Gold Bug Bites, But Fever Stays

When you have been long enough in the game you know you will make good moves and bad moves (both in life and in investing). Also, you learn that you should not look at the charts to determine whether your thesis is working or not. I like a lot this particular Warren Buffett quote (about companies):

“In the short run, the market’s a voting machine and sometimes people vote very non-intelligently. In the long run, it’s a weighing machine and the weight of business and how it does is what affects values over time.”

Diversification is essential. No matter how much you believe in some individual investment you should not put your eggs in one basket. Not even close to half. Never.

Those who have put "all in" on gold are now really tested. Like the famous John Paulson who won big time betting on subprime collapse and is now 85% invested in gold. He lost almost 1 billion in two days during the recent correction in gold. The Gold Bug has bitten.

For us it's not a "biggie" as we are only 5% "sure" (as in the share allocated out of our portfolion) on the yellow metal. The 1 year chart and the 10 year chart start to look equally bad. Is this the end of the decade long bull market for gold?

 

I think both our thesis and the one Paulson has is intact although I'm not betting 85% of my assets here like Paulson seems to be (only 5% which in itself is a big bet considering how you "should" allocate your money according to "theory" and all studies to that end).

The thesis is (quote from the Bloomberg story on Paulson):

“Federal governments have been printing money at an unprecedented rate creating demand for gold as an alternative currency for individual and institutional savers and central banks alike.”That really hasn't changed. Look at USA, Europe, Japan. There is no way out other than to let the inflation handle the debt. So it's going to be print - baby - print for a long time.

My first blog post was titled "Gold Fever!" (posted on February 12th, 2010). At the time gold was trading at around $1090 per troy ounce. Now, after the recent collapse, it's trading at $1400. Quite a drop from the peak of over $1900 from September 2011. Still, I maintain also what I said in my first post:

"This is where the barbaric relic comes into play. Even though gold is not used broadly as currency right now, it has been used as such in history and may be used once more. It is the ultimate benchmark for currencies. Or do you think that the central banks are sitting on it just for fun of it?

Since I don’t like to put my eggs in one basket only, I try to avoid getting too much exposure into any currency or gold for that matter. The problem with gold is that it does not yield anything – it is simply a tool to preserve wealth and take part in speculation regarding its value vs. fiat currencies."

What comes to thesis for owning gold miners. Well, that didn't work out and I finally gave up on it in February 2013 when I let go our positions in Newmont Mining (NEM) and Barrick Gold (ABX). Their costs seemed to raise faster than the price of gold year after year so the thesis of using these as leveraged bets for gold simply did not seem to be working. And certainly now it looks even worse. Not going back on that horse very soon although tempted..

Over the years, consumer demand and exchange traded funds offering direct exposure to physical metal have grown to account for large portion of the demand for the barbaric relic. Therefore, it's not a surprise that when it rains it pours. Panic selling those ETFs is e-z.

You might want to check my old article written for Seeking Alpha titled "Riding the Second Gold Bubble" which reviewed (then) the last 110 years of gold price history as well as supply and demand. That kind of gives the ultimate perspective on the matter.
The author was (still) long gold at the time of writing.

Helsinki Top 20

I use a service provided by Valuatum.com via Pörssisäätiö to screen stocks listed in NASDAQ OMX Helsinki. I use the screen periodically to check where our holdings stand relative to other companies listed in Helsinki. Naturally I am also continuously screening for new investment ideas. Five out of our six positions are in Top 20 of my screen currently, which is not an accident, because the screen is designed to incorporate my preferences.

Currently the results of my personalized screen look like this:
Our positions are marked with prefix ">".

Rank Company (Score)
-----------------------------
#1 Citycon (2,9)
#2 Technopolis (2,8)
#3 Norvestia (2,5)
#4 Nokian Renkaat (2,5)
#5 Sponda (2,5)
#6 Ramirent (2,4)
>#7 Fortum (2,4)
#8 Elisa (2,3)
>#9 Orion (2,2)
#10 PKC Group (2,2)
#11 Sampo (2,2)
>#12 TeliaSonera (2,1)
#13 Teleste (2,1)
#14 Outotec (2,1)
>#15 UPM (2,0)
#16 Sanoma (2,0)
>#17 Metso (2,0)
#18 Cramo (1,9)
#19 Elecster (1,9)
#20 YIT (1,9)
..

>#93 Nokia (0,7)

Average Score 1,4
Median Score 1,5
Worst Score 0,0 (#100 Incap)

Parameters used in screen (weight):
-------------------------------------------
P/B est. 2013 (15%)
P/E 2012, est. 2013 (5%, 5%)
Dividend yield 2012, est. 2013 (5%, 10%)
ROA 2012 (10%)
ROI 3 year average est. 2013 (5%)
ROE 3 year average est. 2013 (5%)
Turnover increase in past 3 years, est. 2013 (10%)
Gross Margin 2012 (10%)
Profit Margin 2012 (10%)
Net Profit increase in past 5 years, est. 2014 (10%)


The used parameters emphasise profitability in broad sense (40% weight), attractive valuation (25%), growth (20%) and dividend yield (15%).

Top 5 consists of three property investment companies: Citycon, Technopolis and Sponda. They all seem to have quite different focus within Finnish property market.

• Citycon is specialised in retail properties, especially in shopping centres, in Finland, Sweden and in the Baltic countries. It was founded in 1988 by several large Finnish Corporations and initially invested in office premises.
• Technopolis core business idea is to combine business support services with modern, flexible, multi-user business environments. It was established in 1982 in city of Oulu to be the first technology village in Nordic countries. Its first customers included a circuit board factory and a number of other electronic manufacturing and design companies. The success of Nokia in both mobile phones and networks has been instrumental to the growth of ICT and electronics industry in Oulu region and has also fueled the growth of Technopolis in the past.
• Sponda's office, retail and logistics properties are located in the largest cities in Finland and Russia. It has roots in the Finnish banking crisis as it was formed in 1991 by the Bank of Finland to take over the Finnish and foreign real estate properties held by the Skopbank Group together with its sizeable equity portfolio. After liquidation of its equity holdings to concentrate on real estate investment it was listed on Helsinki stock exchange in 1998.

Norvestia is an investment company with most of their stock holdings in various Finnish companies. Direct stock holdings made up 41,4% of their portfolio in end of 2012 while 37,8% was invested to funds and 14,4% to bonds.

Nokian Renkaat (Nokian Tyres) has roots in The Finnish Rubber Works founded in the year 1898, which have still a factory producing tyres in the town of Nokia in Finland. The company also has been part of the Nokia Corporation (between 1967 and 1988). “Nokian Renkaat” means literally “Tyres of Nokia”. Their ”Hakkapeliitta” series of winter tyres has been around since 1936 and is very strong and trusted brand in Finland. I for one am willing to pay premium for their tyres that are consistently ranked high in independent comparisons year after year.

I don’t have currently positions in the Top 5 companies, but I think they are all worth a closer look.
I don’t make changes to our portfolio that often and last time I checked two of my holdings actually were in Top 5: Fortum at #3 with score 2,7 and Orion in #4 with score 2,6. The screen relies on estimates about future. Those combined with volatility of stock prices means that you should not try to chase screens like this. Ultimately any investment decision should be based on much more than just looking at the current numbers and estimates of future numbers.

On share dilution and Talvivaara

Talvivaara Mining Company Plc. (LSE: TALV; Nasdaq OMX Helsinki: TLV1V) has an open-pit Nickel mine in Sotkamo, Finland. The project leverages one of the largest known sulphide nickel resources in Europe.

The company has run into all kinds of trouble, ranging from not meeting production guidance to waste pond leakage.

A reader asked my opinion on Talvivaara's situation right now as stock price in Helsinki has been swinging from 1 euro level to above 1,20 euros in last two weeks closing today at 1,13 euros. Frankly, I don't think short term price movement really mean anything. A stock can go from 2 to 4 euros only to fall back to 1. The price has to be related to per-share earnings, dividends etc. i.e. what you really get for your share. Even if tiny piece of company, it's still a piece of the real thing.

Talvivaara makes loss so valuating it is hard to begin with. Even looking at profits it may eventually get from its vast mineral resources is meaningless because it's very hard to predict what will be the amount of shares out there at the time when dividends start to roll in.

There is a good arcticle in Seeking Alpha regarding The Dangers (And Benefits) of Share Dilution. The article illustrates one hypothetical case of share dilution. I'll make another illustration here:

Company A is currently experiencing problems and needs more money to fund its operations. The company has potential to earn steady 1 euros per share annual profit once it fixes all the problems it currently has. Market expects it to get all funding it needs and values it at future P/E 10 at the moment. Thus, share price is 10 euros per share.

The company decides to issue more shares and sell them to investors so that the number of outstanding shares is doubled. This means that future expected per share earnings are halved to 0,5 euros per share. Assuming that the company is still valued at future P/E 10, the share price is also cut half - i.e. to 5 euros.

Back to Talvivaara.
I think it's very difficult to value Talvivaara right now. Certainly all my previous analysis will be void by the time Talvivaara has completed issuing new shares in the massive way it now plans.

With Solidium (i.e. Finnish Government) and other major shareholders backing Talvivaara the likelihood of going totally out of business seems low at the moment provided that they really get soon their act together and return profitable. They are bleeding cash (-60 million EUR in Q4 2012 alone) so even after getting more money via rights issue they can not continue like that for very long.

The proposed EUR 260 million Rights Issue may mean up to 26 billion new shares subject to shareholders' pre-emptive subscription right. Unless you pay more you probably get seriously diluted.

I am certainly going to avoid the Talvivaara stock until
1) they are done issuing new shares
2) they return profitable
3) there is clear evidence that they get the Nickel production running at 30.000 tonnes per year level, which was the original target.

And even after that it's going to depend on how the environmental side of things look and also what's their debt level like. I would expect the turnaround to take quite some time.

In addition to the already mentioned rights issue they seem also be proposing to the extraordinary general meeting of the Company to be held on 8 March 2013:

• Authorising the Board of Directors to decide to issue new shares and/or special rights entitling to shares in deviation from the pre-emptive subscription rights of the shareholders


• ...authorisation to the Board of Directors to decide to issue up to 600,000,000 new shares

According to Talvivaara itself: The number of shares issued and outstanding and registered on the Euroclear Shareholder Register as of 31 December 2012 was 272,309,640

Therefore:

• There is now 272 million shares.


• They might issue up to 26000 million shares subject to shareholders' pre-emptive subscription right


• And then they might issue up to 600 million shares basically in any way they please

I can't estimate what will be the share price after they are done with all that since there is no way to know how many shares there will be in the end sharing the profits they hopefully start spitting out at some point of time.

I have gone through many companies in resource sector and I have to say that I have seen cases where existing shareholders have been diluted quite seriously. Impossible to know how it's going to go in case of Talvivaara, but be warned.

I want to borrow the ending from the Seeking Alpha -article I referred to:

"If you believe a stock offering is imminent, you’ll likely want to stay on the sidelines until after the latest round of dilution."

Full disclosure February 23rd, 2013: The author does not own Talvivaara stock nor has any other kind of position that would benefit in from movement of Talvivaara stock price.

Portfolio update: Allocations and Top 5 positions

Our portfolio is now allocated as follows:

Stocks 94%
Gold 5%
Cash 1%

No bonds.
I simply substitute bonds with quality dividend payers in our portfolio.


Geographical Allocation:

Europe 50%
North America 29%
Emerging markets 21%

Actually, place of incorporation is pretty meaningless for most corporations we have invested in. Most are global.


Sector Allocation:

Information Technology 43%
Other 19%
Health Care 12%
Oil & Gas Production 10%
Communication Service Providers 10%
Low Emission Power Generation 5%
Mining & Exploration 1%

For a long time I tried to keep all sectors within 10-20%, but have since allowed myself to look the portfolio company by company rather than via sector allocation. The current allocation is tactical in nature and I believe long term I will pump at least mining & exploration above 10%. Low Emission Power Generation basically means our allocation to Fortum. I haven't counted UPM's power business there even though it's one of the reasons we are long UPM.


Top 5 positions:

Company/ETF (sector) allocation%

Nokia (IT) 13,6%
Vanguard MSCI Emerging Markets ETF (Other) 10,8%
Western Digital (IT) 7,4%
Orion (Health Care) 6,9%
Intel (IT) 5,6%

Nokia is our turnaround bet and it has come around quite nicely already. Initially the position was below 10%. While I think over 10% allocation to any single stock is risky I don't plan to trim down the position just yet.

Portfolio update: 5 out and one in

I have recently trimmed our stock portfolio down to 18 stocks and 1 ETF. There isn't any one reason behind this. Some companies had proved to be disappointments while others were just sold to make room for companies that I hope have much better future ahead.

We exited from the following positions:

• Becton, Dickinson and Company
• Vodafone Group
• Companhia Paranaense de Energia
• Newmont Mining
• Barrick Gold

Becton, Dickinson and Company (NYSE: BDX) wasn't ever a big part of our portfolio. There isn't anything wrong with the company. I bought it because it's defensive and now is the time to move that money to riskier positions. The yield is also quite low (about 2,2% at the time of writing) and I have plenty of defensive positions with more than 4% yield so I will rather continue to leverage those as defensive cash cows. I have been looking for good time to exit BDX position for some time. At the time of exit the stock traded near 5-year highs after bull run that started May 2012 so it looked like a good time to exit.

Exit from Vodafone (Nasdaq: VOD) wasn't an easy decision. However, I needed to sell it to gather money for other positions I see having way more potential. Vodafone was a defensive position similarly to BDX. Out of the three telecommunication service providers VOD was the one to go. I see more future potential in China Mobile. TeliaSonera on the other hand has tasty yield.

Companhia Paranaense de Energia (NYSE: ELP) like other Brazilian companies in the business of electricity generation and transmission have suffered big time from Brazilian government policies aimed at cutting electricity rates. While I continue to like the company itself, I now view it to be a much riskier investment than at the time when I initiated the position. Compared to Fortum ELP yields also much less. Thus, I wanted to exit this particular position.

Newmont Mining (NEM) and Barrick Gold (ABX) were both positions in the gold mining sector. Their costs seem to raise faster than the price of gold so the thesis of using these as leveraged bets for gold simply do not seem to be working well right now. I might return to the sector if we ever get to the true "mania phase" in the ongoing decade old gold bull run. Between now and then I think our pure gold metal positions are a sufficient bet on gold price.

About half of the money from the exited positions was put to Vanguard MSCI Emerging Markets ETF (NYSE: VWO). My conclusion from my emerging market positions, past and present, is that picking individual stocks from those markets seems like a bad idea compared to passive index investing. Passive ETFs like VWO are a good and cheap way to take a well diverisified position in those markets.

I increased significantly our position in Intel (Nasdaq: INTC). I continue to believe that Intel will be able to leverage it's technological advantages also in post-PC era. While waiting we continue to collect the dividends (at the time of writing projected at 4,26% with stock price $21,11 by Google Finance).

I started one new positions in Baidu (Nasdaq: BIDU) usually dubbed as "The Google of China".
I am planning to write separate posts about it later on. For the time being let's gategorize this company incorporated in Cayman Islands, but having most of its business in China, as a growth play.