Thou Shalt Not Ignore Risk

This story features BOART LONGYEAR GROUP LIMITED. For more info SHARE ANALYSIS: BLY

By Rudi Filapek-Vandyck, Editor FNArena

I have this long standing belief -call it a self-made theory if you like- that the first man who tried to cross the Amazon river was eaten alive by an underwater army of piranhas.

As a matter of fact, I believe several men have died a horrible death as the first would-be heroes would have tried to do this on their own, as men do, and there wouldn't have been any witnesses, and thus no warning messages to pass on to the next would-be hero of the day.

It is not my intention to start a new gender divide among participants in the Australian share market, but it is a fact that female investors are better at coping with challenging circumstances. Academic research throughout the past decades solidly supports this thesis (or should that be: observation?).

The weakness of men is they focus too much on potential gains, and too little on what can possibly go wrong. Women, on the other hand, know too damn well what can possibly go wrong, and they stick to a more cautious approach as a result.

The first woman to cross the Amazon probably asked one of her young admirers to show off his courage first. After that she would have asked the next one to build a canoe.

It's no different in the share market, which is why last year one of my Weekly Insights was titled "Trade Like A Man, Invest Like A Woman" (June 2012). The opening sentence back then reads as follows: "The past four years have taught investors one important lesson about investing in the share market: not only are the companies behind listed equities different in terms of growth and market opportunities, they do not all carry the same gradations of risk either."

It's the kind of market wisdom that has proven its value over and over again over the past twelve months.

There are still plenty of opportunities to swim into a school of hungry piranhas in the Australian share market, as witnessed -again- on Monday by yet another profit warning from mining services provider Boart Longyear ((BLY)) (following hot on the heels of the corporate collapse of junior Allmine Group ((AZG)) less than two weeks ago).

In my view, the most important story FNArena published in June was on Friday when we reported that Citi analysts had come to the conclusion that at US$1300/oz, no less than 90% of all gold miners of the world are losing money. Last week, gold futures briefly traded below US$1200/oz. As I write today's analysis, the price is still well below Citi's cut-off price.

This is not an attempt to single out gold as the place to stay away from. I am merely making the point that many investors (and their advisers) live and decide in the here and now and they tend to underestimate how much more negative news can be forthcoming out of negative developments. Citi's research not only suggests gold miners have been rightfully sold off over the past two years, there will be a plethora of negative consequences now that gold has fallen so deeply in months past.

Cash flows have dried up. For some this implies debt cannot be paid back. Others will have to cut costs, immediately and rigorously. Mines will be closed. Funding will be extraordinarily hard to attract. Write-downs will become unavoidable. Future projects will be re-assessed, and binned. The list goes on and on and on. On the receiving end are not only shareholders who remained loyal throughout the downturn, but also mining services providers, engineers and consultants who have customers in the precious metals space.

Typically, commodities go through a prolonged downturn which suppresses and removes supply, creating the platform for future price recovery, but I doubt whether this will automatically be the case for gold. In years past, the bulk of demand stemmed from financial investors and speculators, not from consumers in Asia or from central banks. It is my personal view that unless the demand from investors and speculators is re-invigorated, the tide will continue to move against the gold-bulls and faithfulls. It doesn't appear a swift turnaround is around the corner.

One of the many analyst teams that have been wrong-footed by the swift sell-off in gold this year, the commodity strategy team at ANZ Bank, last week acknowledged gold has now turned into a technical trade. With price charts showing bearish pictures, the risk remains to the downside. ANZ Bank hasn't yet given up on gold making a come-back. According to the analysts, as long as gold does not sink below USD1,150-55/oz, the prospect of a strong rally higher remains alive.

Already, the CEO of Gold Fields, which has operations in Asia, North America, South America, Africa and in Australia, has declared the industry needs a minimum price of US$1500/oz to remain viable. It is well possible this means gold will trade back at US$1500/oz at some point into the future. It is also possible the road back to US$1500 encounters more weakness and more negative developments first.

Trade like a man, invest like a woman. I don't think there's any need to use more words to describe the risks that remain outside the well-travelled pathways of the Australian share market.

Analysts at stockbroker Moelis quickly responded to the latest Boart Longyear profit warning on Monday. Here's the opening of their initial re-assessment: "We have been cautious towards BLY given its leverage to global exploration spending whilst still seeing the cyclicality as offering an investment opportunity when activity levels inevitably recover; however given the recent fall in the gold price closer to miner cash costs we see a likely protracted 'shakeout' as assertive cost savings initiatives work their way through the sector, prompting a more urgent perspective given such a scenario does not appear factored into the share price."

This is not a story about gold miners and mining services providers. A weaker Australian dollar, growing familiarity with online purchases, and more international competitors setting up shop in Australia by default implies industry dynamics for bricks and mortar discretionary retailers (and related REITs) is to remain challenging for much longer. In addition, what might happen to the Australian media landscape, including traditional TV stations, when Australia has superfast internet access through the National Broadband Network? Do I still need to mention newspapers and print magazines?

I remain of the view that commodity laggards copper, iron ore and crude oil are now going through the same process as was in place not that long ago for nickel, coal, uranium and most other commodities. There will be differences as to how exactly this process will unfold as key differences remain for each commodity, oil has OPEC and iron ore is pretty concentrated at the top, but the base process remains the same.

Among the remaining stocks, mostly industrials, investors will have to carefully asses valuations (for the proven, solid performers) and ongoing risks for disappointment as the weaker AUD and lower interest rates still require time to make their presence fully felt in company sales, margins and profits.

Within this context, I think it is worth repeating one recurring observation from the feedback we have been receiving from investors thus far this year: Amazing how a relatively small part of the portfolio can have such a big (negative) impact.

Surely that experience is worth remembering ahead of the upcoming reporting season, while standing on the banks of that turbulent, wide river, eyes firmly focused on the other side?

(This story was written on Monday, 01 July 2013. It was published on the day in the form of an email to paying subscribers).

(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)

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DO YOU HAVE YOUR COPY YET?

At the very least, my latest e-Booklet "Making Risk Your Friend. Finding All-Weather Performers", which was published in January this year, managed to accurately capture the Zeitgeist.

All three categories of stocks mentioned in the booklet are responsible for the index gains post 2009 and this remains the case throughout 2013.

This e-Booklet (58 pages) is offered as a free bonus to paid subscribers (excl one month subs). If you haven't received your copy as yet, send an email to info@fnarena.com

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FNArena At The Trading & Investing Expo in Sydney

– I will be presenting at the upcoming Trading & Investing Expo in Sydney (Friday 19 and Saturday 20 July at the Sydney Exhibition Centre). Investors can download free tickets to the event, courtesy of FNArena. Simply click on the following link: http://sydney.tradingandinvestingexpo.com.au/visitor/register and when prompted, enter the promotional code FNARENA. Your free tickets will be emailed to your inbox. FNArena will also host a stand at the Expo.

– I will also present at the Trading & Investing Expo in Melbourne, August 23-24 (where FNArena will equally host a stand) – ticket promotion to follow

– Later in the year, I will present to members of AIA NSW North Shore at the Chatswood Club on Wednesday 11 September, 7.30-9pm

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