Gold Miners: Value Trap, Short Term Buy, Generational Buying Opportunity, or None of the Above ?

LST is currently in the mood to play some late night macro jazz, so will jot down below a few (incoherent) thoughts regarding none other than… zee barbaric relic, and those who mine for them:

  • A few of LST’s indicators are signaling accumulate/buy (now, if not within the next few trading days), if not monitor VERY CLOSELY on the long side (especially for medium/long duration holding purposes);
  • A certain @Paul3222 says gold miners will be “stupid cheap” : “…when management stops destroying shareholder value. Or, when recoverable reserves are worth more than the company.”
  • @freegold , Hugh Hendry, and others of the uber-risk conscious mold (rightfully?) believe that one cannot hedge/price in the risk of nationalisation … whether that’s true, or whether the mere headline risk can drive miners to absurdly low prices, it’s something to bear in mind.
  • LST wondered whether Paulson’s 2012 trades gone wrong would be 2013 trades gone right (at some point in 2013)…such as gold/miners …
  • Impact of gold, gold-related ETFs on gold mining stocks (i.e. “market structure” issues of the secular variety)
  • “Gold fundamentals remain strong”
  • Eventual reversal of the short miners, long gld/physical trade?
  • and some food for thought, per @tejus_sawjiani :

2013 Counterintuitive Investment Theme #1: Betting on Paulson (?)

Thesis: Paulson & co’s failed trades in the last few years have tended to perform remarkably well in subsequent years. LST believes short Europe and/or long gold miners may present compelling reward vs. risk at some point in 2013 (if not now). So:

(1) Betting against Europe - Short a basket of EUR, short European sovereign bonds, and long European CDS.

(2) Betting on Gold Miners - The majors and the juniors, e.g. AU, NG, GFI (without loss of generality).

LST will likely do more work (it’s still in idea generation/evaluation stage, granted LST sometimes adheres to the “trade first, analyze later” philosophy a la Soros), possibly updating this post. Let’s examine the case against (1) and (2) (LST prefers the dialectic/socratic approach, rather than the more traditional b-school model where you start with your ‘case for’):

Case against / Counterarguments

(1) Why bet against Europe?

  • Europe is structurally flawed, but the problems are known, priced in.
  • Eurozone has stabilized, low rates are buying time for at risk countries such as Spain to solve its structural problems, e.g. employment.
  • The markets seem to respond favorably to incremental actions by the ECB.
  • The banking sector has been stabilizing, the systemic risk indicators are all pointing to calm.

(2) Why bet on gold miners?

  • The smart macro money is short or looking to short gold (their models say so!), confidence appears to be rising, as the Fed is giving some hope that QE and other “extraordinary” interventions will slow, if not start to reverse. The reflation trade in reverse…
  • Inflation in labor, fuel, etc. would not be good for margins.
  • “The risk premium goes up when the gold price goes up. Societies are more envious of your gold at $3000 than at $300. And there is no valuation argument that protects you against the risk of confiscation.” (Hugh Hendry)

LST wonders if the EUR USD needs to go higher - say 1.40 - before it’s time to short Europe. Similarly, LST wonders if gold needs to see a more meaningful correction (with similar pain in the miners) before going long gold miners.

Deconstructing the case against/counterarguments - LST is not sure yet, needs to gather more information, and think this through more. Having said that, LST likes the short Europe idea as LST can’t recall the last time Europe dominated the headlines.

On the Radar for 2013

These are the areas that currently interest LST, as we head into 2013:

(1) Frauds, Fads, & Failures - Never gets old. While these tend to be inherently of a single-name (and occasionally thematic) nature, it appears there are certain markets where macroeconomic froth/excess may intersect with the three Fs. Those remain of highest priority. Oh, and “activist” shorts are always high priority.

(2) REITs - This is an area where LST feels (relatively) comfortable, as far as getting up to speed, both on a macro and single-name basis. Will be (particularly) on the lookout for the crescendo of foolish, uneconomic, and short-term behavior. It seems markets all too often forget that “innovation” and “creativity” in finance (e.g. the REIT-ization of “non-traditional” names) are euphemisms for “hidden debt” and “hidden risks” and…all too often end in tears.

(3) Special Situation Longs - Names such as CNSI (as inspired by @mojoris1977 ) will take top priority. IRBT, INVN, and a few others are on the evaluation pipeline. Finally, will be monitoring acquisition and/or activist worthy names.

(4) High Yield Credit - Per one of LST’s recent posts…

(5) Japan, the Nikkei, and USD JPY - The recent performance of the USD JPY and Nikkei have gotten the attention of even lowly students of macro jazz such as LST.

(6) IPOs (particularly of the tech variety) - A few sources “familiar with the matter” expect that tech IPO land will be quite busy in 2013. Time will tell, but if supply increases in equity land, LST will be a very happy camper…

Tablets are to PCs, as ___ are to Tablets …


Contrary to what some may think, LST is (usually) not a bear. True bears, in LST’s opinion, are those who have the tendency to play some variety of macro jazz*, i.e. prognosticate on the imminent crash/lost decade in some economy, currency, interest rates, real estate, stock market indices, this, that, and the other.

It’s probably more appropriate to think of LST as part Vampire Slayer** and part…Fantasy-VC*** (venture capitalist). You may be familiar with LST’s vampire slaying activities, if you browse through my tweets and prior posts. This post will introduce you to the latter, in the form of a (conceptual) long idea.


LST (and many others before LST) saw the tablet computer concept coming  years before it became this wildly popular and profitable concern it is today (though Apple, Samsung, and a few others have been the chief beneficiaries of the tablet’s popularity).

As the tablet “ship has sailed” (as far as being a novel idea), what’s next? LST believes that the following concepts (all ideas are 100% generated by LST, though it is very likely that there are many others who have come up with the same ideas) may lead us into the next generation of products:

(1) The CardPhone - Imagine a phone as thin and pliable as a credit card. Imagine also using this CardPhone, for all your communication needs as well as transactional and identification needs (i.e. use it in lieu of a credit/atm card and in lieu of a driver’s license)? You could drop it on the ground all you want, and it would not break. You could also clandestinely slide it into your pocket, and no one would know.

(2) The ThinPad - Along the same lines as the CardPhone, imagine a tablet that could be pliable like plastic, water proof, and durable (so you could drop it all you want)? And thin as a 50 page notepad? A pad made out of pliable material seems particularly promising and appealing for kids, students, and the elderly.

(3) The PowerCell - Now suppose that the CardPhone and ThinPad could easily run on batteries for at least 12-16 hours (roughly a full day for most of us) without charging? This “PowerCell” would do wonders for us all.

LST is no material scientist or engineer, and the technical challenges (or cost constraints) may render the above product concepts commercially unviable  for many years to come.

That said, it would seem prudent to be on the lookout for the innovators and companies out there that are looking to bring the above, or similarly evolutionary concepts to market. Wouldn’t it be something if some under-the-radar entity were to outmatch Apple, and become the next great tech company?


Will the keyboard be around in 10 years from now? If it is around, how widely used (or not) will it be? The popularity of the tablet naturally erodes at the use of PCs … which in turn erodes the “need” for keyboards. If this trend has legs, people will start wondering if information and work can be done via alternative means. Why use a keyboard at all, if __ , ___, and ____ innovations totally transform the way work is done, and the way information is transmitted between human and machine.

Remember, the growth of PCs had a truly revolutionary  (as opposed to evolutionary), impact on the way we humans can do work. Is there another great leap forward, that will render keyboards useless, or will changes in the next few decades be more of the evolutionary variety?

The answer to these questions clearly have ramifications for companies like Hewlett Packard and Dell.

Innovate or…perish.

LST may update this post periodically.



* “Macro Jazz” is a term on loan from a friend of LST. We specifically have used the term semi-pejoratively when we talk about great bottom up value-oriented long/short managers who try to sing to the complex beats and harmonies of macro jazz and… don’t seem to quite pull it off. LST is also an aspiring macro jazz musician, and hope to someday do justice to the macro bebop, funk, etc. that the Soros, etc. of the world have come to master.

** “Vampire Slayer”- Vampires, in the real world, exist in the form of those who promote “frauds”, “fads”, and “failures” for personal gain, at the expense of the general public.

*** “Fantasy VC” is inspired by the expressions “Fantasy Macro Manager” and “Macro Tourist” . (VC-tourist did not sound as cool so went with fantasy vc). For context, look it up.

A 58-Slide Glimpse Into the Mind of a Few Stock Promoters

While the markets remain closed, straight from the horse’s mouth…


Value Investing Congress Day 1: Are the Long Ideas Good … Short Ideas?

Listed below are all the ideas pitched yesterday, the first day of the Value Investing Congress.

Many market participants will look for reasons to agree with the pitched ideas, and will initiate a 1% position if they feel sufficiently comfortable. After all, so-and-so is long ___, has done the research, etc. (of course, this also makes for a convenient excuse if the position goes wrong, and LPs need an answer; blame someone else!).

LST, ever the contrarian, wonders if the longs that were pitched - at least some - might actually end up making good/great shorts (or at least serve as the genesis of some good/great short ideas).

So instead of looking at the ideas pitched as potential longs, LST may look through these (and related names) as potential shorts.

After all, LST doubts that these participants are  sharing their investment theses out of the kindness of their hearts; rather, they hope (and need) a greater fool that will let them exit their positions. To LST, that smells a lot like… motivated sellers.

The Long Ideas:

Bill Ackman / Pershing Square Capital Management - GGP, JCP, PG

Barry Rosenstein / Jana Partners - AGU

Guy Gottfried / Rational Investment Group - CLK, CAM (trade on TSE)

Mick McGuire / Marcato Capital Management - ALEX, GY, BRP

Whitney Tilson / T1 Partners - NFLX, BRK.A, HHC - Tilson suggested he had a short idea in this interview. Not sure what happened.

Kian Ghazi / Hawkshaw Capital - LAYN

John Mauldin / Millennium Wave Advisors - Seems to like MON , though he’s (apparently) more of a “macroeconomic thinker and writer”

The Short Idea

Then there was Zack Buckley / Buckley Capital - He actually had the cojones to pitch a short, SPLK . Ker Splunk.

Make no mistake: some of the above ideas may likely end up being home runs (on the long side). That said, money is often made discounting the obvious, and betting on the unexpected…


The Alchemy of REITs

LongShortTrader loves REITs (Real Estate Investment Trusts). The progression of headlines/developments in credit and REIT-land over the last few years (and especially within recent quarters) is getting LST very interested in this space. The below is one of the best explanations of REITs that LST has ever read:

My best documented encounter with a boom/bust sequence is that of Real Estate Investment Trusts. REITs, as they are called, are a special corporate form brought into existence by legislation. Their key feature is that they can distribute their income free of corporate taxation, provided they distribute all the income they receive. The opportunity created by this legislation remained largely unexploited until 1969 when a large number of REITs were founded. I was present at the creation and, fresh from my experience with conglomerates, recognized their boom/bust potential. I published a research report whose key part reads as follows:


Superficially, mortgage trusts seem to resemble mutual funds designed to provide high current yields. But the analogy is misleading. The true attraction of mortgage trusts lies in their ability to generate capital gains for their shareholders by selling additional shares at a premium over book value. If a trust with a book value of $10 and a 12% return on equity doubles its equity by selling additional shares at $20, the book value jumps to $13.33 and per share earnings go from $1.20 to $1.60.
Investors are willing to pay a premium because of the high yield and the expectation of per-share earnings growth. The higher the premium, the easier it is for the trust to fulfill this expectation. The process is a self-reinforcing one. Once it gets under way, the trust can show a steady growth in per-share earnings despite the fact that it distributes practically all its earnings as dividends. Investors who participate in the process early enough can enjoy the compound benefits of a high return on equity, a rising book value, and a rising premium over book value.

The conventional method of security analysis is to try and predict the future course of earnings and then to estimate the price that investors may be willing to pay for those earnings. This method is inappropriate to the analysis of mortgage trusts because the price that investors are willing to pay for the shares is an important factor in determining the future course of earnings.
Instead of predicting future earnings and valuations separately, we shall try to predict the future course of the entire self-reinforcing process. We shall identify three major factors which reinforce each other and we shall sketch out a scenario of the probable course of development. The three factors are:

1. The effective rate of return on the mortgage trust’s capital
2. The rate of growth of the mortgage trust’s size
3. Investor recognition, i.e., the multiple investors are willing
to pay for a given rate of growth in per-share earnings

Act One: At present, the effective yield on construction loans is at an optimum. Not only are interest rates high but losses are at a relatively low level. There is a pent-up demand for housing and new houses readily find buyers. There is a shortage of funds so that the projects which do get off the ground are economically well justified. Builders who are still in business are more substantial and more reliable than at the tail end of a boom. Moreover, they do their utmost to complete the construction phase as fast as possible because money is so expensive. Shortages of labor and material do cause defaults and delays but rising costs permit mortgage trusts to liquidate their commitments without loss. Money is tight and alternative sources of interim financing are in short supply. Investor recognition of the mortgage trust concept has progressed far enough to permit the formation of new trusts and the rapid expansion of existing ones. The self-reinforcing process gets under way.

Act Two: If and when inflation abates, the effective yield on construction loans will decline. On the other hand, there will be a housing boom and bank credit will be available at advantageous rates. With higher leverage, the rate of return on equity can be maintained despite a lower effective yield. With a growing market and growing investor recognition, the premium over book value may continue to increase. Mortgage trusts are likely to take full
advantage of the premium and show a rapid rise in both size and per-share earnings. Since entry into the field is unrestricted, the number of mortgage trusts will also increase.

Act Three: The self-reinforcing process will continue until mortgage trusts have captured a significant part of the construction loan market. Increasing competition will then force them to take greater risks. Construction activity itself will have become more speculative and bad loans will increase. Eventually, the housing boom will slacken off and housing surpluses will appear in various parts of the country, accompanied by a slack real estate market and temporary declines in real estate prices.

At this point, some of the mortgage trusts will be bound to have a large number of delinquent loans in their portfolios and the banks will panic and demand that their lines of credit be paid off.

Act Four: Investor disappointment will affect the valuation of the group, and a lower premium coupled with slower growth will in turn reduce the per-share earnings progression. The multiple will decline and the group will go through a shakeout period. After the shakeout, the industry will have attained maturity: there will be few new entries, regulations may be introduced, and existing trusts will settle down to a more moderate growth.


The shakeout is a long time away. Before it occurs, mortgage trusts will have grown manifold in size and mortgage trust shares will have shown tremendous gains. It is not a danger that should deter investors at the present time.

The only real danger at present is that the self-reinforcing process may not get under way at all. In a really serious stock market decline investors may be unwilling to pay any premium even for a 12% return on equity. We doubt that such conditions would arise; we are more inclined to expect an environment in which a 12% return is more exceptional than it has been recently and in which
the self-reinforcing processes of the last few years, notably conglomerates and computer leasing companies, are going through their shakeout period. In such an environment there should be enough money available for a self-reinforcing process which is just starting, especially if it is the only game in town.
If the process fails to get under way, investors would find downside protection in the book value. The new trusts are coming to the market at book value plus underwriting commission (usually 10%). Most recently formed trusts are selling at a premium which is still modest. It will be recalled that when their assets 3fe fully employed in interim loans, mortgage trusts can earn 11% on their book without leverage and 12% with a 1:1 leverage. A modest premium over book value would seem justified even in the absence of growth.

If the self-reinforcing process does get under way, shareholders in well-managed mortgage trusts should enjoy the compound benefits of a high return on equity, a rising book value, and a rising premium over book value for the next few years. The capital gains potential is of the same order of magnitude as at the beginning of other self-reinforcing processes in recent stock market history.

My report had an interesting history. It came at a time when go-go fund managers had suffered severe losses in the collapse of the conglomerates. Since they were entitled to share in the profits but did not have to share in the losses of the funds they managed, they were inclined to grasp at anything that held out the prospect of a quick profit. They instinctively understood how a self-reinforcing process works since they had just participated in one and they were anxious to play. The report found a tremendous response whose extent I realized only when I received a telephone call from a bank in Cleveland asking for a new copy because theirs had gone through so many Xerox incarnations that it was no longer legible. There were only a few mortgage trusts in existence at the time but the shares were so eagerly sought after that they nearly doubled in price in the space of a month or so. Demand generated supply and there was a flood of new issues coming to market. When it became clear that the stream of new mortgage trusts was inexhaustible, prices fell almost as rapidly as they had gone up. Obviously the readers of the report failed to take into 4 account the ease of entry and their mistake was corrected in short order. Nevertheless their enthusiastic reception helped to get the self-reinforcing process described in the report under way. Subsequent events took the course outlined in the report. Mortgage trust shares enjoyed a boom that was not as violent as the one that followed the publication of the report but turned out to be more enduring.

I had invested heavily in mortgage trusts and took some profits when the reception of my study exceeded my expectations. But I was sufficiently carried away by my own success to be caught in the downdraft with a significant inventory. I hung on and even increased my positions. I followed the industry closely for a year or so and sold my holdings with good profits. Then I lost touch with the group until a few years later when problems began to surface. I was tempted to establish a short pcsitioo but was handicapped
in that I was no longer famiiiar with the terrain. Nevertheless, when I reread the report I had written several years earlier, I was persuaded by my own prediction. I decided to sell the group short more or less indiscriminately. Moreover, as the shares fell I maintained the same level of exposure by selling
additional shares short. My original prediction was fulfilled and most REITs went broke. The result was that 1 reaped more than 100% profit on my short positions-a seeming impossibility since the maximum profit on a short position is 100%. (The explanation is that I kept on selling additional shares.)

Self-reinforcing/self-defeating cycles like the conglomerate boom and the REITs do not occur every day. There are long fallow periods when the specialist in such cycles remains unemployed.

He need not starve, however. The divergence between underlying trends and investor recognition persists at all times and the astute investor can take advantage of it.

- The Alchemy of Finance , George Soros


Make no mistake, you should get to know your prevailing cap rates, drivers of NOI (rental rates, lease expiry schedule, expenses/costs, etc.), CRE supply/demand  dynamics, capital markets activity (Interest rates, IPOs, credit/equity activity, etc), and a few other things, but let’s be serious… this aint rocket science. Or brain surgery.



Get every new post delivered to your Inbox.

Join 12,774 other followers