Quote of the Day: Own More of the Good Type of Risk

Uncertainty should not bother you. We may not be able to forecast when a bridge will break, but we can identify which ones are faulty and poorly built. We can assess vulnerability. And today the financial bridges across the world are very vulnerable. Politicians prescribe ever larger doses of pain killer in the form of financial bailouts, which consists in curing debt with debt, like curing an addiction with an addiction, that is to say it is not a cure. This cycle will end, like it always does, spectacularly.

When it comes to investing in this environment, my colleague Mark Spitznagel articulated it well: investors are left with a simple choice between chasing stocks that have an increasing chance of a crash or missing out on continued policy effects in the short term. Incorporating a tail hedge minimizes the risk in the tail, allowing investors to remain invested over time without risking ruin...

To be robust, one must construct a portfolio as an engineer would a bridge and ask what your managers expect to lose should the market fall by 10%. Then ask them again what they’d expect to lose in the down 20% scenario. If that second number is more than two times more painful emotionally than the first, your portfolio is fragile. To fix the problem, add components to your portfolio that make the portfolio stronger in a crash, like actively managed put options. You will be able to build stronger, better bridges, with better returns, that will last for the long term.

By clipping the tail, you can own more risk, the good type of risk: upside with limited downside. And rather than helplessly watching your bridge collapse, you can be opportunistic in a crash, and take the pieces from others at bargain prices to increase the size of yours.

This excerpt is from iconoclast risk analyst and author Nassim Taleb at the Hedgefundintelligence.com

Quote of the Day: Watch Asset Classes that are the Most Vulnerable to Wealth Taxes

When a government goes bust in a democracy (and most Western governments cannot possibly meet their unfunded liabilities) the majority of people who have no assets or just a few assets will always find it appealing to collect money from the evil “fat cats” (in the case of the US, the 1% who own 42.7% of financial wealth). It should be obvious that if 80% of the population owns just 7% of financial wealth, they will be tempted to transfer at some point in future, part of the wealth of the 5% or 10% richest Americans to the masses that have no savings.

The problems we face today are there because the people who work hard for a living are now vastly outnumbered by those who vote for a living.

Normally, we analyze various asset markets and individual investment opportunities according to their merits. But now, we also need to think which asset classes are the least and which ones are the most vulnerable to wealth taxes.

(bold mine)

This perspicacious insight is from Dr. March Faber from his latest market commentary. The point is one should think "out of the box". This isn’t your daddy’s markets. Other experts such as PIMCO’s Bill Gross has also echoed on this. 

In the recognition that financial markets are being explicitly and implicitly manipulated, looking at the effects of interventions would be the best approach rather than to just mimic or parrot what the mainstream says or thinks. 

The above also is a great description of today's mob rule politics.

Bank of England: Rising Equity Markets Don’t Reflect the Underlying Economic Situation

The Bank of England (BoE) says what I have been saying all along: markets have functioned in departure from reality or what I call as "parallel universe".

From the Bloomberg

The Bank of England said rising equity markets don’t reflect the underlying economic situation and warned that investors may be underestimating risks in the financial system.

Gains by equities since mid-2012 “in part reflected exceptionally accommodative monetary policies by many central banks,” the BOE’s Financial Policy Committee said today in London in the minutes of its March 19 meeting. “It was also consistent with a perception among some contacts that the most significant downside risks had attenuated. But market sentiment may be taking too rosy a view of the underlying stresses.”

UK’s highly fragile banking system has been amplified by current yield chasing parallel universe. More from the same article:

At the meeting, the FPC recommended that U.K. lenders raise 25 billion pounds ($38 billion) of additional capital to cover bigger potential losses, possible fines for mis-selling and stricter risk models. While banks have strengthened their resilience in recent years, the FPC said today that not all of them may be able to withstand unexpected shocks and maintain lending to companies and households.

The FPC discussed potential threats from the crisis in Cyprus, which agreed on an international bailout last month. While at the time of the March 19 meeting there were “minimal signs” of spillovers to other financial systems, there was “a risk that this situation could change,” the committee said….

In their discussion, the FPC members noted the potential threats to the financial system from increased risk appetite among investors.

“This was evident in the re-emergence of some elements of behavior in financial markets not seen since before the financial crisis, including a relaxation in some U.S. credit markets of non-price terms and increased issuance of synthetic products,” the committee said. “At this stage, they did not appear indicative of widespread exuberance in markets. But developments would need to be monitored closely.”

The FPC also said that banks’ leverage ratios, a measure of their debt to equity level, would remain “very high” even after the new recommendations were met. It said there would be “little margin for error against a backdrop of low growth in the advanced economies.”

As noted in the above, central bank authorities either fail to comprehend on the distortive consequences of their inflationist policies or that they are in deep denial.

Because money is never neutral, central bank’s monetary expansion means “money from thin air” flows into the financial and economic system asymmetrically.

Such polices trigger what is called as the “business cycle”.

As the great dean of Austrian economics explained

The fundamental insight of the "Austrian," or Misesian, theory of the business cycle is that monetary inflation via loans to business causes over-investment in capital goods, especially in such areas as construction, long-term investments, machine tools, and industrial commodities. On the other hand, there is a relative underinvestment in consumer goods industries. And since stock prices and real-estate prices are titles to capital goods, there tends as well to be an excessive boom in the stock and real-estate markets.

(bold mine) 

So England’s property bubble and elevated equity prices signify as a classic example of the business cycle in motion.

And given the increasingly hostile environment where productive (commercial) activities are being punished via higher taxes, financial repression and by increased regulations and mandates, such string of political actions compounds on the skewing of people’s incentives towards yield chasing activities.

Add to this the distorting effects of inflationism on economic calculation, again professor Rothbard: (bold mine)

By creating illusory profits and distorting economic calculation, inflation will suspend the free market's penalizing of inefficient, and rewarding of efficient, firms. Almost all firms will seemingly prosper. The general atmosphere of a "sellers' market" will lead to a decline in the quality of goods and of service to consumers, since consumers often resist price increases less when they occur in the form of downgrading of quality. The quality of work will decline in an inflation for a more subtle reason: people become enamored of "get-rich-quick" schemes, seemingly within their grasp in an era of ever-rising prices, and often scorn sober effort. Inflation also penalizes thrift and encourages debt, for any sum of money loaned will be repaid in dollars of lower purchasing power than when originally received. The incentive, then, is to borrow and repay later rather than save and lend. Inflation, therefore, lowers the general standard of living in the very course of creating a tinsel atmosphere of "prosperity."

Besides, like Spain, central banks have supported asset markets in order to finance unwieldy government spending or their highly tenuous welfare state via Ponzi financing.

In short, lofty equity prices are symptoms of monetary disorder. Another reality is that such policies have been designed to preserve on the unsustainable incumbent political economic cartel of the debt and inflation based crony banking-welfare/warfare state-central banking system through asset bubbles.

Yet if central banks desist from pursuing further monetary expansion that blows today's asset bubbles, the system falls asunder. 

Eventually when a critical state have been reached from these cumulative unsustainable political actions, markets will also unravel.

Central bankers, in essence, have been caught between the proverbial devil and the deep blue sea.

The above also shows why conventional treatment of financial markets will be highly sensitive to significant analytical errors and losses. As hedge fund manager Kyle Bass recently noted, today's markets are largely Potemkin Villages.

Investing Lessons: Sir John Templeton’s 16 Rules For Investment Success

Precious investing lessons from the legendary investor Sir John Templeton's 16 Rules for Investing Success

1. Invest for maximum total real return 

2. Invest — Don’t trade or speculate 

3. Remain flexible and open minded about types of investment 

4. Buy Low 

5. When buying stocks, search for bargains among quality stocks. 

6. Buy value, not market trends or the economic outlook 

7. Diversify. In stocks and bonds, as in much else, there is safety in numbers 

8. Do your homework or hire wise experts to help you 

9. Aggressively monitor your investments 

10. Don’t Panic 

11. Learn from your mistakes 

12. Begin with a Prayer 

13. Outperforming the market is a difficult task 

14. An investor who has all the answers doesn’t even understand all the questions 

15. There’s no free lunch 

16. Do not be fearful or negative too often 

Sir Templeton gives an explanation for each

1. Invest for maximum total real return 

This means the return on invested dollars after taxes and after inflation. This is the only rational objective for most long-term investors. Any investment strategy that fails to recognize the insidious effect of taxes and inflation fails to recognize the true nature of the investment environment and thus is severely handicapped. It is vital that you protect purchasing power. One of the biggest mistakes people make is putting too much money into fixed-income securities. Today’s dollar buys only what 35 cents bought in the mid 1970s, what 21 cents bought in 1960, and what 15 cents bought after World War II. U.S. consumer prices have risen every one of the last 38 years. If inflation averages 4%, it will reduce the buying power of a $100,000 portfolio to $68,000 in just 10 years. In other words, to maintain the same buying power, that portfolio would have to grow to $147,000— a 47% gain simply to remain even over a decade. And this doesn’t even count taxes

For the rest, read them at FranklinTempleton.com

My comment:  

Most of John Templeton's investing tips signify as common sense and self-discipline which should be used by any "serious" investors. I say serious because some people dip their hands on the markets for other reasons than just profits, e.g. ego trip, social desirability bias and etc...

However when dealing with "quality, value, bargain, buy low" these ultimately depends on the operating environment, which in the past had been "conventional". 

Today, we are in unprecedented and uncharted territory when it comes to inflationism and interventionism that has massively distorted and obscured price signals of the marketplace.

In other words, conventional rules may not apply under the current setting which means go back to rule number 3--remain flexible and open minded.

Investing Tip: John Bogle’s 10 Rules of Investing

Investing guru John Bogle founder and retired CEO of the Vanguard group enumerates his 10 rules of investing (source CBSNews.com)

1. Remember reversion to the mean. What's hot today isn't likely to be hot tomorrow. The stock market reverts to fundamental returns over the long run. Don't follow the herd.

2. Time is your friend, impulse is your enemy. Take advantage of compound interest and don't be captivated by the siren song of the market. That only seduces you into buying after stocks have soared and selling after they plunge.

3. Buy right and hold tight. Once you set your asset allocation, stick to it no matter how greedy or scared you become.

4. Have realistic expectations. You are unlikely to get rich quickly. Bogle thinks a 7.5 percent annual return for stocks and a 3.5 percent annual return for bonds is reasonable in the long-run.

5. Forget the needle, buy the haystack. Buy the whole market and you can eliminate stock risk, style risk, and manager risk. Your odds of finding the next Apple are low.

6. Minimize the "croupier's" take. Beating the stock market and the casino are both zero-sum games, before costs. You get what you don't pay for.

7. There's no escaping risk. I've long searched for high returns without risk; despite the many claims that such investments exist, however, I haven't found it. And a money market may be the ultimate risk because it will likely lag inflation.

8. Beware of fighting the last war. What worked in the recent past is not likely to work going forward. Investments that worked well in the first market plunge of the century failed miserably in the second plunge.

9. Hedgehog beats the fox. Foxes represent the financial institutions that charge far too much for their artful, complicated advice. The hedgehog, which when threatened simply curls up into an impregnable spiny ball, represents the index fund with its "price-less" concept.

10. Stay the course. The secret to investing is there is no secret. When you own the entire stock market through a broad stock index fund with an appropriate allocation to an all bond-market index fund, you have the optimal investment strategy. Discipline is best summed up by staying the course.

Quote of the Day: David versus Goliath: Why Underdogs Win

Famed author Malcolm Galdwell talked about his new book “David and Goliath” and has been quoted by the Business Insider (bold original)

The crux of Gladwell's argument is that "underdogs win all the time, more than we continue to think," he told Thompson. "Traits that we consider to be disadvantages aren't disadvantages at all. ... As a society, we depend on damaged people far more than we realize. ... They're capable of things the rest of us can't do [because] they look at things in different ways."

Gladwell says that through his research he found that "'Goliath' only wins 66 percent of the time — which is first of all astonishing — so 34 percent of time someone who is one-tenth the size of his opponent wins. That blew my mind."

Underdogs who win refuse to compete by the same standards as their opponent; instead they use an entirely different strategy that exploits their stronger opponent's weaknesses. In business, this is essentially the judo strategy, or a way of disruptive innovation.

In the field of investment, I would add that underdogs are commonly known as the “contrarians” and are likely to have much greater odds of winning than the mainstream because of their ability to think independently and think 'outside the box' by going against the crowd and by challenging the conventional thinking or wisdom.

Achieving Financial Independence

Self development guru and author Michael Masterson lists Eight Rules for Financial Independence

Mr. Masterson at the Early to Rise writes, (italics mine, bold original)

When I decided to become rich, I began to keep a journal of thoughts I had about making money, losing money, and building wealth.

One chapter of that journal had to do with financial independence. And the eight rules I came up with then are the same rules I follow today:

1. You can't truly trust anybody but yourself with your money.

2. The harder someone tries to convince you to trust him, the less you should.

3. However good a track record someone has, never believe that he/she can't suddenly start your losing money. In fact, if you are like me, the moment you invest will be the moment his/her track record starts falling apart.

4. All markets rise and fall. Don't ever believe anyone who assures you that they can predict the future.

5. If you don't learn to spend less than you make, you will never have peace of mind.

6. Most of what you buy when your income is above $100,000 is discretionary. Don't fool yourself into thinking you need a big house or a fancy car.

7. In making financial projections for yourself or a business, always create three scenarios: one that shows what things will look like if everything goes as hoped; one that shows what will happen if things are mediocre; and one that shows what will happen if things fall apart.

8. Know that the third scenario is optimistic.

Add these up, and you will come to one inevitable conclusion:

The only way to be truly financially independent is to have multiple streams of income, each one of them sufficient to pay for the lifestyle you want to live.

The above mostly signifies common sense, contingency planning. determination and persistence all of which constitutes self-discipline.

Yet the most important point by Mr. Masterson is that “you cannot anybody but yourself.” This resonates with my latest advice:

What can be given are information relevant to attaining knowledge and skills. What can NOT be given is the knowledge that dovetails to one’s personality for the prudent management of one’s portfolio. Like entrepreneurship this involves a self-discovery process.

And most importantly, what can NOT be given are the attendant actions to fulfill the individual’s objectives.

Bottom line: Attaining financial independence starts with the self (Latin “Ï”), or the ability to think independently.

Are High IQs Key to Successful Investing?

Yale Professor Robert Shiller thinks so.

Writing at the New York Times,

YOU don’t have to be a genius to pick good investments. But does having a high I.Q. score help?

The answer, according to a paper published in the December issue of The Journal of Finance, is a qualified yes.

The study is certainly provocative. Even after taking into account factors like income and education, the authors concluded that people with relatively high I.Q.’s typically diversify their investment portfolios more than those with lower scores and invest more heavily in the stock market. They also tend to favor small-capitalization stocks, which have historically beaten the broader market, as well as companies with high book values relative to their share prices.

The results are that people with high I.Q.’s build portfolios with better risk-return profiles than their lower-scoring peers.

Certainly, caution is needed here. I.Q. tests are controversial as to what they measure, and factors like income, quality of education, and family background may not be completely controlled for. But the study’s results are worth pondering for their possible implications.

So how valid is such claim?

Let’s get some clues from some of my favorite investors.

Here is the legendary Jesse Livermore (bold emphasis mine)

The market does not beat them. They beat themselves, because though they have brains they cannot sit tight. Old Turkey was dead right in doing and saying what he did. He had not only the courage of his convictions but also the intelligence and patience to sit tight.

When I am long of stocks it is because my reading of conditions has made me bullish. But you find many people, reputed to be intelligent, who are bullish because they have stocks. I do not allow my possessions – or my prepossessions either – to do any thinking for me. That is why I repeat that I never argue with the tape.

Mr. Livermore simply posits that intelligence can be overwhelmed by egos and cognitive biases (particularly in the second quote the endowment effect, Wikipedia.org—where people place a higher value on objects they own than objects that they do not.).

Here is the 10 investing principles by another investing titan the late Sir John Templeton

1. Invest for real returns 2. Keep an open mind 3. Never follow the crowd 4. Everything changes 5. Avoid the popular 6. Learn from your mistakes 7. Buy during times of pessimism 8. Search worldwide 9. Hunt for value and bargains 10. No-one knows everything

More from John Templeton

“Bull markets are born on pessimism, grown on skepticism, mature on optimism and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.

Here is value investor turned crony, Warren Buffett. I’d say that Mr. Buffett’s original wisdom has been a treasure. (bold emphasis mine)

‘I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful.’

‘Read Ben Graham and Phil Fisher read annual reports, but don’t do equations with Greek letters in them.’

‘Never invest in a business you cannot understand.’

‘You’re neither right nor wrong because other people agree with you. You’re right because your facts are right and your reasoning is right – that’s the only thing that makes you right. And if your facts and reasoning are right, you don’t have to worry about anybody else.’

Does all the above sound like high IQ stuff? Evidently they represent more common sense and the school of hard knocks stuff.

Yet to the contrary, high IQs can translate to portfolio disasters.

The landmark bankruptcy by Long Term Capital Management in 1998 had been a company headed by 2 Nobel Prize winners. The company’s failure has substantially been due to flawed trading models.

In 2008, the 5 largest US investment banks vanished. These companies had an army of economists, statisticians and quant modelers, accountants, lawyers and all sort of experts who we assume, because of their stratospheric salaries and perquisites, had high IQs.

When Queen Elizabeth asked why ‘no one foresaw’ the crisis coming, the reply by the London School of Economics (LSE)

"In summary, Your Majesty," they conclude, "the failure to foresee the timing, extent and severity of the crisis and to head it off, while it had many causes, was principally a failure of the collective imagination of many bright people, both in this country and internationally, to understand the risks to the system as a whole."

Imagination had been scarce because the same army of experts heavily relied on mathematical models in dealing with investments. They did not follow the common sense advise by the real experts.

My favorite iconoclast author Nassim Taleb in Fooled by Randomness offers an explanation (emphasis added)

it is also scientific fact, and a shocking one, that both risk detection and risk avoidance are not mediated in the “thinking” part of the brain but largely in the emotional one (the “risk as feelings” theory). The consequences are not trivial: It means that rational thinking has little, very little, to do with risk avoidance. Much of what rational thinking seems to do is rationalize one’s actions by fitting some logic to them.

What the consensus mistakenly thinks as rational is, in reality, the emotional. Thus, we need more Emotional Intelligence (EI) rather than high IQs

The most important observation or lesson is one of the repeated botched attempts by high IQ people to transform investing into ‘science’.

Well, because investing involves people’s valuations and preferences, all of which constitutes human action, in truth, investing is more than science…

As the great Ludwig von Mises explained. (bold highlights mine)

For the science of human action, the valuations and goals of the final order at which men aim constitute the ultimate given, which it is unable to explain any further. Science can record and classify values, but it can no more "explain" them than it can prescribe the values that are to be acknowledged as correct or condemned as perverted. The intuitive apprehension of values by means of understanding is still not an "explanation." All that it attempts to do is to see and determine what the values in a given case are, and nothing more. Where the historian tries to go beyond this, he becomes an apologist or a judge, an agitator or a politician. He leaves the sphere of reflective, inquiring, theoretical science and himself enters the arena of human action.

...but rather, investing is an art.

Again Professor Mises from the same article.(emphasis added)

The position of science toward the other values of acting men is no different from that which it adopts toward aesthetic values. Here too science can do no more with respect to the values themselves than to record them and, at most, classify them as well. All that it can accomplish with the aid of "conception" relates to the means that are to lead to the realization of values, in short, to the rational behavior of men aiming at ends.

Bottom line: The art of managing our emotions or emotional intelligence, via common sense and self-discipline, is more important than having high IQs.

Sharp Market Gyrations Could Imply an Inflection Point

The path to a robust political economy must begin with treating political decision making (and the incentives and information embedded in that process) in the realm of policy making not as a footnote caution, but at the very beginning of the analysis.-Professor Peter Boettke

Violent gyrations in the equity markets usually occur during inflection or reversal periods of major trends.

While the current upside swing could reflect a bottoming phase, on the other hand, it could also reflect a transition towards a downside bias—a bear market.

For example, in 2007, after the first jolt from the market peak in July, both the major bellwethers of the US and the Philippines, the S&P 500 (blue-bar) and the Phisix (black candle), dramatically recoiled to the upside (red rectangles).

The initial rally saw both indices BROKE out of the resistance levels (green vertical lines) but eventually faltered. The second downswing had almost been a miniature replica of the first violent reversal.

Seen in the lens of a chart technician or chartist, such dynamic represents a chart pattern failure, where whipsaw motions can be identified as ‘bull traps’—or as investopedia defines[1],

A false signal indicating that a declining trend in a stock or index has reversed and is heading upwards when, in fact, the security will continue to decline

Consequently, following the two failed patterns which diminished the vim of the bulls, the bears assumed dominance.

Don’t Get Married to an Investing theme

I am NOT suggesting that today would be a repeat of 2007-2008.

I keep pounding on the fact that patterns only capture parts of the reality, where the motion of time will always be distinctive with reference to the changes brought about by people’s actions, as well as, the changes in the environment.

It would signify a monumental folly to bet the farm based on the expectation of pattern repetition alone.

And one of the major difference between today and 2007-2008 as I wrote last September[2]

Central bank activism essentially differentiates today’s environment from that of 2008.

As I explained before[3], my bias outcome is for a non-recession bear market.

I think current US markets will likely exhibit symptoms of the non recession bear markets of the 1962 (Kennedy Slide) and 1987 (Black Monday).

Charts from Economagic

And this should be reflected on global markets too

But exposing risk money based on personal biases can be very costly.

Individual expectation of the marketplace and reality usually depart. We DO NOT and CANNOT know everything, and should humbly accept such truism. The desire to see certain outcomes, when facts present themselves to the contrary, will inflict not only monetary losses, but most importantly, mental or psychic anguish from stubborn DENIAL.

This explains the popular trading maxim “Don’t get married to a stock.” Rephrasing this, we should NOT get married to an investment theme.

Prudent investing suggest that we should be taking action based on theory and backed by evidences which either confirms or falsifies it. Confirmation means that we can position to gain profits while a non-confirmation should impel us to consider exiting positions regardless of the profit or loss standings. Learning to manage the state of our emotions reflects on our degree of self-discipline.

And since our understanding of the marketplace shapes our expectations and our attendant actions, we need to seek constant improvement. Expanding our horizons should improve the batting average of our profitability or returns.

Going back to the financial markets, it has been my understanding that the principal drivers of the global financial markets has been the actions of political authorities. Their actions do NOT merely influence the markets, current policymaking via accelerating dosages of inflationism, myriad forms of trading controls and the imposition of byzantine financial and bank regulations represent as direct acts of market manipulation.

Political insider trading not only distorts price signals but importantly politicizes the distribution of gains towards the political class and their benefactors.

In short, in the understanding of the above we just should follow the money.

---

[1] Investopedia.com Bull Market Trap

[2] See Definitely Not a Reprise of 2008, Phisix-ASEAN Equities Still in Consolidation, September 18, 2011

[3] See Phisix-ASEAN Market Volatility: Politically Induced Boom Bust Cycles October 2, 2011

Investing Guru Joel Greenblatt: Focus on the Long Term

From Joel Greenblatt, author of The Little Book That Beats The Market and The Big Secret For The Small Investor, as interviewed at the Forbes [bold emphasis added]

if you look at top performers over the last decade, the top 25% of managers that have outperformed – came out with the best record for the last ten years – 97% of those top managers spent at least three years in the bottom half of performance.

79% spent at least three years in the bottom quartile of performance. And almost half, 47%, spent at least three years in the bottom 10% of performance. So all their investors left if they did that, but these are the ones who ended up with the long-term record. Most people leave them, most people don’t stick around for long enough.

Some important pointers from Mr. Greenblatt’s excerpt

Two lessons from planting (farming) which can be applied to investments:

1) time is essential or a prerequisite for a fecund harvest (in equities, outsized payoffs) and

2) we reap what we sow.

From such perspective one should realize that a portfolio built for the long term would likely undergo or endure early testing periods where underperformance represents a necessary but insufficient groundwork for prospective outperformance “Alpha”.

My experience with the domestic mining sector strongly relates to Mr. Greenblatt’s advise—patience ultimately rewarded by a time induced outperformance (following several years of underperformance).

Next, short term yield chasing activities represents as the common sin or shortcomings by the average investor.

Little has such adrenalin rousing actions been comprehended as a tactical folly based on two cognitive biases:

-hindsight bias or “inclination to see events that have already occurred as being more predictable” (or Mr. Warren Buffett’s rear view mirror syndrome) and

-survivorship bias or “logical error of concentrating on the people or things that "survived" some process” or chasing of current winners or market darlings.

Finally, the short term yield chasing approach vastly underperforms long term portfolios (see chart from Legg Mason’s Michael Mauboussin “A Coffee Can Approach”) since this represents as high risk-low return tactic which significantly diminishes returns.

Bottom line: Focus on the long term on the platform of understanding how the market works or has been evolving. In short, surf the bubble cycles.

From one of Warren Buffett’s best advise ever:

Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.

Philippine Mining Index Nearly at 20,000, Fulfilling My Predictions

Bear and endure: This sorrow will one day prove to be for your good. -Ovid

The Philippine Mining index soared to a fresh record high as major mining issues have been on a rampage.

Over the past years, many have questioned my premises and have impatiently chastised me for the underperformance of my pet sector. For me, these people wanted excitement and satisfaction of the ego, more than they desired profits.

And I have always used Ovid’s quote to justify my calls:

Everything comes gradually and at its appointed hour.

Here is what I wrote in November 2009[1],

From this juncture, we believe that the mining index next goal would conservatively be at least 20,000.

With the Philippine mining index at 19,975 or 25 points away, it would appear that NOW is the appointed hour!

It’s not only that the 20,000 level that is in near fulfilment, but most importantly would be how these series of events are being realized.

Again me in 2009, (bold highlights original)

Actions among the mining components appear to be rotational- a classic symptom of bullmarket driven by inflation. This implies that the next major moves could likely come from those that have been in a reprieve.

Market trends are social trends. As mentioned above, the speculative label on the mining industry is a symptom of the lack of social acceptance or persistent aversion emanating from over two decades of depression. Essentially such resistance is psychologically bullish. That’s because despite present levels, only a handful have been invested. In social terms, bandwagon effect occurs when trends are reinforced by confirmation of expectations. In other words, long term trends draws in more converts.

First, today’s fiercely rallying mining issues have been broadening.

The first time the local mining index surpassed the previous record high was due to the blitzkrieg of Philex Mining. Today’s juggernaut has included many other issues as Lepanto [PSE:LC], Semirara [PSE:SCC], Atlas Consolidated [PSE:AT], PetroEnergy [PSE: PERC] and Manila Mining [PSE: MA].

Second, the broad based rally has been winning many converts. Even my mentor who has been a staunch mining critic now trades the sector.

In terms of Peso value traded, the mining sector accounts for 18% of this week’s trade which would have been larger (about 20%) if special block sales is excluded. To consider, the Philippine Stock Exchange has 6 sectors which means the share of the others have been captured by the mining sector.

In addition, the mining sector grabbed the top spot in terms of peso value, in two of the four trading days this week.

These are evidences which continues to manifest how investing in mines and resource sectors have transitioned from the fringes and into the mainstream.

The Rotation to Atlas-APO

The recent actions of the mining sector has shifted to Atlas Consolidated [PSE: AT] and the Forbes 28^th richest[2] Philippine tycoon Alfredo Ramos’ investment vehicle, Anglo-Phil Holdings [PSE: APO]

Many have attributed APO’s eye-popping 66% surge this week to the developments of the Atlas Consolidated, from which APO has an 11.67% stake in[3].

Atlas Consolidated, which gained 19% over the week, has reportedly offered to buy her Singaporean partners in a $368 million deal[4], which will be funded by debt and equity.

Some have speculated that part of this equity side of the deal has been designed to include Manny Pangilinan’s entry into Atlas via Philex Mining[5].

That would be fait accompli.

I would have a different story.

The actions of Atlas [green] and Philodrill [blue; PSE: OV], which APO has a .28% stake in, have been tightly correlated with the actions of APO. Such close correlations can be traced way back to 1998. Though the correlation has not been 100%; seen from major trend movements, the APO and AT-OV correlation seem to be in the bag.

Recently, Atlas has been moving higher along with other mining issues. I was partly concerned that the overbought conditions in major issues as Lepanto, Philex and Manila Mining could affect Atlas[6]. Apparently it didn’t.

Also, I spoke about the resurgence in the oil sector[7] which was led by Philodrill. Yet APO lagged as both Atlas and OV ascended. Such deviation presented a buying opportunity for me. [disclosure: I bought APO shares during this window and perhaps got lucky; I have long been a shareholder of LC, PERC, AT]

Then, I can’t say about the specifics of these deals which I would not ever be privy to until after the fact.

Yet since 2003 (see my initial prediction at safehaven.com[8]), I have long been saying that investments trends will favor the local mining and resource based industries considering that the Philippines is a resource rich nation which has mainly been untapped.

Yet I don’t need to know the specifics. I only need to know about the general trend.

And all these forces have been validating my long held premises.

In the 1970s, Atlas Consolidated was considered a blue chip and was traded at php 400s levels.

For me this means that most, if not all mining and resource based issues, will rise far beyond current price levels over the coming years, but will be subject to the flows and ebbs of the global boom bust cycles.

Not only because these sectors represent as investments, but importantly, because resource based securities will account for as hedges against central bank inflationism.

Once the risk of an inflationary panic becomes a reality, where physical metal will get drained from the spot markets, mining issues will likely serve as the next object of the ‘flight to value’.

For now, APO and AT could be short term sells considering the massive moves that has brought them to overbought levels. Yet momentum and bullmarket sentiment can lead them to vastly extended zones similar to what has been happening to Lepanto.

For most occasions market timing for me is about luck, unless one can spot rare arbitrage opportunities as the above.

Yet I always recommend investments in the prism of medium to longer term basis and hardly about market timing or short term scalps.

Importantly, these themes have to be backed by theories that work with evolving general conditions and not just to feed the intellectual ego.

Yet it does surely feel good to get validated anew. I thank my dear Lord for this special insight.

To close, again I quote Ovid,

Time is generally the best doctor.

Indeed.

---

[1] See Prediction Fulfilled: Philippine Mining Index Tops 9,000 (Now 11,300!), November 15, 2009

[2] Forbes.com #28 Alfredo Ramos, Philippines 40 richest

[3] Anglo Philipines Holdings Corporation Business Interest

[4] Reuters.com Manila's Atlas to fully own Carmen Copper in $368 mln deal, June 24, 2011

[5] Abs-cbnnews.com Philex climbs most in 6 months on Atlas speculation, June 25, 2011

[6] See Phisix: Why I Expect A Rotation Out of The Mining Sector, May 15, 2011

[7] See The Awakening of the Philippine Oil Exploration Sector?, May 22, 2011

[8] Safehaven.com The Philippine Mining Index Lags the World, September 26, 2003

Hi Ho Silver!

Silver prices went ballistic and has virtually outclassed its commodity peers!

I included the S&P 500 (red) and the emerging market benchmark EEM (blue green) [chart from stockcharts.com]

The parabolic rise of Silver (51% year to date) may give the impression of a bubble at work. Could be, but other commodities have not been emitting the same signals.

Bubbles usually can be identified by across the board ‘rising tide lifts all boats’ increases. The same dynamic can be seen in a ‘flight to real asset’ phenomenon. The difference is with the subsequent outcomes: a boom goes bust while a crackup boom segues into hyperinflation.

The exemplary performance of silver can also due to another fundamental factor: A massive short squeeze!

Writes Alasdair Macleod of Goldmoney, (bold highlights mine)

There are a few banks with large short positions in silver on the US futures market in quantities that simply cannot be covered by physical stock. The outstanding obligations are far larger than the stock available. The lesson from the London Bridge example is that prices in a bear squeeze can go far higher than anyone reasonably thinks possible. The short position in gold is less visible, being mainly in the unallocated accounts of the bullion banks operating in the LBMA market. But it is there nonetheless, and the bullion banks’ obligations to their bullion-unallocated account holders are far greater than the bullion they actually hold.

But there is one vital difference between my example from the property market of 1974 and gold and silver today. The bear who got caught short of London Bridge Securities was right in principal, because LBS went bust shortly afterwards; but in the case of gold and silver, the acceleration of monetary inflation is underwriting rising prices for both metals, making the position of the bears increasingly exposed as time marches on.

No trend goes in a straight line. So silver prices may endure sharp volatilities in the interim.

However, if the short squeeze fundamental narrative is accurate, which will likely be amplified or compounded by the monetary inflation dynamics, then as the fictional TV hero the Lone Ranger would say,

Hi-yo, Silver! Away!

Post Script:

Here is where Warren Buffett made a big mistake.

Berkshire Hathaway reportedly bought 130 million ounces of silver in 1998 at an average of $5.25 per oz. which he subsequently sold at about $7 in 2006. His ideological aversion to metals made him underestimate Silver’s potentials.

Lesson: ideological blind spots can result to huge opportunity costs.

Warren Buffett Is Human

What I mean is that investing guru Warren Buffett makes mistakes like anyone else.

Joe Mont writes, (bold emphasis mine)

In a recent annual letter to Berkshire Hathaway (BRK-A) shareholders, an eagerly awaited piece of investing insight, Buffett cops to several mistakes. Among them: authorizing the purchase of a large amount of ConocoPhillips stock when oil and gas prices were near their peak. A dramatic fall in energy prices soon followed.

"The terrible timing of my purchase has cost Berkshire several billion dollars," Buffett wrote, segueing into regret over a $244 million parlay in two Irish banks "that appeared cheap" but soon incurred an 89% loss on the initial investment.

"The tennis crowd would call my mistakes 'unforced errors,'" Buffett said.

When a Buffett, Bill Gross or Larry Fink publicly discusses bad decisions, it makes headlines. But there is hardly an investor, pro or amateur, who doesn't have some woeful tale of a sure thing that wasn't or can't-miss advice that did. The key is learning from mistakes and moving on.

The main difference between the pros and the tyros is the ability to accept the emotional and self-esteem angst of making wrong decisions and consequently adapting remedial measures. Yet for many, investing is like a one way street: cash in on profits (or brag about success) and long the losses (or deny the errors).

Another aspect here, aside from human frailty issue, could be one of “karma”.

I have pointed out that Warren Buffett seems to have been transformed from a value investor to a political entrepreneur or an agent who directly profits from government actions/concessions (such as bailouts). Apparently this time investing on such special political conditions engineered by the government (Irish banks) didn’t work.

Since bailouts signify redistribution of resources to political benefactors at the cost of taxpayers, then Mr. Buffett’s loss could be construed in the light of poetic justice.

Seth Klarman's Forgotten Lessons of 2008

Interesting insights from market guru Seth Klarman, courtesy of My Investing Notebook

(all bold highlights mine), [my comments]

In this excerpt from his annual letter, investing great Seth Klarman describes 20 lessons from the financial crisis which, he says, “were either never learned or else were immediately forgotten by most market participants.”

``One might have expected that the near-death experience of most investors in 2008 would generate valuable lessons for the future. We all know about the “depression mentality” of our parents and grandparents who lived through the Great Depression. Memories of tough times colored their behavior for more than a generation, leading to limited risk taking and a sustainable base for healthy growth. Yet one year after the 2008 collapse, investors have returned to shockingly speculative behavior. One state investment board recently adopted a plan to leverage its portfolio – specifically its government and high-grade bond holdings – in an amount that could grow to 20% of its assets over the next three years. No one who was paying attention in 2008 would possibly think this is a good idea.

``Below, we highlight the lessons that we believe could and should have been learned from the turmoil of 2008. Some of them are unique to the 2008 melt- down; others, which could have been drawn from general market observation over the past several decades, were certainly reinforced last year. Shockingly, virtually all of these lessons were either never learned or else were immediately forgotten by most market participants.

Twenty Investment Lessons of 2008

1. Things that have never happened before are bound to occur with some regularity. You must always be prepared for the unexpected, including sudden, sharp downward swings in markets and the economy. Whatever adverse scenario you can contemplate, reality can be far worse.

[In a world of fiat money, one must realize that bubble cycles are its main feature. It's all a matter of understanding and timing the cycles]

2. When excesses such as lax lending standards become widespread and persist for some time, people are lulled into a false sense of security, creating an even more dangerous situation. In some cases, excesses migrate beyond regional or national borders, raising the ante for investors and governments. These excesses will eventually end, triggering a crisis at least in proportion to the degree of the excesses. Correlations between asset classes may be surprisingly high when leverage rapidly unwinds.

[Bubble mechanism is generally a feedback loop between prices and collateral values]

3. Nowhere does it say that investors should strive to make every last dollar of potential profit; consideration of risk must never take a backseat to return. Conservative positioning entering a crisis is crucial: it enables one to maintain long-term oriented, clear thinking, and to focus on new opportunities while others are distracted or even forced to sell. Portfolio hedges must be in place before a crisis hits. One cannot reliably or affordably increase or replace hedges that are rolling off during a financial crisis.

4. Risk is not inherent in an investment; it is always relative to the price paid. Uncertainty is not the same as risk. Indeed, when great uncertainty – such as in the fall of 2008 – drives securities prices to especially low levels, they often become less risky investments.

["Risk comes from not knowing what you are doing" or "the dumbest reason in the world to buy a stock is because it's going up" to quote Warren Buffett.]

5. Do not trust financial market risk models. Reality is always too complex to be accurately modeled. Attention to risk must be a 24/7/365 obsession, with people – not computers – assessing and reassessing the risk environment in real time. Despite the predilection of some analysts to model the financial markets using sophisticated mathematics, the markets are governed by behavioral science, not physical science.

[models function as scientific rationalizations to peddle unrealistic premises]

6. Do not accept principal risk while investing short-term cash: the greedy effort to earn a few extra basis points of yield inevitably leads to the incurrence of greater risk, which increases the likelihood of losses and severe illiquidity at precisely the moment when cash is needed to cover expenses, to meet commitments, or to make compelling long-term investments.

7. The latest trade of a security creates a dangerous illusion that its market price approximates its true value. This mirage is especially dangerous during periods of market exuberance. The concept of "private market value" as an anchor to the proper valuation of a business can also be greatly skewed during ebullient times and should always be considered with a healthy degree of skepticism.

8. A broad and flexible investment approach is essential during a crisis. Opportunities can be vast, ephemeral, and dispersed through various sectors and markets. Rigid silos can be an enormous disadvantage at such times.

9. You must buy on the way down. There is far more volume on the way down than on the way back up, and far less competition among buyers. It is almost always better to be too early than too late, but you must be prepared for price markdowns on what you buy.

[For a value investor-yes, averaging down is a commendable approach, but for traders the play is different]

10. Financial innovation can be highly dangerous, though almost no one will tell you this. New financial products are typically created for sunny days and are almost never stress-tested for stormy weather. Securitization is an area that almost perfectly fits this description; markets for securitized assets such as subprime mortgages completely collapsed in 2008 and have not fully recovered. Ironically, the government is eager to restore the securitization markets back to their pre-collapse stature.

[the danger from financial innovation stems from elite political entities gaming the system]

11. Ratings agencies are highly conflicted, unimaginative dupes. They are blissfully unaware of adverse selection and moral hazard. Investors should never trust them.

[rating agencies are part of the network of political enterprises]

12. Be sure that you are well compensated for illiquidity – especially illiquidity without control – because it can create particularly high opportunity costs.

13. At equal returns, public investments are generally superior to private investments not only because they are more liquid but also because amidst distress, public markets are more likely than private ones to offer attractive opportunities to average down.

14. Beware leverage in all its forms. Borrowers – individual, corporate, or government – should always match fund their liabilities against the duration of their assets. Borrowers must always remember that capital markets can be extremely fickle, and that it is never safe to assume a maturing loan can be rolled over. Even if you are unleveraged, the leverage employed by others can drive dramatic price and valuation swings; sudden unavailability of leverage in the economy may trigger an economic downturn.

[leverage is the fuel of all bubbles]

15. Many LBOs are man-made disasters. When the price paid is excessive, the equity portion of an LBO is really an out-of-the-money call option. Many fiduciaries placed large amounts of the capital under their stewardship into such options in 2006 and 2007.

16. Financial stocks are particularly risky. Banking, in particular, is a highly leveraged, extremely competitive, and challenging business. A major European bank recently announced the goal of achieving a 20% return on equity (ROE) within several years. Unfortunately, ROE is highly dependent on absolute yields, yield spreads, maintaining adequate loan loss reserves, and the amount of leverage used. What is the bank's management to do if it cannot readily get to 20%? Leverage up? Hold riskier assets? Ignore the risk of loss? In some ways, for a major financial institution even to have a ROE goal is to court disaster.

17. Having clients with a long-term orientation is crucial. Nothing else is as important to the success of an investment firm.

[Amen!!!!]

18. When a government official says a problem has been "contained," pay no attention.

19. The government – the ultimate short-term-oriented player – cannot withstand much pain in the economy or the financial markets. Bailouts and rescues are likely to occur, though not with sufficient predictability for investors to comfortably take advantage. The government will take enormous risks in such interventions, especially if the expenses can be conveniently deferred to the future. Some of the price-tag is in the form of back- stops and guarantees, whose cost is almost impossible to determine.

20. Almost no one will accept responsibility for his or her role in precipitating a crisis: not leveraged speculators, not willfully blind leaders of financial institutions, and certainly not regulators, government officials, ratings agencies or politicians.

[except for leverage speculators, all the rest compose of the political networks]

Below, we itemize some of the quite different lessons investors seem to have learned as of late 2009 – false lessons, we believe. To not only learn but also effectively implement investment lessons requires a disciplined, often contrary, and long-term-oriented investment approach. It requires a resolute focus on risk aversion rather than maximizing immediate returns, as well as an understanding of history, a sense of financial market cycles, and, at times, extraordinary patience.

False Lessons

1. There are no long-term lessons – ever.

[I'd like to add: "Blue chips" are risk free!]

2. Bad things happen, but really bad things do not. Do buy the dips, especially the lowest quality securities when they come under pressure, because declines will quickly be reversed.

3. There is no amount of bad news that the markets cannot see past.

4. If you’ve just stared into the abyss, quickly forget it: the lessons of history can only hold you back.

5. Excess capacity in people, machines, or property will be quickly absorbed.

[digging and filling holes on the ground as proposed by the mainstream will]

6. Markets need not be in sync with one another. Simultaneously, the bond market can be priced for sustained tough times, the equity market for a strong recovery, and gold for high inflation. Such an apparent disconnect is indefinitely sustainable.

7. In a crisis, stocks of financial companies are great investments, because the tide is bound to turn. Massive losses on bad loans and soured investments are irrelevant to value; improving trends and future prospects are what matter, regardless of whether profits will have to be used to cover loan losses and equity shortfalls for years to come.

[not unless taxpayers shoulder the losses]

8. The government can reasonably rely on debt ratings when it forms programs to lend money to buyers of otherwise unattractive debt instruments.

[this called confirmation bias]

9. The government can indefinitely control both short-term and long-term interest rates.

10. The government can always rescue the markets or interfere with contract law whenever it deems convenient with little or no apparent cost.

[this is a fairy tale relied upon by the government and the mainstream]

(Investors believe this now and, worse still, the government believes it as well. We are probably doomed to a lasting legacy of government tampering with financial markets and the economy, which is likely to create the mother of all moral hazards. The government is blissfully unaware of the wisdom of Friedrich Hayek: “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”)-[Indeed!!!]