus far has offered investors a lot more excitement in gold stocks than one would have anticipated from just looking at the struggling price of bullion. As per always, opinions, views and predictions about the direction of gold priced in USD are as diverse as is the market.

My own view has remained consistent: US Treasuries moving out of negative territory into positive real yield has historically not been a beneficial development for the price direction of gold. The Fed is intent on moving up the Fed Funds rate, which should, all else being equal, lift yields on US government bonds and strengthen the USD. The latter usually spells bad news for gold too.

So why are there still so many people excited about gold?

Ignoring tons of flawed, biased and ignorant analysis (and there's plenty of that around), the above implies that one buys gold for two key reasons:

– the Fed's intention to normalise US interest rates is about to run into trouble (or not happening, full stop)
– the Fed shifting to more normal interest rates has already largely been priced in

Amidst all the speculation (or is that anticipation?) of a major correction for US equities this year, this could be one third factor in that weakness in US equities is likely to impact on USD and on Fed policies as well.

All else plays third violin, at best, in the orchestra that is the global mix of influences impacting on the price of bullion.

Feel free to disagree (as that makes "the market"), but one renowned gold expert who recently started up his own newsletter, Michael Belkin, seems to be 100% in agreement with my views as expressed above.

He also believes investors should bulk up on gold and/or selected gold equities. Investors can check out Belkin's voice and recommendations via this recent radio interview: click here.

Your Question: Aged Care Homes

Subscriber John asked about aged care homes and which stocks to play the theme on Monday morning. I thought this is one suitable question to share with a broader audience.

John, the Australian population living longer and getting older is but one side of this sector's back drop. Setting up and running aged care accommodations is an immature sector and consolidation is the main name of the game. Think about pet stores and child care centres that have shown the way it's done in recent years.

This is why some of the ASX-listed companies in this fledgling and burgeoning segment are trading on high multiples. The anticipated strong growth prospects are not dependent on squeezing more money out of elderly people settling in their cabins, but more so on the capability to purchase new assets at below market valuations.

Listed companies include:

– Gateway Lifestyle (GTY)) – just listed
– Aspen Group ((APZ))
– Ingenia Communities ((INA))
– Lifestyle Communities ((LIC))

The only one from that collection which is trading on low multiples and high yield (7%+) is Lifestyle Communities, which to date doesn't seem to be running along in the race to grab higher market share in as short a time as possible.

Warren Buffett Likes Growing Dividends

I like unmasking financial markets myths.

One that certainly has been shredded and torn apart in years past is the one that used to fly directly at me, pre-2012, whenever I spoke about long term investing and solid, sustainable and reliable dividends from industrial companies: Warren Buffett has no interest in dividends. Why should I?

Fast forward to 2015 and the question is hardly ever asked these days. I genuinely cannot remember when was the last time anybody still raised the Warren Buffett myth about the Sage of Omaha having no interest in receiving dividends. Investors wanting to refresh their knowledge on the subject, here's a recent wrap by thestreet.com: http://www.thestreet.com/story/13105055/7/warren-buffetts-7-secrets-to-dividend-investing-revealed.html

Every time analysts at Goldman Sachs confirm my own research that owning sustainable, growing dividend payers is the superior strategy long term, large groups of investors are either converted or shaken in their own knowledge and beliefs. It can be argued, however, that Warren Buffett was already onto it well before I or Goldman Sachs started publishing on the theme. Investing in solid industrials combining yield with growth? It's the Warren Buffett way.

Rudi On TV

– on Wednesday, Sky Business, 5.30-6pm, Market Moves
– on Wednesday, Sky Business, 8-9pm, Your Money, Your Call – Equities (host)
– on Thursday, Sky Business, noon-12.45pm, Lunch Money

Rudi On Tour

I have accepted invitations to present:

– July 2, Invast, Sydney Clients and Contacts evening meeting
– August 2-5, AIA National Conference, Surfers Paradise Marriott Resort and Spa, Queensland – for more information about this event:

http://www.investors.asn.au/events/events-schedule/aia-national-investors-conference/

Note: FNArena subscribers can attend at similar discount as AIA members

(This story was written on Tuesday, 15 June 2015. It was published on the day in the form of an email to paying subscribers at FNArena).

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's – see disclaimer on the website.

In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: info@fnarena.com or via Editor Direct on the website).

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THE AUD AND THE AUSTRALIAN SHARE MARKET

This eBooklet published in July 2013 forms part of FNArena's bonus package for a paid subscription (excluding one month subscriptions).

My previous eBooklet (see below) is also still included.

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MAKE RISK YOUR FRIEND – ALL-WEATHER PERFORMERS

Odd as it may seem, but today's share market is NOT only about dividend yield. Post-2008, less risky, reliable performers among industrials have significantly outperformed and my market research over the past six years has been focused on identifying which stocks, and why, are part of the chosen few; the All-Weather Performers.

The original eBooklet was released in early 2013, followed by a more recent general update in December 2014.

Making Risk Your Friend. Finding All-Weather Performers, in both eBooklet versions, is included in FNArena's free bonus package for a paid subscription (excluding one month subscription).

If you haven't received your copy as yet, send an email to info@fnarena.com

For paying subscribers only: we have an excel sheet overview with share price as at the end of May available. Just send an email to the address above if you are interested.

Click to view our Glossary of Financial Terms