Below is a preview of the CMV (Contrarian Market View) Newsletter for November. See the end of this post for a free book offer with the purchase of a subscription to the full monthly newsletter. (Note: due to the limitations of a blog post the appearance of this preview is not as it will appear in the actual subscriber copy.)
H. L. Quist's
Contrarian Market View
Newsletter
Market Overview
CMV deliberately delayed the November issue in order to incorporate the two major events that will have a significant impact on our country and our economy for the next two years:
THE ELECTION, and
THE FEDERAL RESERVE STIMULUS
It didn’t make sense to speculate on what may happen when we could be more definitive. CMV apologizes for your angst over the delay. The election represents a resounding rebuke of the ideology of Collectivism and the Democrat’s agenda that they didn’t reveal and the voters didn’t want. The great irony of this historical event is:
BARAK OBAMA WAS THE BEST THING THAT
HAPPENED TO AMERICA!
Why? BO woke up a sleepy citizenry whose passivity and complacency allowed Hope and Change to come to power in 2008. Now, the Republicans must deliver and not succumb to the big money special interests and business as usual that has governed for the past 50 years and has brought this country to the abyss. It’s CMV’s view that if the Republicans fail to deliver, the Tea Party will become a new THIRD PARTY and play a pivotal role in 2012 and the future. You read it here first.
The first order of business is to stop the fiscal bleeding (deficit spending) but within months there could be blood in the streets. Numerous cities and states in America have been and are relying next year on the federal government to bail them out. Unknown to most Americans, 30% of California’s debt issuance in 2010 has been subsidized by the federal government in a program known as Build America Bonds. California is not alone. 30% of Illinois’ debt and 40% of Nevada’s debt has also been subsidized. New York state has spent in excess of 250% of its’ tax receipts over the last 10 years. Some of these funds have been used to continue pension payments and salaries. Will the “new” Congress have the fortitude to tell the states to go cold turkey or will it be business as usual? Make no mistake about it, budget cuts and reversal of socialism is going to be accompanied by considerable rancor. There won’t be ‘reconciliation.’
Let’s look at the positive. CMV believes that there will be a sea change in public sentiment in 2011 that will reverse high unemployment and increase the nation’s GDP and tax receipts. Large US corporations, small business owners and investors, and those individuals who are the decision makers can now, more confidently, invest in America. CMV forecasts that the economy’s performance (absent an outside event) will surpass most economists’ projections next year.
The Fed’s long anticipated announcement on QE2 was much ado about nothing. Bill Gross (PIMCO) said it was “neutral.” In short, the Fed’s combined purchases of treasuries and other assets will total $110 billion per month which was already baked into the cake. Also contained in the announcement was the Fed’s commitment to retain all rates at their present level for “an extended period of time.” The Fed’s goal is to create inflation that will ostensibly create new jobs while maintaining historically low interest rates. Sounds more oxymoranic than axiomatic doesn’t it?
Two economists at Goldman Sachs wrote a piece on October 25th that, in their opinion, the Fed really needs to buy a staggering $4 trillion in assets to get the economy rolling. That’s in addition to the Fed’s current bloated balance sheet of $2.3 trillion. The numbers are as incomprehensible as they are unsustainable. The question that should be asked, is, Why will QE2 work when the $800 billion stimulus Plan and QE1 did not? CMV will answer its’ own question. Change in public SENTIMENT. If business and the public are fearful of its’ government, no amount of liquidity could move the yardsticks. QE2 and a change in SENTIMENT (post-election) could lead to overkill and a year from now the “I” word (that’s not impeachment) will be on everyone’s lips. The Fed’s goals is to push investors out of bonds and into higher risk assets. Can you say: REAL ESTATE?
Here’s how the law of unintended consequences will negatively impact the Fed. They presently have $1,079 trillion of 30 year fixed-rate MBS (bonds) on their balance sheet. If (actually when) interest rates rise from 4% to 5%, the net asset value of those MBS securities will decline by about $162 billion! To the Fed it matters not. Their assets are derived from funny money but to bond investors it’s real money. The bond bubble will burst. Before that occurs, however, CMV and its’ subscribers will be on the stage and out of Dodge. In the interim however, let’s ride the wave of asset inflation.
Quantifying Risk
Let’s assume that you’re a subscriber of CMV or have previewed an issue on-line and have a brokerage account with a major Wall St. firm. You’ve observed that certain names recommended by CMV have produced outsized gains YTD in excess of 100%. You suggest to your broker that you would like to add a few of these names to your portfolio. In all probability your broker’s reply will be:
“You don’t want to buy that company. It’s too RISKY!”
It matters not that for the past 10 years ending 12/31/09 you have been at risk in an S&P 500 Index Fund which has produced a zero return. It matters not that your “blue chips” GE, MSFT, et al, have been dead money for 10 years. So, what’s at work here? First, your broker is probably unfamiliar with sectors such as precious metals, uranium, rare earths, commodities, etc. and you can be assured that your broker will be DOWN on what he or she isn’t UP on. Secondly, the Wall St. firm may not allow their reps to buy those names, and thirdly, which is the point of this piece, they don’t know how to Quantify Risk.
The following methodology has been utilized by your writer for many years particularly in a market environment that exists today that, properly administered, results in these outsized gains. Small and large fortunes can be realized in “penny stocks” in the resource sector but an investor must apply a different set of rules in order to Quantify Risk. Here are a few:
1. Sector Rotation & Momentum:
As CMV has repeated over and over, understanding the MACRO picture is critical to investing which is the microcosm. Grasping the significance and purpose of the devaluation of the US Dollar would have enabled the investor to see that there would be a major sector rotation to precious metals, commodities and a short position in the USD. Risk is minimized when you secure a position in the very early stages of a sector rotation that gathers momentum as CMV will illustrate below.
2. Sector Fundamentals:
What sustains a sector rotation over a larger time span is a supply-demand imbalance. Most analysts will take a position that gold is a “timing” asset class and it only appreciates when there’s fear in the global markets or when inflation (which the talking-heads on CNBC say is non-existent) effects the CPI. Almost entirely ignored is the fact that gold bullion has appreciated from $253/oz to $1,350/oz in 10 years, and investor, commercial and industrial demand far exceeds annual supply.
Rare earths are a current phenomenon. Since China controls 97% of the world’s production of rare earth elements that are absolutely essential for a digital and green world and is cutting exports to Japan and the US, fundamentals are driving the price of the metals and thus the stock price.
3. Microcaps (Penny Stocks):
Most large brokerage firms will not allow their reps to purchase penny stocks for their clients. Certainly, brokers and investors have incurred massive losses in this arena but here’s how you can reduce your chance of loss and improve the upside:
a. Management
Choose companies that have executives who have achieved prior success. Use the “net.” You can find out just about anything on anybody searching the Internet. A past failure or SEC censure is a red flag and there are lots of them.
b. Stock Prices & Capitalization
For names under $1.00/sh look for companies with no more than 25 to 50 million shares outstanding. Early stage exploration companies, for example, will need to raise additional capital which means dilution to existing shareholders. If an exploration company has 50 million shares out and sells out for one billion cash the investor will realize $20/sh. If a company has 300 million shares out, the investor would realize $3.33/sh
Assuming that the microcap has the ore in the ground but the grade and the total resource hasn’t been established as yet, the lower the entry price into the stock the better. As the price rises the investor’s risk increases. If you’re in a stock at $.50/sh and it rises to $1.50/sh (which happens all the time) fed by speculation and day traders and the news then is disappointing or problems occur, the stock could retreat very quickly to your entry price. At that point if you’re still in the stock you need to make a decision to sell or hold.
c. Political Risk
You would prefer to invest in a country that respects private enterprise like the US, Canada, Australia, etc. A classic example how bad a good opportunity can become virtually worthless is the story of Chrystallex (KRY). The Canadian company had discovered and proved up a 20 million ounce gold resource in Venezuela. KRY was ready to begin mining and had shipped millions of dollars of equipment to Venezuela. Hugo Chavez and his government withheld final approval and essentially confiscated the property.
d. Patience
There are three ways to play this market. One, when the stock doubles, sell. Two, when the stock doubles, sell half and let the rest ride. Three, go for the home run or four-bagger (investor lingo for hoping the stock will quadruple in price).
In many situations, it is a matter of the individual investor’s mind-set, objectives and financial situation. The old adage “you’ll never go broke taking a profit” holds true but you can make a profit on 9 trades and lost it all on the tenth. The SERIOUS MONEY is made by those who identify the right name and patiently hang in there until the company achieves its goal of a sale or production. One reader bought REE in March around $3.50/sh. It dropped to near $2.00 in July. He called CMV and said it was a “stupid” recommendation and he sold. In October the stock reached $12. He had no patience and no comprehension of the fundamentals. CMV can also err. When REE shot up almost 300% from July to October, CMV sold half its client’s position with the intent to buy the stock back again after a correction. The correction was modest and short-lived. We’re not infallible but we did discover a sector that was off almost everyone’s radar.
This tutorial is by no means complete but we hope it is helpful. The opportunity to profit in microcaps in the resource and commodity sectors will be available for a limited time period going forward. CMV’s position is clear and concise. Make some serious money while the opportunity exists and then get the heck out of the markets. CMV’s value to you is discovering the opportunity and to advise you when the game is over.
Rare Earths Revisited
The global rare earth elements market which has produced spectacular returns in 2010 for CMV subscribers and clients, has amped-up to a new level.
The Japanese, who import 100% of their needs of REEs (about 32,000 metric tons or 24% of world demand) are involved in a serious confrontation with China which controls 97% of the supply. With the Chinese hinting at a further reduction of exports, the Japanese have allocated 100 billion Yen ($1.2 billion) for the development of the elements offshore. The US, which has a demand for 8% of the world supply has Molycorp Minerals, LLC (MCP) fast-tracking their closed mine in California to be in production by next year. Rare Earth Elements (REE) which owns the Bear Lodge property in Wyoming and has seen its share price soar more than 300% in the past 90 days, has completed a feasibility study on its property which shows an exceptional internal rate of return (IRR). CMV has been cautious in adding to positions in both companies recognizing that China could be rationing it’s exports as a negotiating ploy in the World Trade Organization (WTO) talks to head off protectionist policies originating in the US, Japan, and Europe. A concession by China on its exports could precipitate a correction in MCP and REE which would be an excellent re-entry point in both names. Demand should exceed supply for several years. Mines don’t open or re-open overnight — especially in environmentally-challenged California. As CMV goes to press a correction is taking place which has been over due. Please take note that there is a newly issued ETF (REMX) that will allow investors a broad diversification in these companies.
The Real Dirt On Real Estate
Just when you thought you saw a light at the end of the real estate mortgage tunnel, the light turns out to be a train that threatens to leave the tracks. My good friend and first class realtor, Ann Heins, has forwarded the following information that is a MUST read for everyone who has any skin in the game — any game! The breadth-taking disclosures were provided by David Kotok (www.cumber.com) from an unimpeachable source whom he wishes to remain anonymous.
Most of you are aware that the mortgage-backed securities (MBS) were sliced and diced into tranches of home mortgages rated from AAA, the least likely to default, to junk, the sub-prime debt. Different tranches were sold to a wide array of investors worldwide but specific bonds were not actually signed over to the bond holder-investor. The Mortgage Electronic Registration System (MERS) was set up to be the repository of the securitized mortgages to direct the defaulted mortgages to the appropriate tranches of the bonds. MERS didn’t hold any mortgage notes and the Real Estate Mortgage Conduits (REMICs) didn’t own the notes either. The bottom line is that somewhere between the REMICs and MERS the chain of title was broken. In order for the mortgage note to be sold or transferred to someone else and be turned into a MBS, this document has to be physically endorsed to the next person. All the signatures consist of the ‘chain of title.’ If for any reason any of these signatures are skipped, the mortgage note is no longer VALID. Since the chain of title is broken it is conceivable that the borrower no longer owes any money on the loan.
Were you able to translate that sentence?
The dirt becomes even murkier.
People began contesting their foreclosures on the chain of title issue. The banks had retained “foreclosure mills” to speed up the massive volume of defaults and these law firms, quick to observe the broken chain of title, may have fraudulently through “robot-signing” repaired the chain of title. Stories of employees holding up documents to windows to forge signatures and having at ready an ample supply of notary stamps are running rampant. One law firm in Florida where the smell from the swamp originated, has processed 72,000 foreclosures this year! Now, the title companies are refusing to insure the titles. To add to a Halloween Witches Brew of toil and trouble Fannie and Freddie are demanding that the banks re-purchase about $250 billion of loans that lack proper documentation.
Murkier becomes mud.
Congress, anticipating a catastrophe heading into the elections and bowing to the banking lobby, passed the Interstate Recognition of Notarization’s Act so that the foreclosure mills forged and fraudulent documents would not be scrutinized by out-of-state judges. The Senate passed the bill by voice vote so there would be no record of who voted for the bill. The President, pocket vetoed the bill to avoid the wrath of millions of affected homeowners.
The top of the bottom line is simply this. What happens to our fragile economy when citizens realize they don’t have to pay their mortgages? Not only is the chain of title broken, the Rule of Law is breaking down which is a threat to all of us and the entire country. More corruption thrives in this environment created by those Masters of The Universe in banking, Congress and on Wall St., who have assumed no personal responsibility for this crisis and have retained their wealth and retirement free from remorse and restitution.
Could Bank of America Shares Fall to $2.50?
That is the title of an article written by Steven M. Sears in the October 25th edition of Barrons. To most sophisticated observers the major money center banks have successfully survived the financial crisis and more specifically, the mortgage mess. Bank of America, however, with recent revelations of the legality of home foreclosures and the quality of mortgage assets, a conflicting picture emerges. (See Page 4 The Dirt On Real Estate).
Super sophisticated option traders are betting that BofA stock, currently as of October 24th, at $11.36/sh could fall to $2.50 by 2013. Traders are buying PUT contracts (betting that the stock will fall) that will expire in January 2013. What do these traders know that most observers don’t? Here’s an insight.
The Federal Reserve Bank of NY, PIMCO and Black Rock have essentially accused BofA of selling them $47 billion of mortgage-backed securities with enough “junk” that they have impaired the earnings of these buyers. Traders believe that there is a long litigious road ahead for BofA, and in the end BofA will pay multi-billions to settle. In effect, the market has judged the bank guilty.
How did BofA find itself in this unenviable position? In one of the most ill-timed and ill-conceived decisions in the banking industry, BofA bought Countrywide Financial for $4.1 billion in 2008, at a time when it should have been apparent to anyone who could fog a mirror, the mortgage end game was nigh. Rumor now is that the US Treasury “encouraged” a shot gun wedding.
In mid-October, 2010, Angelo Mozilo, the former CEO of Countrywide, agreed to pay the Securities & Exchange Commission (SEC) $67.5 million penalties to settle civil fraud and insider trading charges. Most of Mr. Mozilo’s financial penalties will be paid by, you guessed it, BofA, along with two other former executives. As part of the settlement, Mr. Mozilo agreed to a life-time ban from serving as an officer or director of a publicly-held company.
Unknown to most readers is that this settlement is directly tied to Mozilo’s “pump and dump” scheme whereby he sold $140 million in Countrywide stock when he knew the end game was near and investors took a massive hit when the stock became almost worthless. Still pending, it should be noted, are criminal charges against the “sub-prime mortgage king.”
Another twist to this story is “The Friends of Angelo” who received “sweet-heart loans” from Countrywide. An investigation into the mortgage mess and the influence peddling that occurred, reveals that 30 Senators or Senate employees received VIP loans from Countrywide. For some strange reason a further investigation and charges have been delayed. Jail time for the sun-baked and tanned Mr. Mozilo would be a heinous penalty!
. . .
This is from my friend Nick Tommer in Washington (state) who reports:
Why I’m Depressed
Over five thousand years ago, Moses said to the children of Israel, “Pick up your shovels, mount your asses and camels, and I will lead you to the Promised Land.”
Nearly 75 years ago, (when Welfare was introduced) Roosevelt said, “Lay down your shovels, sit on your asses and light up a Camel, this is the Promised Land.”
Today, the present economy has stolen your shovel, taxes your asses, raised the price of camels and mortgaged the Promised land!
I was so depressed last night thinking about Health Care Plans, the economy, the wars, lost jobs, savings, Social Security, retirement funds, immigration, etc. . . I called a Suicide Hotline: I had to press 1 for English; I was connected to a call center in Pakistan: I told them I was suicidal. They got excited and asked if I could drive a truck.
THE CMV RECOMMENDATIONS
The CMV Portfolio is up 25.23% YTD vs. The S&P 500 at a little north of 5.00%. Advisory clients who are concentrated in Sectors 4, 5, & 8 have unrealized gains of 30% to 50% YTD.
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Financial Questions? Contact hlquist at djmwealth dot com
