Rudi On Thursday

This story features NEWS CORPORATION, and other companies. For more info SHARE ANALYSIS: NWS

Dear Trish,

I apologise for my somewhat annoyed reaction to the message you posted on the website earlier this week. I realise that, of course, you are not continuously following the markets as closely as I am (you probably have better things to do, as for me this is in essence what I am supposed to do), and you probably don’t have as many resources available as we have here at FNArena.

When you asked me on Monday whether there was any news to report about the direction of the oil price I got somewhat annoyed and told you I was getting tired. I was getting tired of repeating that crude oil should have never been at US$147 per barrel, and now that the mass-euphoria was gone (or was it mass-hysteria?) it wouldn’t be long before oil would fall through support at US$110, and after that US$100 would follow and not long thereafter we would see oil priced back in double digits – just like I have been saying for months now.

I do realise that for the most part of the past few months I, and my colleagues here at FNArena, have been a lone voice amidst a tsunami of reports about the new era for oil -essentially US$100-plus forever- intertwined with peak oil theories and other upbeat claims and predictions, none of which will stand the test of reality.

It is not easy, not only for you, but for any investor out there, to see what’s really going on and to make a decision about whose insights you should value more than others’. Common logic tells you the odds are in favour of the majority being right. After all, one of the greatest institutions we humans have ever put in place, democracy, is based upon this simple concept. When in doubt, follow the majority. It always seems to work when you don’t know which way is best, but you somehow guess the others are ultimately heading for the same destination.

Well, if the past has taught me anything it is that following the majority doesn’t work when it comes to investing. Frankly, Trish, the majority is at least equally as often wrong as it is right. And I see confirmation after confirmation of this, all around me, day in, day out. Two years ago I wrote a story about how one certain gold producer in Victoria, Perseverance Corp, was rated Buy by all securities analysts in the country who covered the stock. No matter how hard I sought, and how many phone calls I made, asked around, searched the internet, I couldn’t find one single analyst who did not have a Buy rating on the stock.

Now that deserves a story!

Well, that’s what I thought at the time. At first it seemed like I had picked up the most obvious story at the perfect timing. Stockbrokers around the country sent my story around, internally, and externally to all their prospects and customers. Other media outlets reprinted my story, or quoted from it. And investors bought shares in the company. After all, if everyone says it’s a buy, how wrong can one be?

Very wrong, it turned out. A few months later the company was almost bankrupt. It was forced to hoard cash and saw its share plunge to deeper and deeper depths. Then someone came along and offered a premium. That was the end of Perseverance as a listed entity. Everyone lost money. Including myself. Not that I had bought any shares, but after that people would say Rudi, I know you didn’t recommend the stock, but I bought shares and that decision was made on the basis of your story, so you are at least partly responsible for my losses. In the end there were no winners left standing, except maybe the guys who offered the final bid.

What happened to all those Buy recommendations? Long story cut short: they turned into downgrades after the share price had more than halved.

Since then we at FNArena tend to look with different eyes towards stocks that only carry Buy ratings. Such as News Corp ((NWS)). Anyone looked at the share price graph of News Corp from the past two years? The stock has carried an almost perfect Buy score throughout the full period.

Don’t get me wrong, Trish, I am not saying there’s no value in analysts forecasts and views, or that we should automatically do the opposite, but what I have observed over the years is that one should be very cautious when everyone is pointing into the same direction. As I have previously tried to explain to a few colleague-subscribers of yours, when you see one lone voice outside the large group, go and check him out, because my personal experiences and analyses have taught me that those lone opposing voices are more often than not the ones who deserve your attention.

Unfortunately, there was nobody among those who covered Perseverance at the time with a different view, but when the world awoke to subprime mortgages mid-last year, one JP Morgan analyst said Australian banks were in for a tough time. Everybody else would tell you at the time banks were still among the safest investment options around. Guess who has been proved correct?

There are plenty of similar examples from the recent past I can recall instantly. When everybody was still mesmerised by uranium and in particular by Paladin Resources ((PDN)), analysts at GSJB Were slapped a Sell recommendation on the stock and elevated it to the sole Sell rated stock on their Conviction List. (You know what happened next).

More recently, I noticed everybody was putting Buy ratings on OZ Minerals ((OZL)). Everybody except Deutsche Bank. So what was Deutsche saying? Effectively the same as all the others, except for one thing: don’t expect the share price to recover until zinc prices do.

Are zinc prices going to recover? Well, they cannot go much lower than where they are now, said the others, surely a recovery must follow some time soon. Guess what happened next? More and more price forecasts for zinc are being pulled back. Some experts are now saying they have lost faith in their own conviction; zinc prices might well fall further still as that is effectively what is happening nearly every day. But maybe the most important message from all this is that zinc prices are being scaled back for next year and for the year thereafter too.

How long before others join Deutsche and pull their rating one notch lower?

Don’t get me wrong Trish, there is not one single golden rule that works all the time. There are plenty of examples that would offset all of the above. At one time, in the early beginnings of the past bull market, all analysts rated BHP Billiton a Buy. Well, we have all been able to witness how correct that call turned out to be.

Trish, maybe the best thing to remember from all this is: securities analysts, financial journalists, market watchers and investors – at the end of the day, and above anything else, they are all human. And with that comes failure. And a herd mentality.

Before you ask: I don’t know why we were the only ones who saw what was happening in the oil market. But here’s one question I’d like to ask you in return: did you know that Goldman Sachs and Morgan Stanley are among the largest oil traders in the world? You do remember who was putting out those reports about US$150 and US$200 per barrel price projections, don’t you?

Trish, I really don’t want to know as I like to communicate freely and without any inhibitions, but I suspect you are a current shareholder of Woodside Petroleum ((WPL)) and of BHP Billiton. Well, that would explain your question from Monday. (But please don’t confirm as I don’t want to know). If you feel caught between sitting this current correction out or taking the hard medicine, I have some consolation for you: today it was announced that one of the better known hedge fund operators in the US, Dwight Anderson’s Ospraie, has had to close down one of three hedge funds because of insurmountable losses occurred in energy and resources stocks.

Trish, this is not just another marginal event. Dennis Gartman reported today “Dwight [Anderson] is one of the wisest and most in-depth researchers in the business. His understanding of the fundamentals of many, many different commodity markets is encyclopeadic”.

You are not the only one, Trish.

But having said so, September has started off on a very wobbly note for commodities, crude oil in particular, and maybe this deserves more than your usual attention, Trish. Because if you are currently weighing up your options about what to do, you might want to take into consideration that what has happened over the past two days might just be the key message fund managers in the US are sending to the rest of the world: hey, we’re back from holidays and we’re going to reshuffle things in their right order.

It would seem they don’t think crude oil should be lingering around US$115, or that gold should be anywhere near US$900/oz, or that copper should be close to US$8000/tonne.

I spotted an interview with the always pleasant to watch Marc Faber on the Bloomberg website today. I’d already seen it on TV, and didn’t realise it was the same interview. It’s actually about Thailand, but in between questions the interviewer touches upon a few other themes. It turns out Faber is very firm about what’s going to happen with oil: cheaper, much cheaper. And he says oil will drag down all the other commodities with it.

I tried to insert a direct link to the interview, but that didn’t work. Trish, you can probably search under “oil” or “Faber” on the Bloomberg website and watch the broadcast yourself. In case you are time poor I can report that Faber forecasts the current correction for oil, and commodities in general, has a long way to go still. Three to six months he says in the interview. But more ominously, Faber says he wouldn’t be looking at buying before this correction has fully played out and there is more clarity on what the precise implications from this correction will be.

In other words: whether this will turn out to be a short term phenomenon, or one with longer term implications is yet to become clear according to Faber. I know Trish, I suggested in my Weekly Insights this week that investors in commodities should prepare for a much slower growth pace in the years ahead, but I still find it scary when experts of the calibre of Faber dare to go one step further still.

A few months ago already, I told you and other readers at FNArena, there are more factors than simply the China demand story that move commodities. I also said several of the once supportive factors had started to turn against commodities. Last month I opened one of my weekly editorials with the following statement (I am sure you do remember, but just in case):

“If the dust has settled post the current price correction across the commodities complex it will have turned out to be the most severe correction investors have seen for many, many years. It will certainly be much bigger than anything they have seen since 2002, when the initial beginnings surfaced of what later became a once-in-a-lifetime Super Boom for commodities.

Trish, what I am trying to say here is that I haven’t changed my view on this. And if people such as Marc Faber are now even going one leap further, maybe it’s time to really start paying attention.

Trish, we’ve been corresponding for a while, so I’ll let you in on a little secret. When I look around, read other experts’ views and advice, look at what is happening in the share market and I compare all this with what my own analysis and insights are telling me, I see an eerie similarity between what is happening now in commodity markets and what happened from mid-last year onwards with shares in financial companies. Remember the general theme back then? It would all be ok, temporarily at worst, and surely after every down-day there were a handful of quotes and statements in the media by experts expressing their amazement, if not disbelief, about how investors were treating share prices of those good old reliable, safe and valuable banks and insurance companies.

We know now who was correct.

In my view this whole commodities theme has turned into a religion, Trish. You don’t know me that well, but you would probably have guessed I am not the church going type. I don’t mind if other people do, I respect them for it. However, I do believe religion and financial markets don’t mix. Too many experts out there, I believe, have turned themselves into modern day apostles of the new commodities forever-religion. They don’t know any better than me or Marc Faber how exactly this commodities correction is going to play out, but they have nevertheless elevated investing in commodities into an act of faith.

Don’t question, believe. Believe! Have faith.

Me, I’d rather do some extra research. Hey, you know what I found out this week? In the week past we had a few stories that said September has historically been the worst performing month for US equities. A few of your colleague-subscribers questioned this as their data indicated September wasn’t that bad at all in the years past. So where does this difference come from, they asked?

I just found out that US shares tend to weaken from week three in September till mid-October. This would make sense and as such the ultimate performances of September and October, on historical data, would depend on what happens in the two weeks before and after this seasonal weakness kicks in. Don’t you think this is an interesting insight?

Towards the end of September US investment banks will be releasing their next market updates. Also, the end of September marks a quarterly window for investors in hedge funds who want to withdraw (some of) their funds. Quite feasible hedge funds will be selling assets to generate sufficient liquity to reimbourse those who opt out, don’t you think?

Ok, here’s one more conclusion I have drawn from recent market movements: the sudden switch from inflation worries towards growth concerns has taken most investors by surprise. How else to explain the fall in the Aussie dollar from US$0.97 to US$0.82 in only a few weeks time? And did you notice what the effect was on share prices? Let me point you out a few: ResMed ((RMD)) up more than 50%; Billabong ((BBG)) up more than 30%; PaperlinX ((PPX)) up more than 20% and even News Corp (yeah, yeah, the same as I mentioned above) is up nearly 20%. All currency driven. (All gains mentioned since mid-July).

This reminds me, it’s a still a bear market. Money always has to switch out of something before it can move into something else. See Trish, in a bull market there’s plenty of money around so all stocks can go up. In a bear market a gain somewhere by definition implies a loss elsewhere. I think we both know where the money came from that went into the shares above, don’t we?

I noticed Westpac ((WBC)) shares are trading above their average price target. We’re in the first week of September. Oil has now fallen below its 200-day moving average. You still remember what I reported last week? About October? Maybe have another look at last week’s editorial. Always good to refresh your memory.

Till next week,

Your editor,

Rudi Filapek-Vandyck
(As always firmly supported by Greg, Sarah, Chris, Andrew, Joyce, Todd, Pat, George and Grahame)

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